Post-Jackson Hole low morale

The Jackson Hole discussion

John B. Taylor has a good write-up of the academic discussion, which mostly unfolded around the size of central banks’ balance sheet and the effectiveness of negative interest rates.

Concerning balance sheet size, Ulrich Bindseil argued for returning to a “lean” balance sheet while Simon Potter of the New York Fed argued for a large balance sheet, to have more room for interventions. Jeremy Stein, Robin Greenwood, and Samuel Hanson made a case for more short-term Treasuries to satisfy a liquidity demand, arguing that a large balance sheet at the Fed rather than additional Treasury issuance was the way to achieve that. Christopher Sims noted a problem with the Fed having a large footprint extending into fiscal policy. Darrell Duffie and Arvind Krishnamurthy warned about diminished pass-through from policy rates to other interest rates in the current regulatory environment. Ricardo Reis argued in favor of a balance sheet bigger than the lean version proposed by Bindseil, but not as big as the current one in the US. On negative interest rates, Marvin Goodfriend made the case for un-encumbering interest rate policy so that negative nominal interest rates can be made freely available and fully effective as a realistic policy option in a future crisis.

Janet Yellen speech focused on the past, present and future of the Fed’s monetary policy toolkit. She said she would expect forward guidance and asset purchases to remain important components of the Fed's policy toolkit, but that they may prove inadequate to deal with deep and prolonged economic downturns. Yellen said that future policymakers might choose to consider additional tools that have been employed by other central banks or proposed by academics - such as purchasing a broader range of assets, raising the FOMC's 2 percent inflation objective or implementing policy through alternative monetary policy frameworks, such as price-level or nominal GDP targeting. Adding them to the Fed’s toolkit would require a very careful weighing of costs and benefits and Yellen stressed that the FOMC is not actively considering these additional tools and policy frameworks.

Reactions

Larry Summers is disappointed by what came out of Jackson Hole. The near term policy signals were on the tightening side - which could hurt both the Fed’s credibility and the economy - and the longer term discussion revealed complacency about the efficacy of the existing tool box and failure to seriously consider major changes in the current monetary policy framework. Summers says the Fed has not earned the right to be intellectually complacent or to expect that others will have faith in its current policy framework, particularly in light of its forecasting record.

Larry Summers promises to deal extensively with the Fed’s discussion of a future policy framework in follow-up posts. As far as it concerns the assessment of near term policy,  he thinks that the FED, having emphasized that its two percent inflation target is a symmetric one, should have sent a very dovish signal that it would tighten only when there appeared a real risk of inflation expectations rising above two percent. He also highlights that the discussion has not touched upon important questions such as whether the current policy is highly expansionary, given the current estimated of the real neutral rate running near zero, or whether the 2% inflation target should be reconsidered.

Writing in the Financial Times, Mohamed El-Erian argues that Jackson Hole was a missed opportunity for a policy pivot. He thinks it should be clear by now that central bank’s policy tools alone are ill-suited to overcoming the challenges facing the US, and especially Europe and Japan. The problem is structural, and it requires a change of focus, away from excessive dependence on central banks to a more holistic policy response. If the excessive reliance on central banks continues, there is a risk that the (Bernanke-specified) “benefits, costs and risks” equation will develop in a manner that involves consequential collateral damage and unintended consequences — not only for the global economy but also for central banks’ political autonomy, which would be at risk as they become visibly less effective.

Adam Posen at PIIE also thinks that central banks may have missed the opportunity to have a broader discussion about the full array of monetary tools available to fight the next economic downturn. The result was an uneasy calm, at Jackson Hole.

Gillian Tett at the FT notes that what was notably absent from the agenda was a full-blown discussion about the issue that is on the minds of most financial practitioners: namely some of the peculiar distortions that are developing in the weeds of modern finance, on which the BIS has instead been insisting for some time. Teet argues that But just because policymakers have become inured to a deeply peculiar financial world, that does not mean that it is “normal” or healthy; or not any more than it was in 2006.

Nick Bunker at the Washington Centre for equitable growth says that there has been only a hint of new thinking at Jackson Hole. He says Yellen’s speech pointed toward a view within the Federal Reserve that the current monetary policy path is adequate to prepare for the next recession. This is grounded on the argument, discussed in a paper by David Reifschneider, that by the time the next recession arrives the Fed funds rate will have returned to a level that leaves sufficient room to cut (e.g. 3 percent). Bunker thinks there is considerable uncertainty about when 3 percent might be reached, not to mention on whether it is the correct benchmark rate.

Paul Krugman and Jared Bernstein agree on one things: they think the Fed is being complacent and Reifschneider’s paper optimistic. Bernstein is concerned by the number of “ifs” in Reifschneider’s story. It’s uncertain that the Fed can get to their 3 percent funds rate target, considering that markets don’t seem to believe the Fed’s projections. It’s uncertain that the Fed will be willing to add $3-4 trillion to their balance sheet, and that QE/guidance have the positive growth and jobs impacts the model says they have. Finally it’s uncertain that people’s expectations are truly moved by forward guidance.

Paul Krugman agrees on this assessment, and he cannot help but recall a 1999 paper by Reifschneider and John Williams about inflation targets and the risk of hitting the zero lower bound, where they concluded that a 2 percent target should be enough to make this a minor concern. They argued that the zero bound would probably be binding only 5 percent of the time and ZLB episodes would last on average only 4 quarters - Krugman recalls - while in fact we have just gone through a 32 quarters ZLB episode. He concludes that the optimistic take was off by an order of magnitude, and that miss should give the Fed pause.

John B. Taylor has perhaps the only positive assessment, saying that the 35th Jackson Hole meeting lived up to its billing as “monetary policy frameworks for the future”. Ha argues that one monetary policy framework that was not on the program was the framework in operation during the 1980s, 1990s and until recently — during Volcker’s and much of Greenspan’s time as chair. He argues that this was a monetary policy framework that worked according to historians and econometricians until the Fed went off it, and Taylor says that suggests it could be a good candidate for a future framework.