President Obama's Big, Frothy Hint

President Obama, in an interview with the New York Times, said a few sentences about what he's looking for in the next Fed chair. A few newspapers, including the Washington Post, have already exclaimed that "President Barack Obama says his next Fed chairman should take ordinary people into account when setting monetary policy."

President Obama indeed mentions "the lives of ordinary Americans getting better." But taken in context, his remarks are surprisingly inflation-hawkish and relatively unconcerned with unemployment. He says:

And what I’m looking for is somebody who understands the Fed has a dual mandate, that that’s not just lip service; that it is very important to keep inflation in check, to keep our dollar sound, and to ensure stability in the markets. But the idea is not just to promote those things in the abstract. The idea is to promote those things in service of the lives of ordinary Americans getting better. And when unemployment is still too high, and long-term unemployment is still too high, and there’s still weak demand in a lot of industries, I want a Fed chairman that can step back and look at that objectively and say, let’s make sure that we’re growing the economy, but let’s also keep an eye on inflation, and if it starts eating up, if the markets start frothing up, let’s make sure that we’re not creating new bubbles.

When he says "The idea is to promote those things in service of the lives of ordinary Americans getting better," those things refers to keeping inflation in check, keeping the dollar sound, and ensuring stability in the markets. He's emphasizing the price stability part of the dual mandate much more than the maximum employment part. When he then goes on to mention high unemployment (a much bigger impediment to the lives of ordinary Americans getting better, in my opinion), he is remarkably quick to mention keeping an eye on inflation in the very same sentence.

The President says he wants "somebody who understands the Fed has a dual mandate," but somebody who truly understood this would recognize that the Fed's efforts in this economic environment should be focused on restoring full employment.

And then there are the remarks about frothing markets and bubbles. Now, President Obama refused to answer the NYT reporter's question about who he was considering for chairman--in particular, he refused to say whether he was planning to appoint Larry Summers--but this is a pretty big hint. Fed officials are split over the appropriate role of the Fed in trying to identify and constrain asset bubbles. The so-called "Bernanke doctrine" holds that monetary policy should be used to deal with normal macroeconomic concerns, while regulatory policies should be used to try to alleviate financial imbalances. Ben Bernanke, of course, is a follower of the Bernanke doctrine, as are, among others, Governor Sarah Raskin and Vice Chairwoman Janet Yellen. Yellen, a top contender for the next Fed chair, has said, "I think most central bankers view monetary policy as a blunt tool for addressing financial stability concerns and many probably share my own strong preference to rely on micro- and macroprudential supervision and regulation as the main line of defense."

Governors Jeremy Stein and James Bullard are among the group who don't buy the Bernanke doctrine; they believe that monetary policy (i.e. higher interest rates) should be used to "fight financial excess a little more than we have in the last few years." Larry Summers, also considered a top contender, fits more into this group, expressing concerns that the Fed's monetary policy of recent years creates "an environment that’s going to increase the risk of – going to increase the risk of bubbles."

So I think President Obama's comment, "if the markets start frothing up, let’s make sure that we’re not creating new bubbles," reveals who has his ear, and maybe whom he has in mind: Summers.

But returning to "the lives of ordinary Americans getting better," here's Janet Yellen in 1995:

"I began by asking myself the question, what is it that the public cares about? The answer seems straightforward to me. It is not just high and variable inflation; that is not the only aspect of economic performance people care about. The public also cares about real outcomes. Households and businesses very much dislike fluctuations in output and employment, for good reasons. Quite naturally, they prefer higher average output and lower average unemployment. I consider these goals eminently sensible, not foolish nor irrational. 

Then I ask myself, what is it that the Fed can accomplish? I conclude that the actions of this Committee affect not just the level and variability of inflation but also at a minimum the variability of output and employment. I know that some people would argue against our trying to reduce the variability of output on the grounds that economic forecasting is so uncertain and that there are long and variable lags in monetary policy, so maybe all we would do is to destabilize the economy rather than stabilize it. But when I look at the record, I just do not agree. It seems to me the record shows that within limits, tuning works even if it is not "fine."... 

The moral I draw is simply that the Fed should pursue multiple goals. It follows almost automatically that when the American people have sensible multiple goals and the Federal Reserve affects multiple dimensions of economic performance, that the Federal Reserve Act should enshrine all of those goals and we should do our best to honor them... I understand that the mandate of the Federal Reserve Act to pursue multiple goals is pretty vague. There really is no guidance in the Act as to how to call the tough trade-offs. But I see the objectives as fundamentally sound, and I think this Fed, in pursuing those goals, has enhanced social welfare...I want at least to mention that if this Committee were to decide that it really wanted a quantitative monetary policy rule incorporating a numerical inflation target--for example, because it was thought to be important to have a nominal anchor for monetary policy--we should not go with the type of rule embodied in the Neal amendment, which is a pure inflation targeting scheme. Why? Because there clearly are better rules. We could talk about those at length but a simple approach, not necessarily the best, that dominates inflation targeting would be a hybrid rule that would adjust monetary policy--and this could be a mechanical rule if it were so desired--on the basis of two gaps, not one. These would be the gap between actual and target inflation and also the gap between actual and potential output...Uncertainty about sales impedes business planning and could harm capital formation just as much as uncertainty about inflation can create uncertainty about relative prices and harm business planning."

She got it then and she gets it now. I could say more about her remarkable credentials, but plenty of people have already jumped in to do so in the last week. I can only echo that she is the best choice to replace Chairman Ben Bernanke at the Fed.

***Fun fact: My high school, like most high schools, voted on "senior superlatives" (most likely to succeed, best athlete, etc.) Oddly, I was given "Most likely to be the next Alan Greenspan." I say oddly because I had no interest in economics at the time, and still didn't for another few years after that. Obviously, I did not become the next Alan Greenspan. Ben Bernanke beat me to it! But I was still tickled by Binyamin Appelbaum and Annie Lowrey's remark that "President Obama’s choice of a replacement for the Federal Reserve chairman, Ben S. Bernanke, is coming down to a battle between the California girls and the Rubin boys," and to have the great pleasure of being associated with the California girls!

Economic Storytelling

Near the end of President Obama's first term, he commented that "When I think about what we've done well and what we haven't done well, the mistake of my first term -- couple of years -- was thinking that this job was just about getting the policy right. And that's important. But the nature of this office is also to tell a story to the American people that gives them a sense of unity and purpose and optimism, especially during tough times." Junot Diaz wrote in the New Yorker that

It has always seemed to me that one of a President’s primary responsibilities is to be a storyteller. We all know the importance of narratives, of stories; they are part of the reasons our brains are so damn big. We need stories, we thrive on them, stories are how we shape our universe. Tolkien could have been talking about the power of stories when he described his One Ring: stories rule us, they find us, they bring us together, they bind us, and, yes, they can pull us apart as well. If a President is to have any success, if his policies are going to gain any kind of traction among the electorate, he first has to tell us a story. 

All year I’ve been waiting for Obama to flex his narrative muscles, to tell the story of his presidency, of his Administration, to tell the story of where our country is going and why we should help deliver it there. A coherent, accessible, compelling story—one that is narrow enough to be held in our minds and hearts and that nevertheless is roomy enough for us, the audience, to weave our own predilections, dreams, fears, experiences into its fabric.

Not only the President, but also members of the Fed, act as storytellers. The word "story" is used 34 times in the January 30-31 Federal Open Market Committee (FOMC) transcripts and a total of 82 times in 2007 FOMC transcripts.

The committee members clearly recognized the importance of providing a narrative to the public. Mishkin said that "We need to tell a story, a good narrative, about [the forecasts]. To be understood, the forecasts need a story behind them.  I strongly believe that we need to write up a good story and that a good narrative can help us obtain public support for our policy actions—which is, again, a critical factor." Similarly, Kohn said that "the story we tell, the narrative, is as important as, if not more important than, the particular numbers that we give out.  It’s really the story that people use to inform their own forecasts of the future, to judge how events are unfolding relative to our expectations, to understand which aspects of the economic environment we’re really paying most attention to, and therefore to help predict."

At times, however, the FOMC had difficulties knowing what story to tell themselves, let alone the public. Here are a few excerpts from the January meeting:


MR. STOCKTON.  At the time of the last FOMC meeting, we were feeling as though the  incoming spending data were coming in pretty darn close to our expectations and were pretty consistent with our story about entering a period of below-trend growth.  As we noted, and President Moskow quizzed us about, the big fly in the ointment with respect to our story was the labor market and its ongoing strength.

MR. STOCKTON As Larry said, even given the overall dimensions of the housing shock, we’ve been
encouraged about our story of stabilization.  But I remember that, as we went into the investment
shock earlier in this decade, we just didn’t have enough imagination about how bad things could
get, and we kept thinking that we were seeing signs of slowing or stabilization, that the new
technology was still great, and that there should be reasons or underlying motivation for investment.

MS. PIANALTO For the most part, the intermeeting data have been favorable for the manufacturing sector.  The industrial production numbers, for example, have been strong, but manufacturing employment remains flat. The usual story that makes sense of these disparate trends is the continuing strength in manufacturing productivity.  But I’d like to mention another element in the picture—others have mentioned it this morning—and that’s the skills mismatches.


MS. PIANALTO ...college placements are up 17 percent this year, the strongest showing since 2001.  The story is that relatively high profits and good business prospects
are driving up demand.

VICE CHAIRMAN GEITHNER We see the same basic story that the Greenbook does in support of continuing expansion going forward.

MR. KROSZNER We have good short-term stories about how the slowdown in energy prices in the
second and third quarters and some other temporary factors with respect to owners’ equivalent
rent could be bringing down inflation.  But when we consider a longer period and try to look at
the systematic data, we don’t see those kinds of relationships.  Are we just in some sort of regime
shift?  Are those correlations not very good because we just haven’t had a lot of variation in the
data over the past ten to twenty years, and so those forces are actually there, but we just find it
very difficult to pull them out econometrically?  For me that is a puzzle, to be able to tell a short-term story with each of these pieces, but when I go to the staff and ask, “Well, what is the
systematic evidence on it?” they say, “Well, it really isn’t there.”  That is a bit disturbing for me
in trying to figure out where things are likely to go.


MR. REIFSCHNEIDER...consider one important communication task, the telling of the central story of the outlook...Distilling an informative message from multiple forecasts is difficult, even if those forecasts provide a considerable amount of detail about the outlook.  In fact, it is an open question as to whether it would always be possible to craft a central narrative that would command the consent of a majority of the Committee, given the diversity of your views...Telling the central story would remain difficult if, after settling on, say, a common path for oil prices, you still disagreed markedly about its economic implications.

MS. YELLEN Given the diversity of views, it’s fair to say that in most meetings, no unified forecast or forecast story even exists, and I don’t see how participants who fundamentally disagree could, if we tried to produce a unified forecast, speak in public about the economy without revealing those differences... One way to expedite the preparation of the narrative is for all of us before the meeting to share our individual forecasts along with a brief written story explaining them.

MR. KOHN ... You could tell a coherent story around the central tendencies.  Sometimes we had to use a little imagination, but it wasn’t really incoherent.  [Laughter]  I think that Chairman Bernanke demonstrated this in his last two testimonies—to take the central tendencies as we submit them and tell a pretty good story that’s helpful to the public.

MR. BARRON I believe it is imperative that any forecast be accompanied by a story to support the
outlook... Numbers without the story would be analogous to asking a doctor to treat a patient by seeing only the skeleton.

Keynes Quotes for the 2007 FOMC Meetings

What J.M. Keynes might have said had he been at the 2007 FOMC meetings:

• It would be foolish, in forming our expectations, to attach great weight to matters which are very uncertain. --General Theory (1935) Book 4, Chapter 12, Section 2, p. 148
• The decadent international but individualistic capitalism in the hands of which we found ourselves… is not a success. It is not intelligent. It is not beautiful. It is not just. It is not virtuous. And it doesn't deliver the goods. In short we dislike it, and we are beginning to despise it. But when we wonder what to put in its place, we are extremely perplexed. --National self-sufficiency (1933) Section 3, republished in Collected Writings Vol. 11 (1982).
• This is a nightmare, which will pass away with the morning. For the resources of nature and men's devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life ... and will soon learn to afford a standard higher still. We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time — perhaps for a long time. --The Great Slump of 1930 (1930), in Essays in Persuasion
• The old saying holds. Owe your banker £1000 and you are at his mercy; owe him £1 million and the position is reversed. --Overseas Financial Policy in Stage III (1945), Collected Writings 24:258.

What Keynes might have said today in response to the transcripts:

• There were endless possibilities, not out of reach. --Essays in Bibliography (1933)
• Logic, like lyrical poetry, is no employment for the middle-aged. --Essays in Bibliography (1933)
• Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally. --General Theory (1935) Book 4, Chapter 12, Section 5, p. 158
• The disruptive powers of excessive national fecundity may have played a greater part in bursting the bonds of convention than either the power of ideas or the errors of autocracy. --The Economic Consequences of Peace (1919).
• Words ought to be a little wild for they are the assault of thoughts on the unthinking. --New Statesman and Nation (London, July 15, 1933).
• It is ideas, not vested interests, which are dangerous for good or evil. --Concluding Notes, ch. 24, The General Theory of Employment, Interest and Money (1936).
• I do not know which makes a man more conservative—to know nothing but the present, or nothing but the past. --The End of Laissez-Faire, ch. 1 (1926).

FOMC Transcripts: Housing Edition

The transcripts from the 2007 Federal Open Market Committee (FOMC) have just been released. These transcripts are released with a five-year lag. Naturally, economists and pundits are excited to see what people at the Fed did or did not know back then about the state of the economy and impending financial crisis.

The transcript from the January 30-31 meeting includes multiple discussions of the housing sector that suggest awareness of problems, but underestimation of their depth and duration. I've pasted some interesting housing remarks from the transcript at the end of this post. To accompany those, I took a look at what was actually forecast about housing, both at the Fed and by professional forecasters.

Fed forecasts in the Greenbook are also only available with a five-year lag, but the Survey of Professional Forecasters forecasts are available with hardly any lag. In the graph below, the thick navy line is actual housing starts (in millions of units) per quarter. The green line is the Fed's Greenbook forecast made one year earlier for housing starts in that quarter. The dashed line is the same forecast, made by professional forecasters (the median SPF forecast).

You can see that throughout the housing boom, both Fed and professional forecasters consistently underestimated housing starts. Housing starts started to fall in the second quarter of 2006 and have yet to recover to anywhere near their 2006 peak. Look at 2007 in the graph. The blue line is below the red line and far below the green line, which were the forecasts made in 2006 about 2007. I'll update the graph with Greenbook forecasts made in 2007 about 2008 when those are put online.

Here is another graph that shows Greenbook forecasts for housing starts made at multiple horizons. If you draw a vertical line up from a particular date, you will see forecasts made 1 quarter, 1 year, and 7 quarters earlier about housing starts at that date.

Quotes about housing starts in the January 30-31 transcripts:

Mr. Slifman: As I noted earlier, the leveling-off of home sales, the uptrend in mortgage applications, and the improvement in homebuying attitudes suggest that housing demand may be leveling off... cyclical recoveries in sales and starts have generally been fairly coincident historically...Accordingly, we think that the recent stabilization of sales should be accompanied soon by a stabilization of starts.

Mr. Stockton: As Larry said, even given the overall dimensions of the housing shock, we've been encouraged about our story of stabilization.  But I remember that, as we went into the investment shock earlier in this decade, we just didn't have enough imagination about how bad things could get, and we kept thinking that we were seeing signs of slowing or stabilization, that the new technology was still great, and that there should be reasons or underlying motivation for investment.  Perhaps what we've seen recently as stabilization are the beneficial effects of the drop in long-term interest rates that occurred from last summer into the fall and pulled some people forward, but really we may not have fully made the adjustment yet.  The overhang of unsold homes out there is very large, and we could be underestimating the size and duration of that.     

Mr. Stern: The housing sector is subdued, but the District data on sales and starts suggest stabilization, as do the national data.  The data on the inventory of unsold homes perhaps are contradictory to that statement because there are still a lot of unsold properties; at least those data suggest that it will be some time before there is any pickup in housing activity.  In any event, as Bill Dudley mentioned, mortgage delinquencies and foreclosures are rising, albeit starting from a fairly low level, and though that probably won’t have a significant effect on economic performance, it could be a political issue in Minnesota and elsewhere in the District.

Mr. Fisher: I did talk to two of the top five housing CEOs and a third one, a smaller company.  They seem to confirm the sense of the staff in that they feel that the housing situation is bottoming out, but they continue to caution that any reading of the housing industry between Thanksgiving and the Super Bowl is of questionable value.