Are Yellen and Fischer Really Worlds Apart?, by Tim Duy: This from Bloomberg surprised me:
Michael Gapen, chief U.S. economist at Barclays Plc in New York, said Fischer’s comments “reflect an ongoing divergence of opinion” at the central bank. Fischer “doesn’t see much room for running the economy hot” while Yellen’s views “seem to provide a wide-open door to do that. You have a chair and a vice chair who see policy differently right now,” he said.
I don't think there exists a yawning gap between Federal Reserve Vice-Chair Fischer and Federal Reserve Vice Chair Yellen. The perception of this gap stems in part from what I think was an aggressive reading of Yellen's speech last week. The line in question:
If we assume that hysteresis is in fact present to some degree after deep recessions, the natural next question is to ask whether it might be possible to reverse these adverse supply-side effects by temporarily running a “high-pressure economy,” with robust aggregate demand and a tight labor market.
Is this a call for a “high-pressure economy”? My interpretation is somewhat more muted. Note that this was posed as a potential research question, along with three others, that macroeconomists should pursue in the wake of the Great Recession:
The Influence of Demand on Aggregate Supply
The first question I would like to pose concerns the distinction between aggregate supply and aggregate demand: Are there circumstances in which changes in aggregate demand can have an appreciable, persistent effect on aggregate supply?
My second question asks whether individual differences within broad groups of actors in the economy can influence aggregate economic outcomes–in particular, what effect does such heterogeneity have on aggregate demand?
Financial Linkages to the Real Economy
My third question concerns a key issue for monetary policy and macroeconomics that is less directly addressed by this conference: How does the financial sector interact with the broader economy?
My fourth question goes to the heart of monetary policy: What determines inflation?
She does not actually say that the Fed should run a high pressure economy. Nor should this be seen as a defense of current policy because this is decidedly not a high pressure economy. Instead, Yellen argues we need more research on the topic to understand the costs and benefits of such a policy approach:
More research is needed, however, to better understand the influence of movements in aggregate demand on aggregate supply. From a policy perspective, we of course need to bear in mind that an accommodative monetary stance, if maintained too long, could have costs that exceed the benefits by increasing the risk of financial instability or undermining price stability. More generally, the benefits and potential costs of pursuing such a strategy remain hard to quantify, and other policies might be better suited to address damage to the supply side of the economy.
Now, to be sure, she is willing to delay rate hikes to explore the possibility of drawing more supply from the labor market. From the press conference:
But with labor market slack being taken up at a somewhat slower pace than in previous years, scope for some further improvement in the labor market remaining, and inflation continuing to run below our 2 percent target, we chose to wait for further evidence of continued progress toward our objectives.
Does this mean the economy is a running at a high pressure? Later in the conference:
And that is some news that we’ve received in recent months, that the labor market does have that potential to have people come back in without the unemployment rate coming down. So we’re not seeing strong pressures on utilization suggesting overheating, and my assessment would be, based on this evidence, that the economy has a little more room to run than might have been previously thought.
One reason Yellen is willing to delay rate hikes is because the economy is not overheating. Again, this is not a high pressure economy – and if it was, she would not be so willing to delay rate hikes. Indeed, willingness to accept a high pressure economy suggests that Yellen has abandoned preemptive policy. But:
So I think the notion that monetary policy operates with long and variable lags—that statement is due to Milton Friedman, and it is one of the essential things to understand about monetary policy, and it has not fundamentally changed at all. And that is why I believe we have to be forward looking, and I’m not in favor of a “whites of their eyes” sort of approach. We need to operate based on forecasts.
Compare this with Fischer, via the same Bloomberg story:
“If you go below the full employment rate, or peoples’ estimates of full employment, by a couple of tenths of percentage points, I don’t think there’s any danger in that,” Fischer said Monday in response to questions at an Economic Club of New York lunch. “But saying we should keep going until the inflation rate shows us we’re wrong, then you’re going to change too late.”
Then, back to Yellen:
One is the risk that the economy runs too hot, that unemploy—the labor market tightens too much, that unemployment falls to a very low level, that we need to tighten policy in a less gradual way than would be ideal, and in the course of doing that, because that is a very difficult thing to accomplish, to gently create a bit more slack in the labor market, we could cause a recession in the process.
So you get the idea. There is nothing here to suggest that Yellen looks to generate a high pressure economy. She holds the commonly held view within the Fed that policy makers need to prevent the unemployment rate from sinking too low because they cannot just nudge the rate higher. If anything, with the unemployment rate dancing on the edge of Fed estimates of the natural rate, she would almost certainly react to an acceleration in activity with an acceleration in the pace of rate hikes. So too would Fischer. But with growth around 2 percent per tracking estimates, labor force participation rising to meet job growth, and inflation below target, we do not have a high pressure economy and hence the need for immediate rate hikes dissipates. Yellen will let it play out a bit longer. But if the labor force participation rate stalls out and unemployment starts heading back down, Yellen would become nervous that the Fed is poised to fall behind the curve.
Bottom Line: The key debate within the Fed at the moment centers around the need for preemptive rate hikes. The hawks prefer more preemption, the doves favor less. Federal Reserve Lael Brainard pulled the FOMC to the dovish camp, primarily through her influence at Constitution Ave. Yellen is probably somewhat more sympathetic to Brainard than Fischer, but as I said last week, Fischer has moved substantially in Brainard's direction. It is really the presidents that are on the hawkish side of the aisle. There just isn't that much space between Yellen and Fischer at the moment.