Monday, September 16, 2013

Yellen on Monetary Policy

With Summers out and perhaps Yellen in, it may be interesting to investigate Yellen's views on monetary policy and its efficacy.

Found this old blog at Jesse's Cafe from 2009, so it may be dated, but perhaps still revealing about Ms. Yellen.  "Jesse" sounds way out of it, but he has some interesting excerpts from a speech by Ms. Yellen from that year.  (My comments as to what is "good" and "bad" as far as "in or out of paradigm")

Janet Yellen Channels Ronald Reagan: "Deficit's Don't Matter"

In advanced countries, the problem isn’t that large deficits cause inflation. (GOOD) Rather it’s that they raise long-term interest rates (BAD), thereby crowding out private investment (BAD), which holds back advances in productivity and living standards. Right now, private investment spending is extremely weak (GOOD), so financing for the large federal deficits is readily available. (BAD) But once private spending recovers, the competition for funds between the government and private sectors could drive interest rates up (BAD).
A decline in productivity growth is a serious problem—one we should strive to avoid (GOOD)—but it is not the same as inflation.
So what about the Fed’s unprecedented balance sheet expansion? Our strong steps to avert financial and economic meltdown have caused our assets to more than double, from under $900 billion at the start of the recession to over $2 trillion now. (Ed: now over $3T)   This expansion is largely financed by increases in excess reserves that banks deposit with us. Now we come to the crux of the issue: Will this expansion of credit and bank reserves create high inflation? My answer is no. (GOOD) And the reason again is because of current economic conditions. (BAD)
Monetary policy fosters inflation when it loosens the stance of policy enough to create excess demand for goods and services. (BAD) Right now, we have exactly the opposite—an excess supply of goods and services. (GOOD) We need more demand—not less—to offset slack in labor and product markets. (GOOD)
We have seen a noticeable slowdown in wage growth and reports of wage cuts have become increasingly prevalent. Businesses are cutting prices to boost sales. As a result, core inflation—a measure that excludes volatile food and energy prices—has drifted below 2 percent, a level that I and most of my colleagues consider consistent with price stability. With unemployment already substantial and likely to rise further, and industrial capacity utilization at record low levels, downward pressure on wages and prices isn’t likely to go away soon. I expect core inflation to remain below 2 percent for several more years. (GOOD)
Of course, the economy will eventually recover (BAD) and we will need to withdraw monetary accommodation.(BAD) If we were to fail to do so, we would indeed have higher inflation.(BAD) The Fed is keenly aware of this. (BAD)
We have the tools to tighten policy when the time is right and we have the will to use them.
First, many of our emergency programs are already tapering off as market conditions improve. Second, many of the assets that we have accumulated during the crisis—such as Treasury and mortgage-backed agency securities—have ready markets and can be easily sold. Finally, the Fed can push up the federal funds rate and tighten policy by raising the rate of interest paid to banks on the reserves they deposit with us—authority granted by Congress last year.
An increase in the interest rate on reserves will induce banks to lend money to us rather than to other banks, thereby pushing up rates in the interbank market and, by extension, other interest rates throughout the economy. (BAD) This is an important tool because, even if the economy rebounds nicely, the credit crunch might not be fully behind us and some financial markets might still need Fed support. (BAD)
This tool will enable us to tighten credit conditions even if we maintain a large balance sheet for a time. (BAD) The experience of central banks in Europe, Japan, and Canada suggests that this approach can be effective. (BAD)
7 GOODS and 14 BADS.

Ms. Yellen, while perhaps a better potential regulator of Depository Institutions, seems highly monetarist, and at least back then in 2009, seemed to think that an upcoming QE would be an effective policy.

Boy was she wrong.

As Mike said in a recent comment here:
"fiscal stimulus entails the government piling up dollars into the hands of the non-government, which normally leads to an expanded output of goods and services (real wealth). Everyone benefits. The Fed has nothing to do with this process other than to alter the composition of those dollar assets that the public holds. It cannot increase or reduce them."
Ms. Yellen at least apparently in 2009 did not understand things this way; in fact it seems just the opposite as she seemed to believe that altering the non-government sector's composition of USD assets can have a "stimulative" and/or "tightening" effect on real economic activity.

The only effect "monetary policy" can have on real economic activity seems to be through what Warren has termed "the interest income channel", that is, by lowering the policy rate, the government lowers non-government sector interest income, and raising the policy rate increases non-government sector income as the government is a net payer of interest to the non-government sector.

Each side of this policy having the logical effect on the ability of non-government sector entities to consume or "demand" provision with that sector's income either higher or lower as a result of 'monetary policy'.

Just the opposite of the monetarist view.

Keep your seatbelts fastened, they are still in the driver seat not the car seat.


Tom Hickey said...

Loanable funds. She thinks we are still on the gold standard. We are so screwed.

Matt Franko said...

This was quite a while back and 3 QEs ago Tom...

The saying goes: "when the facts change I change my mind etc..."

So we'll see, I'll try to find some more recent statements this week...


Tom Hickey said...

Let's hope, but I am skeptical. Monetarism assumes loanable funds to work.

Matt Franko said...


Back then IIRC even Bernanke would say "banks lend out the reserves" but at some point he stopped saying that per se...

BB has never said that since VERY early in his Chairmanship...

OTOH, he is still pressing forward with the QE which at core, mathematically, is an activity that indicates the advocates would have to believe the 'banks lend out the reserves' otherwise why would you want to increase reserves? Other than 'confidence fairy' type stuff?

Summers apparently got the MMT data dump from Kelton as you have pointed out but what about Ms Yellen? Have you heard anything along those lines with her?

After 3 QEs and $Trillions of RBs with no predicted effect, any rational/scientific, non-rote, creative thinker would have to surmise that "the facts have changed...", so, will she proceed to change her mind? Will she be able to use her intellect to move past monetarism?

I guess we'll see.... if not, I'd assume QE will be sustained at the meeting this week... if they cut back the QE in the face of current data, maybe they are up to something else...


Clonal said...

Arrange a session for Yellen with Stephanie Kelton - use Brad DeLong as an intermediary. Yellen is very smart. Used to be very open to new ideas.

The Rombach Report said...

"I'd assume QE will be sustained at the meeting this week... "

In other words, beatings to continue until morale improves.

"if they cut back the QE in the face of current data, maybe they are up to something else... "

If so, it makes me wonder if TAPER is already fully priced into the market and we get a relief rally in bonds.