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Did You Hear What Ben Said…and Didn’t Say?

robin anderson

In his high-profile speech to the New York Economic Club yesterday, Fed chairman Ben Bernanke didn’t give any new thoughts on monetary policy. He did reaffirm his view from September – that the Fed will be accommodative not just until the economy recovers, but until it’s clear that the recovery is sustainable.

…we expect – as we indicated in our September statement – that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In other words, we will want to be sure that the recovery is established before we begin to normalize policy.

However, there were some interesting thoughts about the fiscal cliff (a term that Bernanke himself coined) and on where we are headed post-cliff.  First, and not surprisingly, Bernanke was really concerned about the fiscal cliff and the elevated risk of a recession if a deal is not reached. Second, though, dear Ben was downright sunny about the U.S. economy in the event that Washington can make a deal on fiscal policy.  He ended his speech with the following:

In contrast, cooperation and creativity to deliver fiscal clarity – in particular, a plan for resolving the nation’s longer-term budgetary issues without harming the recovery – could help make the new year a very good one for the American economy.

Aside from his thoughts on monetary policy and where we are headed, Ben also had some wonky details worth mentioning.  He talked about the potential rate of output growth and the natural rate of unemployment.  These two economic variables matter because of the speculation that the Fed may (or may not – it depends on which Fed spokesperson and which day) be hoping to target them as their boundaries for the relative effectiveness on monetary policy.  If the economy is currently at its natural rate of unemployment, then monetary policy would seemingly not be effective.  In fact, Robert Gordon, a top researcher studying potential economic growth came out with a controversial paper stating that economic growth may be over in the United States (he posits that the cause of rapid progress is perhaps technologic change).

Bernanke did acknowledge that the U.S. economy actually lost potential growth during the recent recession. Still, he thinks the loss in potential output (and subsequent rise in the unemployment rate) were modest at best. So, in his view (one shared by many on FOMC), the U.S. economy has a way to go to be healthy. His key quotes are as follows:

Output normally has to increase at about its longer-term trend just to create enough jobs to absorb new entrants to the labor market, and faster-than-trend growth is usually needed to reduce unemployment. So the fact that unemployment has declined in recent years despite economic growth at about 2 percent suggests that the growth rate of potential output must have recently been lower than the roughly 2-1/2 percent rate that appeared to be in place before the crisis.

… the consensus among my colleagues on the FOMC is that the unemployment rate is still well above its longer-run sustainable level, perhaps by 2 to 2-1/2 percentage points or so

In particular, even though the natural rate of unemployment may have increased somewhat, a variety of evidence suggests that any such increase has been modest, and that substantial slack remains in the labor market.

He also received a question about signposts. Bernanke said he liked the idea in theory, but that a 3/7 “Evans rule” may be a too blunt to capture the interaction between monetary policy and the economy. “3/7” refers to the Fed continuing its easing until inflation rises above 3%, or the unemployment rate goes below 7%. “Evans” is Charles Evans at the Chicago Fed, who initially suggested the idea.  For what it’s worth, Jeffrey Lacker at the Richmond Fed again came out to criticize explicitly targeting a key economic variable – again, that 3/7 rule that Evans came up with and Kocherlakota (Minneapolis Fed), and Yellen (Fed vice-chair) have supported.

Placing “great weight” on a single indicator of labor market conditions like the unemployment rate “can easily lead you astray,” Mr. Lacker said. “It’s important to avoid spurious precision,” he said.

While 3 and 7 may not be a “perfect 10” for Bernanke and the Fed, as I have said before, tying the end of accommodative policy to the economy is high on the Fed’s agenda.


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