Fed policy: The Golden Age begins

Michael Rulle directed me to a WSJ article by Greg Ip on the decline in central bank effectiveness:

The Era of Fed Power Is Over. Prepare for a More Perilous Road Ahead.

The Federal Reserve and other central banks have long been the unchallenged drivers of financial markets and the business cycle. “Don’t fight the Fed,” goes one Wall Street adage.

That era is drawing to a close. In many countries, interest rates are so low, even negative, that central banks can’t lower them further. Tepid economic growth and low inflation mean they can’t raise rates, either.

Since World War II, every recovery was ushered in with lower rates as the Fed moved to stimulate growth. Every recession was preceded by higher interest rates as the Fed sought to contain inflation.

But with interest rates now stuck around zero, central banks are left without their principal lever over the business cycle. . . .

It’s not just the WSJ, you see this sort of thing all over the place.  Bloomberg reports that Larry Summers is making the same sort of claim:

Summers Calls Bernanke Speech ‘Last Hurrah’ for Central Bankers

Fortunately, this pessimism is 100% wrong. We are entering a golden age of central banking, where the Fed will become more effective and come closer to hitting its targets than at any other time in history. Over the next few decades, inflation will stay close to 2% and the unemployment rate will generally be relatively low and stable. And this certainly won’t be due to fiscal policy, which is currently the most recklessly pro-cyclical in American history.

The conventional wisdom on monetary policy has been pretty consistently wrong, mostly because of the widespread tendency to conflate “monetary policy” with “interest rate path”. At the time, most people incorrectly thought money was not too tight in the 1930s, and not too easy in the 1970s, and not too tight in 2008-09. Today they look at low interest rates and wrongly conclude that the Fed is nearly out of ammo. Ignore the conventional wisdom.

In fact, Fed policy is becoming more effective because it is edging gradually in a market monetarist direction, with more focus on:

1. NGDP growth

2. Level targeting

3. Market forecasts of aggregate demand growth

If they continue moving in this direction, then NGDP growth will continue to become more stable, the business cycle will continue to moderate, inflation will stay in the low single digits, and unemployment will stay relatively low and stable.

It won’t be perfect; the business cycle is not quite dead. There will be an occasional recession. But the business cycle is definitely on life support.

We had 4 recessions during 1920-30, 4 recessions during 1949-60, and 4 recessions during 1970-82. My younger readers will never experience that sort of actual “business cycle”, with one recession right after another.

As an analogy, when I was young I would frequently read about airliners crashing in the US. One crashed a few miles from my apartment during the late 1970s. My daughter is a junior in college and doesn’t recall a single major airline crash in the US, excluding a couple of small commuter planes in the 2000s (she was only 2 during 2001). After each crash, problems were fixed and planes got a bit safer.

Recessions and airline crashes: They are getting less frequent, and for the exact same reason.



23 Responses to “Fed policy: The Golden Age begins”

  1. Gravatar of Brian Donohue Brian Donohue
    16. January 2020 at 13:20

    You are much closer to the truth than Ip, Summers, et al.

    Businesses ebb and flow, and it’s almost certain that every once and a while there will be a confluence of ebbing leading to a general slowdown, but if central banks apply the lessons you and others have been harping on for a decade, they can ameliorate this ebbing rather than exacerbate it.

  2. Gravatar of Brian Donohue Brian Donohue
    16. January 2020 at 13:48

    Hey Scott,

    Do you think this site contains any interesting information?


    Not sure how much this is market-driven, but it traces out an interesting story regarding the 2020 Fed/market dialogue.

    Currently, it shows a 13.8% chance of an interest rate INCREASE at the January meeting and no chance of a cut, but, as we look out to the forecasts for the 12/16/2020 meeting, we see a much greater chance of rates being below current levels than above it.

    It’s as if the markets are expecting an economic slowdown this summer but they expect the Fed to retain a modest “upward bias” on rates, which I think I detected in the current cycle, where the Fed mostly “pulled a truculent market along” for most of the tightening through 2018 but followed the market down last year. Maybe not a huge bias, maybe my imagination, but that’s how it looks to me.

    Anyway, I for one would be surprised if we continue to manage something like the 2 million+ new jobs in 2020 like we have over the past decade- the bench HAS TO be getting pretty thin at this point.

    Your thoughts are appreciated as always.

  3. Gravatar of OtherMichaelM OtherMichaelM
    16. January 2020 at 15:01


    Prime age labor force participation is still about one percentage point off peak. While some of that is going to be younger people (25-30) going to school longer, there seems to still be some slack just from the sidelines.

    People are also working later in life, so not all the major decline in overall LFP is old people permanently retiring. Some of them could, no doubt, be lured back into the labor force.

  4. Gravatar of marcus nunes marcus nunes
    16. January 2020 at 15:25

    What if…
    When he took over the Fed in January 2006, BB had kept NGDP growth on the great moderation trend which Greenspan had regained by the end of 2005 after his “forward guidance” of mid-2003. If that had come about, the economy would have endured some slowdown (shallow recession) due to the supply (oil) shock of 2007-08. The financial mayhem that took place was exclusively due to NGDP growth falling almost 10 percentage points (from 5%+ to minus 4%!).
    Thereafter, without going through a recovery, the economy has experienced a “booming depression”, or a second class “Great Moderation”. This can be extended “indefinitely”, but a “sour taste” remains…

  5. Gravatar of Per Kurowski Per Kurowski
    16. January 2020 at 15:39

    The current quasi-boom, put on steroids by huge central bank liquidity injections, low interest rates, and Basel Committee’s procyclical risk weighted bank capital requirements, could/will end in a horrific Minsky moment bust, equally put on steroids.

  6. Gravatar of Lorenzo from Oz Lorenzo from Oz
    16. January 2020 at 15:47

    If one takes out hostile human action (suicidal pilots, anti aircraft missiles systems) airline crashes are even rarer.

    Agreement from the country without a recession since 1991.

  7. Gravatar of Benjamin Cole Benjamin Cole
    16. January 2020 at 16:55

    Recessions and airline crashes: They are getting less frequent, and for the exact same reason.—Scott Sumner.

    Well, do we then cite an analogy to the Boeing 737 Max?

    A lot of smart people seem to think if central banks and national governments do not embrace some sort of money-financed fiscal programs, then central banks will indeed lack the necessary ammo to counteract the next global recession. Stanley Fischer is one, and I think Richard Clarida is secretly another.

    Almost en masse, central bankers say the ball is in the fiscal court in the next recession.

    No one is ever wrong in macroeconomics, so it is difficult to answer to answer the question if money-financed fiscal programs will be a necessary tool.

    If a recession approaches, certainly such programs strike me as advantageous.

    Which leads to the question, “Why not use helicopter drops hard and fast early in a recession?”

  8. Gravatar of bill bill
    16. January 2020 at 16:56

    Ip writes, “rates are so low, even negative, that CBs can’t lower them further”.
    There is no imagination. You’ve written posts, I think, on “how about negative 50% IOR”. And of course, I wonder what rates would be if the Fed said “we’re buying $100 billion in long term Treasuries next month and we will double that every month until CPI hits 10%”?
    Not that they’d want to do these things but if they even mentioned something like that, I’m sure they could raise inflation or NGDP growth to whatever number they wished.

  9. Gravatar of Benjamin Cole Benjamin Cole
    16. January 2020 at 18:05


    Well…yes and no.

    1. Central banks must maintain an austere image of gravitas. Wacko-pledges might rattle markets.

    2. The Swiss National Bank in fact bought about $100,000 in sovereign bonds per resident, when they were trying to cap appreciation of the Swiss franc. So, that is $100k of QE per resident. Yet, the Swiss inflation rate and GDP growth rate hardly budged. Other than quelling the Swiss franc’s upside, the QE seemed inert.

    The US population is about 330 million. If the Fed entered into a QE program as aggressive as that of the Swiss National Bank’s, it would buy about $33 trillion in sovereign bonds. Does this make sense? Would it have any effect? No one really knows.

    And, of course, the Bank of Japan has engaged in aggressive QR for years, with mild results, although even these results are debatable, as the yen wandered around, and the government also engaged in deficit spending (and is again). The issue is further fogged withJapan demographics yet rising labor participation rates, but declining housing costs in much of Japan.

    (BTW, starting this year, due to JGBs with negative interest rates, the Japan government will begin “collecting interest” on its national debt. That is, in total people are paying the Japan government for the right to own JGBs.)

    Gadzooks, why tweetybird around? You have a recession, send in the helicopters. Send in the money-dropping B-52s.

  10. Gravatar of Don Don
    16. January 2020 at 18:20

    If the Fed has learned about NGDPLT, then Scott Sumner deserves a lot of the credit for his work championing the idea. I hope it comes to be.

  11. Gravatar of Michael Sandifer Michael Sandifer
    16. January 2020 at 21:35

    I agree that monetary policy seems to be improving in the US overall, but I wonder if that will continue given trends in the political environment. I’m not only concerned about ignorant populists making the Fed worse, but also the Fed giving up it’s relative political neutrality by trying to focus on issues such as climate change and income and wealth inequality.

    The problem is, the Fed still isn’t doing a good job. Real growth is considerably weaker than it should be, and it’s just adding heat to a boiling political climate.

  12. Gravatar of Ralph Musgrave Ralph Musgrave
    16. January 2020 at 23:00

    Scott answers the claim that the “Fed is nearly out of ammo” with the idea that NGDP targetting will make up for the lack of ammo.

    Unfortunately the fact having a target does not of itself mean the target is hit. If my target is to improve the miles per gallon of my car, the miles per gallon achieved by the car will not suddenly improve just because I’ve set a target.

  13. Gravatar of ssumner ssumner
    17. January 2020 at 01:11

    Brian, I’ve been surprised by how many workers have come out of the woodwork, but I do agree that employment growth will slow at some point. Perhaps the biggest story will be boomers refusing to retire.

    I tend to look at interest rate futures, which contain some of the same information as that policy forecast site.

    Marcus, I agree.

    Per, There is some risk of that, but it doesn’t have to happen if we are smart.

  14. Gravatar of rayward rayward
    17. January 2020 at 03:09

    Yesterday Trump announced that he would appoint Judy Shelton to the Fed (along with Christopher Waller). Ms. Shelton has a history of being a contrarian. She is a gold bug. She complained that the Fed kept interest rates too low during the 2007-09 crisis. More recently, she has become a Trump follower, calling on the Fed to lower interest rates to zero or negative. Ms. Shelton will be but one voice on the Fed, but a loud voice (and with the ear of the president). Does this portend a golden age for the Fed?

  15. Gravatar of ssumner ssumner
    17. January 2020 at 11:41

    Rayward, Even if she is approved (not at all certain), she’ll have no influence on Fed policy.

  16. Gravatar of Christian List Christian List
    17. January 2020 at 13:04

    Maybe the ECB is becoming more effective as well:

    European Central Bank watchers are virtually convinced President Christine Lagarde will change the institution’s inflation goal for the first time in 17 years.

    Almost 90% of respondents in a Bloomberg survey predicted the ECB will officially alter its strategy to give equal weight to too-low and too-high inflation.


  17. Gravatar of Gene Frenkle Gene Frenkle
    17. January 2020 at 15:44

    I came across this report which states that every major economic indicator from
    2001-2007 was below average except one—corporate profits.


    Since I lived through that time I remember the 2004 election and understanding that the economy was suboptimal and was being propped up by things like home equity loans. So that means cheap credit was available to businesses but many were passing up the opportunity to open up a line of credit to expand their businesses. So why was this?? Because we were undergoing a quiet energy crisis and the people with the best track records of making successful investments didn’t believe the economy was worthy of being invested in. But in modern fiat currency economies capital searches for yield and so the capital found its way to the worst investors and led to malinvestment in the form of a housing bubble.

    So under that context in which malinvestment is occurring in a dysfunctional economy it seems to make sense to increase interest rates in the hopes of stopping the malinvestment.

  18. Gravatar of James James
    17. January 2020 at 21:44

    Christian. Thanks for the ECB story. Super important, super good news. With France and Netherlands on board, flexible inflation targeting is a shoe in. Phew!

  19. Gravatar of Jeff Jeff
    17. January 2020 at 23:23

    Rayward, Scott is correct about Judy Shelton. I retired from the Fed three years ago, and I can’t imagine even the rare Trump supporters there (I was one) being influenced by her brand of moronity.

    Back to the subject of the post: It’s not that monetary policy is not powerful, it’s that when the Fed does it job properly, it fades into the background. The Fed Chairman is no longer perceived as the second-most important person in Washington. Some Congressmen will probably look at the growth in Fed staffing numbers and publicly wonder if we really need all those expensive people when the economy is doing well. And so on. Since politics is largely junior high writ large, some of the people who hoped to somehow get ahead via the Fed are quite upset at the prospect.

  20. Gravatar of David S David S
    18. January 2020 at 03:23

    “Boomers refusing to retire….”

    Indeed. Skilled manual labor will and should demand a premium in the decades ahead. The gods of Silicon Valley haven’t had much impact on the performance of carpenters, plumbers, electricians, or sheet metal fabricators. But, that work takes a physical toll—thank goodness we have such an efficient health care system—move along, no rent seeking to see here folks.

    I’m resigned to another 2 or 3 decades of low interest rates, but it’s fine if there’s no repeat of 2007-2014

  21. Gravatar of Postkey Postkey
    21. January 2020 at 04:21

    No recession. Inflation ‘in the pipeline?

    “In November M3 in the United States of America jumped by another 1.0%. In the last three months M3 rose at an annualised rate of 12.5% and in the year to November it was up by 8.5%. (We use the M3 estimates prepared by the advisory firm, Shadow Government Statistics.) These rates of money growth are a clear departure from the pattern (of annual money growth between 3% and 5%) which prevailed for eight years until spring 2019. If the Institute’s emphasis on the relationships between broad money and nominal GDP, and between real broad money and real aggregate demand, proves correct, early 2020 should see above-trend growth demand growth in the world’s largest economy. Given that the American economy is operating with low unemployment, above-trend demand growth implies capacity strains later in the year and risks of higher inflation in 2021. (The explanation for the upturn in US money growth is that to a significant extent the Federal deficit of $1,000b. is being financed from the banks, i.e., it is being monetised.)

    Elsewhere the message is closer to ‘steady as she goes’. The Eurozone also has enjoyed rather strong money growth in recent months, but this feature has not been as marked as in the USA. In China and India money growth in 2019 has been steady at high rates appropriate in these economies with strong underlying trend growth in output. (But India suffers from serious ethnic and religious tensions at present, which may have economic consequences.) Japan’s money growth is stable at a very low rate, while the UK has a money growth recovery in conjunction with a clarification of the Brexit process. The overall conclusion is that during 2020 the world economy will see at least trend growth of demand and output, after a lacklustre 2019. “


  22. Gravatar of Jonathan Jonathan
    21. January 2020 at 05:04

    I think that what you say is actually that there is nothing that cannot be fixed with 20 year US bonds who carry a negative interest rate. You should state it that way instead of speaking about targets. Otherwise it is like saying that 18th-century Americans could walk on the moon if they had the moon as a target. No, spaceship should have been built first.

  23. Gravatar of P Burgos P Burgos
    21. January 2020 at 11:38

    I think I agree with the gist of B. Cole’s comments. The next time a very big real economic shock comes along, the Fed is only going to be able to keep NGDP growth steady by doing what people have called “unconventional” monetary policy, and at a large scale. Even if all of the members of the Fed buy into the market monetarist paradigm, it will take courage for the Fed to actually follow through on a market monetarist approach when the going gets tough. So I think that whether or not we have another quasi economic depression in the next 20 years or so is going to depend on the Fed having board members who can exercise leadership in a crisis.

    Elizabeth Warren is at least right about one thing: personnel is policy.

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