The Semantics of Monetary Policy

Tim Duy has some questions for the head man at the Atlanta Fed:

…Atlanta Federal Reserve President Dennis Lockhart…was on the speaking circuit today. Via the Wall Street Journal

If the Fed does slow the pace of its bond buying, “this is not a decisive removal of accommodation. This is a calibration to the state of the economy and the outlook. It is not a big policy shift, and I would hope the markets understand that,” Mr. Lockhart said.

I know that the Fed does not want market participants to associate a slowing of asset purchases with tighter policy. I am not sure, however, that it will be easy to persuade Wall Street otherwise. After all, if the Fed wanted looser policy, they would increase the pace of asset purchases. If more is “looser,” then why isn’t less “tighter?” Alternatively, is “less accommodative” really different from “tighter”?

I’m reminded of one of my favorite exchanges from the Greenspan years, with the Chairman responding to Senator Jim Bunning about the motivation for rate increases in 1999:

We did raise interest rates in 1999, and the reason is real long-term interest rates were beginning to accelerate. Had we not raised the federal funds rate during that particular period, we could have held it in check only by expanding the money supply at an inordinately rapid rate.

My interpretation has always been that Mr. Greenspan was saying something like the following: A set federal funds rate target means that the Fed stands ready to supply as much money as demanded at that rate. (More precisely, the Fed stands ready to supply the quantity of bank reserves demanded at that rate.)

If the structure of market interest rates changes and the demand for bank reserves accelerates—say, because economic growth picks up—maintaining a set target means that monetary policy will become increasingly expansionary. In other words, in such circumstances, standing pat on a federal funds rate target does not mean that the stance of monetary policy stays the same. Quite the opposite.

Jerry Jordan, my former boss at the Federal Reserve Bank of Cleveland and an avid sailor, used to explain it this way: When a person sets out to sail across a body of water, you will notice that he will often adjust the position of the sails, the orientation of the boat, and so on. If you know something of sailing, you will realize that he is very likely reacting to changes in the currents, the winds, and other environmental factors. And if that is indeed what he’s doing, you would not infer that he has changed anything about where he’s headed and why he’s heading there. In fact, you would infer that without such adjustments he must have fundamentally changed his intentions.

Of course, we are in the current context referring not to federal funds rate adjustments but to the pace and ultimate quantity of asset purchases. But I think the principle is the same: A given pace or total quantity of purchases does not mean the same thing in all economic circumstances. If circumstances change, so does the degree of “accommodation” associated with any particular course of asset purchases.

Semantics? I don’t think so, and perhaps this is instructive: In the April survey of primary dealers conducted by the New York Fed, the median response to question of when asset purchases will end was the first quarter of next year. At the same time, the median view on what the unemployment rate would be at that time was 7.1 percent. That view would not be out of line with what you might guess on the basis of the Summary of Economic Projections that the Federal Open Market Committee published following its March meeting.

But, as we noted here following the April employment report, the facts on the ground seem to be shifting. We will, as you know, get an update on the employment situation on Friday, and perhaps today’s ADP report (for what it’s worth) wasn’t encouraging. In any event, in our shop we will process these reports by considering exactly what it means to keep policy about where it is.

About David Altig 91 Articles

Affiliation: Federal Reserve Bank of Atlanta

Dr. David E. Altig is senior vice president and director of research at the Federal Reserve Bank of Atlanta. In addition to advising the Bank president on Monetary policy and related matters, Dr. Altig oversees the Bank's research and public affairs departments. He also serves as a member of the Bank's management and discount committees.

Dr. Altig also serves as an adjunct professor of economics in the graduate school of business at the University of Chicago and the Chinese Executive MBA program sponsored by the University of Minnesota and Lingnan College of Sun Yat-Sen University.

Prior to joining the Atlanta Fed, Dr. Altig served as vice president and associate director of research at the Federal Reserve Bank of Cleveland. He joined the Cleveland Fed in 1991 as an economist before being promoted in 1997. Before joining the Cleveland Fed, Dr. Altig was a faculty member in the department of business economics and public policy at Indiana University. He also has lectured at Ohio State University, Brown University, Case Western Reserve University, Cleveland State University, Duke University, John Carroll University, Kent State University, and the University of Iowa.

Dr. Altig's research is widely published and primarily focused on monetary and fiscal policy issues. His articles have appeared in a variety of journals including the Journal of Money, Credit, and Banking, the American Economic Review, the Journal of Economic Dynamics and Control, and the Journal of Monetary Economics. He has also served as editor for several conference volumes on a wide range of macroeconomic and monetary-economic topics.

Dr. Altig was born in Springfield, Ill., on Aug. 10, 1956. He graduated from the University of Iowa with a bachelor's degree in business administration. He earned his master's and doctoral degrees in economics from Brown University.

He and his wife Pam have four children and three grandchildren.

Visit: David Altig's Page

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