Imagine a developed economy with a highly regarded central bank and a long and distinguished tradition of progressive, state-of-the-art monetary policy-making. Imagine that central bank has been given a mandate of high employment and price stability. Imagine that it interprets “price stability” as 2% inflation, and it regards the natural rate of unemployment as being around 6%. Sound familiar?
Now imagine that the current unemployment rate is 7.8%, and inflation is expected to run below 2% over the next few years. They have a policy meeting, where a couple people advocate greater monetary stimulus, while the majority decides to stand pat, despite the fact that their mandate would pretty clearly call for additional easing. Why does the majority favor doing nothing?
There are limits to what monetary policy can achieve. Many of the problems on the labour market are of a structural nature. The structural problems include the possibility for new groups joining the labour force to find work, matching of vacancies to job-seekers and the flexibility of the wage formation process.
In addition, the policy recommended by the doves would better fulfill their mandate, but there are vague “risks” involved in doing the right thing, and “uncertainty” is holding back the economy, not monetary policy:
Although a larger cut, as advocated by Ms Ekholm and Mr Svensson, could bring inflation up to the target more quickly, and the forecast would thus “look better”, Ms Wickman-Parak’s assessment was that the effects on the real economy would not be particularly significant and that there were risks associated with such a policy.
It is not an excessively high interest rate that is holding back investment; this is due to the high level of uncertainty about the future course of the economy.
And let’s not forget that the low level of interest rates show that policy is already accommodative:
Ms af Jochnick pointed out that the Riksbank is currently conducting an expansionary monetary policy.
Sounds exactly like the Fed. But it’s not, it’s the Riksbank, with Svensson playing the role of Charles Evans. And here’s what’s most important, the current level of short term interest rates in Sweden is 1.5%, and the debate is over whether rates should be cut. They aren’t at the zero bound. Sweden faces a situation similar to that of the US, which calls for monetary easing to hit their dual mandate. A few members of their central bank favor a rate cut, but most are opposed. That tells me that the problem probably isn’t the zero bound, rather it’s excessive caution at the Fed. We need to accept that fact that exiting the zero bound won’t end our malaise. The Fed will still be too tight, worried about inflating new bubbles (another worry mentioned in the Riksbank’s minutes.) Like the Riksbank and the BOJ and the ECB, the Fed will raise rates too soon and then have to cut them again.
As usual the markets figured all this out long before I did. The 2.6% yield on 30 year bonds is basically a forecast of future premature tightening by the Fed. What I don’t understand is how markets can be so damn smart when they are composed on individuals who are individually quite stupid. I suppose for the same reason that Albert Einstein’s brain was quite smart, despite being composed of neurons that are individually quite stupid.