Does a Former President of the Dallas FED Believe in the Law of Scarcity?

Robert McTeer writes a Wall Street Journal op-ed that seems to suggest we can expand the money supply with no fear of hitting a full employment constraint:

The main question on financial TV lately has been whether the economy will continue to weaken and possibly slip into recession, but allow inflation to decelerate, or whether it will pick up and cause inflation to accelerate. More slack in the economy, or a larger output gap, would reduce inflation; more output, it is presumed, would make inflation worse. While a weaker economy might well reduce inflation, that isn’t a necessary condition. Faster growth can also reduce inflation … The Phillips Curve is rarely mentioned anymore, but it still pervades the common view that inflation can be tamed only through a weaker economy. Disinflationary growth is not considered an option, probably because we think of output as responding only passively to changes in aggregate demand, so that they rise together or fall together. That may be the usual case, but it doesn’t have to be. Supply-side factors may stimulate output independent of aggregate demand, through shifts in investment, exports or shifts from imports to domestically produced goods. Or animal spirits … Supply-side economics is out of favor at universities that don’t have good football teams. But that’s largely because its bar for success has been raised too high. Tax-rate cuts may not fully pay for themselves at current rate levels, but they certainly have gone a long way in that direction, as the recent sharp decline in the budget deficit despite rapid spending growth clearly indicates. Tax-rate cuts that substantially pay for themselves in higher tax revenue are clearly a good thing. Our economy is remarkably healthy. Inflation has crept above our comfort zone, but current policies are bringing it down without a recession. Monetary policy is just about right, and is being helped in its fight against inflation by other factors: the Internet, globalization, China, India and other new players. Let’s not be afraid of growth.

Brad DeLong takes us back to September 25, 2002 with The WSJ’s Take on the Current Attitude of the Fed:

Greg Ip and E.S. Browning of the Wall Street Journal sketch out their take on the current attitude of the Federal Reserve. It seems to be that short-term interest rates are already so low that spending has to recover and grow sometime in the future … Reflecting the difficulties the central bank faces, two policy makers – Gov. Edward Gramlich and Federal Reserve Bank of Dallas President Robert McTeer – broke with Chairman Greenspan and their other colleagues, publicly declaring themselves in favor of a rate cut. It was the first dissent in favor of cutting rates since 1995. Mr. Gramlich’s vote is especially noteworthy. Since joining the Fed in 1997, the former academic has developed a reputation for urging more aggressive action on both raising rates and lowering them, but he has never felt strongly enough to dissent. His decision indicates a strong conviction that the economy needs help quickly. By contrast, Mr. McTeer has long had a reputation as a dove, dissenting twice in favor of not raising rates in 1999.

Given how strong the economy was back in 1999, I cannot understand how any member of the FED could have disagreed with the interest rate increase back then. Alas, McTeer has doubted the existence of a full employment constraint for years:

I mention this because I think the chairman’s and the FOMC’s finest hours in recent years were their decisions not to tighten during the period when growth exceeded previous speed limits and when unemployment fell below previous estimates of the nonaccelerating inflation rate of unemployment (NAIRU). The committee, in effect, was testing the growth limits of the New Economy. I just wanted to continue the testing a little longer … By elite opinion, I mean the opinion of traditional establishment types who attended universities that don’t have good football teams and who have a large investment, either literally or intellectually, in the Old Economy. Fortunately, I had no such investment and wasn’t too proud to look at the economy as well as models of the economy. In the equation of exchange, MV = PQ, note that solving for prices puts Q in the denominator, not the numerator: P = MV/Q. Other things equal, more Q means a lower P. Most policymakers ignore that because they’re used to taking Q as a given and focusing on effective demand, or MV. Many who might flinch at being called Keynesians seem to believe more in Keynes’ law – that demand creates its own supply – than Say’s law – that supply creates its own demand. It seems to me that both are valid. Those who ignore Q’s denominator status probably assume that it has no life of its own. Output responds passively to demand. I’m not so sure about that. It seems to me that the 1990s were chock-full of supply-side, Q-altering events: the collapse of communism and hardcore socialism; privatization and deregulation all over the world; freer trade and capital flows; more efficient financial markets; an explosion of high-tech invention, innovation, and deployment; venture capital to finance high tech; better monetary policies; budget deficits turning into surpluses; the proliferation of tiny computer chip brains in everything, everywhere.

McTeer certainly likes football analogies! Sure – there may be real business cycle events that increase full employment output – but that does not invalidate the Phillips curve notion that excessive aggregate demand growth during a period when we are near full employment will lead to accelerating inflation. If the Federal Reserve believed back then that aggregate demand growth was becoming excessive, then the prudent course would have been to raise interest rates. If the Federal Reserve believes that we are currently approaching a period of excess aggregate demand (full disclosure – I would not agree with such a view just yet), then the prudent course would still be to raise interest rates. Thankfully, Robert McTeer is not serving on the Federal Reserve at this time.