In the mind of Janet Yellen
In a speech by Janet Yellen on April 11, 2012, she talked about her preferred version of the Taylor rule to determine the Federal Funds rate.
The Taylor (1993) rule calls for the federal funds rate to begin rising in early 2013, whereas the Taylor (1999) rule has its liftoff in early 2015, a lot closer to the optimal control path. A sizable literature has examined the performance of simple rules like these by conducting stochastic simulations with a range of economic models. Many studies, including Taylor’s own analysis, suggest that the Taylor (1999) rule generates considerably less variability in real activity and only slightly more variability in inflation than his original rule. Given the differential responses to economic slack across these two rules, this finding is hardly surprising, but it is a key reason why I consider the Taylor (1999) rule to be a more suitable guide for Fed policy.
The Taylor rule (1999) actually had “liftoff” in early 2014 according to Tim Duy, when the rule (1999) went positive. Then she puts the rule into perspective of her broader view on the future of monetary policy.
“While the Taylor (1999) rule can serve as a useful policy benchmark, its prescriptions fail to take into account some considerations that I consider important in the current context. In particular, this rule does not fully take into account the implications of the zero lower bound on nominal interest rates and hence tends to understate the rationale for maintaining a highly accommodative stance of monetary policy under present circumstances.”
Where is she going with this idea of “maintaining a highly accommodative stance of monetary policy”?
Importantly, resource utilization rates have been so low since late 2008 that a variety of simple rules have been calling for a federal funds rate substantially below zero, which of course is not possible. Consequently, the actual setting of the target funds rate has been persistently tighter than such rules would have recommended. The FOMC’s unconventional policy actions–including our large-scale asset purchase programs–have surely helped fill this “policy gap” but, in my judgment, have not entirely compensated for the zero-bound constraint on conventional policy. In effect, there has been a significant shortfall in the overall amount of monetary policy stimulus since early 2009 relative to the prescriptions of the simple rules that I’ve described.
She mentions a “significant shortfall”. What is this shortfall? In the end, it is not what she thinks.
“Analysis by some of my Federal Reserve colleagues suggests that monetary policy can produce better economic outcomes if it commits to making up for at least some portion of the cumulative shortfall created by the zero lower bound–namely, by maintaining a highly accommodative monetary policy for longer than a simple rule would otherwise prescribe. This consideration is one important reason that the optimal control simulation generates a more accommodative path than the Taylor (1999) rule.
So in effect, she will keep the effective Fed rate at the ZLB beyond the moment when the Taylor rule (1999) goes positive. In her mind, this will compensate for the period when the effective Fed rate could not go negative. Thus presently, she is keeping the Fed rate at the ZLB in order to make up for the shortfalls in policy when the rate could not go negative.
There is a risk though. She is expecting a couple of years of slack in the economy now to give her room for this maneuver and for normalizing the effective Fed rate. That vision of plentiful slack is what is in the mind of Janet Yellen. I for one do not believe that such plentiful slack is available due to the effective demand limit.
The Fed rate should move with the preferred policy rate rule when the rule catches up to the Fed rate.
Let’s say you are walking to the store with a friend, and suddenly the friend drops back to tie their shoe. So you wait for your friend to catch up. When your friend catches up to you, do you allow them to walk a little further ahead to make up for the time they were behind? No… you start walking together. You are supposed to walk together.
Is there an analogy that makes sense of Janet Yellen’s plan? Could it be “affirmative action”?
In affirmative action, you have people who have been disadvantaged for a period of time, so they fall behind everyone else. So you create a policy to give them extra advantages to catch up.
But the analogy of affirmative action assumes a comparison of someone who did fall behind and someone who did not. So who fell behind who? In reality, labor fell behind capital. So does Janet Yellen’s maneuver to hold the Fed rate at the ZLB give labor an extra advantage? No… Her maneuver keeps giving capital extra advantages. It is a backwards policy. She is helping the advantaged thinking that they will help the disadvantaged once the labor market tightens up. However, reports are showing that on balance firms do not plan on raising labor’s share.
The Shortfall is actually Labor’s, not Capital’s
Unless Janet Yellen’s plan can directly help labor gain a higher share of national income, she is simply creating more policy for cheaper capital, cheaper labor and sustained inequality. She is harming society by giving extra advantages to capitalists, who have garnered pretty much all the gains from the recovery…
In her mind, she is on the correct curve for monetary policy. Yet in reality she is putting monetary policy and society behind the curve.
Well, Edward we have been here and done this before, so I shall not go on at length. However, I shall remind you and anybody else paying attention that I have previously suggested that your effective demand limit is too tight because you have not properly accounted for the decline in labor force participation when plugging in the unemployment rate. I would suggest that this is a major reason why you and Yellen differ, and I would remind that she is an especially deep student of labor markets, which is why I think she is aware of this issue.
Yes, we have talked about whether the unemployment rate is a true measure of slack in the labor market. Yellen is a deep student of labor markets. and her models say that many more people could be employed.
And many more people will be employed.
You then would still not see the Taylor rule going positive. You prefer to say there is more slack so the Taylor rule is giving a rate that is too high.
However, keeping the Fed rate low in order to compensate for shortfalls to capital is silly when they are sloshing in liquidity already. Maybe she wants more people to be employed but she must know that incomes for jobs are not sufficient. She knows that the majority of people are suffering. The Fed report on Household Financing came out last week and said that. But she has no other mechanism to help people directly. She is the Chair of a central bank. She has to work through the bank/financial system, which loves her accommodative policy, but people are not benefiting.
I am assuming the decrease in Participation Rate as mentioned is due to the Baby Boomers exiting the Civilian Labor Force into retirement. I would think the offset to this would be the arrival of the Millennial Generation which is a cohort larger than the Baby Boomer cohort. This should offset Baby Boomer departure in terms of viable Labor. I would also think it is them who are under utilized more so than Baby Boomers and should be counted as slack labor or under utilized.
What do you mean when you say that “labor has fallen behind capital” and “labor’s share of national income”?
When laborers are scarce, laborers will command higher prices (wages). When capital is scarce, capital will command higher prices (returns). The relative scarcities has never remained constant.
Perhaps it is not the fed interest rate we should be concerned with, but the illegal immigration rate.
Are you saying that immigrants suppress wages? Because the research shows that immigrants increase the number of total jobs in the economy.
And is it labor who cannot command higher wages? or is it the managers who think they are paying well if they pay $1.50 over the minimum wage?
I said ILLEGAL immigration, Edward. That adjective is vitally important.
The vast majority of unlawful aliens (the term used in the US Code) are unskilled labor. It is simply impossible for unskilled laborers to create more jobs than they take. A hundren unskilled laborers might create ninety jobs, but they will not create a hundred and ten.
So I am confused. You apparently want to raise the fed funds rate but how does that feed into a greater labor share?
I contribute the drop in labor force participation to the drop in labor share. It is a supply/demand thing. I refer back to this post…
to show that falling labor share translates into less labor supplied, which means that the fall in labor force participation will not rise until labor share rises. So I do not agree with Barkley’s view that they will come back once the labor market tightens up. I see that labor who has left the labor force will come back when labor share rises.
And we are seeing just that… labor force participation is not rising yet even though it looks like the labor market is tightening up. Labor share is still not rising much.
Do you consider people who work “informally” (outside of the legal accounting of the US tax system) to be illegal? They don’t pay taxes on their income, yet maybe their kids have full benefits from schools much more than illegal immigrants. They even require benefits for their whole lives, while illegal immigrants may receive benefits for a short while.
How do you see informal work by US citizens?
I know 2 ladies who each make over $60,000/year doing cleaning. They do not declare their income and pay no taxes. Yet they are legal US citizens born in the US. Do you consider them “illegal”?
The PEOPLE are “unlawful”. Their ACTIONS are illegal.
Such “informal” work, by law, must be reported and taxes paid on that work, even if done in barter instead of cash.
If you want to purchase capital equipment now, the funding cost is low. If you want to carry funding to a foreign country, the funding cost is also low.
So capital is cheaper. That is the idea about keeping nominal rates low. Investment is supposed to expand.
Labor to some extent has to compete against cheap capital. So low nominal rates gives capital a marginal advantage over labor.
Yet there are other factors that are bringing down labor’s share. For example, China and some other countries have very low labor share. The return to capital is much higher. So US labor must compete to some extent with low labor share abroad.
Now if you raise nominal rates, the cost of doing business will increase. Businesses will raise prices to cover the increase. Consumers will be faced with inflation pressures. But there isn’t enough demand to support much higher prices. The pressure will then build to raise wages to cover the costs of inflation and increased costs of borrowing.
The key is to build the pressure to raise wages. As it is now with low nominal rates, inflation and wage inflation is muted. There are no building costs to move either upward.
You could just accept the status quo and keep nominal rates low with the hope that the economy will expand and then overheat leading to inflation and wage inflation… but that is not likely this time.
The key to getting inflation to increase is to increase nominal rates. Then inflation will trigger pressure for wage inflation… and in that process, labor will have to find its power to survive. Re-awakening the power of labor is key. The power of labor was alive during the Great Depression and even after WWII. How did that happen? People had to survive. They found their power. FDR helped cultivate that power. It was a desperate time for many people, but the results led to decades of labor power and prosperous times.
“…calling for a federal funds rate substantially below zero, which of course is not possible.”
Every time I read the above, I think “why not”? I mean, negative interest would simply be paying people to take the money.
Are there rules against that? Or does not economic follow physics into the world of negative?
Would it not be paying people to dig up the money? You know, the Keynse’s plan?