Janet Yellen gave a speach which has received a lot of attention and not just because she is one of the most powerful people in the world. I agree with Lorcan Roche Kelly that the best parts are footnotes 28 and 26.
I got into a twitter debate with Andy Harless who was unconvinced by footnote 28
28. My interpretation of the historical evidence is that long-run inflation expectations become anchored at a particular level only after a central bank succeeds in keeping actual inflation near some target level for many years. For that reason, I am somewhat skeptical about the actual effectiveness of any monetary policy that relies primarily on the central bank’s theoretical ability to influence the public’s inflation expectations directly by simply announcing that it will pursue a different inflation goal in the future. Although such announcements might potentially persuade some financial market participants and professional forecasters to shift their expectations, other members of the public are probably much less likely to do so. Hence, actual inflation would probably be affected only after the central bank has had sufficient time to concretely demonstrate its sustained commitment and ability to generate a new norm for the average level of inflation and the behavior of monetary policy–a process that might take years, based on U.S. experience. Consistent with my assessment that announcements alone are not enough, Bernanke and others (1999) found no evidence across a number of countries that the initial disinflation which follows the adoption of inflation targeting is any less costly than disinflations carried out under alternative monetary regimes.
This is my view expressed by my snarky comments about the expected inflation imp. I didn’t know about Bernanke et al 1999 and just looked at the Volcker deflation (which is alleged to show the power of expecations management but doesn’t).
Harless disagreed, Brad DeLong retweeted his tweets, and I promised to write a blog post, so here it is.
Andy Harless @AndyHarless Sep 25
Disagree with Yellen’s note 28. For inflation expectations to have an effect, you don’t need to convince the public, just the smart money.
I disagreed with Harless and will reproduce the tweet debate after the jump. What I should have written is that Yellen’s footnote 28 must be read in the context of footnote 26
26. Another complication is that we do not know whose expectations “matter” for determining inflation. Inflation expectations of professional forecasters (such as those collected in the Blue Chip Economic Indicators, the Survey of Professional Forecasters, or the Survey of Primary Dealers) or inflation expectations derived from asset prices probably capture the views of participants in financial markets but need not reflect the views of households and firms more broadly. As an empirical matter, the little information available on the longer-term inflation expectations of firms from the Atlanta Federal Reserve Business Inflation Expectations survey suggests that firms’ expectations more closely resemble expectations from the University of Michigan Surveys of Consumers than the expectations of professional forecasters. Similarly, preliminary data from a New Zealand study suggests that inflation forecasts of firms are much more similar to those of households than those of professional forecasters (see Coibion and Gorodnichenko, 2015).
The “other members of the public” mentioned in footnote 28 include the managers of firms. Assuming Yellen’s claims of fact are correct and the “smart money” consists of bond traders and professional forecasters but not ordinary people or managers of non-financial firms, how can the “smart money” affect aggregate demand ?
The Harless & Waldmann debate after the jump (but Waldmann gets almost all the pixels as he knows the Angrybear blogger password (or at least his hard disk does)).