Plosser’s Speech

On his blog, Steve Williamson discusses the recent (September 29, 2011) speech by Charles Plosser, President of the Federal Reserve Bank of Philadelphia, to the Business Leaders’ Forum at the Villanova School of Business.  Plosser explains why he disagrees with recent moves by the Fed such as forward guidance about keeping short-term interest rates at current low levels, and operation twist to lengthen the maturity structure of the Fed’s asset holdings.  Williamson likes the speech; I don’t.  So let’s explore my reasons for disagreeing with Plosser and Williamson.

The first half of the speech reviews the current economics situation, the slow recovery from the 2008-09 downturn and financial crisis, and the deteriorating economic situation since the beginning of the year, despite what Plosser calls “the extraordinary degree of monetary accommodation” provided by the Fed, resulting in a tripling of the size of the Fed’s balance sheet, and a shift in holdings “from mostly short- to medium-term Treasuries to longer-term Treasuries, mortgage-backed securities, and agency debt.”  Furthermore,

In August, the FOMC changed its guidance about its expectations for the future path of the federal funds rate. In particular, it stated that economic conditions were “likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.” At its meeting last week, the FOMC announced additional accommodative action. In an effort to reduce long-term Treasury yields from already historically low levels, the FOMC intends to purchase $400 billion of longer-term Treasury securities and to sell an equal amount of shorter-term Treasuries by the end of June 2012.

Plosser goes on to defend his dissent from the recent FOMC decisions, arguing that the ineffectiveness of past monetary stimulus in reducing unemployment should serve as a warning to “be cautious and vigilant that our previous accommodative policies do not translate into a steady rise in inflation over the medium term even while the unemployment rate remains elevated.”  In other words, monetary accommodation has proven ineffective in reducing unemployment, but it may cause inflation in the future, and without reducing unemployment in the process. 

How is that possible?  Wouldn’t an increase in aggregate demand resulting from an easy money policy tend to increase inflation while reducing unemployment?  Plosser thinks not, because monetary expansion could create “an environment of stagflation, reminiscent of the 1970s [that] will not help businesses, the unemployed, or the consumer.” 

This seems to me a most remarkable assertion.  The experience of the 1970s used to be viewed as evidence that the long-run Phillips Curve is vertical, so that monetary policy can’t force the unemployment rate down permanently below its “natural” level, because ultimately, when the price level effects are foreseen, workers will not let themselves be fooled into accepting lower real wages than they are really willing to work for.  From this proposition, Plosser apparently infers that even if there is unemployment, because (in a Phillips-curve framework) real wages are too high to allow a full-employment equilibrium, you can’t use monetary policy to reduce the real wage, because workers won’t let their real wage be reduced by inflation even when the real wage is above its equilibrium level. 

This is actually a curious inversion of Keynes’s argument about the futility of nominal wage reductions as a method or eliminating unemployment.  Keynes held that falling nominal wages would simply be passed through by employers to customers in the form of lower prices, negating the nominal wage cut.  The logic by which Keynes concluded that falling nominal wages would cause a proportionate fall in prices rather than a less than proportionate fall in prices to restore equilibrium was far from ironclad; one could argue at least as plausibly that firms would not be quite so obliging as to pass forward their full savings from reduced money wages to consumers without trying to increase their depressed profit margins even a smidgen.  Similarly, Plosser seems to be suggesting that workers, despite high levels of unemployment, are so determined to preserve their current above-equilibrium real wage that any increase in prices tending to reduce real wages would elicit immediate and effective demands by workers for increased nominal wages thereby negating the incentive to hire additional workers otherwise following from an increase in prices relative to wages.  If this is the lesson Plosser draws from 1970s stagflation, it is a very different lesson from the one that Friedman and Phelps thought that they were teaching when they formulated the natural rate hypothesis 40 years ago. 

The only other possibility is that Plosser thinks that the natural rate of unemployment is now approximately 9%.  Perhaps it is, but if that is what he thinks, he ought to be willing to make that argument explicitly and not pretend that he is simply applying the lessons of the 1970s.

But Plosser seems to be making just that suggestion in the next paragraph of his speech (quoted approvingly by Williamson).

In my view, the actions taken in August and September tend to undermine the Fed’s credibility by giving the impression that we think such policies can have a major impact on the speed of the recovery. It is my assessment that they will not. We should not take certain actions simply because we can. . . . The ills we currently face are not readily resolved through ever more accommodative monetary policy. If we act as if the Fed has the ability to solve all our economic problems, the credibility of the institution is undermined. The loss of that credibility and confidence could be costly to the economy because it will make it much harder for the Fed to implement effective monetary policy in the future.

Plosser offers an assessment that the actions taken by the FOMC in August and September cannot affect the speed of the recovery.  I agree with that assessment, because monetary policy has failed to change pessimistic expectations about the course of future prices and nominal incomes.  Plosser, however, apparently believes that monetary policy could not under any circumstances do any more than it already has.  But he seems unwilling to defend his assessment that monetary policy cannot reduce the current rate of unemployment in terms of any commonly understood macroeconomic model.  We are supposed to just take his word that monetary policy cannot help speed the adjustment of an unemployment rate above its natural level back to its natural level.  So unless Plosser believes that the current unemployment rate is already at its natural level, I cannot understand how he could suggest that a policy of moving the unemployment rate down toward its natural level is tantamount to asking the Fed to “solve all our economic problems.”  And if he thinks that the unemployment rate is now at the natural rate of unemployment, he ought to say that that is what he thinks and explain why he thinks that is the case.

Steve Williamson supports Plosser with the following observation:

A large fraction of the population is significantly worse off than they were in 2007. But there are no monetary policy actions available currently that will make them better off. However, by continuing to engage in unconventional policy actions – QE1, QE2, “forward guidance,” and Operation Twist, the Fed is acting as if it knows what it is doing, and can actually reduce unemployment by taking those actions. Further, public statements by some Fed officials, particularly Bernanke, express confidence that these actions actually work. Bernanke, and like-minded people such as Charles Evans, Chicago Fed President, are unfortunately engaged in wishful thinking.

What is the wishful thinking here?  Is it that speeding the adjustment of unemployment toward the natural rate will make the reduction in unemployment unsustainable?  What is the theory that explains why speeding a reduction in unemployment to the natural level is unsustainable?  What evidence supports such a view?  Or is that the natural rate of  unemployment is now at 9%.  And again I ask, what is the basis for believing that the current natural rate is now at 9%?

13 Responses to “Plosser’s Speech”


  1. 1 Adrian Ravier October 3, 2011 at 8:30 am

    I think you have done a good question at the end of your post. I try to give an answer in this article (http://adrianravier.com/wp-content/uploads/2011/10/Ravier_QJAE-.pdf). I´m sorry I cannot summarize the main argument in a paragraph.

  2. 2 Lars Christensen October 3, 2011 at 12:56 pm

    David, I still have a very hard time understanding why Williamson uses the term New Monetarism to describe his own views as he apparently think that monetary policy is totally useless. Said, in another way, money do not seem to matter to Williamson.

  3. 3 Benjamin Cole October 3, 2011 at 5:19 pm

    I am flabbergasted at Williamson’s blog. He seems to embrace wimp-ism and defeatism. He easily succumbs to the weak premise that suppressing inflation trumps all other concerns, and will be beneficial in the long run (in Japan, they are waiting for 20 years for the benefits of mild deflation, and instead investors in real estate and equities have lost three-quarters of their wealth and are still falling).

    I posted on Williamson’s blog John Taylor’s 9/14/2006 paper in which he absolutely gushes about the positive effects of QE in Japan (then tried fleetingly by Japan). Williamson says there is nothing the Fed can do–then why does Taylor say QE was a huge success in Japan?

  4. 4 David Glasner October 3, 2011 at 6:59 pm

    Adrian, Thanks for your paper. I will try to look it over and give you a further response.

    Lars, I think Williamson would say that the most that monetary policy can do is achieve price stability, and that the real economy must be left to work itself out as best it can. I don’t think that is what Friedman would say, but I can see how one could argue that that is the essential lesson that Friedman taught. But I don’t think that I should try to speak for Williamson.

    Benjamin, I will look at Williamson’s blog and follow any discussion between the two of you.

  5. 5 Barry October 3, 2011 at 7:00 pm

    It’s really political – the right is happy with things. They’ve thrown the blame onto the Democrats, while Wall St and the Corps get bailed out. Labor discipline has been ramped up to savage levels, and the GOP is very successful at a Friedman-Pinochet style ‘reform’ campaign of looting remaining public services.

    All else is justification, without intellectual content.

  6. 6 Kevin Donoghue October 4, 2011 at 1:46 am

    “The logic by which Keynes concluded that falling nominal wages would cause a proportionate fall in prices rather than a less than proportionate fall in prices to restore equilibrium was far from ironclad….”

    That’s true enough but it doesn’t get you very far. A lot of Keynes’s thinking was sketchy, but the details can usually be filled in if one is so inclined. It’s quite possible to construct a respectable model in which a proportionate fall in all nominal values is exactly what you get. All you need to do is eliminate all “outside” assets, so that there is no Pigou effect to halt the deflationary spiral. Hicks discusses this in the final chapter of The Crisis in Keynesian Economics. He refers to it as the Wage Theorem, which is a bit over-the-top I think.

    Whether that’s the way the world works is another question, but economists whose models exclude wealth effects (as many do AFAICT) are poorly placed to fault Keynes’s argument.

  7. 7 Becky Hargrove October 4, 2011 at 6:59 am

    It is one thing to find that some Republicans don’t seem to be concerned with job creation in the present, but this lack of concern about growth itself? Now the tea party base seems to agree with arguments that have been made for decades by some on the left. When I argue for economic growth I get a lot of pushback these days, which really concerns me as to our immediate future.

  8. 8 David Glasner October 4, 2011 at 8:22 am

    Barry, Regular readers of this blog know that I am not a huge fan of Milton Friedman, but reference to “a Friedman-Pinochet style ‘reform’ campaign of looting remaining public services” is offensive and way over the top.

    Kevin, Actually, I wasn’t trying to get that far with that observation about Keynes. It just sort of popped into my head as I was writing about Plosser. It just occurred to me that there was a curious parallelism in the way in which Keynes tried to show that money wage cuts could not restore labor market equilibrium and the way that Plosser tried to show that price increases could not restore labor market equilibrium. Intuition suggests that at least directionally both money wage cuts and price increases would achieve the real wage cuts consistent with labor market equilibrium. I wasn’t thinking of a Pigou Effect, I am questioning Keynes’s premise that real wages cannot be reduced by money wage cuts because prices fall as fast as wages. I don’t accept that premise. Even if Keynes’s argument can be rehabilitated his reasoning in the GT was still sloppy. I think Plosser’s reasoning is also sloppy.

    Becky, You are right that Plosser and other opponents of using monetary policy to speed the recovery seem curiously indifferent to slow economic growth. I am guessing that they believe that the way to promote growth is to cut taxes on capital and marginal rates on labor income and rein in regulation. Some of that makes sense, but we don’t understand the process of economic growth well enough to say whether that would actually make much of a difference. Which left-wing arguments do you think that the Tea Party has adopted?

  9. 9 Ben Fenster October 4, 2011 at 9:18 am

    Both Plosser and Willaimson have invested their careers in models that have nothing to say about the crisis and in which the crisis should never have occurred. Because of that, they have a vested interest in making sure that no policy prescription based on competing economic models has any chance of success. If that happened, their life’s work would be revealed as wasted. That’s the logic behind their stand on the issue.

  10. 10 Becky Hargrove October 4, 2011 at 6:13 pm

    For example, the slogan End The Fed resonates with both groups, which seem to distrust monetary solutions. There is a book, Why Americans Hate Politics by E.J. Dionne Jr. which does a good job of explaining some of this crossover effect, although it was written in 1991. Also, there is the idea of a resource based economy (no money) which people on both the left and the right have embraced.

  11. 11 David Glasner October 4, 2011 at 6:45 pm

    Ben, you said:

    Both Plosser and Willaimson have invested their careers in models that have nothing to say about the crisis and in which the crisis should never have occurred. Because of that, they have a vested interest in making sure that no policy prescription based on competing economic models has any chance of success. If that happened, their life’s work would be revealed as wasted. That’s the logic behind their stand on the issue.

    I think that you should have said: “That’s the psychology behind their stand on the issue.” At any rate, I will leave it to others to speculate about their motives. I will focus on the substance of what they say. I don’t think that you can discredit a proposition by ascribing a psychological motive to the person who advances a proposition.

    Becky, You may be right (as in correct). And the ideological extremes sometimes come together in opposition to the center. Marx, by the way, was a fanatical gold bug. But the signs so far seem to me somewhat opaque. But it’s worth monitoring.

  12. 12 Benjamin Cole October 5, 2011 at 11:48 am

    Williamson made curious statements in the comments,including that he did now know who was George Gilder and that Taylor’s paper on Japan (2006) was not “scientific.”

    I am not sure what Williamson wants to to other than nothing, and passive tightening.


  1. 1 The Fed Is Impotent — But Watch Out for Inflation! « Uneasy Money Trackback on October 5, 2011 at 8:25 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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