The Fed Is Impotent — But Watch Out for Inflation!

Our very own redoubtable Benjamin Cole ventured onto Stephen Williamson’s blog to argue the case for an aggressive monetary policy after Williamson’s admiring post about Charles Plosser’s recent speech which prompted my own, less than admiring, post about the speech.  As you might expect Benjamin was received less than cordially, but he stood his ground and gave as good as he got.  Way to go, Benjamin!

I am not going to review the details of the exchange between Benjamin, Williamson, and an anonymous interlocutor (you can go there and read it for yourselves), but I was struck by what appears (to me at any rate) to be an inconsistency in Williamson’s position.

Replying to Benjamin’s call for a more aggressively expansionary monetary policy, Williamson replied as follows:

[Quoting Benjamin] “I am flabbergasted anyone thinks the Fed is doing enough. Really? Inflation is dead, unemployment is at 9 percent, and we are 10-15 percent below GDP growth trend.”

I am flabbergasted to know that you think there is any action the Fed can take now that would increase aggregate activity and/or increase the inflation rate.

Lest you think that that was a slip of the pen, Williamson makes the same point again, even more explicitly, in response to Benjamin’s reference to Milton Friedman’s advice to the Bank of Japan:

[Quoting Benjamin] “The Fed could announce it is targeting 7 percent nominal GDP growth, and follow Milton Friedman’s advice to Japan, and start printing money.”

The Fed can announce whatever it wants. If it can’t actually accomplish what it announces, what good is the announcement? “Printing money” would be, I assume, exchanging reserves for some Treasury debt. That will be essentially neutral – no effect on any prices or quantities.

Then when Benjamin invokes John Taylor’s 2006 advocacy that the Bank of Japan engage in QE, Williamson dismisses Taylor with the a wave of his hand, while dismissing the idea of any trade-off between inflation and unemployment as akin to a belief in the Phillips Curve, as if that were like believing that the earth is flat or that the sun revolves around the earth.

I would not call Taylor’s 2006 paper serious science. You seem to have a firm belief in a Phillips curve tradeoff. I’m not sure why.

Here is where things start to get tricky.  Why does Williamson think that the Phillips Curve is so off the wall?  Based on his earlier responses, you might think that it is because he rejects the notion that policymakers (i.e. the Fed) can control the rate of inflation.  If you can’t control the rate of inflation, the Phillips Curve is useless.  There is another possibility, however, which is that the rate of unemployment is unaffected by whatever rate of inflation the Fed chooses, because the Phillips Curve is vertical.  Now either view is defensible, but, as far as I can tell, they are mutually exclusive.  Either the Fed is powerless to affect the rate of inflation, or it isn’t.

Yet that is exactly where Williamson is headed, because in his next response to Benjamin, Williamson says the following:

[Quoting Benjamin] “No one suggests that inflation cannot be tamped down at some point–if we were so lucky as to have five years of robust growth, we could then start tightening the money supply.”[

It’s costly to reduce inflation once it gets going, right? What if all your inflation does not produce the robust growth you are expecting. Now everyone is complaining, not only about being unemployed, but about the high inflation rate, just as they were in 1980. Then you have to put them through the wringer again to get the high inflation out of the system. Do you think that will go over well?

So Williamson is no longer flabbergasted at the thought that the Fed might be able to increase the rate of inflation; it’s perfectly doable.  The problem now is that the Phillips Curve is vertical, so even if you raise the rate of inflation, it won’t get you the reduction in unemployment that you thought you would get.

There are two points to make about this.  First, on substance.  The argument that a vertical Phillips Curve means that monetary policy is useless only works if we assume that the natural rate of unemployment is a constant of nature in the sense that the actual rate of unemployment must always equal the natural rate.  If the actual rate of unemployment can exceed the natural rate, then monetary policy can hasten the return of the actual unemployment rate to the natural rate, though, to be sure, there is a risk of overshooting the natural rate.  Opponents of using monetary policy to reduce unemployment like to suggest, but without saying so explicitly, that the natural rate of unemployment has risen sharply so that monetary policy can’t reduce unemployment below its current level.  But to my knowledge, no one has come out and actually said in so many words that the natural rate of unemployment is now 9%.

Second, sliding effortlessly back and forth between an argument that says that the Fed is powerless and an argument that says that although the Fed can indeed raise the rate of inflation, doing so would be bad policy, because higher inflation would drive up unemployment to an even higher level in the endwhen inflation eventually had to be reduced does seem a tad, shall we say, ad hoc.  And, as we all know, serious scientists never engage in ad hocery.  (Query:  but isn’t the Phillips Curve vertical?  Answer: Well, it’s vertical when you increase the rate of inflation, but it’s negatively sloped when you reduce the rate of inflation.  Go figure.)


22 Responses to “The Fed Is Impotent — But Watch Out for Inflation!”

  1. 1 Marcus Nunes October 5, 2011 at 9:53 pm

    David. Correct the mispelling. It´s Benjamin Cole (not Cohen). We´ve had several e-mail exchanges. He´s not an economist but has wholeheartedly embraced “MM principles”!
    In the end Williamson is to people like Plosser and Kocherlakota – fellow RBCers, what DeLong and Thoma are to Krugman – unabashed defenders of their “hero”!
    Finally I managed to get a rejection to a comment (with link) I placed on Krugman´s blog! Maybe I “piqued” him?


  2. 2 David Glasner October 5, 2011 at 10:03 pm

    Marcus, Thanks for catching that one for me. I corrected it. And, of course, my apologies to Benjamin.


  3. 3 Thomas M Cole (@TMCole31) October 5, 2011 at 10:13 pm

    On the contrary, the Fed has accomplished it’s several goals; one, to put the US in a lower economic position in the world, and two, Increase US debt to the point, where class warfare nearly breaks out, and the lower classes decide to force tax raises on the earning classes, to pay for government programs the lower classes need, because the upper classes have off shored US jobs.

    Meanwhile, the nation was further indebted, to bail out the financial industry after it pilfered the nation, again. All of these bailout and government programs create debt and interest to the Fed. They Fed has this method down to a science. They are achieving their goals.


  4. 4 Luis H Arroyo October 6, 2011 at 1:32 am

    Very good, David. How lucky you are you Americans, discussing issues that are on the books, and not entanglements as the euro and its rescue!


  5. 5 Lars Christensen October 6, 2011 at 3:22 am

    David, I continue to think it is weird that Williamson use the term New Monetarism and the same time consistently argues that money have no real or nominal impact.

    And if the Fed can not create inflation in the present situation there is really no reason for the US government to collect taxes. The Fed could fund all public expenditure by Fed printing money and there would not be an inflationary problem.


  6. 6 David Pearson October 6, 2011 at 11:40 am

    I’m not sure you have correctly characterized Williamson’s views on the Fed’s ability to influence inflation. He argues the Fed can raise the price level by lowering the IOR below zero; however, he also believes that the Fed does not have the legal authority to do so. I have not seen this last specific point refuted. Does the 2006 IOR enabling legislation allow the Fed to charge interest on reserves?


  7. 7 Benjamin Cole October 6, 2011 at 12:19 pm

    Well, I am red-faced in embarrassment at this recognition, and I thank David Glasner for noticing my exchange. Oddly enough, my father’s family were Cohens until the late 1930s. Maybe, at long last, I will change the name back.

    One minor clarification: John Taylor in 2006 produced a paper in which he gushes about the positive effects of a QE program then recently undertaken by Japan. He pronounces Japan’s QE program a success–it was Milton Friedman, about a decade earlier, who only advised such a program.

    Here is the Taylor paper, on his website: “Lessons from the Recovery from the ‘Lost Decade’ in Japan: The Case of the Great Intervention and Money Injection,” Background paper for the International Conference of the Economic and Social Research Institute Cabinet Office, Government of Japan, September 2006 pdf

    Imagine—Taylor calling a “Great Intervention” and “Money Injection” a rip-roaring success!!!! But there it is, in black and white (or pixels).

    So, in Taylor’s view, QE was tried and worked in Japan—Taylor’s paper was not a proposal, but a review of events. The problem was that then the BOJ went back to sleep.

    I was disappointed with Stephen Williamson on many fronts, including his casual dismissal of another serious economist’s (Taylor’s) efforts.

    Williamson’s stance that we cannot stimulate the economy as it might lead to inflation, somewhere down the road, struck me as callous to the unemployed, investors and everybody.

    So, first we worship absolute price stability, and second we worship price stability, and third maybe we take some risks to get the economy going? This is the sort of harrumph I would expect from an old man sitting a high pile of bonds.

    When did price stability become a religion? Why this sickly obsession with inflation rates?

    The USA has flourished in many periods of moderate inflation. Yes, inflation is bad when it gets above the moderate stage—but can we take a little heat to get people working again?

    Rather than tackle serious policy alternatives, Williamson simply rammed his head into the sand, and declared monetary expansion can only cause inflation.

    Lastly, I was shocked that Williamson tried to compare the 1970-80s inflation to today’s inflation of sub-2 percent. If we have to put inflation-fighting first now, just exactly when would we like to concentrate on growth instead? Do we have to copy Japan?

    And seriously, he never heard of George Gilder?

    All, in all, I find the market monetarists have the most-sound arguments, and also the best chance for success.

    Again, my thanks to David Glasner, who tolerates my perhaps amateurish enthusiasm. But, i would rather be roughly right than exactly wrong.

    I am confident the Market Monetarists, whatever our flaws, are roughly right, and that will be good enough for the economy and markets, if we can get our views to prevail.


  8. 8 Dustin October 6, 2011 at 3:14 pm

    Benjamin, I share your “amateurish enthusiasm”. I’m just the quiet shy type that doesn’t say much. I enjoy your comments.

    The Market Monetarists, the Glasners, Woolseys, Sumners, Beckworths, and everybody else, make the most sense to me.

    People like Willamson make no sense to me. People like Murphy, who had his usual tripe in today’s, make even less sense to me.


  9. 9 Morgan Warstler (@morganwarstler) October 6, 2011 at 6:49 pm

    Listen to Fisher’s interview on Bloomberg. It’s a hour long.

    I think he perfectly sums this up.

    he says we “could” print money anytime we need to.

    he also says we don’t need to right now, because the economy IS moving forward, just slowly.

    1. there is liquidity, just not being used.
    2. the issue is fiscal
    3. 1974 was FAR WORSE than today, he’s more concerned about not having stagflation, than he is about stagnation.

    I think this is basic bias you have that screws you up.

    to people who OWN STUFF inflation is NOT ACCEPTABLE.

    And since it is not acceptable, everyone is able to say monetary has shot its wad.

    Now I give you a better response, I say – ok, IF Obama is out of office, THEN we can let the fed print money.

    So I give you a magic card to play against the shot its wad crowd.

    I’m the happy middle!


  10. 10 Benjamin Cole October 6, 2011 at 8:08 pm

    Morgan: I own a 6k sf factory in Los Angeles. I dearly want this asset to appreciate, and I want successful tenants to rent space.

    I will embrace 5 percent inflation with 5 percent real growth.

    What assets do you own that would want you to have no inflation? Not real estate not equities. Only bonds.


  11. 11 Benjamin Cole October 7, 2011 at 11:24 am

    Thanks Dustin–being shy is fine, but consider sending e-mails, letters to publications, blogs, even Fed officials. The more buzz around Market Monetarism, the better. Put supportive comments, even brief ones, on market monetarism blogs. These guys need positive feedback.


  12. 12 Barry October 8, 2011 at 6:38 am

    Benjamin, one of the realities brought home hard in this crisis is that Wall St totally trumps Main St. They no longer care at all about the US economy, save that it doesn’t collapse to the point where it’d take Wall St down.


  13. 13 Will October 8, 2011 at 4:52 pm

    I find Williamson perplexing.

    His nihilism — I think this is the appropriate word — regarding policy effects (“printing money will have no effect! changing spending or tax rates will have no effect!”) reminds me of Zeno’s Paradoxes “proving” motion impossible.

    His argument that economic theory in its current state is a market outcome, and thus the best of all possible economic theories, remind me of Thomas Aquinas’s “proofs” of the existence of God.

    His assertion that economists’ lack of agreement on questions central to the macroeconomy is a sign of the profession’s *health* is… interesting.

    To quote Mark Twain: “I have no heart to write more. I never felt so about anything before.”


  14. 14 David Glasner October 8, 2011 at 9:48 pm

    Thomas, You are entitled to your opinion about what the goals of the Fed are; Morgan Warstler, a frequent commenter on this and other blogs, weighs in below on his view about what the Fed is trying to accomplish. I personally assume that they are acting in good faith and are trying to discharge their statutory duties to the best of their (unfortunately imperfect) understanding of the state of the economy and how monetary policy can affect it for good or ill. Silly me! But that’s my view and I’m sticking to it.

    Luis, What a country!

    Lars, Obviously I take a view very different from Williamson’s, but in his defense I think that it is possible to defend his Monetarist credentials. Although Friedman argued that bad monetary policy could have disastrous effects, his dominant message was that all the Fed needed to do was keep the money supply growing at a 3% rate, and everything else would take care of itself. I think that Williamson is seeking a similarly simple rule for monetary policy that would avoid the really bad outcomes that Friedman wanted to avoid, and let everything else take care of itself. At a certain point, Friedman realized that the 3% rule might not be the best rule to follow and that is why you can cite his for advocacy of a more aggressive monetary policy for Japan. I think that Williamson is in the spirit of the earlier Friedman. See also my response below to David Pearson.

    David, You are probably right that I did not take into account Williamson’s views on paying interest on reserves. I have not been following his blog that closely, and although I may have seen some discussion by him of interest on reserves, I did not connect with his responses to Benjamin, which certainly make no explicit reference to IOR. At any rate, even if his position on the impotence of the Fed is premised on the level of interest now being paid by the Fed, I don’t think that the Fed would be legally barred from reducing IOR to zero. It might be barred from charging an interest penalty on excess reserves, but if current legislation has the (presumably) unintended consequence of making the Fed impotent, shouldn’t it be a top priority to amend the legislation to enable the Fed to fulfill its statutory mandate? I also am puzzled by Williamson’s arguments about the Phillips curve which seem to imply that there is no distinction between the short-run and the long run and that the economy is always on the long-run Phillips Curve.

    Benjamin, I don’t always agree with everything you say (you would be a lot less fun if I did), but you have a really good sense of what is important and you obviously read a lot are well informed, so we are lucky to have you as a regular commenter on this blog. So don’t let the embarrassment stop you. I’ll let you sort out the last name, Either one is fine with me.

    Dustin, Glad that you think I make sense. But I think it is actually important to try to understand how people we disagree with look at things. Sometimes it is a little bit too easy to dismiss the other guy and assume that he is just stupid, or silly, or daft. Sometimes I subject stuff I disagree with to some pretty stiff criticism but when I do I at least try to identify something specific and point out what strikes me as problematic. Just saying that the other doesn’t make sense doesn’t really allow for any discussion that could clarify the underlying source of disagreement. So if you want to make comments, a pretty safe way to do so is to ask questions to try to get someone to explain why he takes the position that he does that doesn’t seem to make sense.

    Morgan, Welcome back, it’s been a while. Sorry, but I don’t think that 1974 was worse. Were you alive in 1974?

    Barry, I actually don’t know what Wall St. or Main St. means. Those are just words, like ruling class or working class that have emotive content, but no real substance to them, as far as I can tell.

    Will, Interesting comment. David Laidler has accused Austrian business cycle theory of being guilty of policy nihilism. Williamson would probably not be flattered by being likened to Austrian business cycle theory, but I see a certain similarity in their policy views.


  15. 15 David Pearson October 9, 2011 at 10:06 am


    On the negative IOR, I think chances for Congressional passage would be quite slim at this point. Perhaps Williamson is just recognizing reality.


  16. 16 David Glasner October 9, 2011 at 6:33 pm

    David, Perhaps. But why do you think that Congress is so eager to ensure that banks get paid interest on reserves? If Bernanke said that he needed authority to charge banks a penalty rate for holding excess reserves, why do you suppose that Congress would rush to defend the banks? I am not asking these questions rhetorically. I don’t get it.


  17. 17 David Pearson October 9, 2011 at 9:07 pm

    In today’s climate, the House GOP would simply obstruct any legislation that they see as increasing the scope of Fed powers.


  18. 18 David Pearson October 10, 2011 at 11:03 am


    FWIW, here’s the relevant section from the 2006 “Financial Services Regulatory Relief Act”:


    (a) In General- Section 19(b) of the Federal Reserve Act (12 U.S.C. 461(b)) is amended by adding at the end the following:


    (A) IN GENERAL- Balances maintained at a Federal Reserve bank by or on behalf of a depository institution may receive earnings to be paid by the Federal Reserve bank at least once each calendar quarter, at a rate or rates not to exceed the general level of short-term interest rates.


  19. 19 David Glasner October 10, 2011 at 11:09 am

    David, Thanks, but I am flabbergasted.

    Balances maintained at a Federal Reserve bank by or on behalf of a depository institution may receive earnings to be paid by the Federal Reserve bank at least once each calendar quarter, at a rate or rates not to exceed the general level of short-term interest rates

    The Fed is paying 0.25% IOR and the current rate on a 3-month Treasury is 0.01%. If I am reading this correctly, the Fed is now (and for the past 2 years) is clearly in violation of the statute authorizing IOR. Can you explain this to me?


  20. 20 David Pearson October 10, 2011 at 12:42 pm

    I wondered that myself! I have no explanation, other than perhaps Congress forgot they put that in there.


  1. 1 Economist's View: links for 2011-10-06 Trackback on October 6, 2011 at 12:07 am
  2. 2 Is the Fed Breaking the Law? « Uneasy Money Trackback on October 10, 2011 at 8:19 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.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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