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Richard

"Academics make a lot of claims, certainly. That said, you have your pick of any capitalist economy in the world. Which capitalist economy has stopped the boom/bust cycle? Which capitalist government and/or head of state has claimed it could stop the boom/bust cycle? Take your time."

None but then none of them have implemented the sort of measures that have been suggested.

Jonathan Powell

It was the market that moved the Fed Funds Rate, as it always moves the Fed Funds Rate. As Mankiw points out, the intended rate was still 5.25%. Mankiw just can't decide if the Fed is intentionally or unintentionally sloppy in allowing the market to move rates to this degree. In other words, the Fed failed to engage in battle with the market (as it usually does), and the market pushed rates to the rate it thought appropriate.

That doesn't make sense. The situation at the time was one of tighter credit. In the absence of Fed intervention, the market response would be higher interest rates (i.e. to ration credit and reflect a higher risk premium) which is exactly what happened to the LIBOR rate, as well as to mortgate and savings rates here in the UK. So, if the Fed missed it's target as a result of the market it would be on the other side (it would have overshot). The fact that it undershot by about 0.25% combined with the later announced rate cut of 0.5% strongly suggests that the Fed was trying to ease the credit situation without panicking the markets by holding an emergency meeting. Thus the intended rate was 5% whereas the official rate was still 5.25%

The market determines inflation expectations based on, among other things, CPI, capacity utilization, and unemployment levels. If these and other indicators point to rising inflation, the Fed cannot change those expectations by jawboning the market.

Inflation is always and everywhere a monetary phenomenon, and the Fed determines the supply of money. Moreover, the Fed can affect the real economy by changing short term real interest rates, to offset other factors where appropriate. Thus the Fed determines the rate of inflation and the market must therefore base expectations on the Fed's policies. In the short run, inflation expectations are determined by the Fed's past actions, and are thus fixed. In the longer term, they depend on the Fed's present and future actions.

the Fed can easily fail in controlling inflation expectations. (See: 1970s)

I didn't say the Fed controlled expectations independent of its policies, I said expectations were determined by the Fed, because the Fed determines the actual rate of inflation. In the 1970s, expectations of inflation increased because the Fed was pursuing inflationary policies.

Indeed, it was a unique event. It's not unreasonable to remove it as an outlier given its uniqueness. Just so, it's not reasonable for you to judge the Fed on this single event, which you appear to be doing.

I'm not judging the Fed only on the Depression, but by your own standards the Fed is good insofar as it prevents banking crises, reduces volatility and shortens recessions. Don't you think it's relevant that it presided over the worst incidence of economic volatility in American History and one of the longest lasting recessions (and let's face it, even after 1933 the economy was still in the toilet), and either failed to prevent or actually caused one of the worst banking crises?

How do you explain the Panic of 1873 and the Panic of 1893? Besides the Great Depression, which post-Fed recession can compare to these two recessions in severity?

My data shows positive growth from 1870 to 1888, so the "recession" of 1873 was no worse than that of 1991, in which output declined. As for 1893, the recession of 1920-21 was much worse and those in 1974-75 and 1980-82 were comparable.

Also, there has been research by Christina Romer and others which show that the pre-1929 data on GDP are unreliable and tend to overstate the degree of economic volatility, so one could argue that most of the Fed's rule has been characterized by higher volatility and that only now the Fed has learned enough not to be a source of volatility are we back to the pre-Fed level of volatility.

So ignoring Paul Volcker's actions, why did inflation suddenly subside by 1983? The pro-Fed argument is easy: raising the Fed Funds Rate to a draconian 20% crushed the economy and thus the factors driving inflation.

That isn't a "pro-Fed" argument--it illustrates what's wrong with Fed, namely that it let inflation get out of control, had zero credibility and thus had to cause a recession to get inflation back under control. Since it's mandate is keep keep inflation low and prevent recessions, this shows how useless it was until that time.

I agree that the Fed's policies have improved over time (particularly under Greenspan) and thus the decline in volatility may in part reflect this improvement. But this just means the Fed is doing less harm, not that it does any good.

Tony Emmerson

Given that Mr Burns works in the Whips Office are we to assume that this is officially approved policy? If so it will get a bit sticky having a "special relationship" should Miss Bill lose. If not then they really should set some guards to guard the guards before they all run around having stupid ideas in public.

JF

Jonathan Powell,

That doesn't make sense. The situation at the time was one of tighter credit.

[snip]

the market response would be higher interest rates (i.e. to ration credit and reflect a higher risk premium) which is exactly what happened to the LIBOR rate, as well as to mortgate and savings rates here in the UK.

So the market tightened credit, we're agreed on this. We keep coming back to this issue, that the market determines credit availability and price, not the Fed.

The fact that it undershot by about 0.25% combined with the later announced rate cut of 0.5% strongly suggests that the Fed was trying to ease the credit situation

Why do you assume this was an intentional move on the part of the Fed?

Inflation is always and everywhere a monetary phenomenon

Yes, and it's important to understand why this is so. What is the effect of providing excess liquidity to the market? A greater willingness of financial institutions to lend. If excess liquidity is provided but the financial institutions don't lend, as was the case in Japan, then inflation won't occur. This illustrates my point exactly, that the Fed provides liquidity and credit to the financial echelon, not to the wider economy. It usually works out that the financial echelon then spreads that liquidity to business, but not always.

the Fed determines the actual rate of inflation.

How does the Fed determine the actual rate of inflation? I'm not sure you're stating this precisely. The Fed has influence, but not control, over the real interest rate, and it thus indirectly has influence over inflation expectations, but I am not sure it's possible to state that the Fed determines the actual rate of inflation.

by your own standards the Fed is good insofar as it prevents banking crises, reduces volatility and shortens recessions.

Yes, this is its mandate, and I think it has done more good on these metrics than harm.

Don't you think it's relevant that it presided over the worst incidence of economic volatility in American History and one of the longest lasting recessions (and let's face it, even after 1933 the economy was still in the toilet), and either failed to prevent or actually caused one of the worst banking crises?

Two points here. First, the perfect is the enemy of the good. The Fed was approximately 15 years old at that point and had never been tested on this level before--it was its first test, and it had no precedent to look towards for guidance, and it failed. But as I pointed out, in recent decades, it was faced with crises, and with decades of experience and precedent under its belt, it succeeded. This is normal for any entity, to improve with experience.

Second point: the failure of the Fed in the Great Depression seems inexplicable, but the failure may not have resulted in the Great Depression without the significant context of Smoot-Hawley and the absolute lack of securities laws. Don't forget that until Glass-Steagall, bank regulation was extremely ineffective. The Fed didn't have the tools to carry out its mandate because banks were involved in so many non-banking sectors which it did not have authority to regulate. This cannot be blamed on the Fed.

My data shows positive growth from 1870 to 1888

Fair enough. It was imprecise of me to call them recessions, I should have called them shocks due to the effect on unemployment.

there has been research by Christina Romer and others which show that the pre-1929 data on GDP are unreliable

I am not familiar with that research, but I'll give you the benefit of the doubt. Is this now the consensus view?

it illustrates what's wrong with Fed, namely that it let inflation get out of control, had zero credibility and thus had to cause a recession to get inflation back under control. Since it's mandate is keep keep inflation low and prevent recessions, this shows how useless it was until that time.

Sure, you could argue this if you believe that the economic shocks of the 1970s and the incompetent fiscal policies of the US government at that time played absolutely no part in stagflation. Do you believe that?

I agree that the Fed's policies have improved over time (particularly under Greenspan) and thus the decline in volatility may in part reflect this improvement. But this just means the Fed is doing less harm, not that it does any good.

Perhaps, or perhaps it's improved to the point where it's actually useful. Or perhaps one could argue, as I have above, that the Fed already plays a token role and the market has been largely responsible for the volatility we've seen, anyway. In either case, abolishing the Fed wouldn't necessarily help the economy in a tangible way.

This has been a very interesting conversation, but I'm afraid it's consuming a lot of time for both of us, so I'll let you have the last word and we can leave it at that. Thanks for taking on the opposite side of the debate with good arguments.

Jonathan Powell

How does the Fed determine the actual rate of inflation? I'm not sure you're stating this precisely. The Fed has influence, but not control, over the real interest rate, and it thus indirectly has influence over inflation expectations, but I am not sure it's possible to state that the Fed determines the actual rate of inflation.

The Fed can influence inflation in the short-run in the way you describe, but in the long-run inflation is determined according to the quantity of money (e.g., seeRobert Lucas Jr.'s Nobel lecture--particularly fig. 1). The Fed is responsible for the rate of money growth, hence it determines the rate of inflation. Even if it focuses on other variables day to day, such as interest rates or the exchange rate, its actions will imply changes in the money supply which ultimately determine the rate of inflation.

the failure of the Fed in the Great Depression seems inexplicable, but the failure may not have resulted in the Great Depression without the significant context of Smoot-Hawley and the absolute lack of securities laws.

Whether or not the Fed actually caused the Depression is of secondary importance (I'm not sure that it did, but M. Friedman and B. Bernanke are among the many who do find the Fed culpable) what matters is that having created the Fed to prevent such crises it ended up presiding over the worst ever.

Fair enough. It was imprecise of me to call them recessions, I should have called them shocks due to the effect on unemployment.

in fairness, the episode in 1893 certainly was a recession, and I made a slight error looking at 1873 because while GDP did not decline, I find that GDP per capita did fall slightly in 1873. Also, it turns out the data I was using were actually based on Christina Romer's estimates--on the old (inaccurate) data there was a large recession in 1873-1874.

I am not familiar with that research, but I'll give you the benefit of the doubt. Is this now the consensus view?

I think it's the predominant view--the articles date back to the late 80s and have yet to be disproved.

Sure, you could argue this if you believe that the economic shocks of the 1970s and the incompetent fiscal policies of the US government at that time played absolutely no part in stagflation. Do you believe that?

Large deficits tend to lead to higher inflation unless the central bank is scrupulously independent, and the oil shocks made it harder to fight inflation. But ultimately, whilst the "stag-" was the result of taxes and oil shocks, the "flation" was the responsibility of the Fed.

Perhaps, or perhaps it's improved to the point where it's actually useful. Or perhaps one could argue, as I have above, that the Fed already plays a token role and the market has been largely responsible for the volatility we've seen, anyway. In either case, abolishing the Fed wouldn't necessarily help the economy in a tangible way.

You might be right, but surely it's a debate worth having? And remember, your argument that the Fed is useful completely ignores inflation. It may be true that the Fed has developed to the point where it helps to avoid crises etc, but the benefits of this may be outweighed by the permanently higher inflation it generates.

Christopher

JF, so sorry for the delay. Calling me a liberal is far too generous, being a Republican since the age of 13. However to answer your question it is her ability to mend the fences with former foes, work together with Bill Frist on the medical technology bill and her extremely well run campaign make her miles ahead of a god forbid, Obama presidency.

JF

Christopher,

I can't be sure that the vast majority of HRC's rivals will be willing to compromise with her, based on the Clinton vs. Congress precedent of the 1990s. With all due respect, working on a medical technology bill and running a cautious, and even slightly timid campaign doesn't inspire much confidence in me.

That's why I'm confused as to how you could choose HRC over Romney despite your claims to being a Republican. If you're impressed by work on a medical technology bill, I'm surprised you're not more taken with Romney's healthcare reform in Massachusetts. If you're impressed with HRC's supposed skill in running a campaign, I'm surprised you're not more taken with Romney's equally well-run campaign combined with his superlative experience creating and running Bain Capital, turning around companies and the Winter Olympics alike, and governing as a moderate conservative in the most left-wing state in the country.

It's this preference for HRC over Romney which led me to believe that you were a liberal, and I'm still not sure I'm convinced you're a Republican based on your arguments for voting for HRC over Romney.

That said, I would certainly vote for HRC over Fred "Rorschach" Thompson, who I believe would be a highly dangerous and not particularly conservative president. If that makes me a liberal, so be it. But there can be no comparison between the void of Thompson's life and the accomplishments of Romney.

Jonathan Powell

a god forbid, Obama presidency.

What's so bad about Obama? Sure, he's a liberal, but to me his personal qualities put him far ahead of the cynical opportunism of Hillary (or Romney), and he seems more moderate than John Edwards, for example. Personally I quite like the cut of his jib, whereas I wouldn't trust Hillary as far as I could throw her. I suspect she would embody all of President Bush's bad qualities and none of his good ones.

JF

Jonathan Powell,

Obama is an empty suit. He hasn't accomplished anything of note in his life, he's had the briefest of experience on the national stage, and he doesn't seem to believe in anything except for his own "audacity." I'm even-handed on this, as I distrust and dislike Fred Thompson for exactly the same reason.

Obama seems like a nice fellow. But that's just about all he seems. HRC seems more competent and tough (important for a strong foreign policy), and at the same time, she is polarizing enough to revitalize the unity on the Right, which makes her a much more compelling candidate from a conservative's point of view.

Jonathan Powell

HRC seems more competent and tough

Tough certainly, but I don't buy into her being competent. Most of her "experience" comes down to being Bill Clinton's wife--during which time she failed in forays into policy e.g., her healthcare plan--other than that I don't think she has achieved much more than Obama or Thompson.

JF

Jonathan Powell,

Clinton has shown she's more competent in that she voted to support the Iraq war based on the data available at the time, and has since refused to apologize for voting for the Iraq war based on the data available at the time. That's a huge plus in my book, even if she is a Leftist.

Clinton has shown she's more competent in that she doesn't endlessly rail against the Iraq war and then hypocritically call for the bombing of Pakistan, which has been (however shaky) an ally of the US for decades.

Clinton has shown she's more competent by not choosing the closet Nazi and capitulator-to-terrorism-in-chief Zbigniew Brzezinski as high-level foreign policy advisor.

I'm not saying she's more competent than the Republicans, far from it. But she's far more competent than Obama.

Christopher

Trust me if you go to my blog you will realize that I'm a liberal Republican or as you in England call it, a Tory. I would go along with JF's thoughts on Obama but as a person who met Romney and talked with him, albeit for just a few minutes, I found him likable. But his flip-flopping, disloyalty and just his color by numbers campaign make him the person I like the least.

Justin Hinchcliffe

People like myself - Cameroonies (I assume Simon Burns is one, too?) - should not think about supporting the Democrats until -and if - Rudy Giuliani and John McCain are knocked out. I would not vote for nutty Bible-bashers like Romney or Huckabee. Only then would Hilary Clinton become attractive.

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