Out of Control Policy Blog

Bernanke’s Biggest Cheerleader Advocates Further Fed Action

Any doubt as to who among the FOMC members was advocating more quantitative easing detailed in the latest Fed meeting minutes can now be answered. Perennial FOMC dove, and Federal Reserve Bank of Chicago President, Charles Evans, gave a speech today at the European Economics and Financial Centre in which he pushed strongly for the Fed to “add very significant amounts of policy accommodation” to bring down unemployment. He went so far as to liken the need to someone “acting as if their hair was on fire.”

Addressing the concern that further policy accommodation risks overshooting inflation, he had this to say:

Suppose we faced a very different economic environment: Imagine that inflation was running at 5% against our inflation objective of 2%. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.

In the United States, the Federal Reserve Act charges us with maintaining monetary and financial conditions that support maximum employment and price stability. This is referred to as the Fed’s dual mandate and it has the force of law behind it.

The most reasonable interpretation of our maximum employment objective is an unemployment rate near its natural rate, and a fairly conservative estimate of that natural rate is 6%. So, when unemployment stands at 9%, we’re missing on our employment mandate by 3 full percentage points. That’s just as bad as 5% inflation versus a 2% target. So, if 5% inflation would have our hair on fire, so should 9% unemployment.

You can count Mr. Evans in the “yay” column for the FOMC’s next vote on QE3 later this month on September 20th. Judging by what he said today, you can also count him in for QE4 and QE-indefinite as well. Evans advocates that Fed policy grow the economy and push employment at seemingly any cost, namely that of inflation. Inflation should be the single greatest concern of any central banker, but to Charles Evans, it is a mere formality.

He mentions later in his speech that temporary periods of inflation should be ignored by the Fed and that “reacting too strongly to short-run influences simply adds noise to the policy making process.” He also states that “there are significant lags before policy actions influence inflation.” With that in mind he comes to this conclusion:

So, by this appropriate standard I think inflation likely will be below our goal of 2%. And of course, unemployment is much above its natural rate. Thus, at the moment, there is little conflict between our two goals. Both suggest at least some additional monetary policy accommodation would be helpful. However, given how truly badly we are doing in meeting our employment mandate, I argue that the Fed should seriously consider actions that would add very significant amounts of policy accommodation. Such further policy accommodation does increase the risk that inflation could rise temporarily above our long-term goal of 2%.

But I do not think that a temporary period of inflation above 2% is something to regard with horror. I do not see our 2% goal as a cap on inflation. Rather, it is a goal for the average rate of inflation over some period of time. To average 2%, inflation could be above 2% in some periods and below 2% in others. If a 2% goal was meant to be a cap on inflation, then policy would result in inflation averaging below 2% over time. I do not think this would be a good implementation of a 2% goal.

The reality is that the Fed, and especially Mr. Evans, has no idea where inflation is going in the near-term, let alone what the long-term ramifications will be if Evans’ constant easing logic is applied. Plus, Evans even stated that there are “significant lags” before Fed policy influences inflation. Well, CPI is currently at 3.6 and PPI is approaching dangerous highs at 7.2. QE2 ended in June, and by his own words that means the policy will push inflation even further beyond its 2% target, most likely to more than double.

Also, is he even considering the economic headwinds that inflation causes in the short-term? Higher food and energy costs alone can stall economic growth, and if Fed easing isn’t contained, temporary inflation can remain permanent, while not at all helping the employment situation. It’s time the FOMC, and especially Charles Evans, understand that more of the same is not what this economy needs.

James Groth is Research Associate


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