Minneapolis Fed president Narayana Kocherlakota’s recent speech has unleashed a storm of criticism. The offending remark: “To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation.”
The punditocracy has attacked this statement, and its implications, charging that the underlying economic logic is “unsupportable,” “bizarre” and just plain “wrong,” to cite but three dismal scientists.
Perhaps the bigger story is that Kocherlakota is suggesting that the Fed’s current monetary policy is actually promoting deflation rather than trying to alleviate it. To be fair, there are some economists, such as Scott Sumner, who argue that the Fed isn’t doing enough to provide monetary stimulus. Yes, nominal rates are just about zero, but the Fed can and should do more to minimize the risk of deflation. In other words, the Fed has moved in the right direction, but it hasn’t gone far enough. But that’s a completely different argument than Kocherlakota’s point, which is that the current level of low interest rates will promote deflation. If that’s true, then Bernanke and company are engaging in the biggest monetary mistake since the Great Depression.
In fact, the Fed is doing what it should be doing. It’s fair to argue that it should be doing more with quantitative easing, even though the ammo is “running low.” Kocherlakota’s argument, however, is radically different. And maybe I’m going overboard, but taking Kocherlakota’s assertion at face value all but indicts the Fed’s current stance as reckless (assuming you think deflation would be a bad thing).
Why would the Minneapolis Fed president make such an assertion? Robert Waldmann at the Angry Bear has a theory:
My honest opinion is that he wants to argue for a higher target federal funds rate and he’s decided to present every argument that supports that proposal even if it is half baked, unbaked or negabaked (frozen ?).
Meantime, don’t forget that Kocherlakota is an alternate member of the FOMC. In other words, Kocherlakota’s thoughts are more than just academic ramblings.
Update: Sumner’s post on the Kocherlakota affair offers a timely observation that highlights the macroeconomic stakes and the related challenge for the situation du jour:
…money is a specialized field and I just don’t have much confidence that our decision-makers or the media people who shape the discussion are on top of this issue. We need people who are “fussy” about definitions. Who understand why monetary policy does seem like “magic” to the uninitiated. Every single FOMC voter should have not only a PhD in economics but 20 years of research on monetary policy, monetary theory, and monetary history. Not one, not two, all three areas. It’s that important. (For instance, does Kocherlakota know that the Fed tried Rajan’s exact proposal in 1931, they raised rates by 200 basis points when the economy was weak and rates were very low?)