Markets Insight
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April 17, 2012 1:51 pm
Fed’s doves lose appetite for easing
The Federal Open Market Committee of the Federal Reserve is no longer expected to announce a further round of monetary easing when it concludes its two day meeting in Washington on Wednesday. The fact that the hawks have lost enthusiasm for more quantitative easing is scarcely surprising, given the fall in unemployment, and the stickiness of inflation.
But until very recently the hawks have not been in control of the committee. What is more surprising is that the powerful group of doves which includes Ben Bernanke, Bill Dudley and Janet Yellen, and which normally has disproportionate weight on the FOMC, has also taken QE off the agenda.
The doves seem to have changed their policy conclusion without changing their basic view of the economy. In recent speeches, they have all repeated that the current unemployment rate of 8.2 per cent will remain two to three percentage points above the level consistent with the Fed’s mandate for some time. This judgment depends on their interpretation of the work of three distinguished economists: Arthur Okun (1928-80), William Beveridge (1879-1963) and John Taylor (who is still very much alive and kicking at Stanford University).
First, Okun’s Law. This describes the relationship between real gross domestic product growth and unemployment, which is reasonably stable over long periods. This stability broke down last year, with unemployment falling much more than it “should” have done, given the reported growth of real GDP.
One possible, hawkish, interpretation could be that real GDP growth has been underestimated. But the doves argue that the unexpected drop in unemployment was just a reversal of the abnormally large shake-out of labour by employers in 2009. If this is correct, then unemployment will stop falling soon, unless GDP growth picks up significantly.
Second, the Beveridge Curve. This describes the normally inverse relationship between unemployment and unfilled vacancies in the labour market. Higher vacancies should imply lower unemployment but in the past three years there has been a much larger rise in vacancies than would have been implied by the level of unemployment. The hawkish interpretation of this rise in unfilled jobs is that there is a mismatch between the skills and location of the unemployed, compared with the nature of the new jobs being created in the economy. If so, structural unemployment has risen, leaving less scope for monetary accommodation.
But the doves argue that this is not the case, saying instead that the Beveridge Curve has broken down for temporary reasons. These include the extension in the maximum duration of unemployment benefits and delays between the rise in vacancies and the subsequent decline in unemployment. For these reasons, the doves conclude that the level of structural unemployment has not risen.
Third, the Taylor Rule. This describes the “appropriate” path for short term interest rates, given the behaviour of inflation and unemployment, which are the subjects of the Fed’s twin mandates.
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According to Janet Yellen’s speech on April 11 in New York, John Taylor proposed two versions of his famous “rule”, one in 1993 and the second in 1999. The latter includes a larger role for unemployment in determining the appropriate short rate, while the former gives a bigger role to inflation.
Ms Yellen prefers the 1999 rule, which has more dovish implications when unemployment is high, as it is today. She calculates that, on this version of the rule, short rates should stay at zero until the end of 2014, as implied in the Fed’s latest policy announcements. She also reckons that monetary policy has been too tight since 2008, because quantitative easing has not been powerful enough to allow for the fact that short rates could not be reduced below zero. In compensation for this, she argues that monetary policy should be kept easier for longer than the 1999 Taylor Rule implies.
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John Taylor has denied Ms Yellen’s claim that he ever proposed the 1999 version of his rule, saying it was an idea that emerged from the Fed itself. And anyway he strongly prefers the 1993 version, which has the hawkish implication that short rates should already be positive and should certainly be rising by 2013. But the doves see things differently.
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Given the doves’ determination to interpret these key issues in the direction of highly accommodative policy, it is hard to explain why they have shelved their desire to introduce another bout of QE. To judge from their underlying economic rationale, they are probably just biding their time while inflation is somewhat above target, and will seek to bring easing back on the agenda as soon as they can.
.
Gavyn Davies is co-founder of Fulcrum Asset Management and Prisma Capital Partners, and writes a regular blog on macroeconomics at FT.com
.
But until very recently the hawks have not been in control of the committee. What is more surprising is that the powerful group of doves which includes Ben Bernanke, Bill Dudley and Janet Yellen, and which normally has disproportionate weight on the FOMC, has also taken QE off the agenda.
So is that the end of QE? Not necessarily.
The doves seem to have changed their policy conclusion without changing their basic view of the economy. In recent speeches, they have all repeated that the current unemployment rate of 8.2 per cent will remain two to three percentage points above the level consistent with the Fed’s mandate for some time. This judgment depends on their interpretation of the work of three distinguished economists: Arthur Okun (1928-80), William Beveridge (1879-1963) and John Taylor (who is still very much alive and kicking at Stanford University).
First, Okun’s Law. This describes the relationship between real gross domestic product growth and unemployment, which is reasonably stable over long periods. This stability broke down last year, with unemployment falling much more than it “should” have done, given the reported growth of real GDP.
One possible, hawkish, interpretation could be that real GDP growth has been underestimated. But the doves argue that the unexpected drop in unemployment was just a reversal of the abnormally large shake-out of labour by employers in 2009. If this is correct, then unemployment will stop falling soon, unless GDP growth picks up significantly.
Second, the Beveridge Curve. This describes the normally inverse relationship between unemployment and unfilled vacancies in the labour market. Higher vacancies should imply lower unemployment but in the past three years there has been a much larger rise in vacancies than would have been implied by the level of unemployment. The hawkish interpretation of this rise in unfilled jobs is that there is a mismatch between the skills and location of the unemployed, compared with the nature of the new jobs being created in the economy. If so, structural unemployment has risen, leaving less scope for monetary accommodation.
But the doves argue that this is not the case, saying instead that the Beveridge Curve has broken down for temporary reasons. These include the extension in the maximum duration of unemployment benefits and delays between the rise in vacancies and the subsequent decline in unemployment. For these reasons, the doves conclude that the level of structural unemployment has not risen.
Third, the Taylor Rule. This describes the “appropriate” path for short term interest rates, given the behaviour of inflation and unemployment, which are the subjects of the Fed’s twin mandates.
.
According to Janet Yellen’s speech on April 11 in New York, John Taylor proposed two versions of his famous “rule”, one in 1993 and the second in 1999. The latter includes a larger role for unemployment in determining the appropriate short rate, while the former gives a bigger role to inflation.
Ms Yellen prefers the 1999 rule, which has more dovish implications when unemployment is high, as it is today. She calculates that, on this version of the rule, short rates should stay at zero until the end of 2014, as implied in the Fed’s latest policy announcements. She also reckons that monetary policy has been too tight since 2008, because quantitative easing has not been powerful enough to allow for the fact that short rates could not be reduced below zero. In compensation for this, she argues that monetary policy should be kept easier for longer than the 1999 Taylor Rule implies.
.
John Taylor has denied Ms Yellen’s claim that he ever proposed the 1999 version of his rule, saying it was an idea that emerged from the Fed itself. And anyway he strongly prefers the 1993 version, which has the hawkish implication that short rates should already be positive and should certainly be rising by 2013. But the doves see things differently.
.
Given the doves’ determination to interpret these key issues in the direction of highly accommodative policy, it is hard to explain why they have shelved their desire to introduce another bout of QE. To judge from their underlying economic rationale, they are probably just biding their time while inflation is somewhat above target, and will seek to bring easing back on the agenda as soon as they can.
.
Gavyn Davies is co-founder of Fulcrum Asset Management and Prisma Capital Partners, and writes a regular blog on macroeconomics at FT.com
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Copyright The Financial Times Limited 2012
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