The markets have been nervous as we await Janet Yellen’s speech at Jackson Hole. Now that the agenda for the Jackson Hole symposium has been released, I believe that Yellen is unlikely to announce any major shift in monetary policy in her speech.
The intent of the Jackson Hole symposium is for Federal Reserve officials to think long term. The intent isn’t to make a decision on whether to raise interest rates in September, December, or next year. Instead, the purpose of the meeting is to think about different frameworks for Fed officials to do their job. Possible topics include the conduct of monetary policy and their mechanisms, financial regulation, and so on.
Three camps at the Fed
If Yellen did indeed want to signal a philosophical focus in the conduct of monetary policy, then the logical course of action is to allow one or more academics to present research in support of such a shift. Ostensibly, the presentation would be for discussion purposes only, but the real intent would be to create sufficient buzz to change how the discussion could be framed at future FOMC meetings. I had been watching the agenda for some hints that Yellen could find herself shifting her opinion towards one of three camps at the Fed:
The traditionalists: The leader of the traditionalist faction is Stanley Fischer. Fischer is an experienced old-time central banker who views the world in a conventional way. Traditionalists think mainly in terms of economic cycles. So when Fischer said in his most recent speech:
The Fed’s dual mandate aims for maximum sustainable employment and an inflation rate of 2 percent, as measured by the price index for personal consumption expenditures (PCE). Employment has increased impressively over the past six years since its low point in early 2010, and the unemployment rate has hovered near 5 percent since August of last year, close to most estimates of the full-employment rate of unemployment. The economy has done less well in reaching the 2 percent inflation rate. Although total PCE inflation was less than 1 percent over the 12 months ending in June, core PCE inflation, at 1.6 percent, is within hailing distance of 2 percent–and the core consumer price index inflation rate is currently above 2 percent.1
So we are close to our targets.
By the remark “we are close to our targets”, Fischer means it’s time to start raising rates. The Fed has done its job as a fire fighter in the Great Financial Crisis and rescued the economy. It’s time to normalize monetary policy.
The uber-doves: By contrast, there is a group of doves at the Fed led by Lael Brainard and Charles Evans. Brainard is highly focused the global downside risk of raising rates. In a speech on June 3, 2016, she warned about the global effects of rising US interest rates:
Of course, there are risks to the projection that future GDP growth will be strong enough to deliver progress on inflation and employment. Most immediately, there is important uncertainty surrounding the United Kingdom’s June 23 “Brexit” referendum on whether to leave the European Union (EU). The International Monetary Fund has noted that a vote in favor of Brexit could unsettle financial markets and create a period of uncertainty while the relationship between the United Kingdom and the EU is renegotiated. Although the economic effects of this uncertainty and the costs of adjusting to altered trade and financial ties are difficult to quantify, we cannot rule out a significant adverse reaction to such an outcome in the near term, such as a substantial jump in financial risk premiums. Because international financial markets are tightly linked, an adverse reaction in European financial markets could affect U.S. financial markets, and, through them, real activity in the United States.
In addition, we should not dismiss the possible reemergence of risks surrounding China and emerging market economies (EMEs) more broadly. In recent months, capital outflows in China have moderated as pressures on the exchange rate have eased. Should exchange rate pressures reemerge, we cannot rule out a recurrence of financial stress, which would affect not only China but also other emerging markets that are linked to China via supply chains or commodity exports and, ultimately, conditions here. China is making a challenging transition from export- to domestic demand-led growth, and the cost of reallocating resources from excess capacity sectors to more dynamic sectors could further impair growth in the near term. While China has taken policy steps to limit the extent of the slowdown, there is an evident tension in policy between reform and stimulus, and the effect of the stimulus may already be waning. Vulnerabilities–such as excess capacity, elevated corporate debt, and risks in the shadow banking sector–appear to be building, and could pose continued risks over the medium term.
The fragility of the global economic environment is unlikely to resolve any time soon. Growth in the advanced economies remains dependent on extraordinary unconventional monetary policy accommodation, while conventional policy continues to be constrained by the zero lower bound. Conventional policy, whose efficacy is more tested and better understood than unconventional policies, can respond readily to upside surprises to demand, but presently would be constrained in adjusting to downside surprises. This asymmetry in the capability of policy effectively skews risks to the outlook to the downside.
Brainard has been highly focused on the tight global linkages between markets. Her dovish ally has been Charles (don’t raise until you see the whites of inflation’s eyes) Evans.
The secular stagnationists: The third camp at the Fed are those who advocate the view that the economy is caught in a slow growth environment. The spiritual leader of this movement is Larry Summers, who is not a Fed official. His allies are Williams of the San Francisco Fed and Bullard of the St. Louis Fed.
Most recently, John Williams penned a provocative essay, “Monetary Policy in a low R-star World“. In that essay, Williams fretted about the low level of neutral interest rate, or r*, that the economy seems to be caught in. What happens in the next recession? Will the Fed be out of ammunition?
The critical implication of a lower natural rate of interest is that conventional monetary policy has less room to stimulate the economy during an economic downturn, owing to a lower bound on how low interest rates can go. This will necessitate a greater reliance on unconventional tools like central bank balance sheets, forward guidance, and potentially even negative policy rates. In this new normal, recessions will tend to be longer and deeper, recoveries slower, and the risks of unacceptably low inflation and the ultimate loss of the nominal anchor will be higher (Reifschneider and Williams 2000). We have already gotten a first taste of the effects of a low r-star, with uncomfortably low inflation and growth despite very low interest rates. Unfortunately, if the status quo endures, the future is likely to hold more of the same—with the possibility of even more severe challenges to maintaining price and economic stability.
To address these problems, Williams suggested that the Fed consider either raising the inflation rate target, or target nominal GDP growth as a policy framework.
Larry Summers, who is the leader of the secular stagnation camp, went even further. He thought that John Williams was being too wimpy:
I am disappointed therefore that Williams is so tentative in his recommendations on monetary policy. I do understand the pressures on those in office to adhere to norms of prudence in what they say. But it has been years since the Fed and the markets have been aligned on the future path of rates or since the Fed’s forecasts of future rates have been even close to right. I cannot see how policy could go badly wrong by setting a level target of 4 to 5 percent growth in nominal GDP and think that there could be substantial benefits. (I expect to return to this topic in the not too distant future)
Please tell us how you really feel, Larry.
No sign of a policy shift
As I mentioned, the way Janet Yellen might signal a shift in how she thinks about monetary policy would be to *ahem* plant academic papers that support the views of one of the major camps. Instead, there is no sign of such a speech on the agenda. Here is the schedule:
Friday (all times local)
0800 Janet Yellen, opening remarks
0830 Adapting to Changes in the Financial Market Landscape, Darrell Duffie and Arvind Krishnamurthy
0955 Negative Nominal Interest Rates, Marvin Goodfriend
1055 Evaluating Alternative Monetary Frameworks, Ulrich Bindseil (ECB)
1300 Luncheon address, Christopher A. Sims, Nobel laureate
0800 Central Bank Balance Sheets and Financial Stability, Jeremy C. Stein, Robin Greenwood, and Samuel G. Hanson
0900 The Structure of Central Bank Balance Sheets, Ricardo Reis
1025 Overview Panel, Agustín Carstens (Bank of Mexico), Benoít Coeuré (ECB), and Haruhiko Kuroda (Bank of Japan)
When I look over the schedule, a few things jump out at me. First, Janet Yellen’s speech is only 30 minutes, which is not a lot of time to announce a major policy shift. The papers being presented are mostly technical in nature about the nuts of bolts of monetary policy and financial regulation and show few signs of a shift in philosophical focus.
The only possible exception is the Sims luncheon address. Here is how Wikipedia described the work that led to his Nobel prize:
On October 10, 2011, Christopher A. Sims together with Thomas J. Sargent was awarded the Nobel Memorial Prize in Economic Sciences. The award cited their “empirical research on cause and effect in the macroeconomy”. His Nobel lecture, titled “Statistical Modeling of Monetary Policy and its Effects” was delivered on December 8, 2011.
Translating his work into everyday language, Sims said it provided a technique to assess the direction of causality in central bank monetary policy. It confirmed the theories of monetarists like Milton Friedman that shifts in the money supply affect inflation. However, it also showed that causality went both ways. Variables like interest rates and inflation also led to changes in the money supply.
Bottom line: I don’t expect much in the way of new policy direction out of Jackson Hole. In that case, any risk premium developed over the past few days should contract. Expect a brief but short relief rally.