(Pre-)Occupied

In Chicago last week, for an event in honor of the 100 birthday of Milton Friedman, I briefly stopped by the Occupy Chicago protest to get a breath of fresh air. Since I'm interested in monetary policy, I was interested in why they'd chosen the Chicago branch of the Federal Reserve (there are 12 branches) as the venue for their demonstration. There turned out to be no particularly clear ideological reasoning behind the choice and, in fact, some sentiment that they really ought to decamp in favor of the Chicago Mercantile Exchange. Nobody had especially strong views on monetary policy. It made me wish Chicago Fed President Charles Evans would come down and speak to the protesters. He, though by no means a drum-circle type, is just about the best central banker we have at this point and recently gave a speech that, in my view, is the best explanation of why we need a 99 Percent Movement today.

The speech, to be clear, isn't the stuff of protest rallies. It includes math. Specifically, Evans argued that a central banker ought to try to "minimize the equally weighted sum of squared inflation and unemployment deviations L = (n-n*)2+(u-u*)2 where u and u* are the actual and natural rates of unemployment." I don't think "What do we want? State-contingent price-level targeting! When do we want it? Now!" is going to get the troops fired up.

But lingering behind the jargon and math was a clear and powerful point. The Fed has what's called a "dual mandate": It is charged both with the competing goals of controlling inflation and propping up employment. As the recession has dragged on, some economists have criticized the institution for being more concerned about the inflation rate than the jobs situation.

"Imagine," Evans asked, "that inflation was running at 5 percent against our inflation objective of 2 percent." He observed that if this were happening, his colleagues on the Fed's Open Market Committee "would be acting as if their hair was on fire." Evans' core claim, embedded in that equation about the equally weighted sum of squared inflation and unemployment deviations, was that with unemployment at 9 percent, central bankers should be in hair-on-fire mode.

The central bank can't solve all our problems. But there's a lot it could do to help. In particular, they could offer different, better, guidance about their future plans. For the past three years, the Fed has made a lot of unusual moves to stave off deflation and banking crises. At the same time, it's taken pains to state firmly and clearly that these are temporary measures and that they're committed to keeping inflation low. As if to underscore that point, they've from time to time tightened policy by allowing measures like QE2 -- a program in which the Fed bought up financial assets to pump money into the economy -- to expire. This naturally leads people to think that an improvement in the economy might lead to an early tightening of monetary policy.

To take a scenario: If the unemployment rate were to fall from 9.1 percent to 8 percent, that would mean a lot of extra people driving to work every day. That might push up the price of gasoline, causing a bit of inflation and prompting the Fed to slow things down. And if people anticipate that tight money will strangle a recovery, they won't invest, and the drop in unemployment won't happen in the first place.

Evans' proposal, in layman's terms, is for the Fed to clarify that it's much more worried by 9 percent unemployment than by the prospect of a year or two of 3 percent inflation. That would, on its own, boost the growth outlook and encourage some of our cash-rich and profitable corporations to start investing in expanding their operations.

That's what a hair-on-fire Fed would be doing. So why isn't the Fed's hair on fire? I don't think it's brute interest-group politics. But I do think it has something to do with the fact that the labor market pain isn't spread evenly. Unemployment is concentrated among the young, the relatively uneducated, and racial minorities. Economic policy is made by middle-aged white people with advanced degrees. They travel in circles full of other highly educated, middle-aged white people. If 9 percent of Ben Bernanke's friends were unemployed, I bet his hair would be on fire. If 9 percent of Richard Fischer's friends were unemployed, he wouldn't be criticizing Bernanke from the right. But they're not. Key decision-makers throughout the economy are oddly insulated from the misery afflicting young people and huge swathes of the working class.

And that, ultimately, is why getting people into the streets matters. Something has to be done to make the pain real to the people who count. To make them see that in many communities across America the unemployment rate is 10 percent or 15 percent, with underemployment and short hours even more widespread. In those places, hair is on fire already. But to fix our problems, the fire has to spread to the people with the power to change things. A few good protests may be just what it takes to do the trick.

Comments

The inflation average over the last 30 years is 3.2%. Yeah, I'd agree they have their balancing game and 2% inflation target shifted too much the wrong direction.

I think you greatly overestimate how much monetary policy can impact unemployment. The banking system is already holding very large amounts of excess reserves. How would adding to that lower unemployment?  Also, your example about gasoline ignores the fact that the Fed uses core inflation indicators in setting monetary policy. The increase in gas prices would not cause the Fed to tighten.

Matt, I know you've mentioned the interest paid on bank reserves before and wondered if you caught this from David Glasner:

http://uneasymoney.com/2011/10...

The Fed is now paying 0.25% interest on reserve balances while and the interest rate on 3-month T-bills is now 0.01%.  Yet the statute states in black letters that the rate that the Fed may pay on reserves is “not to exceed the general level of short-term interest rates.”

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