Inflation and Unemployment

From the Wall Street Journal article Fed's Kocherlakota Shifts on Unemployment:

“Mr. Kocherlakota's transformation caught many Wall Street observers off guard. Eric Green, an economist at TD Securities, called Mr. Kocherlakota's plan "positively preposterous stuff" because it would hurt the Fed's inflation credibility.”

The proposal in question is the following.

His proposal: Pledge to keep short-term interest rates very low until the unemployment rate, which was 8.1% in August, falls to 5.5%. He said it could take four or more years to reach that goal.

While what Eric Green says is certainly possible, the Japan experience also showed us that the suggested proposal does not necessarily end with run-away inflation. Here’s the Japan CPI courtesy of FRED (link here; note my plot goes from 1998 to now) over the past decade.

The Bank of Japan started unconventional policies in 1998 – first with what is commonly referred to as ZIRP (Zero Interest-Rate Policy) and then the QEP (Quantitative Easing Policy) from 1999 to 2006. While there is a spike from 2007 to 2008 – that is largely due to the rise in oil prices over that period.

Do note that the QEP that the Bank of Japan conducted conditioned the exit of the policy to the core CPI being above zero, while what Mr. Kocherlakota proposes conditions the exit on unemployment rate of 5.5%. If you believe the NAIRU (Non-Accelerating Inflation Rate of Unemployment) will be above 5.5% for the next few years, then some concerns about future inflation might be warranted.

Risks to Nominal GDP Path Targeting?

Quoting from a paper by Professor Michael Woodford, titled "Methods of Policy Accommodation at the Interest-Rate Lower Bound" (available here):

A more useful form of forward guidance, I believe, would be one that emphasizes the target criterion that will be used to determine when it is appropriate to raise the federal funds rate target above its current level, rather than estimates of the “lift-off” date. If such an explicit criterion made it clear that short-term interest rates will not immediately be increased as soon as a Taylor rule descriptive of past FOMC behavior would justify a funds rate above 25 basis points, this would provide a reason for market participants to expect easier future monetary and financial conditions than they may currently be anticipating, and that should both ease current financial conditions and provide an incentive for increased spending. 

An example of a suitable target criterion would be a commitment to return nominal GDP to the trend path that it had been on up until the fall of 2008. This would both make it clear that policy will have to remain looser in the near term than a purely forward-looking Taylor rule would imply, and at the same time provide assurance that the unusually stimulative current policy stance does not imply any intention to tolerate continuing inflation above the Fed’s declared long-run inflation target — that in fact, it will not led to a future level of nominal income any higher than what people had reason to anticipate at the time that they acquired their existing nominal assets and undertook their existing nominal obligations.

If the Federal Reserve decides to do this and then inflation hits 5% with GDP continues to lag - then what? Shouldn't a threshold for inflation also be announced along with the GDP target path - perhaps 3% over the medium term as Chicago Fed President Charles Evans suggests?

Now, if both the GDP targeting and an inflation threshold are announced by the Federal Reserve, could someone plausibly infer this to be a negative outlook on the economy? I.e., someone viewing the Federal Reserve as believing stagflation as possible (due to quantitative easing, labor market structural issues, oil shock, and a plethora of possibilities)?

Path targeting can be beneficial, but it has some risks that need to be weighed against.

Prominence of Apple

Hoping to make use of my camera more for note taking – I am setting up Evernote on my laptop (because of its supposed feature of image OCR search.)  The default installation file for Evernote is for the Mac, and not the PC.

To get to the PC installation file, I need an extra click.

What is striking to me is how far Apple has come in terms of dominance – in particular in the education field. (I envision Evernote’s main demographics to be students.) Since I am using a Firefox browser on a PC to access the site, I don’t believe the website auto-detect my browser agent and give me the Mac version as the default.

Yield Curve on 2012-09-06

Presumably because of: ECB Details Bond Plan.