Fed Vice Chair Kohn, Still Babbling Out of the Side of His Mouth
Zimbabwe Ben gets all the attention but this guy is a real winner. Fed Vice Chair Donald Kohn (remember him? The "it's none of your business where this $1.2 trillion went" guy?) spoke today to Princeton on Interactions between Monetary and Fiscal Policy in the Current Situation - oh that already sounds like a winner.
Kohn is a sublime scientist of perfect central bank tongue; few manage to spit out as many played-out Fed cliches as Kohn can in a single speech, each statement as vague and pointless as the next. That being said, don't even bother reading as there is absolutely nothing of value to be found in this speech. Kohn should be put in central banker time-out for abusing the phrase "to be sure."
So while the entire thing is terribly droll and useless, I did find this bit to be humorous. I love watching the Fed defend its potency despite overwhelming evidence pointing to a crippled central bank that has been castrated in terms of available monetary policy.
Watch for it, and just to make your life easier, I'll even point out the funny without you having to slog through the gibberish.
Fiscal Policy When Monetary Policy Is at the Zero Lower Bound
During normal economic circumstances, most economists do not view expansionary fiscal policy as an especially effective tool for producing a sustained increase in aggregate demand and in resource utilization. Ordinarily, financial market participants would expect monetary policy to react by increasing the target federal funds rate over time to keep output near potential and inflation near its desired level. Thus, the enactment of a sustained fiscal expansion would trigger an increase in expected short-term interest rates and hence long-term interest rates. The higher long-term rates would also tend to reduce asset values and boost the foreign exchange value of the dollar. As a result, any initial increase in aggregate output and employment from the fiscal expansion would be soon crowded out by reductions in household spending, business investment, and net exports.
But in the current weak economic environment, a fiscal expansion may be much more effective in providing a sustained boost to economic activity. With traditional monetary policy currently constrained from further reductions in the target policy rate, and with many analysts forecasting lower-than-desired inflation and a persistent, large output gap, agents may anticipate that the target federal funds rate will remain near zero for an extended period. In this situation, fiscal stimulus could lead to a considerably smaller increase in long-term interest rates and the foreign exchange value of the dollar, and to smaller decreases in asset prices, than under more normal circumstances. Indeed, if market participants anticipate the expansionary fiscal policy to be relatively temporary, and the period of weak economic activity and constrained traditional monetary policy to be relatively extended, they may not expect any increase in short-term interest rates for quite some time, thus damping any rise in long-term interest rates. Moreover, if the initial boost to aggregate spending from fiscal stimulus raises inflation expectations, then real short-term interest rates would tend to decline, given that the nominal short-term interest rate is constrained at the zero lower bound. All told, the result is likely to be considerably less of the usual crowding out of fiscal stimulus in these circumstances, thereby increasing the effectiveness of fiscal policy to boost the level of aggregate economic activity in the short to medium term.
This scenario is supported by simulations using the Federal Reserve staff's FRB/US model, assuming all agents have rational expectations.
Donald Kohn, can I let you in on something? I hope you're paying attention.
I understand that teaching accountants to pass the CPA exam isn't anywhere near as complicated as dictating monetary policy for the United States, especially in such a, erm, dangerous economic time as ours. That being said, in my little office we have a jar with a Post-in note taped across the front of it that says simply "assumption jar." I assumed my colleague would do it so I didn't check to see if they had will cost you a quarter. I left my computer on assuming it wouldn't run up the electricity bills will cost you a quarter.
FYI, Mr Kohn, I assume rational expectations from the Federal Reserve would cost you by my estimate around $9 - 14 trillion. That is where the still entirely unknown liabilities of the Fed balance sheet fall, right? Somewhere?
Kohn does suggest that interest rates will likely stay low for quite some time. Thank you for that, Captain Obvious.