by Calculated Risk on 11/22/2010 09:38:00 PM
Monday, November 22, 2010
NY Times: Odd corollary to the Volcker Fed?
From Sewell Chan at the NY Times: Fed Adopts Washington Tactics to Combat Critics
Faced with unusually sharp ideological attacks after its latest bid to stimulate the economy, the Federal Reserve now faces a challenge far removed from the conduct of monetary policy: how to defend itself in a hyperpartisan environment without becoming overtly political.
...
The situation forms an odd corollary to the early 1980s, when ... Paul A. Volcker, sharply raised interest rates, setting off back-to-back recessions in a painful but effective war on inflation.
Liberals attacked Mr. Volcker, a Democrat, as an inflation-fighting zealot who disregarded the plight of the unemployed. Now conservatives are portraying Mr. Bernanke, a Republican, as trying too hard to stimulate growth and underestimating the risk of inflation.

When Paul Volcker became Fed Chairman in August 1979, inflation was close to 10% (year-over-year change in core CPI). The unemployment rate was close to 6%. As the Fed tightened (taking the Fed funds rate to around 20%), the unemployment rate started to rise sharply.
So there were two problems in the early '80s: very high inflation, and a rising unemployment rate. It is understandable there was friction between the dual mandates of the Fed - especially when inflation started to fall and the unemployment rate was in double digits.
Now the unemployment rate is at 9.6% - a real and painful problem. And inflation is low and falling. So what is the source of the friction today? The risk of future inflation? This "odd corollary" doesn't work.