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Tuesday, July 09, 2013

Fed's Williams: "A Defense of Moderation in Monetary Policy"

by Calculated Risk on 7/09/2013 06:24:00 PM

From San Francisco Fed President John Williams: A Defense of Moderation in Monetary Policy. From the abstract:

This paper examines the implications of uncertainty about the effects of monetary policy for optimal monetary policy with an application to the current situation. Using a stylized macroeconomic model, I derive optimal policies under uncertainty for both conventional and unconventional monetary policies. According to an estimated version of this model, the U.S. economy is currently suffering from a large and persistent adverse demand shock. Optimal monetary policy absent uncertainty would quickly restore real GDP close to its potential level and allow the inflation rate to rise temporarily above the longer-run target. By contrast, the optimal policy under uncertainty is more muted in its response. As a result, output and inflation return to target levels only gradually. This analysis highlights three important insights for monetary policy under uncertainty. First, even in the presence of considerable uncertainty about the effects of monetary policy, the optimal policy nevertheless responds strongly to shocks: uncertainty does not imply inaction. Second, one cannot simply look at point forecasts and judge whether policy is optimal. Indeed, once one recognizes uncertainty, some moderation in monetary policy may well be optimal. Third, in the context of multiple policy instruments, the optimal strategy is to rely on the instrument associated with the least uncertainty and use alternative, more uncertain instruments only when the least uncertain instrument is employed to its fullest extent possible.
emphasis added
Currently inflation is below the Fed's target (and is forecast to remain below the target), and unemployment is significantly above target (and forecast to remain above target). In general the current situation and forecasts would suggest more accommodation.

Williams argues because of uncertainty that current policy might be optimal. Note: Williams is an influential Fed president and has been supportive of QE.  Maybe ... but high unemployment is a serious problem now (and also keeps down wages for almost everyone), and I'd think monetary and fiscal policymakers would be discussing this daily.  With the current Congress, fiscal policy aimed at reducing unemployment is off the table, so all we have is monetary policy.   And now Williams is defending "moderation" ...