Whether it’s Janet Yellen (almost certainly) or Donald Kohn (far less likely) or Timothy Geithner (in President Obama’s dreams), Ben Bernanke’s successor at the Federal Reserve will have to make a big call about the glacially healing American labor market. Has the central bank done close to all it can? Or is there actually room to do a whole lot more without risking an inflation surge or dangerous asset bubbles?
Minneapolis Fed president Narayana Kocherlakota argued Thursday it’s the latter in a Churchillian speech — well, for a talk on monetary policy — titled “A Time of Testing.” Kocherlakota said the next Fed boss faces a moment similar to that which confronted former chairman Paul Volcker when he took over in 1979. Many economists back then said high inflation was here to stay. There was little monetary policy could do about it. In an October speech that year titled “A Time for Testing,” Volcker rejected the perma-inflationista claims. He then followed through with action. He tightened monetary policy to push down inflation even as interest rates and unemployment soared. But Volcker broke the back of inflation and inflation expectations.
Today, as back then, some experts are saying the Fed is helpless to deal with a big economic problem. This time, however, the challenge is a persistently weak job market rather than stubbornly high inflation.
But Kocherlakota thinks that through clear communication and aggressive action, this battle is winnable. First, “the FOMC’s goal should be to return employment to its maximal level as rapidly as it can, while still keeping inflation close to, although possibly temporarily above, the target of 2 percent.”
Second, the FOMC has to act on that goal. Kocherlakota:
It must do whatever it takes to achieve its communicated goal. … Doing whatever it takes in the next few years will mean something different. It will mean that the FOMC is willing to continue to use the unconventional monetary policy tools that it has employed in the past few years. Indeed, it will mean that the FOMC is willing to use any of its congressionally authorized tools to achieve the goal of higher employment, no matter how unconventional those tools might be. Moreover, doing whatever it takes will mean keeping a historically unusual amount of monetary stimulus in place—and possibly providing more stimulus—even as:
- Interest rates remain near historic lows.
- Economic growth rises above historical averages.
- Per capita employment begins to rise appreciably.
- Asset prices rise to unusually high levels, leading to concerns about “bubbles.”
- The medium-term inflation outlook rises temporarily above 2 percent.
It may not be easy to stick to this path. But I anticipate that the benefits of doing so, in terms of employment gains, will be significant.
I would prefer to clearly and transparently target the level of total spending or output, but Kocherlakota is close enough for government work. He doesn’t want to let bygones be bygones, he wants to play some catchup. And what a fascinating intellectual journey for this central banker, from worrying about structural unemployment to making a foreful case that it’s a weak economy slowing job growth. Whoever the next Fed chairman is, Kockerlakota is a pretty good candidate for second in command.