Kocherlakota: Monetary Policy Is Too Tight, Not Too Easy

Minneapolis Federal Reserve President Narayana Kocherlakota continues his tear of insightful statements with a chat on the basics of the Fed and monetary policy that ends with this contrarian but correct conclusion:

Congress has charged the Fed with making monetary policy to achieve two Main Street objectives: keep inflation close to 2 percent and unemployment low. Monetary policy tools operate with a lag of a year or two. These lags mean that the FOMC’s policy decisions are based on how it expects the economy to perform over the medium term. My own forecast, conditional on the FOMC’s current monetary policy stance, is that inflation will run below the Fed’s target of 2 percent over the next two years and the unemployment rate will remain elevated. This forecast suggests that, if anything, monetary policy is currently too tight, not too easy.

This is how Milton Friedman saw things and thus one might think it had become conventional wisdom. But it hasn’t. The normal way of talking about things is to say that money is “easy” if interest rates are low, regardless of how forward-looking nominal variable perform. That standard leads to the absurd conclusion that money was tighter throughout the seventies inflation than it’s been at any point since Alan Greenspan took the helm. As best I can tell nobody actually thinks that, but people say things about real growth being slow and unemployment low and stable “despite” easy money that logically commit them to that view. But Kocherlakota has this right. Low and stable inflation plus stubbornly high unemployment means relatively tight money, just as high and rising inflation mean easy money regardless of interest rates.

Kocherlakota’s an interesting character. He very much started out the crisis as part of the freshwater school but changed his mind during 2012 in response to the evidence. That’s a stark contrast to other regional Federal Reserve presidents like Jeffrey Lacker who just keep saying the same thing no matter how many times their model fails. For his trouble, Kocherlakota’s gotten smeared by Stephen Williamson but otherwise I haven’t seen the tight money crowd do much of anything to engage with what he’s actually saying.