THE FEDERAL RESERVE’S CONTINUING EXPERIMENTS WITH UNOBSERVABLES RISK ERRORS IN INFLATION FIGHT, SAYS NEW LEVY INSTITUTE PAPER

January 10, 2022 in News by RBN Staff

 

 

Source: BARD COLLEGE NEWS RELEASE 

Press Contact: Mark Primoff

845-758-7412

primoff@bard.edu

FOR IMMEDIATE RELEASE

 

THE FEDERAL RESERVE’S CONTINUING EXPERIMENTS WITH UNOBSERVABLES RISK ERRORS IN INFLATION FIGHT, SAYS NEW LEVY INSTITUTE PAPER

 

ANNANDALE-ON-HUDSON, NY —Against a backdrop of rising prices, attention has turned to the US Federal Reserve with the expectation the central bank will soon raise interest rates in an effort to control inflation. In their new Public Policy Brief, “Still Flying Blind after All These Years,” Levy Institute President Dimitri B. Papadimitriou and Senior Scholar L. Randall Wray argue not only that this would be a mistake, but that the prevailing approach to monetary policymaking is flawed due to its reliance on theoretical constructs that are poorly supported by evidence.

 

Examining two previous cases in which the Fed raised rates too soon alongside the evolution of the Fed’s thought and practice over the past three decades, Papadimitriou and Wray write that this has been a period in which “the Fed has increasingly turned to unobservable indicators that are supposed to predict inflation and unobservable tools that are supposed to fight inflation.”  The authors target concepts such as an equilibrium (natural or neutral) rate of interest, potential growth, and inflation expectations—which are not just little supported by evidence, they argue, but “in some ways cannot be proven or disproven by evidence.” Noting that similar criticisms have begun to be raised by some of the Fed’s own members and research staff, Papadimitriou and Wray propose that “it is time to put to rest policy that is overly focused on unobservables.” Moreover, in their view the upshot of these critiques indicates the need for “an alternative framework for monetary and fiscal policy.” In particular, they write, “it might … be time to reexamine our reliance on the Fed as the primary inflation fighter.”

 

According to Papadimitriou and Wray, “control over the fed funds rate probably gives the Fed less control over spending and inflation than typically presumed, and it might not even move spending in the direction desired. In any event, the experience of the past two decades has raised the possibility that the Fed’s policy is less potent than previously believed. At the very least, we need to consider putting more responsibility on fiscal policy for maintaining aggregate demand.”

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To download Public Policy Brief No. 156 click here.

The Levy Economics Institute of Bard College, founded in 1986 through the generous support of the late Bard College trustee Leon Levy, is a nonprofit, nonpartisan, public policy research organization. The Institute is independent of any political or other affiliation, and encourages diversity of opinion in the examination of economic policy issues while striving to transform ideological arguments into informed debate.

 

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