Why Monetary Policy Should Ignore Financial Stability

Financial stability is apparently the new hot reason to tighten monetary policy, and in this article for Quartz I go in on some reasons for why this is a horrible idea. An excerpt

Janet Yellen’s confirmation hearing showed signs that US monetary policy will soon adopt a third mandate. She said: “Overall, the Federal Reserve has sharpened its focus on financial stability and is taking that goal into consideration when carrying out its responsibilities for monetary policy.” While Yellen has traditionally downplayed this mission, the December FOMC meeting minutes also revealed a growing chorus of FOMC participants who believe that monetary policy should do more than just ensure full employment and price stability. Rather, they believe that monetary policy should look out for bubbles and pop them before they jeopardize financial stability. 

At first glance, this sounds like a good idea. After all, who wants financial instability? 

But back in 2002, Bernanke outlined several reasons why tightening monetary policy in response to bubbles is unlikely to work in practice. First, there’s no reason to believe that the Fed can accurately identify bubbles in advance. Second, even if a bubble appears, it’s not clear that raising short term interest rates could pop it. Third, even if monetary policy ends up bringing asset prices down, it is likely to do so only through hurting the livelihoods of average Americans.

Something that should be added, though, is that I still believe research on how monetary policy affects financial stability can be useful. Such research can help us better understand how monetary policy transmission might work, and what things regulators should look out for as the monetary policy landscape changes. However, none of this is any reason why the central bank should base the stock of money on the caprices of the financial markets.

Milken Institute Review: China's Latest Growing Pain

After writing a Quartz article on Chinese regional development over the Summer, the Milken Institute Review approached me to write a longer article on the history of Chinese regional inequality, and what the Chinese government can do going forward. My basic argument was that the last decade of growth, unlike the decade prior to that, was one of convergence among provinces. However, to ensure that this can continue going forward, it will be important to continue the process of urbanization and expansion of social services. Read more here.

Quartz: "Stop the taper talk—the Fed has actually done too little"

In light of the recent monetary/fiscal policy debate, here's an excerpt of my take from the end of November on monetary offset in the context of the Taper on Quartz:

In its recent minutes, it appears that the US Federal Reserve has been preparing to taper. Yet given the outsize role the Fed has played in supporting the recovery, that would almost certainly be a mistake. Unemployment has been ticking down, yet long-term unemployment is still very high and labor force participation is still low. While the recovery has made progress, it is still not guaranteed, and the Fed’s accommodation will be critical if the economy is to secure the gains it has made. 

The key to understanding the argument is to understand a concept central to economic analysis: the counterfactual. Counterfactuals are alternative histories of what could have been. In military history they are the answers to questions like “What would have happened if Napoleon had won the battle of Waterloo?” In this case, the key counterfactual is “What would have happened to the economy if the Fed hadn’t done quantitative easing?” Throughout this recovery, the federal government has been tightening its belt. Indeed, as MKM Partners chief economist Michael Darda has repeatedly noted, net government outlays have fallen for two consecutive quarters during this recovery, making the recent bout of austerity the biggest since the Korean War demobilization. Had the Fed not offset such a large contraction in spending, the US almost certainly would have been sent into another recession.