Martin Feldstein on Wall Street Instability and Interest Rate Policy

Martin Feldstein, chairman of the Council of Economic Advisers (CEA) during the Reagan administration, and one of the most influential economists in policy circles says that: "Market participants know that the economy is now essentially at full employment, that the consumer-price index is close to 2% and that there is little risk of deflation."

Few things. This:

Broader measure of unemployment is at 10.4%. Then this:

That is, the increase in employment, for the growing population, since the crisis has been almost nil. And finally this:

That is, wages have not increased much in real terms (click on figure for a better image).

Also, the deflation that matters (again) is asset deflation, not CPI, or some broad price index, deflation. Funny thing is that Feldstein thinks it's possible that asset deflation would have real effects. He says: "Much of this mispricing will likely unwind in the months ahead. What isn’t clear is whether the fall of equity prices and other corrections will have adverse systemic effects as they did in 2007-08, bringing down consumer spending and business investment and thereby reversing the recent labor-market improvement. Only time will tell."

I'm more skeptical that the effect would be big. For most consumers the effects of the Wall Street crash are irrelevant. But clearly there is no risk of inflation. In sum, not at full employment, and inflation is not really a problem, since wages are subdued. So his call for higher interest rates is hard to defend. Unless there is something else going on.

PS: Feldstein was on the board of AIG for many years, and he received a lot of money (millions?) from the company, which was at the center of the financial meltdown in 2008. He never defended regulation of financial markets. It might be a coincidence of course that his personal interests and his views are well aligned. But it would be good to know who are his clients now. I mean, just to make sure that his advise on interest rates is not biased ("Nudge, nudge. Wink, wink. Say no more").

Martin Feldstein doesn't care about the inflation target

But he does want the Fed to raise rates soon and resolutely. Why? Because the labor market is too tight. Yes, I know (see here and here). One interesting thing is that a prominent Republican economist says that this is a "solid economic upturn." So there are some Republicans for Obama then.

More interestingly he suggests that the Fed's lack of preoccupation with inflation, since Janet Yellen does not seem to believe that 5.5% is the natural rate, is misplaced. But there is more. In his view, nobody should be concerned if inflation is below the target. In his words: "who cares if the inflation rate is a bit below an arbitrary 2% target?" Exactly, who cares about an arbitrary 2% target. Who? Feldstein of course, since he is really concerned that inflation would be above the arbitrary 2% target.

Besides, the notion that double digit inflation rates are around the corner is preposterous. And the problem of financial stability is not related low interest rates, but to the lack of regulation and the gutting of the Dodd-Frank legislation.

Blanchard and the lessons of the crisis, again

Olivier Blanchard has again posted on the lessons from the crisis, and one has reasons to be underwhelmed again (his previous attempt is discussed here). The general tone is the same as before, we don't know enough (#1 on humility is about that, but also #2 that suggests that we don't know enough about how financial markets operate). Caution here is at the service of an Hippocratic oath suggesting that an intervention carries an obvious risk of harm but a less certain chance of benefit.

His rule #4 says that macro-prudential regulations like capital controls "don’t work great. People and institutions find ways around them. In the process of reducing the problem somewhere you tend to create distortions elsewhere." So, first do no harm [no mention of George DeMartino's actual economic oath, by the way], and please don't use capital controls [that's why I remain very skeptical about the IMF's new view on capital controls; for more go here].

The lesson #3 is simply funny; what they didn't know that there are spillover and contagion effects? He is even making the mainstream sound worse than it is [for a more thorough discussion of what the mainstream learned and its limitations go here].

Last but not least there is lesson #5, which suggests that Central Bank Independence (CBI) does not work if the tasks go beyond inflation targeting. Note that he had defended as a change in macro the idea to raise the inflation target from 2% to 4% [seriously!]. Here he tells you that CBI has been "one of the major achievements of the last 20 years." The problem is not with CBI per se, but that with new demands on central banks (why the new demands appeared is an incognita, and he does not think is deregulation, or at least doesn't say so) CBI becomes more difficult.

There is no discussion of why CBI has been orthogonal to the so-called Great Moderation, caused by stagnant real wages and globalization. The problem with CBI is that by definition it imposes a rule of not coordinating with the Treasury on fiscal policy, and in some cases the central bank might be forbidden to do basic things like buying government debt (like the ECB). The justification is the fear of inflationary pressures, while the truth might be closer to Kalecki's view that fiscal and monetary policy are used to maintain a significant level of unemployment to keep workers in line.

So again it seems that Blanchard has learned nothing from this crisis. Mind you, John Taylor, Martin Feldstein and others are out there calling for higher interest rates. So, all in all, you might think that Blanchard, like Krugman and DeLong, is among the most moderate and reasonable in the mainstream. However, he is at the IMF, an institution that is still pushing fiscal austerity, and his inability (or unwillingness) to learn from the crisis has considerably more impact on economic policies around the world.