Wednesday, June 27, 2007
Federal Reserve policy makers disagree with their own staff economists, and a growing chorus on Wall Street, who say the U.S. economy can't expand as fast as it used to without pushing up prices.An interesting paper by Lawrence White -- OK, maybe just interesting to me -- points out that the staff of the Federal Reserve tends to have a status quo bias. Particularly for Board of Governors' staff, turnover is low and there's a tendency to protect the institution:
The split, signaled in the minutes of May's Federal Open Market Committee meeting, may reflect debate over whether a slowdown in U.S. productivity is permanent. ``Many'' FOMC members were ``somewhat more optimistic'' than lower-ranking officials about the economy's speed limit, the records showed.
To repeat Fettig�s (1993) characterization of Milton Friedman�s view: �if you want to advance in the field of monetary research . . . you would be disinclined to criticize the major employer in the field.�If a particular Board of Governors (or perhaps more appropriately, a particular FOMC) should create extra inflation, it may not damage that board in the short run but it reduces the reputation of the institution in the long run. The Staff is more likely to safeguard those. The proponents of the more optimistic view (which is a little weird in this case, since as Barry Ritholz argues, that optimistic view on rates includes a higher probability of recession) can be wrong without bearing too much consequence, and if they are right their next jobs will have more prestige and more money. If they're wrong, they go back to, well, academia.
These incentives and filtering mechanisms may produce a result as if the Federal Reserve were deliberately subsidizing research that takes the institutional status quo for granted. This should not be surprising, nor is it scandalous. We naturally expect the research that any organization sponsors to tend to promote rather than to undermine that organization�s interests. When (say) the insurance industry sponsors a report on the advisability of federal subsidies for terrorism insurance, the sponsorship alerts cautious readers to scrutinize the research methods and findings for pro-industry bias. Raising the question of the Fed�s status quo bias alerts us that the same sort of scrutiny is appropriate to monetary policy research, to avoid employing a double standard.
Though when I look at housing (say, as James Hamilton and Mark Zandi did last week), I am tempted to think the "optimists" are right.