Monday, May 8, 2017

Palley on Two Kinds of Recession

I'm reading the simple version of Thomas Palley's Monetary Policy and the Punch bowl. In it Palley writes

In effect, the monetary policy framework of the past three decades has had the Federal Reserve pursue “stop-go” interest rate policy, raising interest rates to tamp down Wall Street exuberance and slow the economy before it reaches full employment, and then lowering them again to escape recessions.

Reminded me of Paul Krugman's thoughts on recession that I touched on a couple months back. The "two kinds of recession" are quite clear in the Krugman view, but not so much in the Palley view.

Palley says the recessions of the past 30 years have been brought on by the Fed raising interest rates. That's what Krugman says caused recessions until about 30 years ago.

"Since the mid 1980s," Krugman says,

recessions haven’t been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand.

I don't know now. I think maybe Palley is on to something. What's the same about recessions before and after the mid-80s is that interest rates rise until recession occurs, and interest rates fall until recovery occurs.

What's different in the more recent period is that the Fed raises interest rates in response to "credit bubbles or other things" as Krugman puts it, or, in Palley's words, "to tamp down Wall Street exuberance".

The Fed's focus shifted from inflation to asset inflation. Maybe that's the difference.


jim said...

"What's the same about recessions before and after the mid-80s is that interest rates rise until recession occurs, and interest rates fall until recovery occurs."

Let's assume that's true, where is there any factual evidence that the Fed is the cause of those observed changes in interest rates? By factual evidence I mean something besides people telling stories. There is certainly plenty of story-telling, but the stories disregard the fact that changes in Fed interest rates have consistently lagged behind and followed market interest rates.

The Arthurian said...

dAMN... I struggled for a long time to learn it. And then after I learned I I knew it for long time. And now it is stuck in my head and I just say it and you always catch me...

Actually I'm pretty happy thinking of the demand for borrowable money as market driven and the supply as Fed-and-creditor driven. And the Fed is capable of doing things (like quantitative easing) that creditors cannot match.

And perhaps Fed rates and market rates generally move together. But the Fed is not obligated to make decisions based on the profit motive, so there may be differences. Maybe the Fed can slow an increase or speed up an increase in market rates, or slow or speed up a decrease.

How would you say it Jim?

jim said...

I say stories that contradict the evidence I can see are probably fiction.

It's curious that you bring up QE as evidence that the Fed controls interest rates. Interest rates remained unchanged for some time before, during and after QE so I don't see any evidence from the QE that the Fed is behind rate changes.