Regarding the FOMC September Meeting, Stephen Williamson Heaps Scorn on Journalists

     There's been a lot of criticism of the Fed's September 2008 decision not to cut interest rates despite the Lehman bankruptcy and burgeoning financial crisis going on at the same moment. The Fed seems to have done there what Sumner is always saying you shouldn't: reasoning from a price change. Basically the Fed wrongly were concerned about inflation because of the rise in oil and other commodities, but, since the cause of this was supply rather than demand the Fed should not have been concerned by this. 

    It would seem that this is a classic confirmation of Sumner's oft repeated dictum of reasoning from a price change-the CB should only concern itself with prices due to demand shocks never supply shocks. As David Glasner chronicles, most everyone is agreeing with this in the case of the FOMC decision of September, .2008. 

    "Publication of the transcripts of the FOMC meetings in 2008 has triggered a wave of criticism of the FOMC for the decisions it took in 2008. Since the transcripts were released I have written two posts (here and here) charging that the inflation-phobia of the FOMC was a key (though not the sole) cause of the financial crisis in September 2008. Many other bloggers, Matt Yglesias,Scott Sumner, Brad Delong and Paul Krugman, just to name a few, were also sharply critical of the FOMC, though Paul Krugman at any rate seemed to think that the Fed’s inflation obsession was merely weird rather than catastrophic."

    http://uneasymoney.com/2014/03/06/stephen-williamson-defends-the-fomc/

    Except Stephen Williamson. He thinks all these critics are barking up the wrong tree-basically his answer to them is: shut up journalists, that being in his mind the worst insult you can pay an economist. 

    "Stephen Williamson, however, has a different take on all this. In a post last week, just after the release of the transcripts, Williamson chastised Matt Yglesias for chastising Ben Bernanke and the FOMC for not reducing the Federal Funds target at the September 16 FOMC meeting, the day after Lehman went into bankruptcy. Williamson quotes this passage from Yglesias’s post.

New documents released last week by the Federal Reserve shed important new light on one of the most consequential and underdiscussed moments of recent American history: the decision to hold interest rates flat on Sept. 16, 2008. At the time, the meeting at which the decision was made was overshadowed by the ongoing presidential campaign and Lehman Brothers’ bankruptcy filing the previous day. Political reporters were focused on the campaign, economic reporters on Lehman, and since the news from the Fed was that nothing was changing, it didn’t make for much of a story. But in retrospect, it looks to have been a major policy blunder—one that was harmful on its own terms and that set a precedent for a series of later disasters.

      "To which Williamson responds acidly:

So, it’s like there was a fire at City Hall, and five years later a reporter for the local rag is complaining that the floor wasn’t swept while the fire was in progress

     SW can't hide his contempt for the 'journalists.' He doesn't seem to realize that journalists perform a vital public service. In addition, these are not just journalists as he likes to call them. There was no way to criticize the FOMC meeting before as this is the first we know what was actually said. So his usual heavy level of snark may well lead many just to dismiss him as an oddball. Glasner: 

    "Now, in a way, I agree with Williamson’s point here; I think it’s a mistake to overemphasize the September 16 meeting. By September 16, the damage had been done. The significance of the decision not to cut the Fed Funds target is not that the Fed might have prevented a panic that was already developing (though I don’t rule out the possibility that a strong enough statement by the FOMC might have provided enough reassurance to the markets to keep the crisis from spiraling out of control), but what the decision tells us about the mindset of the FOMC. Just read the statement that the Fed issued after its meeting.

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

What planet were they living on? “The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee.” OMG!

       "Williamson, however, sees it differently.

[T]he FOMC agreed to keep the fed funds rate target constant at 2%. Seems like this was pretty dim-witted of the committee, given what was going on in financial markets that very day, right? Wrong. At that point, the fed funds market target rate had become completely irrelevant.

     "Williamson goes on to point out that although the FOMC did not change the Fed Funds target, borrowings from the Fed increased sharply in September, so that the Fed was effectively easing its policy even though the target – a meaningless target in Williamson’s view – had not changed.

     "Thus, by September 16, 2008, it seems the Fed was effectively already at the zero lower bound. At that time the fed funds target was irrelevant, as there were excess reserves in the system, and the effective fed funds rate was irrelevant, as it reflected risk."

     I actually find this a very interesting argument. Ironically, it kind of helps another 'journalist' SW is not such a big fan of: Paul Krugman. Sumner has often said that Krugman's liquidity trap can't begin to explain the EU which had a an interest rate of 2%-they even raised it in 2011!. So the argument for the LT dissipates entirely. Yet, if SW is right, then Krugman isn't wrong to referring to the EU as at the ZLB the last 5 years. 

    As I mentioned yesterday, I'm currently reading Richard Koo's The Holy Grail of Macroeconomics.

    http://diaryofarepublicanhater.blogspot.com/2014/03/dont-call-richard-koo-keynesian.html

   He makes the same argument about the interest rate not mattering-not for Sumner's reason where the important monetary target is not interest rates-because of the excess reserves in the system. I don't know that he would agree with Koo about the balance sheet recession idea-this goes against standard Macro that firms are always maximizing, though I don't know for sure. I tend to doubt he'd be a fan of Koo but on the fed funds rate he and Koo agree. 

  Glasner is right that Bernanke didn't see it that way. He really seems to have thought that cutting further may have spiked inflation. Yet what's interesting is that Koo also argues that a CB can lower inflation when it's rising but can't hike it when it's falling, He argues that the Fed can't raise the inflation rate, but that in any case deflation wasn't the problem but rather that firms are paying down debt rather than seeking new debt. This fact makes the FF rate irrelevant as SW says.