RE: PKT Seminar: FRB Theories

["Alan G. Isaac" <AISAAC@xxxxxxxxxxxx>]

In attributing motives to the Fed, I think it is odd to suggest
that unemployment per se is sought. For one thing, I do not think
the Fed reaction function literature supports this. Also, when I
chat with people at the Fed, I don't get this impression (at all).

Of course, if you take seriously the price Phillips curve, the
Fed focus on controlling inflation may impose higher unemployment.
This is especially true when they attend to unemployment rates
and capacity utilization as leading indicators of inflation.

But I share Doug's scepticism of Jamie's project of finding the
"theory"  underlying Fed behavior. I think the Fed relies on
an array of indicators selected for their past correlations
and occasionally for better reasons. The one piece of "theory"
that I do think is relevant is a conviction that monetary
policy is a more important determinant of inflation trends
than of unemployment trends or real income trends. (And, if
the period over which we are trending is long enough, it
is far from obvious that this is mistaken.)

Finally, I hope that Jamie or someone else will respond to
Doug's request for evidence (below).

--Alan G. Isaac

On Tue, 1 Nov 1994 08:42:40 -0700 Doug Henwood said:
>Does the Fed really need a theory to operate by? Volcker's embrace of
>monetarism was in all likelihood a ruse, designed to cover driving up
>interest rates to 20%. They're just a bunch of pragmatists, who want to
>keep inflation low, unemployment tolerably high, but stopping short of a
>debt deflation and political rebellion. We may not like it, but is it
>*that* hard to figure out what they're doing?
>
>Are they wrong to associate present levels of capacity utilization with
>an acceleration of inflation? That's a different question from whether
>inflation is now serious or trivial, obviously. But they've made it
>clear, and the credit markets have made it clear, that they do not want
>the inflation rate to rise much past the present 3% level. That may be
>the wrong target, but are they wrong to suspect that inflation rates are
>poised to rise? They've already risen from about 2.5% in early 1994 to 3%
>now.
>
>Several other questions:
>...
>What is the evidence that tightening helps the banks at the expense of
>mutual funds and the stock and bond markets?