Scott Sumner  

Should declining mobility impact monetary policy?

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David Beckworth has a new post discussing the implications of declining interstate mobility for whether or not America is an optimal currency area. Adam Ozimek has a post suggesting that lower labor mobility might imply a need for additional monetary stimulus:

So overall, we less mobility out of struggling places, and even if we could incentivize more mobility out of struggling places it is likely that this adjustment measure's efficacy has fallen as declining populations create a different negative economic shock that would counteract the positive effects of a tighter labor market. What is the implication for monetary policy? If the Fed was setting interest rates for the worst performing 20% of the U.S., it would keep interest rates lower for longer. This would result in overheating in some parts of the country that are farther along in their recoveries. However, the costs of above trend inflation in the cyclically recovered parts of the country are lower than the costs of remaining cyclical slack in the struggling parts. Letting inflation run ahead of target will help the places that are behind catch up, while those places that are ahead will merely experience some low cost excess inflation.
I don't think this is correct, although I have an open mind on the issue. Here are some thoughts:

1. The Fed targets inflation at 2%. Monetary theory suggests that policy is roughly superneutral with respect to changes in trend inflation, at least in the long run. That means there is no long run trade off between inflation and unemployment. The average unemployment rate will be about the same at 2% trend inflation and 6% trend inflation. I say "roughly" because this is not exactly true, but the science of economics is not far enough advanced to know whether average unemployment would be slightly lower at 6% trend inflation, or slightly higher.

2. Because of point one, it's meaningless to talk about monetary policy "hawks" and "doves". A hawk or a dove is someone who does not have a clear understanding of monetary theory. The decline in mobility has no obvious implications for the optimal trend rate of inflation.

3. Ozimek's post doesn't mention a higher trend rate of inflation, but rather the possibility that monetary policy should be more expansionary at this point in time. This raises the question of whether declining mobility impacts the optimal degree of flexibility in the Fed's "flexible inflation target." This is certainly possible.

4. The best way to think about flexibility is to start by imagining a simple inflation target---single mandate---and then consider what happens if Congress adds a second mandate for employment. Most economists don't think the second mandate affects the optimal trend rate of inflation (except ruling out ultra-low trend inflation), but do think that it impacts the optimal cyclicality of inflation. With a dual mandate, policy should be a bit more expansionary during periods of high unemployment and a bit more contractionary during periods of low unemployment. That is, policy would be slightly more countercyclical---"leaning against the wind." NGDP targeting is one example.

5. I'm not sure how declining labor mobility impacts the optimal degree of flexibility, but I'd guess that it implies that the Fed should pay a bit more attention to unemployment than would be the case if labor mobility were high. Adam seems to have the same view.

6. The unemployment rate is currently 4.3%, which is the lowest rate since 1970, excluding a two-year period around the millennium. Obviously this is a period of relatively low unemployment. Thus if we are going to ask monetary policy to pay a bit more attention to the unemployment rate, then we'd actually want a tighter monetary policy at this point in time.

In general, the best way to think about monetary policy is not to imagine what sort of policy would make us better off at this moment in time (that would almost always be a more expansionary policy), but rather what sort of monetary regime performs best over a long span of time, given the structure of the economy. For this timeless perspective, the issue is not about hawks vs. doves, it's about how much weight to put on the employment part of the dual mandate. But remember, if you put more weight on employment it means a tighter monetary policy when the unemployment rate is lower than average---like right now.

I wish monetary policy could always be more expansionary than average, but unfortunately that only works in one place:

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PS. I think you could actually make a stronger argument for declining mobility creating a need for a higher inflation target---based on how the zero bound problem affects the Fed's ability to hit its dual mandate. But that's very different from calling for easier money right now.




COMMENTS (9 to date)
Andrew_FL writes:

Kouparitsas found in 2001 that the US was already not an Optimum Currency Area according to the classic criteria. In all likelihood it has never been one.

Airman Spry Shark writes:

I think this misses Ozimek's (implicit) point; I'll try to illustrate with a toy example.

Assume two regions of equal size (for easy math) with a shared currency. Under their current monetary stance, average NGDP growth is 3%: 8% in the recovered region & -2% in the recessed region.

Additional NGDP growth would be necessary to get the recessed region into positive territory; Ozimek passes this through the common "inflation" distortionary filter, but the mechanism seems straightforward.

John Hall writes:

Two sources of the decline in labor mobility: government regulations and changes in risk aversion.

If government regulations are the cause, then that would be consistent with a world where aggregate supply has shifted left. So the slowing growth we see is consistent with moving along the aggregate supply curve. However, wouldn't that also predict a higher inflation rate?

I would think that an increase in risk aversion would have the same effect on aggregate supply.

Colin W writes:

Scott, regarding your first point, I think an issue is that even if monetary policy is super neutral over long horizons, this is clearly not true over shorter time spans, and for regions where the current monetary stance is too tight, this may impose significant welfare costs. Obviously the welfare cost of business cycles is an unresolved topic in the econ literature, but my own belief is they are certainly non-trivial.

Of course, there are others like Roger Farmer who believe that the persistance in the data imply that there are multiple steady state unemployment rates, and that monetary policy can move us between these rates...

Thaomas writes:
The Fed targets inflation at 2%.

1) No, the Fed SAYS it targets inflation at 2% but if that were true, the price level would not have drifted farther and farther below a 2% pa increase. If that were true, the Fed would not have raised ST interest rates in December 2015 and several time since and wold not be threatening to raise them again. I think the term "inflation target" has become so contaminated by the Fed's actions that we need a new term, something like "price level increase target."

2) Yes it does make sense to talk about "hawks" and "doves." A hawk is one who supports further monetary tightening when the price level is still below trend. A "dove" supports monetary stimulus when the price level is below target.

3) The optimal inflation target (price level increase target) ought to depend on the degrees of rigidity in wages and prices relative to the shocks that the economy is subject to, i.e. to the number of wage rates and prices that need to fall relative to the average by more than the price level increase target to maintain microeconomic equilibrium. I'd suppose that a growing disinclination to move (a larger wage differential becoming necessary) would count a the kind of increased rigidity that should push the FEd to increase its price level increase target

4. I agree even if/when the Fed has a price level increase target. And I agree that an NGDP level increase target would be one interpretation of a dual mandate, one specific parameter value for how much the Fed would allow the PL to move away from target based on the cyclical unemployment rate.

5) Yes. See point 3)

6) I agree agree if a) the Fed were actually following a price level target. That is if the PL were one target, the unemployment rate would suggest some slight tightening b) and if one could be sure "the" unemployment rate is the right measure of labor market slack. In 2017 the first of these conditions does not hold and the second -- given the still low employment rate -- may not.

Gordon writes:

If the Federal Reserve responded in the way Ozimek suggests, I could see the higher NGDP (and higher prices) giving ammo to those who seek a significant increase in the national minimum wage. It would be one thing if the 20% worst performing areas of the US could hold down labor prices while they rise elsewhere. But a significant increase to the national minimum wage would completely undermine that.

Thaomas writes:

@Gordon

If more monetary stimulation during recessions whether through a symmetric inflation target (= PL targeting) or NGDP targeting were successful in stimulating higher real growth, as I think it would, and at least some of the higher real income went into rising real wages and fewer workers actually earning the legal minimum, as I think it would, the result ought to be somewhat less pressure to increase the real minimum wage. A higher minimum wage would, however, remain an inferior tool for redistributing income to a higher EITC

Scott Sumner writes:

Airman, Yes, I understood that was his argument, but I don't accept it for the reasons I stated. You should not think about monetary policy in terms of what's best at a point in time, but rather what sort of regime is optimal over an extended period of time.

John, Whether a decline in AS raises inflation depends on what's happening to AD.

Colin, I agree that money is not superneutral in the short run (or even neutral), and that cyclical costs are large. That's all accounted for in my answer.

Thaomas, The Fed continues to forecast 2% inflation. The fact that actual inflation has recently fallen short does not prove they are not forecasting 2% inflation. The consensus of private forecasters also calls for 2% inflation.

Gordon, Yes, that's possible.

Colin W writes:

Scott, sorry, I misunderstood some of your points; I was thinking about things too much in terms of the question in preserving the currency union, which is not the point of the Ozimek excerpt. Agree with your postscript about a higher inflation target. I wonder how much declining mobility in the U.S. will raise political scrutiny of the Fed and its regime choices/monetary goals, as states/regions may feel that monetary policy is harming them but benefitting others.

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