If you’re walking down the street and then you fall into a giant hole, and then you climb 10 percent of the way up the hole, you have two choices. One is to keep climbing until you’re not in the hole anymore. The other is to note that you’re actually moving surfaceward quite rapidly and should maybe try to slow down. The former option will be taken by any sensible person. The latter option will be taken by Minneapolis Federal Reserve President Narayana Kocherlakota:
“As the economy recovers, the FOMC should respond by reducing the level of monetary accommodation,” Kocherlakota said.
“The FOMC should only increase accommodation if the economy’s performance, relative to the dual mandate, actually worsens over time,” he said, referring to the central bank’s goals of maintaining price stability and ensuring full employment.
Levels and rates, my friends. Stocks and flows. It’s true that if you start from a decent position, monetary policy should adjust to the direction of change. But if you start from 9.1 percent unemployment and respond to growth with tighter money, then you’re simply guaranteeing that the economy never regains full employment. There’s no way to go from 9.1 percent unemployment to 7 percent unemployment without many more people driving their cars to work, increasing demand for gasoline and pushing oil prices up. If you don’t accommodate that increase in inflation you can’t ever get the 7 percent unemployment. Kocherlakota’s view is that given the initial failure that led to mass unemployment, it’s not permitted to ever correct the failure. We just pretend it never happened.