More on the Output Gap

Only time for a quick post between classes today…

Hoisted from the comments from my last piece, Steve notes:

In an interview with Bloomberg last week, Bullard explicitly said he expected the economy to follow a new output trend out of the base of the recession rather than a recovery to a trend from the previous peak. The written media didn’t pick up on these quotes; rather they focused his comments that explicit inflation targeting is near.

I missed that interview, but found it here.  And yes, St. Louis Federal Reserve President James Bullard does say that estimates of the output gap are too high and will be revised downward. He says the outcomes of the last expansion were not related to economic fundamentals and thus we should not expect to be able to return to those levels of output and, presumably, employment.  He does not aim to return to the pre-recession trend of output growth and is instead ready to manage the economy along the new path.  Bullard does admit, however, that he has gotten little traction for his view.

On the other end of the spectrum, San Fransisco Federal Reserve President John Williams offers an interview to the Wall Street Journal, and sounds dovish even after the most recent employment report:

In a follow-up email exchange, Mr. Williams wrote that the report didn’t fundamentally alter his views on the economy.

“My view of it is inflation is going to be for a sustained period below target,” he said. “Unemployment is going to be sustained above a reasonable estimate of the natural rate of unemployment, which is closer to 6.5% than the 8.5% that we have now. That does make an argument that we should have more stimulus.”

There is a caveat, however:

Mr. Williams also hedges, though, adding that it “really depends in how much confidence you have in that forecast. And also there are costs to taking greater policy action. There are always trade-offs that have to be weighed.”

This is frustrating, because if there is indeed an argument further stimulus, what is holding the Fed back?  Why hedge by questioning the forecast?  And what are the costs?  Presumably the cost is higher inflation, but Williams already says he expects inflation to be below target.  So why pull your punches?

I am starting to wonder if the whole “we can do more” meme from the dovish side of the FOMC has more to do with just offering a counterweight to the hawks who seem to see an imminent need for tightening rather than a push for an actual policy change.

This post originally appeared at Tim Duy’s Fed Watch and is posted with permission.