Thursday, May 03, 2012

Reasons for "apparent status quo" bias at the Fed

As a follow-up to my last post, I want to think out loud a little more about why the Fed should have a bias toward doing nothing. Warning: these thoughts just came off the top of my head, and may be crazy. But anyway...

For a doctor, status quo bias makes sense, because of the principle of "first do no harm". For a government, status-quo bias in the form of laissez-faire bias makes sense when you believe in free markets. But the Fed is different. Because for the Fed, "doing nothing" is not really doing nothing! Even when the Fed is keeping interest rates unchanged and refusing to engage in quantitative easing (as it is now), it is still printing money, and it is still managing expectations. (In fact, since silence affects expectations differently the longer you keep it up, Fed policy is always changing even if the Fed clams up completely!) What looks like the "status quo" is really only the apparent status quo.

So why would the Fed have a natural bias toward seeming to do nothing? I thought about it, and came up with the following reasons:

1. Internal politics bias. The Fed's decisions are probably dependent on some sort of internal decision-making procedure in which the opinion of the different governors are taken into account in some way. Current Fed actions reflect a balance between hawks and doves. As long as this balance is stable, the Fed will be biased away from taking any apparent actions. Only outside events or a change in the opinions or composition of the factions within the Fed will alter the balance of power.

2. Reputational bias. Anything the Fed does is going to make someone mad. People pay more attention to things that make them mad than to things that please them. And people pay more attention when the Fed is in the news (i.e. when it appears to do something) So any action that the Fed appears to take is going to result in negative attention directed at the Fed chairman. The Fed chairman, being human, probably doesn't enjoy negative attention. So this is a reason for the Fed chairman to keep a low profile by seeming to do nothing.

3. Credibility bias. Again, people tend only to pay attention to what the Fed seems to do, rather than what  the Fed actually does. And each time the Fed seems to do something, it makes people more uncertain as to what the Fed actually wants, what it knows, what it believes, and what it is planning to do. The Fed values credibility, so it will seek to minimize taking headline-grabbing actions that make people actively wonder what the Fed is going to do in the future.

4. Asymmetric model uncertainty. This applies specifically to the Fed's reluctance to engage in quantitative easing. Paul Krugman has discussed this before. To make a long story short, history has seen many changes in the Federal Funds rate, but not many instances of QE, so it's more difficult to select a model to give you guidance when contemplating QE than when contemplating routine open-market operations. Therefore, to do QE, you have to take a much bigger leap of modeling faith. This will bias the Fed toward apparent inactivity when short-term nominal interest rates are at the Zero Lower Bound, as they are now.

So these are some reasons why Fed policy might currently be "stuck". Hawks inside the Fed are not strong enough to make Bernanke raise interest rates, and this will probably be the case for the foreseeable future. But a combination of reputation bias, credibility bias, and model uncertainty make Bernanke very reluctant to engage in further QE. And a combination of reputation bias and credibility bias make Bernanke reluctant to make additional statements about future Fed policy.

So what can academic economists do to convince Bernanke to do more QE? Well, they can write papers about QE, thus reducing (slightly) model uncertainty. They can try to get the public to realize that Fed "inaction" is really just stealth action, by couching their public complaints in different terms ("Why is the Fed doing X" rather than "Why is the Fed doing nothing"). But these efforts are not likely to have huge success. Is there any other way to reduce "apparent status quo" bias? I'm not sure.


  1. Anonymous6:08 PM

    Have a look at the posts at interfluidity. He has lots of intuition about our current stagnation malaise.

  2. i agree with all these reasons and would add another: no accountability - no incentives whether they are wrong or right. think of the number of times their forecasts have been dead wrong yet there were no consequences.

  3. Anonymous8:22 PM

    I agree with all the reasons, but there's a very basic reason: which is the dual mandate of price stability and full employment. A wise man once said:

    These dual mandates are like fair weather friends, because when the heat is on—like it is today—they actually become dueling mandates.

    Is that not true today? Some board members may want to do more QE (e.g, Evans) in order to achieve the target of full employment, while there are real risks of adversely affecting general price level.

    Here's my thinking: aren't both price stability and full employment in some way directly related to the velocity of money ? Are there any statistics that actually measure the velocity of money?

    If the value of monetary unit (based on the goods and services that it can purchase) should remain more or less constant [which leads to the goal of price stability], then the velocity should be stable and low right? It shouldn't go to zero obviously, then we have a severe contraction.

    Shouldn't this velocity be high for full employment (which essentially increases the overall wage level, therefore more money for people to spend on goods/services)?

    Can we agree that the FOMC should essentially be able to directly affect the velocity of money in the desired direction in order to achieve their goal? If we agree on that, can we take this one step forward and see if their tools can actually be able to do this? To me, it feels like the velocity is a non-linear and a moving target and they can't really control it as much as they think they can ;).

  4. Noah, your problem is that all of this is indistinguishable from the Fed having a strong right-wing bias, and Bernanke not having the stones to literally kick some *ss (because he's an economist, and economists tend to be right-wing).

  5. Circling back for another run:

    Let's try thinking like a real, honest economist. The 'do nothing' policies are promoted by people who are:

    Wrong again
    Wrong again and again and again............
    Not displaying any sign that they give a f*ck about being wrong.
    Not incentivized in any way, shape or form to be right.

    Now, please tell me why we should follow their advice?

  6. Anonymous11:08 PM

    Suggested topic for Oxford Union debate: This house believes the American economics profession presents a large negative externality to the world economy and should be taxed out of existence.

  7. Another possible reason: The non-presidential appointees from the regional reserve banks are mostly from culturally conservative places, and lean conservative. This implies a rejection of novelty, and an outsized respect for wealthy "job creators." Meanwhile, it has been a standing convention since the 80s that the board presents itself as united, so the presence of these members forces the more activist members not to say what they really think.

  8. Anonymous9:15 AM


    You might be interested in an article by economic sociologist Greta Krippner on the recent history of US monetary policy: "The making of US monetary policy: Central bank transparency and the neoliberal dilemma." I think her historical analysis gets at a lot of the same tensions you are describing in terms of privileging "seeming to do nothing" even though that's not actually possible for the Fed.