The Myth of Expectations

Yglesias today has a post titled "
FOMC Adopts Game-Changing Conditional Inflation Targeting Rule."If you've read his site much you can probably guess the rule - as Matt puts it the Fed "has stopped screwing around and started doing real expectations-based monetary easing.".

I've had beef with Matt about this expectations business for years, and I'm glad to see that Matt is enthusiastic about this change and not saying "well, true NGDP targeting would be better."  He's recognizing that this is the idea Matt has been flogging and if it doesn't spur economic growth by easing monetary conditions, that's a bust to the idea.

The thing Matt - and many others - fail to understand about the so-called "expectations channel" is that it's something that occurs as a result of other consequences of a policy, not as something unique unto itself.  The Fed makes a policy change, the policy change makes an impact, and then there is additional impact because people's expectations about economic performance change.

The idea that economic conditions today are being impacted by expectations about Fed action in 2014 is completely unfounded.  The new Fed targeting model may well be a great idea!  It could lead to better policy!  Hooray!

What the new model doesn't do is give the Fed new policy tools.  Fed policy is the same as it was yesterday - as expansionary as possible for as far as the eye can see.  Expectations don't change conditions, conditions change expectations.  THEN expectations can theoretically have an accelerating effect.