NY Fed talking their book?
Below a piece from the NY Fed’s relatively new blog. Although the contributors are somewhat in Fed’s hands, some parts are worth reading, although the message is not new.
In 1937, on the eve of a major policy mistake, U.S. economic conditions were surprisingly similar to those in the nation today. Consider, for example, the following summary of economic conditions: (1) Signs indicate that the recession is finally over. (2) Short-term interest rates have been close to zero for years but are now expected to rise. (3) Some are concerned about excessive inflation. (4) Inflation concerns are partly driven by a large expansion in the monetary base in recent years and by banks’ massive holding of excess reserves. (5) Furthermore, some are worried that the recent rally in commodity prices threatens to ignite an inflation spiral.
While this summary arguably describes current trends, it is taken from an account of conditions in 1937 that appears in “The Mistake of 1937: A General Equilibrium Analysis,” an article I coauthored with Benjamin Pugsley. What we call “the Mistake of 1937” was, in broad terms, a decision by the Fed and the administration to implement a series of contractionary policies that choked off the recovery of 1933-37 and brought on the recession of 1937-38, one of the worst on record. What is particularly noteworthy is that the inflation fears that triggered the Mistake of 1937 were largely driven by a rally in commodity prices. These circumstances invite direct comparison with our own time, when a substantial recent rise in commodity prices (which now seems to be abating somewhat) stoked inflation fears and led some commentators to call for an increase in the federal funds rate.
The question for the contemporary reader is this: If we could transport a modern-day economist back to 1937, would he or she have made the same mistake? My suggested answer—admittedly somewhat hopeful—is no. I base this view on the fact that most economists today distinguish between the temporary movements in the consumer price index that stem from volatility in commodity prices and the movements that reflect fundamental inflation pressures. Hence a modern economist most likely would have identified the price rise in 1936 and 1937 as a temporary upswing in commodity prices that did not signal a significant increase in overall inflation.
It is unlikely, however, that a modern economist put in the same position would respond to the commodity price rise in the same way. Economists today generally do not focus on commodity prices without regard to the behavior of the aggregate price index. The rally in the commodity markets in 1936 and 1937 seems to have been driven largely by temporary supply factors, rather than by upward pressures in the overall price level. This finding is borne out by the fact that while the price of some commodities (such as corn) more than doubled between 1936 and the Mistake of 1937, the CPI rose at a slower pace (see the first chart in this post), peaking at a 4.8 percent year-on-year rate in May 1937. What this reflects, I believe, is that while some components of the CPI were very volatile, the aggregate index was not moving much at all.