Mr. Kocherlakota’s outspoken advocacy for stronger action is particularly striking because he spent his first three years at the Minneapolis Fed, after his appointment in 2009, loudly arguing that the Fed should do less. It also represents a sharp break from the Minneapolis Fed’s longstanding association with economists who contend that monetary policy lacks the power to reduce unemployment.That's correct, but it might lead you to think that everyone who works or has worked for the Minneapolis Fed thinks that monetary policy is irrelevant. If you analyzed all of the research coming out of the Minneapolis Fed for the last 40 years, I don't think you would find it any more representative of that view than what you see in the economics profession at large. Of course there were prominent people in Minneapolis - Prescott being the standout - who pushed that view. But anyone who has been around the Minneapolis Fed knows that the people in that place take nothing for granted. Certainly Prescott's view of the world is not taken as religion on the premises.
I disagree with this statement:
Mr. Kocherlakota’s shift has surprised and dismayed some people at the Minneapolis Fed and economists who supported his appointment because they expected him to be a principled opponent of the Fed’s stimulus campaign.I don't think the potential policy positions of Kocherlakota were a concern of anyone who cared about who the replacement for Gary Stern would be. Within the institution, as in any research institution, people I think were concerned about having a leader in place who understood research and the role it could play in policy. Much work had gone into building a top notch research institution in Minneapolis, beginning in the early 1970s, and everyone who contributed to that effort seemed interested in furthering the tradition. Kocherlakota was chosen by the Board of Directors of the Minneapolis Fed, but I think the views of researchers in the institution played an important role in the choice. And I don't think there were litmus tests about policy views that went into that determination.
Here's another point of contention:
In October, Mr. Kocherlakota fired Patrick J. Kehoe, an economics professor at the University of Minnesota, from his position as a monetary policy adviser at the Minneapolis Fed. Another Fed adviser, Ellen R. McGrattan, was given a new position as a consultant. Both Professor Kehoe and Ms. McGrattan are proponents of the view that monetary policy has little power to lift an economy from recession.That last sentence is incorrect. Factually, it's hard to nail Kehoe as a proponent of monetary policy neutrality, as I argued here. This also gives the impression that the disagreements with Kehoe and McGrattan were based on policy. As far as I can tell, that's wrong.
Here's something interesting. Prescott is quoted in the article as follows:
It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed.So, my guess is that, when you read that, you're wondering what kind of lunatic this Prescott is. I've known Ed for long enough to know that he's a very deep thinker, and a serious scientist. He also loves to be provocative. So, what could Prescott be thinking when he says the Fed is irrelevant?
Let me play devil's advocate, and argue Prescott's point. The U.S. has had a central bank only since 1914, but somehow managed to surpass the U.K. - the home of the first central bank, established in the 1694 - in terms of per capita income sometime during the 19th century. But maybe you think that the Fed was important as an institution for eliminating or at least mitigating the effects of financial panics, which occurred repeatedly in the U.S. after the Civil War and before the Federal Reserve Act was passed? On this, Canada is an important counterexample. There was no Canadian central bank until 1935, but Canada managed to avoid the financial panics that occurred in the U.S. in the 19th century. Thus, it appears that central banking is not necessary for development, nor does it appear to be necessary to prevent panics.
What about the Great Depression? Friedman and Schwartz thought that the Fed's behavior during that period was important, at least in propagating the Great Depression. But in Kehoe and Prescott's book, Hal Cole and Lee Ohanian make the case that we can make sense of the Great Depression without thinking much about monetary factors, or banking, for that matter. Again, if we were to view central banking as the key to preventing banking crises, obviously the presence of the central bank didn't prevent 1/3 of U.S. banks from failing in 1933, and Canada sailed through the early part of the Great Depression with no central bank, and no bank failures.
In terms of aggregate fluctuations, it was once thought that a cursory look at the time series showed the benefits of stabilization policy - clearly post-WWII volatility in real GDP was much smaller than pre-Great Depression real GDP. But Christina Romer's work called that into question. If you do the measurement in a different way, it's not so clear. In more recent times, we all know about the Great Moderation, which was supposed to have been a great victory for monetary policy, but was followed by the immoderate recession of 2008-09.
If we look at what explains the differences in levels of per capita income across countries, I don't think anyone argues that central banking is an important factor. But there is plenty of work ascribing the dispersion in standards of living in the world to misallocation in factors of production, human capital, productivity at the firm level, political factors, and property rights. Ross Levine makes the case that financial factors are important for economic growth (poor financial arrangements could be part of what the factor misallocation comes from), but it's not clear what link might exist between central banking and general financial health.
So, I don't want to put words in Prescott's mouth, but that's the case he might make. On the other side of the argument, we have Friedman and Schwartz's monetary history, and a wealth of other empirical evidence aimed at showing that monetary policy matters. I think there are few macroeconomists who would argue that short-run nonneutralities of money are non-existent, though many of them would give you an argument about the wisdom of exploiting those nonneutralities.
Further, in spite of the fact that some countries functioned well in the past without central banking, in the complicated world of modern finance, it's possible these institutions are critical. Friedman was of course a big advocate of laissez-faire, but not in monetary arrangements - he thought the government should be the monopoly supplier of currency, and that the central bank had an important role to play. We may now consider some of his monetary policy prescriptions wrongheaded, but if Friedman were alive and were Prescott's colleague, he would be giving him a hard time over lunch.
In any case, we should not be dismissive of what Prescott is saying. We need to think carefully about what our central banks are good for. Perhaps central bankers, and the public, have been taking the role of monetary policy too seriously. One can certainly make a case, as I have, that the Fed has recently been inclined to confidently leap into unknown territory, with too little thought for the consequences.