By Steven K. Beckner

(MNI) – When it comes to a key monetary policy issue — the amount
of “slack” in the economy — opinions vary widely among Fed
policymakers, but Atlanta Federal Reserve Bank President Dennis Lockhart
has it about right with his belief that resource slack is neither as
great as some contend or as small as others maintain, according to an
aide.

Michael Bryan, vice president and senior economist for the Atlanta
Fed says the evidence supports what Lockhart has called his position in
the “gray middle” on the amount of slack.

Macroeconomists and Fed officials are more inclined to talk about
the size of the “output gap” — the difference between actual and
potential GDP growth — than about slack. Either way, a debate has been
raging for months on the Fed’s policymaking Federal Open Market
Committee about how big the gap, or the slack, really is.

It’s not an inconsequential issue.

Those, such as Fed Vice Chairman Janet Yellen, who think the gap is
large, that there are a lot of unused or under used labor and other
resources, are inclined to think there is ample room for monetary policy
to stimulate demand and reduce unemployment without fear of engendering
inflation pressures.

Those, such as Richmond Fed President Jeffrey Lacker, who think
various “structural” factors have narrowed the effective output gap, are
inclined to think the Fed has less room to safely inject additional
stimulus.

As Bryan writes on the Atlanta Fed’s “macroblog” after quoting
Yellen and Lacker, “The positions outlined above lay bare why estimates
of the output gap command such weight in the discussion of monetary
policy — both ends of the FOMC’s dual mandate of maximum employment and
price stability may run through it.”

“If the output gap is large, that is, if the level of gross
domestic product (GDP) is running significantly under potential GDP, the
economy is obviously not in a position of maximum employment,” he says.
“And if that is the case, the inflation trend is likely to be headed
lower and so the price stability mandate may also be in jeopardy.”

Lacker has said he thinks labor market inefficiencies, extended
unemployment insurance and the like “account for a quite substantial
portion of our elevated unemployment rate.”

Yellen, on the other hand, has asserted that “the bulk of the rise
(in unemployment) during the recession was cyclical, not structural in
nature.”

Lockhart, an FOMC voter, takes a middle position.

“I think the output gap — the amount of slack in the economy –is
neither as sizeable as the high-end estimates, nor is it zero,” Lockhart
said in a recent speech in Jackson, Mississippi.

“If there were no slack at all, 8.2% unemployment would represent
full employment,” he continued. “If this were so, the economy would have
undergone profound structural change over the last five years. As I
weigh the findings of research by Federal Reserve economists and others,
I do not think a compelling case has yet been made that structural
adjustment has played a dominant role in slowing growth and progress
against unemployment.”

“If, on the other hand, slack in the economy were close to the high
estimates, we should have seen more and more persistent downward
pressure on prices and wages than has, in fact, been the case,” Lockhart
went on. “Deciding on the extent of the output gap is not
straightforward. I believe the truth is in the gray middle.”

Bryan defends Lockhart’s position.

“To emphasize, this ‘gray middle’ isn’t a compromise but a weighing
of the available evidence,” he writes. “If the GDP gap really is close
to zero, the profound structural change that the economy ought to have
experienced hasn’t found great support in the data.”

“But if this is just a bigger version of gaps of recessions past,
then where is the great disinflationary pressure such slack would
ordinarily imply?” Bryan asks.

The size of the output gap almost certainly is up for discussion
again at this week’s FOMC meeting.

** MNI **

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