First let’s get the bad news out of the way. Greg Mankiw is much too kind to the Fed:
Mr. Bernanke became the Fed chairman in February 2006. Since then, the inflation measure favored by the Fed — the price index for personal consumption, excluding food and energy — has averaged 1.9 percent, annualized. A broader price index that includes food and energy has averaged 2.1 percent.
Either way, the outcome is remarkably close to the Fed’s unofficial inflation target of 2 percent. So, despite the economic turmoil of the last five years, the Fed has kept inflation on track.
Two quick reactions:
1. Remember the man who drowned in the lake that averaged 2 feet in depth?
2. Remember the Fed’s dual mandate?
Nonetheless, Mankiw (who I’ve recommended before) is the perfect choice. He’d fly through the Senate. Academically impeccable Bernanke and Mankiw, both Republicans, would form a one-two punch that the hawks couldn’t resist. And he’d be pushing for the most expansionary policy that is politically realistic:
What the Fed could do, however, is codify its projected price path of 2 percent. That is, the Fed could announce that, hereafter, it would aim for a price level that rises 2 percent a year. And it would promise to pursue policies to get back to the target price path if shocks to the economy ever pushed the actual price level away from it.
Even better, Mankiw has anticipated the argument of the hawks, and pre-empted it:
Such an announcement could help mollify critics on both the left and right. If we started to see the Japanese-style deflation that the left fears, the Fed would maintain a loose monetary policy and even allow a bit of extra inflation to make up for past tracking errors. If we faced the high inflation that worries the right, the Fed would be committed to raising interest rates aggressively to bring inflation back on target.
MORE important, an announced target path for inflation would add more certainty to the economy. Americans planning their retirement would have a better sense about the cost of living a decade or two hence. Companies borrowing in the bond market could more accurately pin down the real cost of financing their investment projects.
This puts sand under the tires of the Obama administration. Yes, they would no longer be able to do anything with fiscal stimulus (zero multiplier), but if you’ve been reading the news you know that’s not happening anyway. It is an insurance policy against fiscal tightening. And it lets the Obama people push the SRAS as far right as they can, knowing the Fed has committed to keep up with AD. Bye-bye to Paul Krugman’s depression economics. Hello to supply-side econ. You do an emergency two year cut in minimum wages. Don’t think a Democrat can cut wages? Have you been following the Socialists in Greece? Cut UI benefits to 52 weeks max. Cut the employer side of the payroll tax for two years, and raise the employee side equally. Worried about the effect of the employee side on AD? You haven’t been paying attention—price level targeting means adverse demand shocks don’t matter, because they’re offset.
I think Mankiw knows the oil shock is probably about over. That means the economy’s slack will push inflation back down toward 1% to 1.5% over the next few years. This policy would force the Fed to move aggressively. And the more Obama tries to reduce business costs, the more he forces the Fed to boost the economy.
I’m sure most people read Mankiw and thought “blah.” He doesn’t have the extremism of this blog. But he’s a very canny pragmatist, and is much better at the practical side of politics than I am. My role in life is to try to rearrange people’s brain cells. It’s people like Mankiw that actually make the world run.
I don’t know if he’d accept the job, but it never hurts to ask.
HT: Marcus Nunes, JTapp
Update: I forget to mention that they should target core inflation—a robust recovery might push up oil prices. Oh, and cut government wages for two years, to free up more NGDP for private hiring.