Again I’m way behind with everything, but a quick comment on my “ban” of the term ‘inflation’. I’m way too lazy to go through and censor every comment, what I really meant was “not respond to comments that don’t clearly express the concept they are discussing.” Inflation doesn’t clearly express any meaningful economic concept. (I erred in using the term “ban.”) And even that was done half jokingly–just to be provocative. Knowing my lack of self-control, I’ll probably be back responding to “inflation” comments within weeks. So stop worrying about 1984.
Greg Ip has a very long piece discussing all sorts of potential problems with NGDP targeting. Since I don’t see any major faults in the idea, it’s not surprising that I don’t agree with Ip. But I’ll focus on one passage for the moment, and perhaps consider the other objections in a later post:
So why doesn’t it? The Fed now finds itself in the odd position of being blasted from one side for doing too much and the other for doing too little. There is far more substance to the latter arguments than the former, but NGDP advocates base their arguments on a flawed premise: that with a different framework the Fed would have been less concerned about inflation and more about output, and would have thus eased more aggressively.
That was true for only for a narrow window: the summer of 2008 when oil prices spiked; at the time, the Fed, worried that high headline inflation could find its way into higher expected inflation, paused in its easing, although at least, unlike the ECB, it did not tighten. But for most of 2008, the Fed was easing. Scott Sumner and other NGDP advocates claim that had the Fed been targeting NGDP, it would have responded sooner and far more aggressively.
This fundamentally misinterprets the Fed’s behavior. The Fed’s failure to act sooner and more aggressively was down not to its policy framework but its forecast. As late as October, 2008, it thought unemployment would peak around 7.5% in 2009 and GDP would grow slightly. It also thought inflation would fall to around 1.5%, below its long-term objective. This forecast led it to lower short-term interest rates over the next two months to zero and initiate its first round of quantitative easing. A more pessimistic, and accurate, forecast would have resulted in a more aggressive policy.
If money was easy in the US during 2008, then it was easy during the US during the 1930s and Japan during the late 1990s and 2000s. Is that really Ip’s view?
More importantly, this episode is a perfect example of the trouble central banks get into when they use their own judgment, and don’t rely on market forecasts. The Fed had no business (in October 2008) forecasting 1.5% inflation for 2009. All the market indicators were screaming deflation and deep recession. So they need to start targeting market forecasts.
But it’s even worse than that. Even if I’m wrong, and if the Fed should ignore markets and use its own internal forecasts, Ip’s data shows that Fed policy was disastrously off course in October 2008. Indeed I started my crusade for easier money that very month because it was obvious to me (and others I talked to in late 2008 like Greg Mankiw) that demand growth in 2009 was likely to come in at levels below what the Fed wanted. They weren’t even expecting to hit their own policy goals.
Think about the Fed’s dual mandate; low inflation and high employment. In October 2008 they forecast inflation of 1.5%; below their 2% implicit target for “stable prices.” And they forecast a sharp rise in unemployment. The Fed should never make that sort of forecast, as it implies their policy is far too tight. That’s the sort of policy that would make Lars Svensson roll over in his grave. (Actually he’s still alive—it would give him a fatal heart attack, and then he’d roll over.) Why was the fed funds target set at 2% in early October, and 1.5% in mid-October? Why initiate the interest on reserve program in October, a policy the Fed admits had a contractionary intent? This policy stance makes no sense if you anticipate 1.5% inflation, and 7.5% unemployment. The Fed should always set policy so that either both variables are on target, or if one variable calls for easier money, the other variable calls for tighter money. And yet both the inflation and unemployment forecasts called for easier money. (I really wish I’d had a blog then, as I wasn’t reading this critique from most other bloggers–who were obsessed with bank bailouts at that time.)
If Greg Ip thinks I’m wrong, then he should do this thought experiment. Imagine Bernanke can go back in time to September or October 2008, and ask whether he would have cut rates much more aggressively, and started QE much sooner. I think we all know what the answer is, after all, by early 2009 he was favoring fiscal stimulus. Coming from a central banker, a call for fiscal stimulus is basically an admission that as far as AD is concerned “we blew it.” But what’s most dismaying is that the Fed had all the justification it needed for easier money in its own forecasts, hopelessly flawed as they were. And yet the Fed ignored those signals.
Greg Ip’s long post touches on three distinct issues, which are not always easy to disentangle:
1. Can the Fed control AD at the zero bound? Bernanke says yes.
2. Would an explicit NGDP target, level targeting, lead to faster NGDP growth? We don’t know what Bernanke thinks, but everything in his academic writings suggests the answer is yes, and he hinted as much for a price level target in a 2010 speech. (And the correct answer is yes)
3. Is stable NGDP growth a good idea, or is there some other superior central bank objective? You can’t beat something with nothing. If there’s some combination of price and output combinations that NGDP critics like better, say so and explain why. I might even agree.
HT: Dilip, Bill Woolsey.
PS. Here’s the Financial Post, no time to comment now.