Goldman Sachs always seems to have something interesting to say about monetary policy. The following is proprietary information, so I can only quote portions:
Q: There has been increased talk recently that the Federal Reserve may soon adopt an explicit inflation target. Is this likely?
A: It’s certainly very possible. Chairman Bernanke is a long-standing advocate of inflation targeting. It was discussed at the September meeting, and Bernanke has mentioned it in recent speeches and congressional testimony. Moreover, it appears that Fed officials have the legal authority to adopt an explicit inflation target without congressional sign-off. If the FOMC decided to adopt an inflation target, it would undoubtedly be a “flexible” one—that is, it would explicitly allow for significant short-term deviations from the target for the sake of output stabilization.
Q: Would such an explicit inflation target be a good idea?
A: It probably wouldn’t make much difference compared with the current framework for monetary policy. Already, Fed officials talk about the “mandate-consistent” inflation rate of 2% or a little less. Moving from this to a flexible inflation target would only be a small step.
That said, we believe that such a step would be somewhat counterproductive at the margin under current circumstances.
That’s exactly my view. Do something effective, or do nothing. Don’t do things that make monetary policy look ineffective.
Q: So what should Fed officials do instead?
A: One way to address the asymmetry without resorting to a hard employment or output target—with the problems that this could entail—would be to target the level of nominal GDP extrapolated from the pre-crisis trend. This would effectively increase the weight of the employment part of the dual mandate while allowing Fed officials to hedge their bets with respect to uncertainty about the natural rate of unemployment or the level of potential output. It is a way for them to focus on a nominal variable over which they have a substantial amount of control, while leaving the split of nominal GDP between real output and inflation up to the supply side of the economy.
. . .
Third, Fed officials could move more incrementally, adding NGDP to a longer list of intermediate targets that might already include asset prices or bank lending conditions. Chairman Bernanke indicated some sympathy for this option in response to a question at his most recent post-FOMC press conference.
Did I miss something at the press conference?
Q: Is it likely that the FOMC will soon adopt an NGDP target?
A: We certainly do not expect a full-blown NGDP target along the lines of Exhibit 1 anytime soon. It would be quite a radical move for the Federal Reserve, an institution that typically moves in a deliberate manner.
However, we see a somewhat bigger chance of a gradual move toward an NGDP target that is “watered down” with some of the modifications described above. First, if there is one central bank in the world that could conceivably go down this route, it is probably the Federal Reserve because of its dual mandate. Most other central banks operate under mandates that focus mainly or exclusively on the delivery of low and stable inflation.
Second, the “optics” of an NGDP target are much better than those of other “unconventional unconventional” monetary policy steps such as a higher inflation target or a price level target. It is deeply counterintuitive to most people that higher inflation per se could help the economy grow faster, because they think of higher inflation as a cut in real income. This is not really correct because a higher inflation target would imply a higher target for wage as well as price inflation, i.e. it wouldn’t have direct implications for real incomes. But it is nevertheless much easier to convince people that a higher target for overall income and spending in the economy might have an expansionary impact. This means that if the Fed decided that a substantial amount of added stimulus was needed—more substantial than what’s available via “conventional unconventional” means such as further QE—an NGDP target would be a natural option. (Emphasis added.)
Where’d they get that clever idea? If only I could patent ideas, and charge Goldman Sachs a commission for using them. We award patents to companies for stupid things like click to buy. (BTW, does the word “patent” derive from “patently obvious?”) And then we don’t allow patents for ideas that might lead to lots of jobs. How many jobs?
However, in our model presented a month ago, which is based on empirical estimates of the linkage between spending and expectations, these expectational channels are quite powerful. Exhibit 2 shows that the combination of an NGDP target and renewed QE might lower the unemployment rate by nearly 2 percentage points by the end of 2014, compared with the “baseline” scenario, in which the Fed just follows our estimated Taylor rule. Exhibit 3 shows that the policy might boost inflation by ½-1 percentage point, although this is relative to a “baseline” prediction of inflation well below the Fed’s implicit target. Analysis of the regime shifts by the Fed and the Swedish Riksbank in the 1930s also suggests that such shifts can be powerful even if the instrument set is limited.
So we reward inventors of “click to buy,” but not persuasive arguments for policies that might create 3 million jobs at very little cost of extra inflation. Oh well, you got to like any investment bank that takes the time to study Sweden’s 1931 experiment in level targeting of prices.
Third, an NGDP target enjoys growing support from economists on both sides of the political aisle. Several prominent economists who have recently advocated NGDP targeting, including Paul Krugman, Christina Romer, and Bradford DeLong, lean toward the Democratic side. However, many of the long-standing “market monetarist” supporters of NGDP targeting such as Scott Sumner and David Beckworth identify themselves as political conservatives. Beckworth recently wrote an article advocating NGDP targeting with political journalist Ramesh Ponnuru in the conservative National Review. Gregory Mankiw, an adviser to Republican presidential candidate Mitt Romney, has in the past also published research favorable to NGDP targeting, although he has to our knowledge not weighed in on the current debate.
That was included because I like seeing my name in print.
Weakness in actual NGDP would increase the probability that the FOMC might go down this path. Although the recent data on US economic activity have looked a bit better recently, we do expect NGDP growth to slow from the 5% pace of the third quarter to only about 2½%-3% in the first half of 2012. This is both because we see real GDP growth slowing due to greater spillovers from the European crisis and tighter US fiscal policy, and because we expect a meaningful slowdown in inflation.
Q: So what is your actual forecast for Fed policy?
A: We expect another quantitative easing program to be announced sometime in the first half of 2012. The timing, size, and asset mix will depend on how the economy performs, but it seems likely that agency MBS would be included in any new program.
We should also see the FOMC take further steps to clarify its policy framework. An explicit inflation target is possible, and a move to start publishing information about the path for the federal funds rate expected by different FOMC members is quite likely. We believe that an NGDP target could usefully complement these steps, although we recognize that it would be a large shift in the framework that is unlikely to happen overnight.
Too bad “The Goldman Sachs” already has such a talented monetary analyst—I’d love to go work for them. If Hatzius retires, I hope they keep me in mind.