George Selgin has a characteristically thoughtful column warning against excessive gloating by market monetarists. He points out that the new Fed policy is far from optimal (and far from the recommendation of us market monetarists) and that there’s a danger of it generating another cycle of boom and bust–just like the low rate policy of 2003-04.
My views on monetary policy aren’t actually all that different from George’s, but I have a somewhat different view of the overall picture. I’ll try to break it down into several separate issues:
1. When I started blogging in 2009 there was almost no one who believed the Fed could do more, and should do more. I believe that by 2010 we (market monetarists) where able to convince many in the blogosphere that the Fed could and should do more. Here’s Ryan Avent in 2010:
I SEE that Scott Sumner is taking a victory lap of sorts—not unearned—over the fact that views of monetary policy have come full circle since the years before the crisis. Once upon a time, the Fed was viewed as having near-absolute power over the path of the economy. Then crisis struck and many argued that the Fed had run out of ammunition and fiscal policy was required. Eventually people began arguing that the Fed could do more and should do more, thanks largely to the efforts of Mr Sumner himself.
Ouch! I guess I do gloat too much. Sorry.
But I do take great satisfaction that there has been progress on that front. I believe that George Selgin agrees with me that the Fed should have and could have done more in 2009, although he is less convinced about the need for monetary stimulus under current conditions. I’ve also tried to convince the blogosphere of other ideas, such as “targeting the forecast” and that there is no “wait and see.” I think it’s fair to say I’ve completely failed (thus far) to make headway in that direction. Roughly 100% of the blogosphere has reacted to QE3 by discussing likely future outcomes for AD/NGDP, as if in the future we’ll learn more than we already know. I view that as akin to astrology. I’ve argued that the lack of a government subsidized RGDP and NGDP futures market represents gross negligence on the part of the Fed, and more broadly the economics profession, which has not demanded that such a market be created and subsidized. It would be as if astrologers opposed Federally funded studies to see whether people with certain birth “signs” had certain personalities. Oh wait . . . the astrologers do oppose those studies.
Despite those failures, I can’t help but be pleased that the market monetarists have been successful in convincing many pundits (perhaps including the Fed) that monetary policy can and should do more when NGDP growth has been the slowest since the Herbert Hoover administration. At the same time, I’d like to emphasize that most of the “gloating” has been done by non-market monetarists. Numerous press outlets have basically said; “The Fed is doing market monetarist policies, and it’s likely to be highly successful.” I’ve consistently said they are only doing about 10% of what we advocate, and it’s likely to be only modestly successful in boosting RGDP. We already know that it’s only been modesty successful in boosting NGDP expectations–that’s not even in doubt.) In the post that George linked to I emphasized that the Fed still wasn’t doing targeting the forecast, or level targeting, which were two key components of market monetarism. So most of the gloating has been in the popular press. I still think money’s too tight.
I have a “glass half full” personality, so I tend to focus on where progress has been made. Take the problem of deciding on an optimal policy target. Some advocate a weighted average of inflation and output gaps. Some advocate a weighted average of inflation and unemployment gaps. Market monetarists advocate the sum of inflation and real growth, level targeting. Unfortunately the Fed did not adopt NGDP targeting. But in my view the main problem in recent years is not the failure to adopt NGDP targeting, but rather that policy has been far too contractionary using any plausible policy target. So I can take pleasure in the fact that the Fed is finally waking up to the reality that it needs to do much more to hit its own preferred policy target(s). And yet I still believe that we’ll have to return and fight another day for NGDP level targeting. It’s progress, but there is much more work to be done.
George’s most serious charge is that this policy initiative might lead to another boom/bust cycle, such as the recent housing bubble.
Having kept the federal funds rate at 1.75 percent for a year after the economy began to recover in November 2001, the Fed lowered it to 1.25 percent in November 2002, and to 1 percent in June 2003. Then, in August 2003, the FOMC, still unhappy with the sluggish pace of the recovery, and especially with the high unemployment rate, announced that the f.f.r. was “likely” to remain low for an “extended” period of time. Not for the first time, the Fed in its zeal to assist recovery was in fact setting the next boom in motion. And how!
I’m tempted to respond; and how? Most people, including George Selgin and market monetarists like David Beckworth, believe that an easy money policy during the early 2000s led to an overheated economy in the middle of the decade, and that this was one factor in the crash during the latter part of the decade. I’m not convinced, or perhaps I should say I doubt the effect was as strong as most people believe. First of all, I see little evidence that monetary policy was particularly expansionary during the early 2000s. Some people cite the low rates, but we all know what Milton Friedman said about that. I agree with Ben Bernanke that NGDP growth is a good indicator of whether money is easy or tight. Here are the facts about NGDP growth during the previous expansion:
1. NGDP grew at a slower rate during the 2001-07 expansion than during any other expansion during my lifetime.
2. NGDP growth modestly exceeded 5% during the peak of the housing boom.
Those facts tell me that while monetary policy might have been a bit too expansionary during the housing boom, the overall level of spending wasn’t particularly excessive, at least by historical standards. So I reject the implication of “and how!” George seems to imply that easy money was the key mistake that led to the boom/bust cycle of 2003-09. I believe there were two key policy failures:
1. Flawed regulation of banking combined with financial innovation, which pumped up the housing boom. (Not easy money.)
2. Tight money in 2008 that turned a mild slowdown involving Hayekian reallocation of capital into a deep “secondary deflation.”
George is particularly concerned about our (my?) silence on the dangers of targeting employment:
But the Fed, in insisting on treating the level of employment as an indicator of whether or not it should cease injecting base money into the economy, departs not only from Market Monetarism but from the broader monetarist lessons that were learned at such great cost during the 1970s. If Market Monetarists don’t start loudly declaring that employment targeting is a really dumb idea, they deserve at very least to get a Cease & Desist letter from counsel representing the estates of Milton Friedman and Anna Schwartz telling them, politely but nonetheless menacingly, that they had better quit infringing the Monetarist trademark.
I have two responses to that charge:
1. Targeting Employment is a really, really bad idea!!
2. A target that is a weighted average of inflation and (estimated) employment gaps, is also a somewhat bad idea. But it’s also almost indistinguishable from targeting a weighted average of inflation and (estimated) output gaps (the Taylor Rule.) After all, output gaps are estimated partly on the basis of whether or not unemployment looks “high.” Obviously I believe the Fed is not just targeting employment, they are targeting a weighted average of inflation and employment gaps. Yes, NGDP targeting is superior, but I’m less concerned about this than George is. Late in his life Friedman admitted that Taylor Rule-type policies can do about as well as money supply targeting. The disastrous monetary policies of the 1960s-1970s were not primarily caused by the Fed putting too much weight on employment (though they were), the key problem was that they were ignoring the rise in inflation. They frequently cut interest rates during periods when inflation was far above 2%. I don’t see any evidence that the Fed is about to repeat that mistake. Nor do the markets, which I trust much more than my opinion, or the opinion of any other individual.
Here’s where I think we are:
1. Market monetarists have a set of ideas that constitute optimal monetary policy. Others like George Selgin have slightly different views, but accept some of our broad principles.
2. The Fed is not following the sort of policy that either George or I would favor.
3. It is often the case that two economists who have almost identical views of the optimal policy rule, have very different views on the best “next step” for a central bank operating under a discretionary regime (like ours.) I feel that as a public policy pundit I am almost forced to hold my nose and say “well done” when the Fed moves from 4 to 5 on a scale of one to 10. And I do this knowing that people in the press will misinterpret this “support” as implying I don’t think the next 5 steps (to get to 10) are very important. I may say they are important, but the message gets lost in all the “gloating.” So maybe George is right, maybe I need to try harder, so that we don’t rest on our laurels. I’ve gotten way more laurels in the last week than I deserve, so it shouldn’t be hard for me to pivot to the “glass half empty” message.
PS. Many NGDPLT advocates favor going back to the pre-2008 trend line. I’ve recently been arguing for going perhaps only one third of the way back, given how much time has gone by. So as a born and bred University of Chicago inflation hawk, I’m not unaware of the dangers mentioned by George Selgin. I want to go to LA, but I’m sitting in the back seat of a car driven by someone who has turned off the GPS. Despite my annoyance at the driver’s method of navigating, I feel I must do my best to give advice, so that the
Fed car doesn’t end up lost in the middle of the Nevada desert.
PPS. Ryan Avent does a really outstanding job of explaining market monetarism. But my “no such thing as wait and see” comments are partly directed at his post. He’s also too generous in his evaluation of my role—but I’m not going to complain.
PPPS. I don’t like to read other relies before writing my own. So after I was surprised to find that Lars Christensen’s reply had so many uncanny similarities, such as the “glass half full” metaphor, and the use of bold font in opposing employment targeting.