Here’s Stephen Williamson:
That seems to be what Kocherlakota is attempting here, and he goes even further than you might expect. His conclusion is:
“…monetary policy is, if anything, too tight, not too easy.”If you have not fainted and fallen on the floor, take a couple of deep breaths, and we’ll figure out what Narayana has on his mind.
If you did faint and fall on the floor, you are probably someone who thinks money was “easy” in 1932, when the base was soaring under an aggressive QE program, and rates were near zero. Or perhaps you are a follower of Joan Robinson, who thought easy money couldn’t have caused the German hyperinflation, because interest rates were not low. So I hope all my readers are still conscious.
Monetary policy should respond to forecast inflation, not actual inflation. You would think Kocheralakota would know better. Does a forecast give us any more information than what is in the currently available data? Of course not.
This one had me scratching my head. When it was announced that the Bank of England would become independent the TIPS spreads in the UK fell on the news. What sort of “currently available data” was that in response to? You target the ratex forecast, not some sort of crude adaptive expectation equation using past inflation.
So let’s do a test. When the Fed met on September 16, 2008, the trailing 12 month inflation data was quite high, in contrast the TIPS spreads were showing only 1.23% annual inflation over the next 5 years, well below the Fed’s target. One can’t imagine a better test of market monetarism against new monetarism. Should we have a forward-looking monetary policy and target the forecast (preferably the level of NGDP, BTW, not inflation), or a backward-looking monetary policy as Stephen Williamson seems to favor. Should we drive the car while looking down the road, or in the rear view mirror?
The Fed opted for new monetarism. Citing an equal risk of recession and HIGH inflation (yes, you read that right, high inflation), they refrained from easing two days after Lehman failed, keeping the fed funds target at 2%. In mid-2009 NGDP fell 9% below trend. And that’s why we are in a little depression. Bad demand-side policies lead to bad supply-side policies (just as in the 1930s), making the contraction longer than necessary.
I can’t imagine someone advocating a policy that doesn’t target the forecast. Why adopt a policy stance that is expected to fail? Right now, Fed policy is set at a position that will likely deliver less NGDP growth than would be optimal, given the Fed’s dual mandate. Money is tight in the only sense of the term ‘tight’ that is meaningful, relative to what’s necessary in order that policy be expected to hit the policy goal.
I remember in late 2008 all sorts of conservatives mocking the fear of deflation, mocking the claim that we needed demand stimulus. Then we got deflation in 2009, and the biggest fall in NGDP since 1938. They were wrong in late 2008, 2009, 2010, 2011, and they are still wrong. High inflation is not just around the corner. Just as the doves were wrong in 1965, 1966, 1967, 1968, 1969, 1970, 1971, 1972, 1973, 1974, 1975, 1976, 1977, 1978,
1978, 1979, 1980, and 1981. Both hawks and doves were about right between 1985 and 2007.
HT: Lars Christensen
PS. Commenter Declan sent me an interview of Warwick McKibbin, who is a former central banker in Australia. I haven’t had time to hear the entire interview, but in the 37:00 minute to 40:00 minute area he confirms that Bernanke abandoned the advice he gave the Japanese and speculates that there were political constraints involved. A bit after the 40:00 minute mark he endorsed NGDP targeting.