There is one unfortunate paragraph in Woodford and Mishkin’s recent WSJ op-ed:
Instead, the Fed’s new approach is a temporary policy to keep interest rates low for longer, to make up for the inadequate nominal GDP growth that has occurred since 2008. Once the nominal GDP growth shortfall has been eliminated, it will be appropriate to again conduct policy much as was done before the crisis. That means ensuring a long-run inflation rate of 2% in terms of the PCE (personal consumption expenditure) deflator, and an average unemployment rate that is consistent with price stability.
Once we shift to NGDPLT, there won’t be any going back, because NGDPLT is far superior to inflation targeting. Whenever inflation and NGDP diverge sharply, the Fed will be under tremendous pressure to target NGDP, not inflation. For instance, if inflation rises to 2.8% due to an oil shock, and output growth falls from 2.5% to zero, the Fed will cut rates, not raise them as inflation targeting would imply. Eventually central banks will stop paying attention to inflation.
I would add that Woodford’s preferred interest rate policy instrument is also obsolete. In the next recession, and probably the one after that, interest rates will again fall to zero. Indeed the only real suspense is whether they’ll be able to rise significantly above zero before the next recession hits. In the US in 1937, Japan in 2001, and the eurozone in 2011, rates had barely nudged above zero before the next recession hit. Ryan Avent has an excellent post discussing this issue.
[BTW, unemployment in the eurozone rose to 11.8% today, 400 basis points above the US. As bad as Fed policy has been, it’s far better than ECB policy. The Fed is also doing a much better job of keeping GDP deflator inflation close to 2%]
We need a new policy instrument, one that doesn’t become mute when nominal rates fall to zero. We could use the monetary base (QE), but I would prefer pegging the price of NGDP futures contracts. And then adjusting the monetary base as required to keep the Fed’s net position in the NGDP futures market close to zero.
Recessions are when you really, really need a monetary policy instrument that is effective. Yet the preferred Keynesian instrument (short term nominal rates) locks up at the zero bound. Because it is not likely to be effective in future recessions (given the secular decline in real interest rates) the Keynesian policy instrument is now obsolete. So is the preferred new Keynesian policy target—inflation. NK policy-making did a reasonably good job during the Great Moderation. But only market monetarism can guide policymakers through the much more difficult challenges of the 21st century.
Update: Marcus Nunes agrees that NGDP will not be just a temprorary expedient, and has a much more insightful take on what’s going on.