Is Bernanke too melancholy?
Nick Rowe continues to provide interesting feedback. This is the tail end of a much longer comment he left at the end of my Richard Rorty post from a few days back:
Here’s another one, that’s both fun, and deadly serious in current contexts:
Horizontal axis: belief that monetary policy is interest rate policy.
Vertical axis: truth that monetary policy is interest rate policy.
Here we have a positive feedback system. There are probably two (stable) equilibria: one in which monetary policy *is* interest rates, and we can get stuck in liquidity traps; and a second in which it isn’t, and we don’t get stuck. Social construction of reality, again, which is just an extreme form of a convention, which not only affects how we behave, but how we see the world. It defines the “social facts” of what central banks “do”.Question: if this (above) view is correct, what exactly is it that Scott Sumner is *doing* (on this blog)? What *is* he? Not a policy advocate, in the standard sense.
And, if this view is correct, forget about trivia like cutting the overnight rate by 0.25%. Banning all public mention of the overnight rate would be a more effective policy!
I think I may have jumped the shark. Never mind.
He is being too modest; this raises all sorts of interesting issues. Yes, other economists have discussed somewhat similar ideas. I seem to recall Krugman used the “Peter Pan” analogy at one point. Something to the effect of “if we think monetary stimulus can work in a liquidity trap, then it can work.” But Nick’s comment raises some deeper issues.
In another post one commenter contested my view that investors were paying a lot of attention to Fed policy in October 2008, the period when I alleged that policy was too tight. He argued that investors were focusing on falling GDP. I replied that expectations of falling NGDP is exactly what I mean by tight money. At this point you might say “but for the Fed to have been able to prevent this, they would have had to have been able to change NGDP growth expectations with their policy tools. Unless investors see the connection, they won’t be able to do that.”
Normally it would be easy for me to swat away that objection, as stock prices often rise or fall 2% or 3% minutes after the 2:15 Fed policy announcements. So clearly Fed policy has a powerful effect on expectations. And I think my argument even applies to early October 2008, when the Fed funds target was still 2%. But what about later, when there was a widespread sense that rates could be cut no further. Was the Fed no longer able to affect market expectations of NGDP growth?
That is where Nick’s observations come in. Nick and I have both argued that there are a variety of policy levers by which the Fed can impact nominal spending. But suppose everyone else thinks the fed funds rate is the only possible tool? Does that make the Fed powerless? I am going to argue that the answer is no. But first suppose that the answer were yes. Then Nick is arguing that my blog (and by implication blogs like his and Bill Woolsey’s as well) are providing a valuable public service. We are like those slightly ridiculous 60s hippies that were “trying to blow people’s minds, to get them to see reality in a new way.” And if people can see there are other ways out of the liquidity trap, then they will be more optimistic that the Fed can avoid the worst case of another Great Depression.
[BTW, my blog started in February 2009, and caught on in March 2009. Just saying . . . ]
Well this is all very flattering, but I don’t think it is that simple. It’s up to the Fed to decide what sort of policy tools they want to use. In the early 1980s the Fed announced it was targeting M1, and almost immediately the various Wall Street markets started reacting strongly to the unanticipated part of the money supply announcement. When they stopped a few years later, the markets stopped reacting to M1 announcements. In 1933 FDR announced he was using the price of gold as the level to move prices higher, and the markets immediately started responding to changes in the price of gold. It’s really all up to the Fed. Whatever tools they choose to use, the public will follow. In my view the tool should have been NGDP futures prices. If they had done so, the public would have followed these prices as closely as they now follow changes in the fed funds rate.
So I don’t buy versions of the Peter Pan argument that make success seem very iffy, very contingent on luck, on whether the well-intentioned Fed is able to convince to the narrow-minded public of their wisdom. That’s getting the problem backward; the public knows exactly what is going on, it is the Fed that needs to wake up and “have its mind blown.”
But given where we are, stuck with a Fed that can’t think beyond interest rates, what would be the best type of Fed chairman? In the 1980s and 1990s, when most academics thought the “time inconsistency problem” biased us toward excessively fast NGDP growth, there was a view that we needed a sober, conservative central banker. Maybe even someone a bit heartless. Someone who could hold down inflation expectations. Of course macroeconomists are exactly like the generals who are always fighting the last war, and this was all an attempt to build models out of a single observation—the 1970s. In retrospect the models were wrong. So if we are stuck with interest rate targeting, what sort of central banker do we need?
During most times a sober, responsible figure like Volcker/Greenspan/Bernanke is fine. They can use their Taylor Rules to try to keep NGDP growing at a low and stable rate. But the minute interest rates hit zero (or even close to zero) there should be a provision that the entire FOMC is replaced with a new FOMC. And who should be on the new FOMC? Sit down before you read this . . .
I’m thinking of people like Jim Cramer and Larry Kudlow. When I say “like them,” I don’t mean people with similar views on monetary policy, I mean people with similar personalities. People who are optimistic about America, strongly pro-growth, people that are not passive, but rather want to make things happen. You get the idea. The point is to instill the public with a feeling that good times are just around the corner, and that they will pull out all the stops to make it happen. The last thing we need right now is a central banker with shoulders hunched over, who solemnly intones about the looooong difficult period America has ahead if it. Who keeps talking about how we need to tighten our belts, and get used to a lower standard of living. Come to think of it, I’d like to nominate my commenter JimP to the FOMC.
Back to reality, I have two serious points in this post. One is that Nick has correctly pointed to the key role played by beliefs in the transmission of monetary policy. Academic economists have an enormous responsibility to make people understand that liquidity traps do not limit the effectiveness of monetary policy. Unfortunately among the people who need to be educated are Fed Presidents like Janet Yellen, and what Krugman calls the “economic analysts” who advise them. But my second point is that this “expectations” issue should not be misunderstood. The previous examples of monetary policy at the zero rate bound (US in the 1930s, Japan more recently) make it crystal clear that (contrary to Krugman) there is no such thing as an expectations trap. No central bank has ever tried but failed to reflate. Central bankers set the agenda, it is up to them to provide leadership, if they wish to do so. But right now the leaders of the Fed, ECB, and BOJ, have absolutely no desire to raise NGDP growth expectations. And that’s a shame.
PS. Regarding Nick’s proposal for no more discussion of the short term policy rate; my dream is a macroeconomics with no discussion of either interest rates or inflation. Just aggregate hours worked for the real (cyclical) variable, and NGDP for the nominal variable. Monetary policy targets NGDP expectations rather than the short term rate.