The first step is getting NGDP targeting on the agenda. Getting the Fed to talk about this option. Marcelo sent me the minutes of the recent Fed meeting, which shows that market monetarists (with help from high profile endorsements) have achieved as much as could be realistically expected–a serious discussion of NGDP targeting:
The Committee also considered policy strategies that would involve the use of an intermediate target such as nominal gross domestic product (GDP) or the price level. The staff presented model simulations that suggested that nominal GDP targeting could, in principle, be helpful in promoting a stronger economic recovery in a context of longer-run price stability. Other simulations suggested that the single-minded pursuit of a price-level target would not be very effective in fostering maximum sustainable employment; it was noted, however, that price-level targeting where the central bank maintained flexibility to stabilize economic activity over the short term could generate economic outcomes that would be more consistent with the dual mandate. More broadly, a number of participants expressed concern that switching to a new policy framework could heighten uncertainty about future monetary policy, risk unmooring longer-term inflation expectations, or fail to address risks to financial stability. Several participants observed that the efficacy of nominal GDP targeting depended crucially on some strong assumptions, including the premise that the Committee could make a credible commitment to maintaining such a strategy over a long time horizon and that policymakers would continue adhering to that strategy even in the face of a significant increase in inflation. In addition, some participants noted that such an approach would involve substantial operational hurdles, including the difficulty of specifying an appropriate target level. In light of the significant challenges associated with the adoption of such frameworks, participants agreed that it would not be advisable to make such a change under present circumstances.
Now we need to correct the errors in this statement. I plan to start with a policy I don’t favor, but which would still be an improvement over current policy—price level targeting. The Fed may have underestimated two advantages of price level targeting:
1. The Fed can raise the expected inflation target without changing the politically sensitive 2% inflation goal. This can be done by starting the price level trajectory at the point where the US began paying interest on reserves and thus effectively neutralized conventional monetary stimulus. The price level has risen at a rate well below 2% since October 2008, and thus a 2% price level growth target would allow quite a bit of catch-up over the next few years. And recall that the Cleveland Fed currently estimates the expected inflation rate for the next 5 years to be far below 2%. Thus shifting to a 2% price level growth target backdated to October 2008 would cause three year inflation expectations to rise from less than 1.5% to closer to 2.5%. If (as Keynesians assume), the SRAS is currently fairly flat, this implies much faster RGDP growth that what is currently expected.
2. The adoption of price level targeting would greatly increase the effectiveness of supply-side fiscal stimulus. Recall that as long as the Fed targets inflation or the price level there are huge constraints on demand-side fiscal stimulus. For demand-side policies to be effective they must boost inflation. But that won’t happen if the Fed targets inflation or the price level. Supply-side policies that reduce the cost of production (such as employer-side payroll tax cuts), suddenly become highly effective with price level targeting. Not only do they shift the AS curve to the right, but they also force the Fed to shift the AD curve to the right.
I was confused by the following:
More broadly, a number of participants expressed concern that switching to a new policy framework could heighten uncertainty about future monetary policy, risk unmooring longer-term inflation expectations, or fail to address risks to financial stability.
What policy framework would they be abandoning? It certainly would not mean an abandonment of the dual mandate—the Fed could easily argue that NGDP targeting is an effective way of achieving the dual mandate. So presumably what the Fed means by “framework” is something akin to the Taylor Rule. But the Fed is not currently following the Taylor Rule; they abandoned that long ago, when they started doing QE, Operation Twist, IOR, MBS purchases, and various other unconventional policies. (Or even earlier, according to John Taylor.) So it’s a bit late in the game to worry about abandoning the Taylor Rule.
Perhaps there’s a sort of implied assumption that the Fed would be switching from inflation targeting to NGDP targeting. BUT THE FED DOESN’T DO INFLATION TARGETING. Yes, you could argue the Fed does flexible inflation targeting (although I don’t know if they’ve even admitted that much.) But they certainly don’t do strict inflation targeting. Let’s assume they do flexible inflation targeting. What exactly would they have to give up in order to do NGDP targeting? Flexible inflation targeting doesn’t mean keeping inflation at 2%, it means letting inflation rise above or below 2% depending on whether output is below or above target. It is supposed to mean that inflation is allowed to be above target when output is below target, although the Fed tends to do the exact opposite, which calls into question whether they really do flexible inflation targeting, or just pay lip service to the idea. I didn’t see inflation soar far above 2% during 2009, when output fell far below trend.
NGDP targeting is basically flexible inflation targeting, where you let the inflation rate deviate above or below 2% as output growth deviates from 3%. If there is any fundamental shift in framework, it would not be going from (flexible) inflation to NGDP growth rate targeting, it would be going from flexible inflation targeting to flexible price level targeting, or NGDP level targeting.
2. As I’ve argued many times, the so-called “costs of inflation” that are (wrongly) associated with long term inflation expectations being unmoored are in fact generated by allowing unmoored long term NGDP growth.
3. The Fed needs to address financial stability through better regulation. Not punishing the entire economy just because one sector misbehaves. But let’s say I’m wrong. How does NGDP targeting reduce their ability to stabilize the financial sector relative to current practice? Or relative to strict inflation targeting? Under strict inflation targeting the bubbles would be even bubblier and the crashes would be even deeper, as monetary policy would be much more procyclical. Indeed NGDP targeting is exactly what the doctor ordered if you are worried about financial instability.
Alternatively, maybe the concern about financial instability refers to a perceived lack of flexibility with any target, including NGDP. I actually think the lack of flexibility is a good thing, not allowing disastrous policy mistakes like 2009. But even if I am wrong, that’s not an argument against NGDP targeting, it’s an argument for NGDP targeting with some flexibility. Maybe NGDP growth should have been a bit below 5% during a bubble year like 2006, and a bit above 5% in debt crisis year like 2009. I could live with that. But that’s not what the Fed is currently doing with its “flexibility.”
Several participants observed that the efficacy of nominal GDP targeting depended crucially on some strong assumptions, including the premise that the Committee could make a credible commitment to maintaining such a strategy over a long time horizon and that policymakers would continue adhering to that strategy even in the face of a significant increase in inflation.
In the preceding sentence replace “efficacy of nominal GDP targeting” with “efficacy of inflation targeting” and “significant increase in inflation” with “significant increase in unemployment.” We’ve had dozens of countries do inflation targeting for decades, and continue to do so in the face of punishingly high rates of unemployment during recent years. So why would NGDP targeting be politically difficult? And here’s something to think about, inflation targeting is far more procyclical than NGDP targeting, which means that, a priori, one would expect it to be far harder to maintain inflation targeting for long periods, as compared to NGDP targeting. Since many countries have maintained inflation targeting for long periods, I see no basis for assuming that NGDP targeting would not be politically feasible. It’s a policy that has significant support from both left and right wing economists, something that one cannot say about inflation targeting.
In addition, some participants noted that such an approach would involve substantial operational hurdles, including the difficulty of specifying an appropriate target level.
This is a phony problem. Exactly the same issue applies to inflation targeting, and yet everyone at the Fed seems to think the target should be in the 1.7% to 2.0% range. It’s obvious to me that if the Fed goes this way the rate will be about 4.5%. I bet every single FOMC member would pick a number between 4% and 5%. So do a vote and pick the median number. Then repeat every five years for your new 5 year target. I don’t believe that even a 5 year rethink is necessary, but there’s no reason not to make that concession to those obsessed with “inflation becoming unmoored” just because long term RGDP growth fluctuates a few tenths of a percent above and below 2.5%.
And they end with this:
In light of the significant challenges associated with the adoption of such frameworks, participants agreed that it would not be advisable to make such a change under present circumstances.
That’s all?!?!? Those are the only faults they could find with NGDP targeting? Just a few nitpicks that apply equally well to current policy? I’d say NGDP passed its first test with flying colors. Now we have to keep hammering these points home.
I used to think it unwise to do such a major policy change without further study. But after seeing this I see no reason not to go forward and immediately implement NGDP targeting. Where are the significant risks that do not exist under current policy? I don’t see the FOMC as having even laid a glove on the proposal. As the Fed staff indicated, it gives you a faster recovery without leaving long term inflation unmoored. And all they can do is nitpick? All they do is make complaints that could equally apply to any flexible inflation target? Is that showing “Rooseveltian resolve?” Is that doing “whatever was necessary to get the country moving again?” Either Bernanke doesn’t think our 9% unemployment is as critical an emergency as Japan’s 5% unemployment, or he no longer believes in showing Rooseveltian resolve. Or maybe he does favor more action, but doesn’t have the votes. Let’s hope the Fed wakes up to the fact that (even w/o Europe) all the risks are on the downside, that wage inflation will be low for many years, almost regardless of what the Fed does. It’s no longer the 1970s–stop trying to fight that battle.
The Fed needs to think long and hard about WHAT NEEDS TO BE DONE, and then work out the policy framework that best allows them to meet their objective. But they won’t get anywhere until they decide where they want to go. Do they think we need more AD, or not? As Yoda said: “Do or do not. There is no try.”
