Beyond hawks and doves, Part 2

A question by Michael made me wonder how we can improve the currently dysfunctional FOMC.  If you read the FT article I linked to and the Fed bios, it is obvious that the current FOMC is like rowers pulling in all sorts of different directions.  As a result we have a policy that satisfies no one.  Because monetary policy often looks much more expansionary and contractionary than it really is, in certain economic conditions the hawks get the upper hand, in others the doves prevail.  This leads to cyclical instability.  Why are FOMC members allowed to pull in all sorts of different directions?  Because the mandate from Congress is hopelessly vague, just a few platitudes about price stability and full employment.  We need a single goal.

You might despair of the prospect of getting a single goal, after all some Congressmen put more weight on unemployment and growth, while others care more about inflation.  Even worse, many economists passionately believe that the Fed cannot target real variables, only nominal variables.

Suppose I came up with a policy goal that was 100% nominal, and yet implicitly put equal weight on price and output fluctuations.  Impossible?  May I remind you that when you multiply an even and odd number, the product is always 100% even, not 50/50.

Congress should spell out the desired growth rate in this single goal variable.  Here you might argue that we still haven’t got beyond the hawk/dove problem.  The hawks will still prefer to err on the side of less than target growth, while the doves will prefer to err on the side of more than target growth.  So there would still be FOMC members pulling in slightly different directions.

But that problem can be solved with level targeting.  Now if Congress set a 5% target path, and the aggregate grew 6% one year, the target for the following year would be 4%.  Hawks would know that if they “cheated” and aimed for a bit less growth in the aggregate than Congress wanted, they would be forced to shoot for higher growth in the future, presumably at the cost of higher inflation.  Doves would face the same constraint.  It is a perfect way of keeping everyone honest.  Robin Hanson should like this idea.

Can anyone suggest a good nominal aggregate that implicitly gives equal weight to price and output fluctuations?  Something Congress could accept as a good compromise, and yet still meet the criterion that it not leave the price level indeterminate?  Something simple—Congress won’t enact a “Taylor Rule” equation into law, nor should it.  Any ideas?

Of course FOMC members will still disagree about technical issues, such as which instrument setting is most likely to produce on target growth.  That’s the advantage of having a committee rather than a dictator—the wisdom of crowds.  But then why stop at 12 members?  How about 310,000,000 members, one-dollar-one-vote?  In 2008 I didn’t vote for Obama, but I bet $50 that he’d win.  As Robin Hanson says; “let’s vote on values but bet on beliefs.”


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5 Responses to “Beyond hawks and doves, Part 2”

  1. Gravatar of Michael Michael
    10. January 2010 at 18:52

    “Now if Congress set a 5% target path, and the aggregate grew 6% one year, the target for the following year would be 4%. Hawks would know that if they “cheated” and aimed for a bit less growth in the aggregate than Congress wanted, they would be forced to shoot for higher growth in the future, presumably at the cost of higher inflation. Doves would face the same constraint. It is a perfect way of keeping everyone honest.”

    I do think this is much better than the current policy, and would certainly make setting monetary policy more a matter of economics than values.

    One more thing I’d like to see to add some certainty is a more thorough explanation of what lag FOMC members expect between changes and effects in monetary policy, as, for example, some hawks seem to claim runaway inflation at some indistinct future time. I’d like to know when they expect to find this inflation showing up, and an explanation of what indicators they might be looking for that will indicate this future inflation. The same would go for doves.

    I wouldn’t want members to be able to constantly claim that they missed the target this year, but their actions are going to show up “soon”.

    I’m also wondering just how accountable you can actually make the FOMC members for missing targets.

  2. Gravatar of scott sumner scott sumner
    11. January 2010 at 07:02

    Michael, I have become increasingly skeptical of policy lags. There is no large between changes in policy and change sin inflation EXPECTATIONS (in say TIPS markets). Many of the inflation fears are not justified by movements in TIPS.

    In late 2008 5 year TIPS showed deflation expectations, so money was clearly too tight even if you believe in lags.

  3. Gravatar of Doc Merlin Doc Merlin
    12. January 2010 at 01:32

    “In late 2008 5 year TIPS showed deflation expectations, so money was clearly too tight even if you believe in lags.”

    You keep saying this, Scott, but I am not convinced it was as strong as you say it was. Bill’s latest post suggest that the fed was heavily preferentially buying up long term debt which would destroy the 5 year TIPS T-bond, spread. I am not saying that the Tips market couldn’t be used to gauge the level of inflation, I am saying that it can’t be when the fed is manipulating the bond market.

    I agree that the shorter term TIPS market was a good predictor for inflation/deflation. But with the amount of market manipulation by the fed, I have a lot of trouble thinking that the longer term TIPS market was useful for this.

    p.s.: I mostly agree about the lags, lags only exist where the effects of policy changes aren’t isn’t understood beforehand by the market.

    Url for Bill’s post: http://monetaryfreedom-billwoolsey.blogspot.com/2010/01/feds-security-portfollio.html

  4. Gravatar of ssumner ssumner
    12. January 2010 at 13:41

    Doc Merlin, Possibly, although I am not convinced the 5 year yields were that distorted. They have stayed low even though the various maturities are close substitutes, and even though the Fed holds a modest share of all T-securtities.

    In any case I think everyone would agree that NGDP was falling fast, and that is a better indicator than inflation.

  5. Gravatar of The Politics of Fed(merica) « It Don't Mean Much, These Seats are Cheap. The Politics of Fed(merica) « It Don't Mean Much, These Seats are Cheap.
    2. March 2010 at 01:46

    […] For your reading pleasure: Scott Sumner, Beyond Hawks and Doves[1,2]. […]

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