Back in 2006 I read an interesting post by Greg Mankiw, which advocated a monetary regime where the Fed would use market expectations to set the monetary policy instrument at the level expected to hit their inflation target.  Given my longstanding interest in futures targeting, I was naturally encouraged to see a highly respected mainstream new Keynesian endorse this type of policy regime.  Before looking at his specific plan, however, it will be useful to review his more recent essay on negative interest on money.

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I’ve had a lot of questions about NGDP futures targeting, and so I thought I should do a post answering some of those questions.  My preferred target is a 5% NGDP growth trajectory (aka level targeting) but to keep the discussion manageable I’d like to put off practical questions about which target, which time period, levels vs growth rates, etc.  Let’s just focus on the core concept.  Will it work?  By “work,” I mean would it have prevented the crash of 2008?  I say yes.

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I was originally going to entitle this entire post “Why me?”  But I thought that would be too self-indulgent, even by the standards of this blog.  What I would like to do here is trace the development of my research into monetary economics since 1986, so that you can see things through my eyes.  Almost no one accepts my view that a tight money policy by the Fed caused the crash that occurred in late 2008.  I hope that if you better understand the development of market-based monetary policy proposals, you will come to see my hypothesis as natural, even inevitable.  If you’ve ever read Murders in the Rue Morgue, you might recall a scene where the detective walks silently through the streets of Paris with a friend, observing all the things his friend notices along the way.  Then he suddenly breaks into his friend’s (silent) internal monologue, as if they had been conversing all along.  That’s what I hope to do here.

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In an earlier post I discussed my favorite monetary policy regime, under which the Fed buys and sells unlimited CPI or nominal GDP futures contracts at a price equal to the policy goal.  There is actually a fairly large literature on this idea, including people like Kevin Dowd, Bill Woolsey, David Glasner, and (my coauther) Aaron Jackson.  Slightly different approaches were taken by Robert Hall and Robert Hetzel.  At one time I thought that I had discovered the concept back in 1986, but I later learned that Earl Thompson had already mentioned the idea, but never published it.

Because it’s such an unusual way of thinking about monetary policy, it might help to compare it to the gold standard.  The U.S. successfully pegged the price of gold at $20.67/oz. from 1879-1933, and at $35/oz, from 1934 to 1968.  So in a technical sense a gold standard is very doable, even the devaluation of 1933-34 was not done because we ran out of gold, but rather to further FDR’s macro objectives.  But that is also exactly what is wrong with a gold standard, pegging the nominal price of gold does not stabilize the relative price of gold (in terms of other goods.)

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I need a short post.  Here’s a monetary policy for all seasons:

Have the Fed commit to buy and sell unlimited quantities of 12 month forward nominal GDP futures.  The price paid by the Fed will start at a level 4% above current nominal GDP, and rise by 4% per year.

The purchases and sales will constitute open market operations, and will continue until the monetary base settles at a level expected to produce 4% nominal growth.  Voila, no need for DSGE models, no liquidity traps, no worries about policy lags.  Dual mandate addressed.  It even overcomes Bernanke and Woodford’s “circularity problem,” as the market doesn’t just forecast GDP, it forecasts the instrument setting required to meet the Fed’s target GDP.

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