Friedman’s 4% Rule, Version 2.0

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.

It can’t be that easy?  Are you sure?  If you don’t like nominal GDP, replace it with CPI futures.  I have yet to see a persuasive objection to this sort of policy, which I have been peddling for 23 years.  Imagine if it had been adopted in September 2008.  Nominal GDP growth expectations would never have fallen below 4%.

For those interested, my 2006 paper in BEJ, Contributions to Macroeconomics has my most recent defence of this policy.

Update 2/28/09:  Bill Woolsey just reminded me that I had forgotten my own 2006 proposal.  The transactions in futures contracts do not directly impact the money supply, but rather they each trigger parallel open market operations (purchases when traders short the NGDP futures, and open market sales when traders go long on NGDP futures.)



9 Responses to “Friedman’s 4% Rule, Version 2.0”

  1. Gravatar of TheMoneyIllusion » Why did monetary policy fail? TheMoneyIllusion » Why did monetary policy fail?
    23. February 2009 at 05:05

    […] but it can certainly control nominal GDP with an aggressive enough policy (see my earlier proposal here.)  So from this perspective the fact that nominal GDP fell 5% last quarter, and may be falling as […]

  2. Gravatar of Bill Woolsey Bill Woolsey
    27. February 2009 at 15:07


    Purchases and sales of futures contracts are not open market purchases and sales.

    Purchasing a future contract is an aggreement to make a payment in the future at an agreed price, not a purchase of anything at this time.

    Selling a future contract is an aggreement to make a sale in the future at an agreed price, not selling anything now.

    With index futures, the payments made (or received) will be equal to the difference between the actual value of the index and the agreed price multiplied by an arbitrary dollar amount defined by the contract.

    Of the Fed sells or buys unlimited quanties of these things at a fixed price, the only payments that will occur is at settlement if the index is not on target. Then the Fed, and anyone else who was also wrong, will pay off those investors who were correct.

    Usually, both buyer and seller must put up funds in a margin account. Assuming the Fed is excused from this requirement, then it would be a bit like an open market sale no matter whether the Fed was buying or selling.

    Usually, when the price of the contract changes, funds are moved to or from the margin accounts. But with the Fed keeping the price pegged, that won’t be an issue.

  3. Gravatar of ssumner ssumner
    28. February 2009 at 14:49

    Bill, Thanks for the reminder. You’d think I’d remember my own proposal (which I published as recently as 2006) but I had obviously forgotten that point. I’ll add an update.

  4. Gravatar of Brilliant or Crazy? I Really Don’t Know. « The Emergent Fool Brilliant or Crazy? I Really Don’t Know. « The Emergent Fool
    1. March 2009 at 15:40

    […] Apropos of Rafe’s last post on Complexity Economics, I ran across an economic stability proposal that is either brilliant or crazy. I both haven’t thought it over enough and am probably not […]

  5. Gravatar of Random Links XXIX « Random Musings of a Deranged Mind Random Links XXIX « Random Musings of a Deranged Mind
    26. April 2009 at 17:36

    […] […]

  6. Gravatar of Jiang Li Jiang Li
    6. May 2009 at 05:25

    There is obviously a lot to know about this. I think you made some good points in Features also.

  7. Gravatar of Random Links LI « Random Musings of a Deranged Mind Random Links LI « Random Musings of a Deranged Mind
    2. June 2009 at 16:30

    […] […]

  8. Gravatar of Ash Ash
    5. April 2010 at 08:02

    The only issue I see with this proposal right now is the fact that in a debt-based money system, such as the US economy, most money is endogenously created by the private sector. So it would still be difficult for the Fed to control the money supply simply through open market operations adding or subtracting from the monetary base.

  9. Gravatar of ssumner ssumner
    5. April 2010 at 15:36

    Ash, I don’t want the Fed to control the money supply. As long as they control the monetary base, they can contol the price level and NGDP.

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