Grumbling on the left

Dilip just sent me a very interesting post by Dean Baker:

If Bernanke Did Not Know the Fed’s Mission, Would That Be News?

Not at the WSJ, nor it seems anywhere else. Yesterday, Federal Reserve Board Chairman Ben Bernanke referred to the “our dual mandate, which is growth and inflation.” In fact, the dual mandate is full employment (defined as 4.0 percent unemployment) and price stability. Presumably Bernanke had unemployment in mind when he said “growth,” but it striking that he would not use the right term. The two are of course not synonymous.

In the past I would have taken Bernanke’s side here, and dismissed Baker’s comment as quibbling about the distinction between growth and jobs (which Bernanke presumably sees as connected.)  Indeed Baker acknowledges that connection.  So why do I take Baker’s side here?  Not just because my Grandpa’s last name was Baker.  Rather, I think his intuition is right, regardless of the technical connection between U and RGDP.

In the previous post I talked about why it is essential that we think in terms of level targets, not growth rate targets.  And that is equally true for prices or NGDP.  But suppose we target growth instead.  Indeed suppose the Fed aims for 2% inflation and 3% RGDP growth.  That doesn’t sound too bad does it?  Normally it wouldn’t be bad.  But recall that 3% RGDP growth is what we normally get when the unemployment rate is stable, when you have 1% population growth and 2% productivity growth.  That’s fine if unemployment is low.  And not necessarily 4% BTW, the natural rate might be 5%.  The point is that 10% is way too high.  And if the Fed is forecasting only about 3% RGDP growth, then that suggests that they are settling for far too little growth in AD, or NGDP.

On the other hand if we think in terms of unemployment, then we almost automatically think in terms of levels, not growth rates.  People would be outraged in the Fed seemed complacent about 10% unemployment as far as the eye can see.  But the bland talk about “real growth” is actually disguising a monetary policy that has drifted uncomfortably close to the sort of passivity we have seen in Japan during the last two decades.

I don’t favor targeting unemployment directly.  But I do favor “level targeting” for NGDP, which means we need to now shoot for much higher than normal NGDP growth to at least partly catch up to the old trend line.  How fast should NGDP growth be over the next two years?  I can’t say.  So much time has passed that it is probably foolish to go all the way back to the old trend line.  But as Woolsey showed, even if we aimed to return to a 3% trend line from the beginning of the recession, not the old 5% trend line, it would require a far faster rate of NGDP growth than anyone expects, and this would reduce unemployment much more rapidly than the current policy.  So Baker was correct in sensing something was wrong here, despite the obvious connection between jobs and growth.  What I take away from his post is not that the Fed must necessarily target unemployment directly, but rather that they need to work out a NGDP growth target that has a high probability of reducing the unemployment rate sharply.  And I believe that means NGDP level targeting, not growth rate targeting.

I’d like to think that my post aimed at “liberal pundits” contributed to the rising criticism of the Fed from liberals.  In the Friday “Wall Street” post I linked to recent critical articles by DeLong and Yglesias.  However my hunch is that Tim Duy and Free Exchange have had more of an impact—they have both been very aggressive on this issue.  Here’s the concluding sentence from another Free Exchange post sent to me by Dilip:

But that’s not how a Fed chairman is supposed to act. Congress is busy trying to wring explanations out of Mr Bernanke for missteps (real and imagined) made in 2006 and 2007. I wish they’d ask him why he’s refusing to do his job right now.

Part 2:  Support from Blanchard and Gali:

Kevin Dick sent me an interesting Ambrosini post.  I don’t often see people link to Ambrosini, but he often has good posts on macroeconomic issues.  Here he discusses a recent paper by Blanchard and Gali that shows the different paths for unemployment under two different scenarios.  (You need to first click on the Ambrosini link to look at the two graphs.)

Notice that the rise in unemployment is an order of magnitude greater when the central bank targets only inflation during a negative real shock, as compared to when the central bank targets a weighted average of inflation and unemployment.  Of course a NGDP target is quite similar to inflation plus unemployment, as by targeting prices and RGDP it is indirectly targeting prices and unemployment.

So in theory a NGDP target makes a big difference.  How about in practice?  Compare the small rise in unemployment when the housing market was tanking between 2006 and mid-2008, and when energy prices were soaring, with the huge rise in unemployment after mid-2008, as the housing market continued to fall.  How did the two periods differ?  NGDP rose during the former and fell during the latter.  In addition, during 2006-08 the Fed did not follow a strict inflation target.  They let the headline CPI inflation rate rise to a peak of over 5% when oil prices soared in early 2008.  So I think those two periods pretty nicely match the predictions of the Blanchard/Gali model.  Indeed the deflation observed after mid-2008 suggests that the Fed was even tighter than they would have been under a strict inflation target.  So they made the recession even worse than in the first (i.e. bad) scenario.



12 Responses to “Grumbling on the left”

  1. Gravatar of rob rob
    6. December 2009 at 14:47

    Free Exchange, whoever that is, took his/her cues from your blog. I spent months in the comments there requesting they read you and they finally started quoting you. OK, they probably started reading you due to MR.

  2. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. December 2009 at 15:33

    I’m still in the relatively early stages of absorbing your excellent blog. However something occurred to me today in the course of my readings.

    Forgive me if you have discussed this already with some other commenter. What if the focus of a petition of monetary economists were on only one simple issue that achieves an important goal at a relatively low cost? I’m thinking in particular of the issue of the elimination of interest payments paid on reserves (since Oct. 6th 2008).

    If a major push were made to successfully address only one elementary but nevertheless important issue then it could lead to to a successful impact on NGDP expectations. And if so, then it could lead to further attention to similar policy proposals.

  3. Gravatar of Don the libertarian Democrat Don the libertarian Democrat
    6. December 2009 at 15:33

    This was Bernanke on Oct. 14th, 2008:

    “As in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets, which has had cascading and unwelcome effects on the availability of credit and the value of savings. The actions today are aimed at restoring confidence ( NB DON ) in our institutions and markets and repairing their capacity to meet the credit needs of American households and businesses.”

    On Jan. 13th, 2009:

    “However, at some point, when credit markets and the economy have begun to recover, the Federal Reserve will have to unwind its various lending programs. To some extent, this unwinding will happen automatically, as improvements in credit markets should reduce the need to use Fed facilities. Indeed, where possible we have tried to set lending rates and margins at levels that are likely to be increasingly unattractive ( NB DON )to borrowers as financial conditions normalize.”

    On Oct. 20th, 2008:

    “All that being said, with the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate.”

    On July 21st, 2009:

    “Nevertheless, even as important steps have been taken to address the recession and the intense threats to financial stability, maintaining the confidence of the public and financial markets requires that policymakers begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in the costs of Medicare and Medicaid. Addressing the country’s fiscal problems will require difficult choices, but postponing those choices will only make them more difficult. Moreover, agreeing on a sustainable long-run fiscal path now could yield considerable near-term economic benefits in the form of lower long-term interest rates and increased consumer and business confidence. Unless we demonstrate a strong commitment to fiscal sustainability, we risk having neither financial stability nor durable economic growth.”

    Given the remarks here:

    I have been assuming that Bernanke believes in the Chicago Plan of 1933, which includes QE plus a reinforcing stimulus. Indeed, Donald Kohn said as much here:

    In that light, I have been puzzled by the focus and worrying about tightening. However, it might be that Bernanke is worried about the fiscal response going forward. Although a number of economists have shown that we can get out of this fiscal mess, that’s not the same thing as political action or commitment. Having made a commitment to take care of the monetary part of the equation going forward, and not seeing enough political commitment to improving the fiscal situation going forward, he might believe that the Fed has to take more responsibility for the fiscal side of things than he’d like. This doesn’t seem a silly concern, and Buiter, for one, has been making the point that some political reassurance needs to be put forward now.

    For that reason, I like the plan put forward by Milton Friedman in “A monetary and fiscal framework for economic stability”. The point is to put in place policies that will automatically deal with such issues going forward. Samuel Brittan has a similar view:

    “The most important error, however, was to take too seriously the voices clamouring for a re-entry path to sound finance once the recession is over. Hence the projections showing a return to current budget balance by 2015-16. Hence, too, the assumption of a sharp but short-lived V-shaped recession. Thinking about alternatives led me to re-read a 1948 paper by Milton Friedman entitled A Monetary and Fiscal Framework for Economic Stability, reprinted in Essays in Positive Economics (1953).”

    “Clearly much work would be required to adapt the Friedman framework to today’s institutional structures. In any case, it would not make sense to stake out a public expenditure path and corresponding tax rates until we have a better idea of the sustainable employment level (or output gap) likely to emerge from the present turmoil and also the new trend growth rate. But it is not too early to start preparing.”

    So, I agree with the critiques of the current policy, but find the concern about political will and commitment going forward real and important.

  4. Gravatar of ssumner ssumner
    6. December 2009 at 18:18

    rob, I have noticed that Free Exchange comments on me frequently. I think that has helped my blog, because The Economist is a publication that is respected by economists on both the left and the right. So I think it has given me a bit of credibility.

    Mark, That was my view early on. But the problem is that Fed policy won’t be effective unless it is credible. And the Fed might respond to the elimination of interest with a tighter policy in some other area. So that’s why I switched my focus to an explicit nominal target, level targeting. I’d like to think a petition would work, and even tried it early on. But I think it is unrealistic. I think what I am doing now is the most influence I can have. At this point it is up to others in the blogosphere to either run with the ideas or ignore them. I think we have made some progress, indeed more than I would have expected given the long odds.

    Don, I believe that plan can work, but I also believe the fiscal side is not really needed. As we’ve seen with the recent policy, even a combined $800 billion dollar fiscal deficit and MB increase won’t work if it is perceived as temporary, and on the other hand the $800 billion increase in the MB alone would have worked if perceived as permanent.

    So if someone in Washington says lets do a lump sum $500 billion tax cut along with a equal increase in the MB, I would not oppose it, but I don’t think it is the most cost effective solution right now.

    My perception is that Bernanke got nervous last fall and asked for a fiscal backup, and then got nervous about the long run fiscal picture and is now backing off. I don’t think Bernanke had a well thought out plan, nor do I think he realizes how much the loss of credibility in monetary policy last fall hurt the US’s fiscal situation.

  5. Gravatar of ssumner ssumner
    6. December 2009 at 18:21

    Don, That 1948 Friedman proposal is quite interventionist and left wing. I don’t think he would have supported it later in life.

  6. Gravatar of Don the libertarian Democrat Don the libertarian Democrat
    6. December 2009 at 22:27


    He did still agree ( at least for a long time ) with Narrow Banking, QE in a crisis and and paying down in an upturn, and a Negative Income Tax. That’s 1-3 of his proposals. ( pp. 135- 137 “Essays in Positive Economics” ). I’m guessing that 4 is the Left-Wing part. I have a purely pragmatic approach to 4. What he was advocating was a way that taxes would vary automatically with the Fiscal Situation. I agree with that.

    It is true that he became more libertarian as he got older from my point of view. I tend to advocate his earlier positions, and the positions of Hayek that could in any sense be called Burkean. But it is a weird world, in my view, where advocating the actual positions held by Friedman, Hayek, Fisher, Knight, Viner, and Simons, is considered Left-Wing. I tend to see many people who say such things as closer to anarchism. They are certainly not Burkean or followers of Adam Smith.

    The one book that I like which develops such a position is David Friedman’s “The Machinery of Freedom”, which actively tries to get rid of most govt. He seems consistent and persuasive to me, whereas other such writers aren’t.

    But at least Samuel Brittan seems to agree with me on that essay. I guess he’s a Left-Winger, as is John Kay, who advocates Narrow Banking, and Charles Murray, who advocates a Guaranteed Income.

  7. Gravatar of MIke Sandifer MIke Sandifer
    7. December 2009 at 07:04

    Friedman didn’t even favor having the Fed late in his life.

  8. Gravatar of Matthew Yglesias Matthew Yglesias
    7. December 2009 at 08:40

    The main writer of Free Exchange, FYI, is a guy by the name of Ryan Avent. He lives in DC and I assume that he, like me, picked up this blog from reading Tyler Cowen.

  9. Gravatar of Don the libertarian Democrat Don the libertarian Democrat
    7. December 2009 at 10:03


    Here’s Friedman in 1999:

    “FRIEDMAN Yes. I have always been in favor of abolishing the Fed, primarily from a political point of view.

    ROBINSON And how would you handle the currency, how would you then manage the currency without the Fed?

    FRIEDMAN My favorite proposal is to have a fixed amount of what’s called high-powered money and just keep it there.”

    One way that I think about this is to say that I favor his Pragmatic positions. About his more libertarian positions, I’m agnostic. If we can get there in small steps and they work, they’re fine with me.

    To you and Scott,

    Take care, and thanks for the response,


  10. Gravatar of ssumner ssumner
    7. December 2009 at 12:33

    Don, Like most economist one can find many conflicting opinions. I can also find Friedman advocating that the Fed try to increase M2 at 4% a year, which is completely different from a fixed base. I also believe that Friedman favored a flat tax, but am not certain. Of course a flat tax can be combined with a negative income tax, but your article mentioned tax “rates” which I took to mean a progressive rate structure.

    Paying higher unemployment benefits in a recession is a terrible idea. It raises the unemployment rate in recessions. I hope he didn’t hold on to that throughout his career.

    Having said all that, you make some good arguments and I am willing to accept that Friedman was more liberal than many of us perceive him to have been. I view that as a plus, even where I disagree. It shows he is a true pragmatic libertarian, not a dogmatic libertarian. And you know where I stand.

    Mike, That’s right.

    Thanks Matthew, I didn’t mention his name because I wasn’t sure if he wrote all the articles. Does anyone know what other bloggers do? Do they address their responses to Ryan Avent? if so, I’ll do the same.

  11. Gravatar of D. Watson D. Watson
    8. December 2009 at 09:42

    Earlier this week in the comments section, you said: “Doc Merlin, No the ultimate goals of policy are stable growth and stable prices.”

    “In the past I would have taken Bernanke’s side here, and dismissed Baker’s comment as quibbling …” The past, as in … two days ago?

  12. Gravatar of Scott Sumner Scott Sumner
    8. December 2009 at 18:21

    D. Watson, No. A year ago. My quote wasn’t opposed to what Baker was saying. I was talking about from a position of normalcy. If you are in deep recession, you need faster growth for a period to catch up. That’s what Baker was complaining about. But I see why it looks like it conflicts. The key is what sort of growth rate are you looking at.

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