It’s the target, stupid

Many people have argued that if QE2 didn’t have much effect, the amount of money required to provide adequate NGDP growth must be truly stupendous.  But this gets things exactly backward.  Base demand is high precisely because the Fed has such a contractionary policy.  Because the Fed seems content with the fact that NGDP has risen 4% over the past 3 years, not the normal 15%.  Because Ben Bernanke sounded horrified when Brad DeLong suggested 3% inflation.

The Fed has plenty of credibility, that’s not the problem.  The problem is that they are using the credibility to assure investors that low inflation is here to stay.  With the right target, there would probably be no need for massive quantitative easing, or other extraordinary policies.  There are excellent posts by Josh Hendrickson, David Beckworth, and Marcus Nunes, that all explain this point in more detail.

The punch line is that the problem isn’t the Fed’s unwillingness to do enough QE, twists, or cuts in IOR, the problem is the Fed’s inadequate target, just like in Japan.

One of the great mysteries of this recession is how the Fed has been able to get away with doing “the wrong thing” for three years in a row.  The BOJ would often claim to be unable to boost NGDP.  It was wrong, but the explanation sort of made logical sense.  But Bernanke could never make that claim, as his academic research showed the Japanese explanation was preposterous.  For instance, why did the BOJ repeatedly tighten monetary policy in the 2000s?

Of course the Fed never claimed to be out of ammo; indeed they have argued the exact opposite.  This makes the Fed’s public relations success an even bigger mystery.  Why have they gotten away with this stance?

Perhaps it’s all due to a very careful ambiguity.  They’ve become impossible to pin down; as no matter what argument is raised, they simply shift the discussion on to a different topic.  Higher inflation?  A bad idea, we have a hard-won victory against inflation.  But what about just getting up to the informal target?  Yes, we missed over the past three years, but expect to do better soon.  Really?  What about the TIPS spreads?  They aren’t perfect.  What about the dual mandate, the 9.1% unemployment?  Monetary stimulus is no panacea, fiscal policy must do its part.  What does “no panacea” mean?  It could mean liquidity trap, or it could mean structural problems.  Those two meanings have vastly different implications.  But Bernanke doesn’t say–the ambiguity leads both liberals and conservatives to read into it whatever their uninformed prejudices suggest.

The Fed has put out two messages.  To the public the message is; “we’ve done all we could.”  To academics like me the message is; “we haven’t done all we could, we could do lots more.”  And they’ve succeeded brilliantly.  Indeed it’s a PR victory of stunning proportions; I have a hard time recalling anything so successful.  Except perhaps Paul Krugman’s blog posts of late 2008 and early 2009, which told almost all his readers that the Fed was out of ammo and fiscal stimulus was needed, and at the same time told a tiny elite of macro insiders (like me) that the Fed was not out of ammo, but that the Fed wouldn’t use it’s ammo, and hence fiscal stimulus was needed.  But it’s understandable that a single brilliant individual could pull off that sort of coup.  What shocks me is that a big clumsy institution could be so successful.

Whenever something seems miraculous there is always a mundane explanation.  And I suppose the explanation here is obvious.  As Christy Romer discovered, most average people think it obvious that the Fed was out of ammo.  So if the Fed loudly said lots of things that seemed to dodge responsibility for the collapse in NGDP growth, then that’s what most people would hear.  Then they could simultaneously send “dog whistle” messages to the financial markets, assuring them “the Fed isn’t out of ammo and don’t you dare price in expectations of outright deflation.”  And it worked.



14 Responses to “It’s the target, stupid”

  1. Gravatar of marcus nunes marcus nunes
    2. October 2011 at 09:17

    One Fed mantra is: We´re ready to do more if the situation warrants it. This from Bernake on Wednesday:
    “Federal Reserve Chairman Ben Bernanke on Wednesday signaled he is prepared to take more unconventional policy steps if the weak U.S. economy worsens too much”.
    It´s like an army in a constant state of readiness who´s defeated because the “enemy” was “invisible”!

  2. Gravatar of Scott Sumner Scott Sumner
    2. October 2011 at 10:14

    Marcus, Good post. Some needs to tell Bernanke that it’s already weakened enough, and more stimulus is badly needed now.

  3. Gravatar of Benjamin Cole Benjamin Cole
    2. October 2011 at 10:43

    Brilliant post. I wonder if the explanation for the Fed’s behavior is simply institutional inertia coupled with the fact that the Fed bankers are not unemployed looking for work. You think Fisher of Dallas is out pounding the streets looking for a paycheck, with a house mortgage payment coming up?

    If one operates in the free market system, one wants to see a lot more demand. Give me five percent real growth annually for five years, and I will eat inflation for breakfast. I am sure every operating businessman in America feels the same way.

    A central banker, safely ensconced in a sinecure, and meeting with effete academics all day (and GOP sappers) might come to a different conclusion.

  4. Gravatar of John John
    2. October 2011 at 18:44


    A few blog posts ago you accused me of being an internet Austrian with no idea of the actual Austrian framework. I replied to that that Rothbard and Mises, the two most important economists in developing Austrian thought favored gold, while later in his life Hayek favored a system of privately issued competing currencies. Here I find Hayek coming out against price stabilization and, by extension, NGDP targeting.

    “While, in the country where in consequence of the changes in international demand some prices will tend to fall the price level will be kept stable, it will certainly be allowed to rise in the country which has been benefited by the same shift in demand. It is not difficult to see what this implies if all countries in the world act on this principle. It means that prices would be stabilised only in that area where they tend to fall lowest relatively to the rest of the world, and that all further adjustments are brought about by proportionate increases of prices in all other countries.”

    Hayek argues that price level stabilization would just lead to higher inflation worldwide. Hayek’s ideas evolved over time, and it’s possible at some point he might have considered NGDP stabilization as a better alternative than something else, but to call any sort of targeting or stabilization a part of the Austrian framework is ludicrous.

  5. Gravatar of Matt Waters Matt Waters
    3. October 2011 at 06:43

    To extend Marcus’ metaphor further, the issue for the Fed is that they’re always fighting the last war. That includes not just inflation-fighting in the early-80’s, but the micromanaging of interest rates for business cycles since then.

    In normal times, cyclical employment sectors such as construction and manufacturing are sensitive to interest rates and cost of capital. The housing stock in the 80’s and 90’s grew healthily to match a growing population and interest rates would accelerate or decelerate that demand as needed.

    Since many FOMC members such as Fisher came from banks, they see monetary policy in exclusively these terms. If consumers got overleveraged while savers hold on to money and banks can’t find credit-worthy customers who also want loans, then that’s just tough luck for the economy. Better build some bridges or give out loans to Solyndra for the economy to have any hope.

    Of course this approach does not realize that sources other than traditional consumer loans can increase demand. Savers can in fact decide to spend money, in one way or another. The fact that many savers are holding longer-term treasuries, with considerable interest rate risk, shows that they do not want money to just sit in a vault somewhere. If given new cash in exchange for longer-term Treasuries, many will in fact seek to spend it elsewhere. Many more long-term Treasury investors would also spend their money if the government did not pay them 0.25% a year guaranteed not to spend it.

    Unfortunately, I do not think Fisher and others are ever genuinely challenged about these misconceptions. Outside of their banks, when they only talk with people from member banks, they only see conflicting views in FOMC. And apparently even completely ineffectual steps like Twist or keeping interest rates low for two years are too close to Weimar Germany for them.

  6. Gravatar of johnleemk johnleemk
    3. October 2011 at 06:48


    Indeed. One of the biggest problems I see with financial regulation is that it is always fighting the last war. I don’t pretend to have a better idea, but it’s especially worrying when it comes to inflation and deflation…central banks cranking up the printing press in the ’70s because it worked in the ’30s, and now shutting it down in the ’00s and ’10s because it worked in the ’70s and ’80s. Unlike with regulation, there’s nobody here to outsmart. The central bankers are just outsmarting themselves.

  7. Gravatar of Scott Sumner Scott Sumner
    3. October 2011 at 09:05

    Thanks Ben.

    John, Bot Hayek and I oppose price level targeting. We both favor NGDP targeting. You are wrong. There is no “may have.” He favored NGDP targeting.

    Late in his life he regretted his opposition to monetary stimulus in the 1930s. He came to realize that monetary stimulus would have been desirable at that time. That’s my current view. I got there much more quickly than he did.

    Matt, Good points.

  8. Gravatar of John John
    3. October 2011 at 09:42


    NGDP targeting seems like an especially sweeping form of price level targeting; the price of US output has to rise by 5% each year. I think it would suffer from the same problem that Hayek discussed above with price level targeting. If NGDP contracts in one country for supply side reasons, that country can no longer demand as many goods from other countries, leading to higher inflation worldwide.

    I’m not gonna ask you to provide a quote or anything for where Hayek said he favored NGDP targeting, I’ll just take your word for it as long as you admit that advocating NGDP targeting is well outside the general Austrian framework which principally favors gold or some form of privately issued money (which could also be precious metals). With this type of money, there is no “monetary policy” in general, and that is the whole point. Here’s Rothbard’s pity review of why monetary policy is bad. This is a great quote because it lays out the fundamental difference between Austrians and other schools of thought in the clearest manner possible.

    “We conclude that there is no such thing as ‘too little’ or ‘too much’ money, that whatever the social money stock, the benefits of money are always utilized to the maximum extent. An increase in the supply of money confers no social benefit whatever; it benefits some people at the expense of others, as will be detailed further below.”

  9. Gravatar of W. Peden W. Peden
    3. October 2011 at 10:19


    “We conclude that there is no such thing as ‘too little’ or ‘too much’ money”

    I’m looking forward to using that quote against paleo-Austrians. Thanks!

  10. Gravatar of John John
    3. October 2011 at 13:01

    W. Peden,

    Go for it! Obviously, if there was no medium of exchange that wouldn’t work, but the point Rothbard is trying to make is that almost any amount would do. If people in a market system freely selected a certain item as a medium of exchange, that in and of itself tells you that there is a sufficient quantity of it for it to perform the function of money. The rest is just a question of prices.

  11. Gravatar of johnleemk johnleemk
    3. October 2011 at 16:20


    Indeed. In his commentary on the 1930s, Hayek was definitely fighting the last war. Can’t really blame him either, since he’d just lived through the collapse of the Weimar Republic and the rise of Nazism as a result of Germany monetising its debt!

    But as Bernanke promised Friedman, we’ve learned our lesson — no central bank other than those run by tinpot dictators would monetise the debt. Anyone who believes otherwise is kidding themselves — the only way you can believe the US or EU will monetise their debt is if you believe they will be taken over by a tinpot dictator or otherwise descend into chaos.

    It’s so frustrating to see Paleo-Austrians still fighting the last war. Yes, government intervention in the monetary system is a mistake — but right now intervention is leading to deflation, not inflation, and all the Paleo-Austrians can do is freak out about how the US is “debasing” the dollar!

  12. Gravatar of Scott Sumner Scott Sumner
    3. October 2011 at 18:42

    John, NGDP doesn’t contract for supply-side reasons. And even if it did, it wouldn’t cause price changes in other countries.

    Johnleemk, I agree, except that it was deflation that caused the rise of Nazism in Germany (between 1929-33) not inflation.

  13. Gravatar of thruth thruth
    4. October 2011 at 12:13

    Why is the mere act of announcing an inflation target enough? I get the idea that when expectations are well-anchored in an explicit targeting regime that it probably only takes small moves in Fed instruments to get the desired impact. But now that we are in a poorly anchored state, it is not obvious that the Fed merely announcing a targeting regime would be enough to get us back to a state of growth. (analogous to Krugman’s confidence fairy.) I think we all agree that if the Fed were to credibly announce that it will permanently increase reserves until NGDP grows by X%, that it would have the desired impact. In contrast, if the Fed says “I’m going to hit you with a soggy biscuit until NGDP grows by X%”, I’m not convinced this will have any impact at all.

  14. Gravatar of ssumner ssumner
    5. October 2011 at 18:39

    thruth, I certainly meant they have to buy as many assets as it takes. When you set the target, M become endogenous.

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