Replace FAIT with FAIT
Politico has a piece showing how the recent inflationary surge has discredited the run the economy hot approach to monetary policy. Good riddance.
But let’s not throw out the baby with the bathwater. The recent policy errors were not due to FAIT, indeed this never would have happened if we had actually targeted the average inflation rate. So here’s my proposal (which is pretty similar to the way Jim Bullard interpreted FAIT back in 2020):
Each decade have the Fed estimate the trend rate of RGDP growth in the US. Then set an NGDP level target at 2% plus trend RGDP growth for the following 10 years.
Under this regime, the rate of inflation will average about 2% in the long run. But it’s also “flexible”, allowing for some year-to-year fluctuation in inflation due to supply shocks.
Of course I still think simple NGDPLT is better, especially if done on a per capita basis. But this proposal is 98% as effective and would not require a humiliating retreat by the Fed. They could claim they are sticking with their 2% FAIT policy, albeit with a slightly different interpretation.
PS. George Selgin has a good twitter thread on the Politico piece.
PPS. David Beckworth has a nice graph showing how the Covid inflation has gradually morphed from being a supply problem to a demand problem:
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7. June 2022 at 17:18
A better approach than adjusting nominal GDP every 10 years would be to have a 40 quarter moving average of real GDP growth and add to this the inflation rate of 0.5% every quarter to determine what the desired quarterly target for nominal GDP should be. This would be much smoother.
8. June 2022 at 00:16
Is the supply shock inflation in David’s analysis naturally neutral in the long run. In other words, should we expect 20% relative deflation in the future as the supply shocks unwind?
8. June 2022 at 06:14
Nice proposal. Being able to save face is going to be essential for the Fed to buy in to any new plan.
Based on the Beckworth plot, inflation is showing no signs of letting up, and will continue to increase if current trends continue. Has the Fed done anything to reverse the trend? Halting QE and raising interest rates by a token amount don’t seem like enough at this point.
8. June 2022 at 07:15
re: “set an NGDP level target at 2% plus trend RGDP growth”
That’s what I originally said. But economists don’t know money from mud pie.
re: “simple NGDPLT is better”
It’s less controversial and easier to hit.
Milton Friedman never said excess reserves were a tax – only required reserves. Paying interest on IBDDs induces nonbank disintermediation. It destroys the savings-investment process. It reduces the net interest rate margin, or spread, in the carry trade.
Every man a banker, share the remuneration.
8. June 2022 at 07:34
Economics is political not pragmatic. If you haven’t figured it out yet, the American Bankers Association is public enemy #1. Powell has appeased the bankers. Powell eliminated required reserves and destroyed deposit classifications. The money stock can never be properly managed by any attempt to control the cost of credit.
The higher the GINI coefficient, the higher the incidence of violence. Remunerating IBDDs exacerbates income inequality.
8. June 2022 at 07:55
Richard, I’d say slightly smoother, not much smoother. But also harder to communicate.
Kevin, I suspect that the unwinding of the supply shocks will slightly reduce inflation, but not dramatically. Of course oil disproportionately affects headline inflation.
Chris, The Fed has not done enough.
8. June 2022 at 08:44
re: “The Fed has not done enough.”
You can’t tell. O/N RRPs cause the money stock to fall. They absorb cash. But the FED’s accountants incorrectly claim that the money stock is not drained, and thus the money #s reported are wrong. They are overstated.
9. June 2022 at 08:37
Does anyone understand the methodology behind the Beckworth chart? I read his post but am not really understanding how the breakdown into supply- and demand-driven inflation is carried out.
9. June 2022 at 09:19
Beckworth does a good job of explaining NGDPLPT:
https://www.mercatus.org/system/files/beckworth-ngdp-targeting-mercatus-special-study-v2.pdf
As Donald Kohn says: “The FAIT framework is well designed to counter the disinflationary bias imparted by policy being constrained by the ZLB from time to time. FAIT promises to make up for inflation below 2 percent by aiming to run it “moderately above 2 percent for some time”—a flexible form of price-level targeting.
https://www.brookings.edu/opinions/assessing-the-federal-reserves-new-monetary-policy-framework/
Economists don’t know a debit from a credit, nor money from mud pie. You can’t quickly stop long-term money flows (inflation) without a more dramatic stoppage in short-term money flows (real output). It’s due to the distributed lag effect of money flows, the volume and velocity of money (correctly defined).
U * and R * are fictitious (there’s no such thing as a liquidity trap or pushing on a string). But Janet Yellen didn’t know that. She raised rates as inflation was falling (as the unemployment rate fell to too low levels).
It’s all transpired as when I gave Dr. Robert Auerbach Prichard’s money and banking book to comment on. No economist has been more prescient than Dr. Leland Pritchard. Nobel Laureate Dr. Milton Friedman: “The only relevant test of the validity of a hypothesis is comparison of prediction with experience.”
The question is how to get the Reserve authorities to target N-gDp? (a tangible and thus an accountable and justifiable figure).
9. June 2022 at 10:45
I want to believe that we’re turning a corner, both with Fed actions and people starting to temper some demand. Yglesias has a twitter comment on the current contradiction between people’s inflation expectations and their active belt-tightening.
It would be really nice if we found a way to increase housing supply and immigration over the next decade. Those may sound at odds with one another, but we used to do positive population growth with housing growth without screwing up the rest of the economy.
9. June 2022 at 12:14
As Sumner said: “simple NGDPLT is better, especially if done on a per capita basis.” We can’t afford increased immigration. Price stability is accomplished by targeting NGDPLT.
10. June 2022 at 05:49
Productivity is falling! Whether guided by NGDPLT or FAIT or plain old “2% target,” the fiscal/regulatory combination of supply restrictions and fiscal firehose imposes on Fed a painful choice between inflation and tighter money. Fed has to offset regulation-induced price increases as well as spending, whether that regulation pertains to climate change, COVID mandates, or fighting over the Donbas.
Last month’s 8.6% number may fall dramatically in June as QT starts to pull tens of billions per month out of the economy at an accelerating rate, but without a fiscal fix to both supply and demand, rates may still need to rise a quite a bit.
10. June 2022 at 07:46
They will NEVER target NGDP, because it means admitting their mistake, losing their job to Sumner or someone else, and losing prestige within the community. They are not scientists; they are religious zealots desperately seeking power.
The inability to admit one’s mistakes publicly is a direct result of postmodern marxist arrogance taking over academies. These people keep going down the anti-science rabbit hole, “Reimagining” failed ideas, “reshaping democracy”, “realigning values” and my new favorite term of the day “reintroduction to free speech”. It’s all marxist jargon. Notice their emphasis on carefully hand-picked “trusted experts” while canceling other experts by any means necessary.
I’ll now go back to silencing myself for fear of the NKVD.
11. June 2022 at 09:37
“They will NEVER target NGDP, because it means admitting their mistake, losing their job to Sumner or someone else, and losing prestige within the community. ”
That’s the whole point. Mainstream isn’t doing science or academia. They are doing politics.
It’s way past time we drop the “Queensbury Rules” and did the same. These people are religious quacks and should be called out as such. There is nothing to be gained by fighting on their turf.
Change Management is about human behaviour. Almost entirely about that.
That’s what we do. Everything is a human system. The majority of the work is largely dealing with people who think they know how things work, but actually they don’t. Generally that is a result of varying degrees of prejudice.
I don’t have to explain why papal infallibility is BS.
11. June 2022 at 09:38
There is no such thing as a “neutral rate of interest”. It’s complete woo. Up there with homeopathy, crystal healing and alchemy.
Under their “expectations theory”, where everybody has the capacity to discount their future income flows to the present, if there was such a thing they would automatically know what it was.
It’s all self referential BS. Modern Ether Theory.
12. June 2022 at 09:02
The biggest mistake in the history of the world is that banks are intermediary financial institutions serving as a conduit between savers and borrowers. Alt-M gets it wrong: “they therefore entail financial intermediation in which the depositor can be thought to lend cash to the bank, which then relends part or all of it”
https://www.alt-m.org/2015/11/07/monetary-base-total-reserves-fed-confusions-misreporting/
“Canada, the UK, New Zealand, Australia, Sweden and Hong Kong have no reserve requirements…However those “banks are constrained by capital requirements”. And because they make no difference between money and liquid assets, those Central Banks manage their economies via interest rates as their monetary transmission mechanism. But Powell made no such offsetting compensation and doesn’t track the figures.
Even Trump was more prescient than Powell: “Trump criticized Powell saying the Fed chair raised rates “too fast” and lowered “too slow.”
The 14.5% N-gDp in the 4th qtr. of 2021 reflects the FED’s ignorance. Income velocity, Vi, is a contrivance. Vi has fallen and not recovered with the incidence of Covid-19. In the 4th qtr. of 2021, the “demand for money” (inverse of Vt), suddenly collapsed (“the amount of cash the average person holds as a percent of his or her annual income”). The Fiscal helicopter drops injected sharp destabilizing disturbances in money demand.
The claim that the nonbanks were in competition with the banks is a lie perpetrated by the ABA. The lending capacity of the banks is determined by monetary policy, not the savings practices of the nonbank public. The ABA is in charge of policy, not the economics’ profession (paying for the deposits that they already own). The FED can only hit a N-gDp target if they average the figures.