Rules vs. political interference
The relative advantages of rules vs. discretion is a frequent topic of debate in the field of monetary economics. But perhaps the more important distinction is “rules vs. political interference”. The following is from a column I wrote for “The Bridge“:
When considering the President’s criticism of Chairman Powell, it’s important to distinguish between tactical disputes and strategic disputes. Thus, one could imagine someone preferring that the Fed set a different inflation target, say four percent inflation instead of the current two percent target. That would represent a difference in preferred strategy. Alternatively, a Fed critic might accept the desirability of the two percent inflation target, but question whether the current policy stance was appropriate, i.e. likely to achieve two percent inflation. To my knowledge, the President has not made clear whether he is making a tactical or strategic criticism. In fairness, one often sees Fed critics gloss over this distinction. . . .
If Fed independence is desirable, then it is important to consider policy targets that are less ambiguous, less likely to be criticized by public officials. For instance, the ECB has a single mandate to control inflation and thus may have an easier time brushing aside political calls for easier money to boost the economy. Unfortunately, a simple inflation target is subject to the “never reason from a price change” problem. Rising inflation might represent excessive spending, as in the 1960s, or it might represent an adverse supply shock, as during 2007-08. If the Fed responds to supply-side inflation in the same way as demand-side inflation, they may end up destabilizing the economy.
A better approach is to find a single policy goal that best incorporates the Congressional goals embedded in the dual mandate. An increasing number of prominent economists have suggested that targeting nominal GDP growth at a steady rate of four or five percent/year is the best way to achieve the dual mandate, as NGDP growth includes both inflation and real GDP growth. With a single NGDP growth target, the Fed would have an easier time brushing aside political criticism.
Read the whole thing.
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8. November 2018 at 17:07
The more I ponder the Fed independence question, the more I conclude the macro economics profession is barking up the wrong tree.
Even if the Fed followed policies automatically, the results of those policies are too slow. How quickly does a decrease in interest rates or an increase in QE work? Of course this slow-working policy response is exacerbated by the fact we have to wait for Fed officials to reluctantly make the decision to stimulate.
It seems to me that payroll tax cuts should be triggered whenever GDP growth rates fall below a certain level. The lost revenue could be recouped by money-financed fiscal program— that is the Fed prints money and sticks it into the Social Security and Medicare trust funds.
Or, we can wait for Fed officials to believe there is a recession, and then slowly implement programs that might slowly stimulate the economy— you know, like 2008.
8. November 2018 at 22:14
Scott,
just a small quibble on how you are selling NGDP targeting in the media. It took me a long time to visualize precisely _why_ an NGDP target is so much more directly economically meaningful than an inflation target or a growth / employment target and how NGDP makes more sense than RGDP alone for purposes of employment stabilization.
Your best reasoning for NGDP targeting on this blog was, it’s because you want to keep stable the proportion of GDP that a single dollar can buy. This immediately does away with any issues of measuring the magnitude of inflation, or its causes, and of quantifying real output and the causes for its variation. The “same % of GDP per dollar” concept on the other hand relates the monetary stock to the economic flow directly, and is an intuitive, natural metric. It is, however, not a metric I would have understood if you hadn’t verbalized it specifically. With a framing such as “NGDP growth includes both inflation and real GDP growth”, as you wrote in your article, I would forever have grappled with inflation vs RGDP and why and how they are related in a complex way. I think it’s the same for the average reader.
9. November 2018 at 04:51
> Even if the Fed followed policies automatically, the results of those policies are too slow. How quickly does a decrease in interest rates or an increase in QE work? Of course this slow-working policy response is exacerbated by the fact we have to wait for Fed officials to reluctantly make the decision to stimulate.
Benjamin, monetary policy decisions have long and variable foreshadowing. See Scott Sumner’s Midas Curse for examples and details.
The markets merely need to be able to predict future decisions, and then will move the future into the present. (Which a rule would make easier.) The mechanism is straight-forward exploitation of arbitrage opportunities.
9. November 2018 at 04:54
mbka, I found George Selgin’s Less Than Zero really useful for understanding what you are talking about. I think Scott just wrote a new foreword to George’s book this year, too.
Less Than Zero is a plea for a constant NGDP per capita, and marshals similar arguments to the ones you quoted.
9. November 2018 at 11:15
mbka, One problem there is that I actually favor the dollar losing 4% of its value each year, in terms of the share of NGDP that can be purchased. That’s harder to explain to people.
9. November 2018 at 16:26
Scott,
I know you do, and you’re right this is harder to get in. I just thought, when explaining this to people it might help to use a 2-stage process and to start with the constancy concept first.
Matthias,
thanks for the references.
9. November 2018 at 16:40
Matthias: yes I think the market does anticipate federal monetary and fiscal decisions, but is anybody sure by how much?
We also will run into this problem in the next recession: we will hit zero lower bound in the first inning and no one really knows if QE works or not. The market may well anticipate that the Federal Reserve is impotent.
On the other hand, an automatically triggered payroll tax cut will immediately put spending power in the hands of people who tend to spend every penny they get.
My plan avoids wasteful federal spending, and indeed I am reserved about most social welfare programs and very reserved about military outlays.
I think the market would anticipate my automatically triggered payroll tax cut plan as it would Federal Reserve actions.
9. November 2018 at 18:43
Matthias: Add on.
David Beckworth suggests QE did or may not work, as the Fed promised to sell back its bond hoard, which meant the money expansion was not permanent and the market knew it. So QE was futile, given the constraints, suggests Beckworth.
If Beckworth is correct, we face this situation in the next recession:
We hit lower zero bound, and the market knows it, and knows the Fed is out of interest-rate ammo in the first inning.
So, the central bank turns to QE, but the Fed will never (never, ever, never) say, “And we promise never to sell back the bonds. Never! So this money expansion is permanent!”
So the market again knows the Fed is all mouth and no punch.
What happens when the market says, “The Fed King has no clothes!”
I hope macroeconomic policy makers are not so hidebound, not so orthodox, not so conventional, not so theological as to eschew the tools that will work. That being money-financed fiscal programs.