Taylor and Cochrane on monetary policy targets

John Taylor recently criticized central bank policies in the major economies, and re-iterated his support for a clear rule for the policy instrument.  John Cochrane responded:

John Taylor has a lovely little blog post, encapsulating so much in a few sentences. An excerpt with comments (emphasis mine)

…there is a crucial issue which explains much of the enormous difference of opinion between critics and supporters of the Fed’s current policy. Critics such as me and Allan Meltzer … argue that monetary policy should focus on a clear strategy for the instruments of policy. A goal for inflation or other measures of macro performance is not enough if it is simply part of a whatever-it-takes approach to the instruments. Such an approach results in highly discretionary and unpredictable changes in policy instruments with unintended adverse consequences, as we have been seeing in recent years.

Supporters such as Adam Posen… are just fine with the Fed using, even year after year, a whatever-it-takes approach to the instruments of policy as long as there is an overall goal. With such a goal in mind, so their argument goes, the central bank can and should always intervene in any market, by any amount, over any time frame, with any instrument or program (old or new), and with little concern for unintended consequences in the long run or collateral damage in the short run (say on certain groups of people or markets) as long as it furthers that goal.

Critics are very concerned about those unintended consequences and collateral damage; they are also concerned about an independent government agency wielding such a great deal of power as it carries out a year-after-year whatever-it-takes approach. Supporters are much less concerned.

I have always had this problem with nominal GDP targets, inflation targets, and so forth. Ok, the Fed adopts your target. Now what? If nominal GDP doesn’t do what the Fed wants it to do, what should the Fed do about it? Talk more? (Monetary policy is starting to look more and more like foreign policy here).

.  .  .

Taylor, of course, would like the Fed limited to the instrument of short-term rates, and to follow the Taylor “rule” for setting them. But the principle is larger than that instance.

Like Cochrane and Taylor, I’m not happy with current policy, but I don’t believe they have the right answer.  Let’s start with the fact that the Taylor rule is a sort of flexible inflation target, so it’s not clear to me why Cochrane would oppose inflation targeting and praise Taylor’s defense of the Taylor Rule.  Any instrument-based monetary regime must have a nominal anchor, or else the price level becomes indeterminate.  Of course there are some instruments (the price of gold, for instance) that do anchor the price level, but I doubt Cochrane favors a return to the gold standard.

If we’ve learned anything in the past few years it’s that the Taylor Rule (and indeed any regime based on an interest rate instrument) is a lousy system.  It freezes up just when you need it most, at the zero bound.  I like to compare it to a car that has steering that works fine, except that it locks up when driving on twisty mountain roads.

A much better system would be to use NGDP futures as the policy instrument, i.e. make dollars convertible into NGDP futures at a fixed price, which rises by roughly 5% per year.  But that’s not going to happen anytime soon.  So how can I defend recent policies like QE, as being better than nothing?  One answer is that stock markets in the US and Japan love QE.  Conservatives are supposed to believe that markets are efficient, so the stock market response must be telling us something.  Now I suppose one could argue that stocks rose because of much higher expected inflation.  But in fact (PCE) inflation has fallen to 1% in the US, and market indicators of inflation continue to show that market monetarists have been consistently right about inflation (over the past 5 years), and the rest of the conservative movement in America has been consistently wrong.  Surely that counts for something?  My guess is that the markets see more NGDP leading to more RGDP in the short run, and that’s why stock investors love QE.

To summarize; Taylor and Cochrane are right that there is a lot to criticize in current monetary policy.  But the problem is not that central banks are targeting things like NGDP, rather the problem is that central banks are focusing on policy instruments, and are not targeting things like NGDP.  We have monetary policy as a series of “gestures.”  “We’ll do this and that, and then see what happens.”  A policy of NGDP targeting, level targeting, would provide transparency, as markets would know how much NGDP would rise over the next 10 years.  The monetary base and interest rates should be set at a level where the market expects NGDP growth to be on target.  Indeed John Cochrane has endorsed a slightly different market-based approach in previous posts.

The market’s are telling us that the “whatever-it-takes approach” is the right one, and this is why the US and Japan are now doing better than the eurozone.   The markets don’t care how big the monetary base is; they care about NGDP.  We need to focus on goals (hopefully NGDP level targeting) and let the policy instrument be the servant.

PS.  Re-reading Cochrane I’m not sure he does oppose inflation targeting, perhaps he simply opposes inflation targeting regimes that lack a clear instrument rule.  If so, I exaggerated our differences.

HT:  Michael

PPS.  Garett Jones makes an argument that seems related to Cochrane’s post:

So in many policymaking situations, more action means more uncertainty about the effects of the action. And if your goal is to be close to your target, then more uncertainty is a genuine cost of taking more action.

Hence, Brainard’s Conservatism Principle. Alan Blinder, formerly vice chair of the Fed, summed the Brainard Conservatism Principle this way when he applied it to monetary policy:

Estimate how much you need to tighten or loosen monetary policy to “get it right.” Then do less.

Actually you should do exactly as much as the markets think necessary to “get it right.”  (It doesn’t matter what you think.)  Period, end of story.  The mistake people make is thinking about monetary policy is terms of more or less “instrument action.”   There are two big problems with this worldview:

1.  There are many policy instruments; the base, interest rates, exchange rates, etc.  More of one might easily mean less of the other.  I favor NGDP futures targeting, and hence would never change my preferred instrument at all, relative to the trend line.

2.  The second problem is that many people (implicitly) assume that if all this QE hasn’t raised NGDP growth up to 5% or 6%, we’d need even more QE to get there.  On the contrary, if a robust NGDPLT regime were adopted, at say 5%, then the demand for base money would be much less, and hence the Fed could get by with even less QE.

Rather than thinking in terms of “effort,” think of monetary policy as steering an ocean liner.  It doesn’t take more effort to set the wheel at NE as compared to NNE.  So you always want to set the wheel in such a fashion as to equate the forecast of the port you will reach, with your desired destination.  Monetary policy is no different.

HT:  Saturos



41 Responses to “Taylor and Cochrane on monetary policy targets”

  1. Gravatar of Justin Justin
    5. May 2013 at 06:29

    What exactly is meant by “instrument?” I would think the instrument means the tool by which the Fed conducts monetary policy, ie open market operations. I have trouble seeing why a nominal interest rate is an instrument but the level of nominal GDP is not.

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. May 2013 at 06:46

    How does Taylor think the Fed moves interest rates, by waving a magic want?

  3. Gravatar of J J
    5. May 2013 at 07:14

    It seems Taylor does think that: he has made complaints about low interest rates as if they were a price ceiling, not the result of open market operations.

  4. Gravatar of marcus nunes marcus nunes
    5. May 2013 at 07:27

    Long ago I wrote:
    (Insisting on) Targeting the Fed Funds rate can be bad for the economy´s health:

  5. Gravatar of ssumner ssumner
    5. May 2013 at 07:32

    Justin, Unfortunately the term is not well-defined. It’s generally viewed as a variable under relatively direct control of the Fed (i.e. that can be controlled on a day-to-day basis), which is adjusted to influence other macroeconomic goal variables that are difficult to control in real time.

  6. Gravatar of Tommy Dorsett Tommy Dorsett
    5. May 2013 at 08:06

    It’s funny that free market economists trade in the EMH for an anti EMH view when markets contradict their theories and views (such as breakeven spreads and the S&P 500, which say what the Fed is doing is helpful not harmful). And I’m specifically referencing Cochrane and Taylor here and the gaggle of Rick Sentelli nincompoops on CNBC. Clownshow in clownshoes.

  7. Gravatar of Howard Howard
    5. May 2013 at 08:09

    expectations channel, expectations channel, expectations channel!

  8. Gravatar of Ashok Rao Ashok Rao
    5. May 2013 at 08:23

    Tommy, just because stock markets are going up doesn’t signal good or bad policy. Asset appreciation happens by the fact with quantitative easing.

    If the government decides to subsidize Apple for giggles, there would be appreciation. What success is this?

    Asset inflation is a byproduct of a policy that strives for both low consumer inflation and full employment. It’s not an end, and hence we must measure success by output gap or unemployment.

  9. Gravatar of TallDave TallDave
    5. May 2013 at 08:48

    The second problem is that many people (implicitly) assume that if all this QE hasn’t raised NGDP growth up to 5% or 6%, we’d need even more QE to get there. On the contrary, if a robust NGDPLT regime were adopted, at say 5%, then the demand for base money would be much less, and hence the Fed could get by with even less QE.

    That’s an interesting point. Is the argument that “demand for base money” decreases because cash would be less attractive due to higher NDGP expectations? Or because demand for liquidity decreases?

  10. Gravatar of TallDave TallDave
    5. May 2013 at 08:51

    Ashok — but the correlation only emerged in 2008, the Fed isn’t buying stocks, stocks have risen more than other assets, and stocks are an asset whose value varies with their future expected profit growth. So the markets seem to be saying “looser money means more future profit growth.”

  11. Gravatar of Ashok Rao Ashok Rao
    5. May 2013 at 09:02

    Not directly, but asset prices tend to rise together, so as the balance sheet grows it’s a natural by product.

    That said, I agree, stocks are responding to healthier future profits and growth. But looser money doesn’t explain everything.

  12. Gravatar of Michael Michael
    5. May 2013 at 11:23

    TallDave wrote:

    “That’s an interesting point. Is the argument that “demand for base money” decreases because cash would be less attractive due to higher NDGP expectations? Or because demand for liquidity decreases?”

    Probably both. Any increase in inflation expectations should reduce the damend for base money. In addition to that, having just lived through a major crisis, most people (and instituions) have some concerns about a double dip. Cash preferences are probably correlated with recession expectations.

  13. Gravatar of maynardGkeynes maynardGkeynes
    5. May 2013 at 11:26

    @ TallDave@ “So the markets seem to be saying “looser money means more future profit growth.””
    If the stock market was actually saying what you say it is, how does one explain the fact that long term treasuries have zoomed so high, even higher, in fact, than the stock market? These should not be happening at the same time. The most likely explanation that I see is yield-hunting, brought about by ZIRP and QE. Such asset appreciation doesn’t mean much, because the FED has purposefully distorted the pricing signals in all asset markets.

  14. Gravatar of kebko kebko
    5. May 2013 at 12:18

    Maynard: the yield curve has steepened during the QE’s.

  15. Gravatar of Steve Roth Steve Roth
    5. May 2013 at 12:25

    “It doesn’t take more effort to set the wheel at NE as compared to NNE.”

    Just the metaphor but…this is just not correct.

    It takes more or more sustained oomph to turn a ship through 45 degrees than through 20 degrees. And you don’t “set the wheel at NE.”

    You could set an autopilot to NE…

  16. Gravatar of Ricardo Ricardo
    5. May 2013 at 12:38

    Possible path to explict central bank NGDP targeting:
    Initially, NGDP targeting has to work w/o the expectations channel: it has to work in reality first. Only then, will the market believe it.

    Here’s what you do: implicitly target NGDP and get there in reality. First, you get NGDP back on trend.

    Then, the central bank can say: “Hey, we’ve been really been running an NGDP targeting regime for awhile. Obviously, we’ve succeed for the past two years. So, now we’re making that policy explict.”

    In other words, Chuck Norris could never credibility threaten kick-ass, if he hasn’t first convincing demonstrated kick-ass.

  17. Gravatar of J J
    5. May 2013 at 14:09


    Yet, if I see Chuck Norris’ superhuman muscles and he starts walking toward me like he’s ready to kick ass, then I might be convinced that he will kick my ass and run away.

  18. Gravatar of ssumner ssumner
    5. May 2013 at 14:27

    TallDave, You asked:

    “Is the argument that “demand for base money” decreases because cash would be less attractive due to higher NDGP expectations? Or because demand for liquidity decreases?”

    Higher NGDP expectations make cash less attractive.

    Ashok, You said.

    “Not directly, but asset prices tend to rise together, so as the balance sheet grows it’s a natural by product.”

    It depends why prices rise. Monetary stimulus often raises stock prices and lowers long term bond prices.

    Steve Roth, You missed the metaphor, I was referring to the steering wheel, not the direction of the ship.

    Ricardo, The central bank of the US already has plenty of credibility, they just need to use it.

  19. Gravatar of Ricardo Ricardo
    5. May 2013 at 14:41

    Ok, I’ll be less subtle with the thrust of my point.

    In the current environment, the Fed DOES NOT have credibility with the market wrt hitting a nominal GDP target in the near-term.

    Specifically, and relatively recently, there’s been a market consensus/opinion/expectation tipping point *against* monetary policy effectiveness vis-a-vis sustaining an inflation target of 2-2.5%.

  20. Gravatar of Benjamin Cole Benjamin Cole
    5. May 2013 at 18:34

    Excellent blogging.

    Cochrane’s post in mindnumbing in its ability to sound intelligent and be, well, obtuse.

    BTW, Cochrane is forever bewailing the perils of pending inflation. I guess he never heard about Japan.

    He still thanks the risks are from inflation. Despite Japan. Despite what has happened to inflation in the uSA since the 1980s. Despite the fact we are running at 1 percent inflation now, miles below the 4-5 percent inflation Volcker obtained, and was considered a huge success (by the right wing, no less).

    With Taylor and Cochrane, I think you have nice and smart guys, but they start from a premise, and that is inflation is ever the most serious and evil peril, and that anything liberals want or anything that hints at government activism is bad (unless it be be hugely expensive military ventures or endless Homeland Security spending and intrusion).

    In the end, Cochrane and Taylor are just thumping for tight money and devising intelligent sounding reasons for an obdurate, unreasoning fixation.

    The problem is, tight money does not work. See Japan.

    Forget the theories, for get the models, forget the putative superior morality of zero inflation. In practice, tight money does not work.

    Okay, so then what? Market Monetarism offers the best option.

  21. Gravatar of maynardGkeynes maynardGkeynes
    5. May 2013 at 19:45

    @kebco: I was referring to the absolute level of the long bond, not the steepness of the yield curve. I find it hard to reconcile a booming stock market with a 30 year yield of approx 3% on any basis except “yield chasing” brought about by zirp. Also, I’m not sure how much steepness matters when the absolute level of IRs is so low.

  22. Gravatar of Steve Roth Steve Roth
    5. May 2013 at 19:49

    “Steve Roth, You missed the metaphor, I was referring to the steering wheel, not the direction of the ship.”

    You don’t set the steering wheel to NE. You turn it to port or starboard (by some greater or lesser amount, for some period of time) until the ship points NE.

    Not important but might as well use a metaphor that aptly says what you’re trying to say.

  23. Gravatar of Saturos Saturos
    5. May 2013 at 20:38

    But I don’t think you addressed Taylor’s concern that fixed goals are more discretionary and interventionist, less free-market, than fixed instruments. Perhaps Lars or David should do a post.

  24. Gravatar of Saturos Saturos
    5. May 2013 at 21:16

    The repercussions of Abenomics (and this blog?): http://www.japantimes.co.jp/news/2013/05/03/national/girl-group-bases-style-on-nikkei-ups-and-downs/#.UYWDwrVJMhW

    HT: Tyler Cowen, of course.

  25. Gravatar of Saturos Saturos
    5. May 2013 at 21:21

    “Abeno mix”: a market monetarist anthem?

    “Fix the yen’s appreciation. Quantitative easing. Don’t forget public investment,” a line in the dance-pop tune goes. “Monetary easing. Construction bonds. Let’s just revise the Bank of Japan Law.”

    But Sakura warns that much more needs to be done for the public to be able to enjoy the good economy.

    “Previous administrations were overly conservative and couldn’t push forward huge changes. We expect the administration to implement drastic changes that will stimulate individual spending,” she said.

    “We don’t see AKB48 and other idol groups as our rivals,” Mori said.

    “If I had to pick our rival, I’d say it is an economic depression.”

  26. Gravatar of Ashok Rao Ashok Rao
    5. May 2013 at 21:48

    “It depends why prices rise. Monetary stimulus often raises stock prices and lowers long term bond prices.” Right, right – but again this is the ultimate point, it has to happen by virtue of the way monetary policy works (encourage people to borrow and invest in capital markets).

    In Europe the bond markets and stock markets seem to be moving together. Of course, more than anything, that’s a sign that bonds are risky etc.

  27. Gravatar of Joe Eagar Joe Eagar
    5. May 2013 at 21:57

    I’m surprised there isn’t any political interest in shifting the inflation target from 2% to 3-3.5%. That would make the zero lower bound much less of a problem.

    It wouldn’t be ideal; I support NGDP level targeting, myself. It’s not like the 2% inflation target isn’t itself arbitrary, and even the Taylor Rule makes major assumptions about the long-run Wicksellian interest rate. And let’s not forget the sheer difficultly of estimating the output gap.

  28. Gravatar of Ben J Ben J
    6. May 2013 at 02:15


    You said that monetary policy works by “encourag(ing) people to borrow and invest in capital markets”.

    This is not the case; that’s a simplistic (and wrong!) view of monetary policy that comes from the fallacy of composition.

    Nick Rowe says it best:

    “It’s even more horribly wrong when we think about another accounting identity that holds in aggregate: for every $1 borrowed there’s $1 lent. To keep it very simple, imagine an economy where everyone is identical. If I wanted to borrow then so would everyone else want to borrow, which means nobody would want to lend to me, so I wouldn’t be able to borrow from anyone else. And to keep it even simpler, imagine that people pay for everything with central bank cash, and that the velocity of circulation is almost infinite and so the amount of cash in circulation is vanishingly small. (Yep, like Woodford’s New Keynesian model). If the central bank lowers the rate of interest, people borrow a tiny amount of extra cash from the central bank (they all want to borrow from each other but nobody wants to lend), and spend that cash, and their incomes increase as others spend, which increases their spending even more, and incomes and spending keep on rising until it reaches a level where nobody wants to borrow from other people or from the central bank (or the central bank decides it has increased enough and raises interest rates again).
    This is a world in which a cut in interest rates makes people want to borrow, and monetary policy works by making people want to borrow, but there is never any actual borrowing (except for a tiny amount of borrowing cash from the central bank).
    Monetary policy does not work by increasing actual borrowing. That is not the causal channel of the monetary policy transmission mechanism. Monetary policy works by increasing spending, not borrowing. And one person’s spending is another person’s income, so people in aggregate do not need to borrow more in order to spend more. Their increased spending finances itself.”

  29. Gravatar of Ashok Rao Ashok Rao
    6. May 2013 at 02:56

    I agree with that, investing in capital markets (by giving companies more cash), should increase spending and business operation expansion. If someone who needs a house buys a house from someone who’s been wanting to sell for a while – at a good price – we’ll find more spending.

    Also, as I note here (http://ashokarao.com/2013/05/05/never-a-lender-or-lender-be/), the monetary policy transmission mechanism doesn’t always hold true:

    “My parents, and many like them, have a fantastic credit history, secure employment, and sound prospects for retirement. They should be borrowing money to buy a second house. Or at least that’s what economics says. They’re not. Behaviorally they are risk averse (loosing more than a years salary in a few days because of financial collapse can do that to you). They, and many other relatively high-savings folks, are immigrants. Even though now’s a great time to buy that fancy audio equipment they always wanted on consumer debt, I’m sure we’ll irrationally wait longer.

    And they have a busy life. No one likes borrowing. It is a source of comfort (not to mention pride) not to be in debt. So when people don’t maximize their borrowing limits for irrational reasons, it is time for the federal government to act as borrower of last resort.”

    It’s particularly true that America’s traditionally “spending” classes (say top 5% to top 1% excluding top .5%) have been a weak link this recovery in terms of spending. These are the people that have access to strong lines of credit, etc. but are not. I’m sure many would love to remodel their kitchen with fancy subzero appliances, but are not – why?

    This is in response to Greg Ip on the “Third Lever” of macro policy.

  30. Gravatar of TravisV TravisV
    6. May 2013 at 04:40

    Market Monetarists,

    This would be a good article for you to comment on:

    Alan Reynolds: “Is the Fed Getting Too Much Credit for This Rally?”


    “the dramatic unlinking of multiples from bond yields since 2009 strongly suggests the Fed’s bond buying program did not raise stock prices through this channel. Fed policy might nevertheless have lifted stock prices by raising earnings rather than multiples, but that conjecture is difficult to reconcile with the weak pace of economic growth. It is facile to claim the economy would have grown even more slowly if monetary and/or fiscal wizards had not done whatever they did. Such ad hoc apologetics would make all policies untestable “” a matter of faith rather than fact.

    On the basis of facts, it is highly unlikely that the Fed deserves credit for the stock market’s cyclical recovery, or for favorable effects of higher stock prices on household wealth and economic growth.”

  31. Gravatar of ssumner ssumner
    6. May 2013 at 05:36

    Ricardo, I strongly disagree. It’s not that the Fed can’t hit its target, it’s that they have the wrong target. They don’t have a 2.5% inflation target, they have a maximum 2.5% target, which they are currently hitting with ease. Inflation is less than 2.5%, just as the Fed says it wants. In addition, they are not doing level targeting. When DeLong asked Bernanke “why not a 3% target?” he didn’t respond the Fed couldn’t hit it, he said it would be a bad idea. So if they want to avoid 3% inflation they can certainly do so, and have done so.

    Steve Roth, OK, my terminology was non-nautical. Set the wheel such that the rudder is straight. Paint a red mark at the top of the wheel. If you move the red mark to 1:30 you are at NE using a compass metaphor. I realize that doesn’t mean you are moving in a NE direction–I should not have implied that. The wheel setting is the instrument, the ship direction is the macro outcome.

    Saturos, You said:

    “But I don’t think you addressed Taylor’s concern that fixed goals are more discretionary and interventionist, less free-market, than fixed instruments. Perhaps Lars or David should do a post.”

    Taylor is not proposing a fixed instrument, as that would be unstable. He has an instrument rule. I also offered an instrument rule. But right now the Fed won’t do my rule and can’t do Taylor’s (zero bound) so the markets say QE is better than nothing.

    At the zero bound his rule is not even an option. When not at the zero bound I’d argue that NGDP futures targeting is slightly better than the Taylor rule, but not much. Obviously neither of us favor QE when not at the zero bound. So the key difference is at the zero bound, when the Taylor rule becomes obsolete.

    Setting policy where the market expects success is obviously much more market-friendly than setting policy where John Taylor expects success.

    I saw the Japanese girl group story a month ago, but forgot to do a post. Very amusing. Wasn’t there a theory that hemlines follow the US stock market (high in the 1920s and 1960s?)

    Ashok, I don’t think monetary policy works by encouraging people to borrow, I think it works via the hot potato effect.

    Joe Eager, Good point. A few people like Krugman, DeLong, Rogoff (Blanchard?) have made that argument. The fact that you hear very little support for the idea tells me that very few people understand what’s going on. Even British uber-Keynesian Ed Balls opposes a higher inflation target.

    Travis, Obviously the Fed is not the only factor here, but it’s also undeniable that the Fed has had some impact, as stocks consistently rally on Fed easing.

  32. Gravatar of Ashok Rao Ashok Rao
    6. May 2013 at 05:48

    How would we measure the efficacy of this mechanism: money velocity?

  33. Gravatar of Saturos Saturos
    7. May 2013 at 01:36

    Scott, I guess Taylor would reply that we should be trying to define “success” at all, that targeting market forecasts of long run RGDP performance would end up justifying too much intervention of all kinds, that the point is to keep the scope of intervention-methods delimited in order to be properly free-market. (Just going off of what Greg Ransom might say as well.) As for the ZLB Taylor would assert that if the natural rate were that low there must be deeper problems with the economy than can be fixed by messing with interest rates anyway. Even so he’d rather you specify a clause delimiting instrument behavior under these conditions than “whatever it takes” to acheive whatever goal you deem “successful”, regardless of whether you use a market forecast to stay on that track.

    Ashok, money velocity isn’t the mechanism, demand for holding money (affected by Fed moves) is. If NGDP goes up independently of moves in M0 then it is efficacious.

  34. Gravatar of Saturos Saturos
    7. May 2013 at 02:40

    I’ll never be able to read articles like this with a straight face again: http://www.aljazeera.com/news/2013/2013/05/20135792145195989.html

  35. Gravatar of Bill Woolsey Bill Woolsey
    7. May 2013 at 03:54


    You write that you agree with Taylor that interest rate targeting is better than quantitative easing away from the zero nominal bound.

    In my view, quantitative easing is about using base money as an instrument. An instrument rule for base money would be something like adjust the growth rate (or path) of base money in order to keep the inflation rate (or the growth path of nominal GDP) on target. As we know, McCallum did work on this regarding nominal GDP targeting.

    Taylor believes that we should use econometric methods to estimate the relationship between the instrument (base money or interest rate) and the policy goal (inflation or nominal GDP) and then set the instrument according to what past experience tells us should result in reaching the policy goal.

    If we don’t reach the goal, then it is better to stick to the rule than adjust it.

    The rule is more important than the goal.

    By the way–why target inflation? Because it is s “easier” to hit. Given the social engineering framing, it will take more changes in the instrument to adjust to a price level growth path or nominal GDP growth path than an inflation target.

    With the interest rate instrument, it will take more changes in interest rates and the engineering mentality, it will take more adjustments in the interest rate to keep the price level of a target growth path.

    The Blinder – Brainard approach means — don’t change interest much. This fits in with the “true” goal of central bankers, which seems to be to keep short term interest rates stable.

    In the past, it appeared that changes in interest rates were more closely associated with future changes in inflation (and the output gap) than changes in base money. So, Taylor favors sticking to a rule developed over past periods that appeared to relate changes in the Federal Funds rate to inflation and output gaps. (And he favors dropping the output gap parts.)

    My view is that any such “rule” should be tentative. I don’t believe that it is desirable for the central bank to make committments about what interest rates or the level of base money will be at future dates even as a function of what inflation (or the level of nominal GDP or inflation modified by an ouptut gap) happen to be at those future time.

    I very much agree with your point that the future level of base money is not important in and of itself. That is only important if the level of base money is to be the nominal anchor. It is a poor nominal anchor, requiring estimates of the demand to hold money to figure out the impact on the price level or nominal GDP. The price level itself, or the level of nominal GDP, are much better as nominal anchors.

    Future interest rates (nominal and real) are of fundamental interest. But stablizing them is like stabilizing the price of corn. Yes, knowing the price of corn in the future would be nice. But not if the result is shortages or surpluses of corn.

    For many years, Monetarists used past experience of M2 velocity to argue for a “k” percent rule for M2. It is simple and the level of M2 does provide a decent nominal anchor, though inferior to the price level or nominal GDP itself.

    And now, Taylor is doing the same using past experience between the Federal Funds rate at the inflation rate and output gap. But the Federal Funds rate is a horrible nominal anchor. The inflation rate is a weak nominal anchor (rising 2% from whever it happens to be doesn’t really tell us where it starts from.) And, the output gap is a horrible nominal anchor.

    The Taylor rule is clearly a rule of thumb. It begs for adjustment over time. And, in retrospect, the same was true of the “k” percent rule for M2. (Today, we might use a “k” percent rule for Divisia 4. But not as something that is reified, but rather a rule of thumb.)

    Finally, the Taylor rule approach leads to the notion that when it fails it is not the “rules” fault but rather the economy’s fault. To start, that is what fiscal policy is about. Rather than use taxing and spending to fund desirable public goods in an efficient way, spending (and tax changes) are directed to “fixing” the economy when really it is just overcoming deficiencies in the monetary regime. Complaints about the Obama administration’s “anti-business” policies are even worse. Should pro and anti business propaganda be tailored so that the interest rate spit out by a taylor rule clears market at the target inflation rate and zero output gap?

    It is absurd.

  36. Gravatar of Bill Woolsey Bill Woolsey
    7. May 2013 at 04:00


    It seems to me that your approach uses base money as the instrument. The tentative setting of the instrument by the central bank can depend on a rule, but it is entirely a tentative rule of thumb. Then there is a rule for adjusting the tenative target according to trades of a futures contract on the goal, (nominal GDP.) So, the market is given complete discretion to adjust the base money instrument. Traders in the futures are free to use whatever rules they like to judge whether to buy, sell, or stay out of the market.

    To me, seeing this as usuing the index futures as an instrument is really not right. The instrument is base money. If there are no trades of the future, then the central bank just sets it where it thinks best. And the trades of the futures just changes who sets the instrument.

    As you sometimes say, it is like increasing the size of the FOMC.

  37. Gravatar of ssumner ssumner
    7. May 2013 at 06:53

    Ashok, What do you mean by “mechanism?”

    Saturos, You said;

    “As for the ZLB Taylor would assert that if the natural rate were that low there must be deeper problems with the economy than can be fixed by messing with interest rates anyway.”

    I’m confused, it’s Taylor that favors “messing with interest rates” not me. And the Taylor rule is also a sort of “whatever it takes” approach. If inflation soars to 1000%, the Taylor rule calls for interest rates above 1500%.

    In addition, Taylor can’t just claim my proposal is more “interventionist”, otherwise it’s pure “he said she said.” He needs evidence. And I don’t see any. My proposal is 100% rule-based. The Taylor Rule inevitably leads to discretion when nominal rates hit zero.

    And let’s say I’m wrong and my policy is more interventionist. That’s still not an argument, as the gold standard is less interventionist than the Taylor Rule. Does Taylor favor the gold standard? Obviously not. So what’s the point of showing one policy is more “interventionist” by some arbitrary definition?

    Bill, You said;

    “In my view, quantitative easing is about using base money as an instrument.”

    I misspoke. I meant that away from the zero bound I don’t like policies of a large monetary base combined with IOR. I do agree that all OMOs are “QE” in some sense, so yes, in that sense I favor QE during normal times.

    I agree with your comments on the flaws in the Taylor Rule, but despite those flaws it actually works tolerably well when nominal rates are positive.

    Regarding your second comment, there’s a lot of ambiguity as to what we mean by “instrument.” Under NK policy both the fed funds target and the base can be viewed as instruments. It depends how you define the term.

  38. Gravatar of Ricardo Ricardo
    7. May 2013 at 18:52

    ssumner, I very poorly articulated my primary concern in my last comment. (I may do so again, but I prefer brief comments. 😉

    I said: “relatively recently, there’s been a market consensus/opinion/expectation tipping point *against* monetary policy effectiveness”

    What I mean is, IMO, the market isn’t seeing addl sustainable NGDP per dollar of addl QE, just mostly asset inflation. That’s why a policy of more QE may costing the Fed credibility.

    There’s a growing chorus citing the “costs and risks.” Its not just “hard money” folks anymore that are saying asset prices are becoming disconnected from fundamentals. Quotes like “only a 50-50 chance” the fundamentals improve to support the increased asset prices.

  39. Gravatar of ssumner ssumner
    8. May 2013 at 07:52

    Ricardo, I always tune out people who say stock prices are at the wrong level. Remember Shiller’s buy call when the S&P was 700 in 2009? Neither do I. How about Roubini in 2009?

    I’ll take the EMH over market skeptics any day.

    There is no way that QE can boost stock prices w/o boosting NGDP. It’s impossible.

  40. Gravatar of Geoff Geoff
    8. May 2013 at 10:33

    “I always tune out people who say stock prices are at the wrong level. Remember Shiller’s buy call when the S&P was 700 in 2009? Neither do I. How about Roubini in 2009?”

    Well, when you pretend that those who correctly forecasted stock prices are dead, then of course you’ll only see incorrect forecasts.

    “I’ll take the EMH over market skeptics any day.”

    Forming a forecast, and acting on a forecast, of future stock prices that differs from other formations and actions on forecasts, IS a part of the very market process itself!

    The market isn’t some monolithic entity that has a single judgment of stock prices. There are *always* disagreements among investors. These disagreements manifest themselves in a single set of stock market prices, but that does not at all mean that the single set of market prices are a reflection of a single “market” forecast of the direction of future stock prices.

    Every movement of stock prices, EVERY SINGLE ONE, is associated with some investors being right and some investors being wrong. The only way stocks can be traded in the first place is if there are disagreements on the value of those stocks. If everyone agreed on the valuations of all stocks, there would be no trading of any stocks. Trading presupposes different, indeed offsetting, judgments of value and price between the exchangers.

    One does not have to be a market skeptic if one rejects EMH. One cannot reject both without contradiction.

  41. Gravatar of Geoff Geoff
    8. May 2013 at 10:43

    Dr. Sumner:

    “There is no way that QE can boost stock prices w/o boosting NGDP. It’s impossible.”

    The Fed buys $10 million of Treasury bonds from a bank.

    The bank takes that money and bids for stocks. Stock market prices go up.

    At this point, stock prices have gone up w/o a single penny boosting of NGDP.

    What you probably meant to say is that there is a very small probability that QE, if it increases stock prices in the present, that there won’t be any increase the prices of goods and services in the future.

    But that’s just it! In a modern, worldwide, complex division of labor economy with billions of participants, that “in-between time” can be stretched for long periods of time, such that any cross sectional price analysis along the way will show stock prices that have risen relatively more than consumer goods prices, sometimes dramatically so.

    Like I have said a zillion times, but seemingly on deaf ears, inflation of the money supply does not affect the prices of all goods equally across the board. Inflation almost always increases the prices of higher order goods more than it increases consumer goods, in the present, and then, after some time has elapsed, the prices of consumer goods rise once the money spending extends into larger and larger markets away from the higher order stages. Why does it do this? It’s because of two main effects. One is the Cantillon Effect, and the other is the effect that the resulting changed interest rates have on the allocation of new dollars for spending. If inflation brings about the liquidity effect, and interest rates fall, then there will be a greater concentration of spending in the higher order stages relative to the consumer goods stage. Or, what can also happen, lower interest rates will have a greater concentration of spending in both the higher stage and the final consumer stage, relative to the “middle” stages. In this case, the economy will be “stretched at both ends” in real terms, stressing the sustainability and making recession inevitable at some point, depending on the extent of inflation response.

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