The Evans Rule needs to be symmetrical

Last December the Fed adopted a so-called “Evans Rule,” which calls for near-zero interest rates (at least) until one of the following two boundaries are hit:

1.  Core PCE inflation is expected to exceed 2.5% on a sustained basis.

2.  Unemployment falls below 6.5%

This brought some welcome transparency to the monetary policy process, but falls well short of what’s needed.  The basic problem is that the boundaries are in one direction only—markers for when to tighten policy.  There are no boundaries provided as to when monetary policy needs to be made more expansionary.

Suppose it took 1000 years for the US to reach either of the 2 boundary conditions.  The Fed could still claim that it had adhered to the Evans Rule, yet no one would regard the policy as a success.  Indeed something like this was occurring in Japan, until the recent policy change (and it’s unclear as to whether they will hit their 2% inflation target.)

Michael Darda recently sent me data showing that the PCE is up only 1.0% over the past 12 months, and the more important core PCE is up only 1.1%.  The obvious solution is to make the Evans rule symmetrical around 2%.  Thus if more than 2.5% core PCE inflation triggers tighter money, then less than 1.5% inflation triggers easier money.

Interestingly, this proposal seems more “dovish” than the Evans Rule, and it is, and yet it’s still too hawkish to fit the Fed’s dual mandate, as it’s equivalent to a 2% inflation target with no weight on employment.  That’s right, my dovish reform proposal is still too hawkish to be legal.  Just one more indication of how far monetary policy has drifted from the golden age of the Great Moderation.  But even small blessings would be welcomed.

I could extend this idea to the unemployment boundary, but I’m not really a fan of targeting unemployment. Obviously I’d prefer a 5% NGDP target path, with 4% and 6% boundaries, if the Fed wants to actually adhere to its dual mandate.  (In a few years we could gradually reduce that growth rate, if we opt for level targeting.)

We can discuss what additional stimulus would be adopted when inflation falls below 1.5%.  It might be lower IOR, but additional QE is more likely.  I’ve argued that QE should increase by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first.  Whatever the Fed decides, they need to be more aggressive.  Although nominal growth has been pretty stable in recent years, despite increasing austerity, it’s also been below the Fed’s forecasts, and below their policy target.

The Fed hopes things will pick up soon.  But hope is not a plan.


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28 Responses to “The Evans Rule needs to be symmetrical”

  1. Gravatar of Geoff Geoff
    29. April 2013 at 17:07

    “I’ve argued that QE should increase by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first.”

    Hi, I’m Dr. Sumner. I’m a free market economist, but I’m OK with communism too.

    This blog is becoming an asylum for the mentally insane.

  2. Gravatar of Benjamin Cole Benjamin Cole
    29. April 2013 at 17:40

    Michael Darda recently sent me data showing that the PCE is up only 1.0% over the past 12 months, and the more important core PCE is up only 1.1%. –Sumner.

    There should be fighting in the streets about this, assaults on the Federal Reserve. We have the lowest sustained rates of inflation since the immediate postwar era—-while the US economy cannot generate jobs to even regain to the 2008 level.

    I have always wondered why the Bank of Japan did nothing for 20 years when inflation was dead. Now I know.

    New norms are developed, and become reinforced inside the cloistered walls of central bank-land. Now, inflation at 4 percent seems like a monetary holocaust. There was time when 5 percent inflation was regarded as a victory and time to ease up. Those ancient days of Ronald Reagan.

    Now, we are at 1 percent inflation, and no one seems to care.

    The United States of Japan.

  3. Gravatar of Rob Rawlings Rob Rawlings
    29. April 2013 at 17:49

    “I’ve argued that QE should increase by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first.”

    I assume that Paul Krugman and other believers in liquidity traps think that the CB owning Planet Earth would come sooner.

  4. Gravatar of Suvy Suvy
    29. April 2013 at 17:52

    The Fed needs to stop pegging the yield curve; the Fed should just target monetary aggregates and a 5% NGDP target. As Keynes said, low interest rates could actually be damaging in a situation like this because they reduce the inducement of people to invest and I think low interest rates right now actually reduce the velocity of money.

  5. Gravatar of TravisV TravisV
    29. April 2013 at 17:58

    Joe Weisenthal:

    “Did The Japanese Economic Comeback Just Begin?”

    Good datapoints related to labor, manufacturing, and spending. That’s a trend.

    http://www.businessinsider.com/japan-abenomics-strong-manufacturing-and-consumer-spending-data-2013-4

  6. Gravatar of ChargerCarl ChargerCarl
    29. April 2013 at 18:24

    Didn’t the BOJ promise 2% inflation in 2 years? How could they fail to hit that?

  7. Gravatar of Greg Hill Greg Hill
    29. April 2013 at 18:44

    Scott,

    “I’ve argued that QE should increase by 20% per month, until we are out of the zero rate bound, or **the Fed owns planet Earth,** whichever comes first.”

    I appreciate your willingness to take your policy proposal to its theoretical limit. One question: in what order should the Fed purchase the assets of planet Earth? Seriously, what comes after government bonds? Just very generally: corporate bonds, equities, real estate?

    When you put it so boldly (a good thing), it becomes more clear (to me at least) that, under your approach, and as a result of your approach, asset prices will rise by varying amounts, with lots of distributive and allocative implications. As a consequence, it’s not transparent obvious that your massive asset purchases would be more efficient, and, to provisionally adopt your own standard of comparison, produce more welfare (judged in utilitarian terms), than, say, having the federal government become “the employer of last resort.”

  8. Gravatar of Edward Edward
    29. April 2013 at 19:00

    “”I’ve argued that QE should increase by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first.”

    Hi, I’m Dr. Sumner. I’m a free market economist, but I’m OK with communism too.

    This blog is becoming an asylum for the mentally insane.”

    The only one who is insane here is you, major freedom

  9. Gravatar of ChargerCarl ChargerCarl
    29. April 2013 at 19:04

    Edward, its just a thought experiment.

    Chill bro.

  10. Gravatar of ChargerCarl ChargerCarl
    29. April 2013 at 19:05

    edit: nvm, edward geoff said that.

    sorry, i didnt see the quotation marks and I usually ignore his posts.

  11. Gravatar of ssumner ssumner
    29. April 2013 at 19:55

    Greg, That was a joke.

  12. Gravatar of Greg Hill Greg Hill
    29. April 2013 at 20:01

    Scott,

    “Greg, That was a joke.” OK, but I’m still wondering what criteria you apply in deciding which assets to buy?

  13. Gravatar of TravisV TravisV
    29. April 2013 at 20:53

    Prof. Sumner,

    Noah Smith mentions you in this piece:

    “Can “culture” predict economic development?”

    http://noahpinionblog.blogspot.com/2013/04/can-culture-predict-economic-development.html

  14. Gravatar of Paul Andrews Paul Andrews
    29. April 2013 at 23:14

    Greg Hill,

    “OK, but I’m still wondering what criteria you apply in deciding which assets to buy?”

    I think Scott, like Ben Bernanke, believes it doesn’t matter. Mr. Bernanke once said that the Fed could buy ketchup.

    Of course, it does matter because Fed purchases have a direct effect on supply, and hence on the price of the asset purchased, over and above the general effect of the increase in money supply. Surely everyone would agree that ketchup suppliers would very much like Mr. Bernanke to follow through on his idea?

    There is a comment thread pertaining to this here: https://www.themoneyillusion.com/?p=20457&cpage=1#comment-240477

  15. Gravatar of Max Max
    30. April 2013 at 00:06

    “I’ve argued that QE should increase by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first.”

    A logical stopping point for QE is when the yield on base money exceeds t-bills. What’s the point of going further? If the demand for money is so satiated that the CB has to pay people to hold it, you have to admit that a lack of money is not a problem.

  16. Gravatar of W. Peden W. Peden
    30. April 2013 at 02:07

    Can’t the Fed also affect the demand for base money by promising to keep interest rates low and QE large for longer periods?

  17. Gravatar of Full Employment Hawk Full Employment Hawk
    30. April 2013 at 05:06

    “Those ancient days of Ronald Reagan.”

    During the Reagan recession, Fed took its foot off the monetary brakes when it had brought the rate of inflation down to about 4% and let the economy grow again. If they had kept the brakes on until it had reached 2%, Reagan might well have been defeated. (Was the FOMC trying to help Reagan get reelected?) And it made no further attempts to bring the inflation rate down. It was perfectly willing to live with that.

  18. Gravatar of Full Employment Hawk Full Employment Hawk
    30. April 2013 at 05:17

    “The Fed hopes things will pick up soon. But hope is not a plan.”

    With the Fed being unwilling to offset contractionary fiscal policy with more expansionary monetary policy, we are in a Keynesian world where fiscal policy affects output, and fiscal policy has become incrasingly contractionary especially with the sequester. So the Fed, if it does not act boldly to offset this, has very solid reasons to expect things to get worse.

    But the Fed has engaged in wishful thinking throughout most of of the Little Depression. It’s economic forecasts have repeatedly underestimated what the unemployment rate wold be. As a result, it has repeatedly failed to give the economy sufficient monetary stimulus and therefore failed to comply with its congressional mandate to seek maximum employment.

  19. Gravatar of Full Employment Hawk Full Employment Hawk
    30. April 2013 at 05:24

    “The Evans Rule Needs to Be Symmetrical”

    AGREED! RIGHT ON! But symmetry also requires that an unemployment rate boundary be included.

    Replacing this with a NGDP target would definitely be better, but as long as the Fed is not doing this, symmetry requires an unemployment target.

  20. Gravatar of Daniel Daniel
    30. April 2013 at 05:25

    I honestly don’t know what’s better – the blog posts themselves – or watching Geoff lose his sh*t.

    Keep it real, bro.

  21. Gravatar of Saturos Saturos
    30. April 2013 at 05:43

    Noah Smith describes QE as mercantilism, cites this post: http://www.econbrowser.com/archives/2013/04/unconventional.html

    And Melanie Friedrichs believes in the confidence fairy (she has other interesting posts too): http://www.smithandkeynes.com/2013/04/the-sorry-demonization-of-confidence.html

  22. Gravatar of Saturos Saturos
    30. April 2013 at 06:06

    Japan’s household spending: http://www.reuters.com/article/2013/04/30/us-japan-economy-idUSBRE93T03R20130430

    Reuters’ new “Abenomics” index: http://www.reuters.com/video/2099/01/01/reuters-tv-video?videoId=242354831

  23. Gravatar of Saturos Saturos
    30. April 2013 at 06:07

    Krugman sums up his life these days: http://www.nytimes.com/2013/04/29/opinion/krugman-the-story-of-our-time.html?src=me&ref=general

    And Noah Smith on “culture”
    http://noahpinionblog.blogspot.com.au/2013/04/can-culture-predict-economic-development.html

  24. Gravatar of Saturos Saturos
    30. April 2013 at 06:08

    Finally, more people see talent in the paintings of the former US President: http://www.thesmartset.com/article/article04291301.aspx

  25. Gravatar of ssumner ssumner
    30. April 2013 at 08:29

    Greg, Buy T-debt.

    Max, You don’t need to pay people to hold dollars–doing so is contractionary.

    W.Peden, Maybe, but those promises are also consistent with a Japan-type outcome.

    Saturos, Thanks, there are some great links there.

  26. Gravatar of Max Max
    30. April 2013 at 12:53

    “Max, You don’t need to pay people to hold dollars-doing so is contractionary.”

    You took me too literally. The point applies to 0% base money. That’s also paying to hold money if the (most money-like) bond yield is below 0%.

  27. Gravatar of Hawks, Doves, and Forward Guidance | uneconomical Hawks, Doves, and Forward Guidance | uneconomical
    17. July 2013 at 05:01

    […] b) A “thresholds” approach fails the test of proper Svenssonian monetary policy – you must target the forecast.  Scott and others have written about this many times in the context of Bernanke/Evans rule. […]

  28. Gravatar of Welcome to the Lost Decade(s) | uneconomical Welcome to the Lost Decade(s) | uneconomical
    7. August 2013 at 02:53

    […] MPC expects to fail.  As with the Fed, we could have unemployment at 8% for the next century and the MPC cannot be judged to have […]

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