What does it mean to ask “Is money too loose?”

Is money too loose?  That might seem like a simple question, calling for a yes or no answer.  But it isn’t, because people wrongly think of monetary policy is a series of gestures, not a regime.

Our current regime has multiple goals, including an average inflation rate of 2%, and cyclical stability.  Often the two goals do not conflict, as in 2009.  But sometimes they do, like right now.

For example, monetary policy in Japan became more expansionary under Prime Minister Abe, producing slightly higher inflation and substantially higher NGDP growth.  I’ve argued that it’s still too contractionary because Japan remains well below its 2% inflation target.  Others say the labor market is now very strong (which is true) and that no further monetary stimulus is needed.  That’s also true, if you are focusing on the “stabilization” part of monetary policy.  But I believe Japan would still benefit from raising trend inflation high enough to escape the zero rate bound.

Recent Fed policy has given the US economy exactly the same sort of sugar rush as the Japanese felt after 2013.  Both NGDP growth and inflation are accelerating modestly.  From a “stabilization” perspective, policy may be too expansionary.  On the other hand, core PCE inflation is right at 2%, after a long period of underperformance.  From this perspective, policy is finally getting right on track.

Here’s another way of thinking about the dilemma.  The Fed’s dual mandate calls for above 2% inflation when unemployment is high, and below 2% inflation when unemployment is low.  The average rate should be 2%.  Unemployment is currently low, and hence the Fed should shoot for below 2% inflation.  But the Fed ran a tight monetary policy during the Great Recession and slow recovery, so if they run below 2% inflation right now they may lose credibility.  If you run below 2% inflation during both recessions and booms, then the average rate will obviously fall below 2%.

Right now, the Fed can either try to make its 2% long run inflation target credible at the expense of cyclical instability, or it can try to smooth out the business cycle at the expense of its long run 2% inflation target.  It cannot do both.

Or the Fed can adopt NGDPLT and do its best to run a countercyclical inflation rate.  Under NGDPLT, there are no “dilemmas”, just a clear target to shoot for, each and every day.

PS.  Demand-side fiscal policy is quite expansionary, but that doesn’t change anything I said here.  RGDP growth has been raised by supply-side reforms like the corporate tax cut, and that does interact with monetary policy by boosting NGDP growth (assuming the Fed targets inflation at 2%.)  In retrospect, Obama’s biggest policy mistake was not cutting the corporate income tax sharply in early 2009, instead of enacting the actual stimulus bill.  Of course if he’d had that ideology then he never would have gotten the Democratic Party nomination.



28 Responses to “What does it mean to ask “Is money too loose?””

  1. Gravatar of Cove77 Cove77
    30. August 2018 at 09:52

    Another great post though I’m not sure Obama would’nt have beaten crooked Hillary anyway.

  2. Gravatar of John hall John hall
    30. August 2018 at 10:39

    Scott, you said: “The Fed’s dual mandate calls for above 2% inflation when unemployment is high, and below 2% inflation when unemployment is low.”

    According to the link below

    “These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.”

    Also, they are pretty clear about these being short-term deviations from the 2% target and that they don’t want to specify exactly what they consider low or high unemployment.


  3. Gravatar of Christopher Faille Christopher Faille
    30. August 2018 at 12:46

    Lautrec? Is that you?

    (Too loose, get it?)

  4. Gravatar of jj jj
    30. August 2018 at 13:38

    Scott, it’s always a bit jarring to read “zero rate bound” in one of your posts. Maybe it’s beating a dead horse but why not call it the “self-inflicted zero rate bound”?

  5. Gravatar of Effem Effem
    30. August 2018 at 13:56

    I see so many dilemmas with NGDP targeting. We already have Trump complaining about the Fed amidst a moderate tightening cycle. Imagine if NGDP were the target: could any president ever resist “more growth.” At least with an inflation target a future president is probably not so sure that we rigging the game for “more inflation” will get him re-elected. Further it has many decades of credibility. Once you change a rule, why not change it again, and again…?

    Political volatility is going to increase, not decrease, as our population ages and govt spending explodes. The Fed needs to ensure it’s independence above all else.

    These are dilemmas indeed. Monetary policy is not a textbook effort.

  6. Gravatar of ssumner ssumner
    30. August 2018 at 13:58

    John, I agree they don’t explicitly describe the dual mandate the way I describe it. But when you think about what they are trying to do, my description is the only one that makes any sense. If they always aimed at 2% inflation, then you would no longer have a dual mandate. Procyclical inflation would make the economy even more unstable. So I conclude that countercyclical inflation is the only sensible interpretation of the dual mandate. What else could it mean?

    JJ, My way has fewer keystrokes. 🙂

  7. Gravatar of ssumner ssumner
    30. August 2018 at 14:01

    Effem, Trump’s views on monetary policy are utterly irrelevant. It’s the Fed that sets policy, following a Congressional mandate. Trump’s views don’t matter.

  8. Gravatar of Doug M Doug M
    30. August 2018 at 15:33

    “But the Fed ran a tight monetary policy during the Great Recession and slow recovery, so if they run below 2% inflation right now they may lose credibility.”

    Your comment reminds me of the old joke:

    Three economists are hunting. They spot a deer in the distance. One takes aim and fires and misses 100 yards to the right. The deer is unfazed. The second fires and is 100 yards to the left. The third says “we got him.”

    If the target is 2 and they get 3 that is a miss. And it is not “less of a miss if last years inflation came in at 1. No you have two years with two consecutive misses, one high one low. They do not average out.

    The Fed is targeting future inflation. The mistakes of the past are in the past. What we can say is that core PCE is at 2% over the last year, so over the last year the Fed has been on-target. Doesn’t matter if they were off target for most of the last few years before that. But what really matters, is is the current policy appropriate to hit the target next year?!

  9. Gravatar of Christian List Christian List
    30. August 2018 at 16:50

    I thought the same thing. He won against Hillary easily even though he was a complete nobody back then. You also don’t have to mention your real intentions beforehand. Not to mention that politicians will tell voters whatever they want to hear during the primaries, see Hillary and Trump for examples.

  10. Gravatar of Benjamin Cole Benjamin Cole
    30. August 2018 at 16:59

    I salute NGDPLT.

    But I think the Fed would not. I mean even if it adopted NGDPLT.

    Suppose the economy does not enter a recession but grows slowly at 1% a year real. Perhaps due to very low productivity growth and flatlining labor participation.

    Even under a tight 4% NGDPLT, the Fed should tolerate 3% inflation.

    I do not think it would, certainly not for more than a year.

    The 2% inflation target has become iconic, even totemic.

    And the Fed is independent.

  11. Gravatar of Benjamin Cole Benjamin Cole
    30. August 2018 at 17:16

    Add on: suppose the economy flatlined for a couple of years. Does anyone really believe that Fed would tolerate 4% inflation to hit a 4% NGDPLT?

    Would the Fed run with 4% inflation for several years?

  12. Gravatar of ssumner ssumner
    30. August 2018 at 20:07

    Doug, I would agree if the Fed did not have a dual mandate.

    Christian, You said:

    “He won against Hillary easily”

    Completely false. Try doing some research before you post.

  13. Gravatar of P Burgos P Burgos
    30. August 2018 at 20:55

    Why is the economy so sensitive to the decisions of the Fed? Is it simply that the Fed serves as a huge coordinating mechanism for th economy? Are all that many investment decisions dependent on the real rate of interest, such that a small variation in it hugely sways estimates of what is and isn’t profitable? Is it the compound effect of lower expected revenue and higher interest costs? Perhaps my view is distorted by the Great Recession, and most of the time Fed policy isn’t all that impactful, only moving growth up or down a little bit from what are themselves relatively minor fluctuations in economic activity.

  14. Gravatar of mpowell mpowell
    31. August 2018 at 05:58

    Obama did consider lowering the corporate tax rate and eliminating deductions. Would not have been a bad move. But there are plenty of ways that Dodd-Frank could have been structured to be actually helpful instead of detrimental, and it would not have been hard to sell it to the base since it’s mostly policy details that hardly anyone understands. Especially if the Obama administration had funded and aggressively pursued a decent number of financial crimes cases. Hindsight is 20/20 and Obama certainly did not have perfect policy priors, but there was certainly a path for a Democratic like Obama to get elected with a set of policy preferences much more suited for the situation. The big question in my mind is if the Obama administration had really gone all-in on rapid economic recovery, the mid terms (in particular state house elections) possibly come out differently? Would that have been possible while also passing the ACA? There was an extremely narrow window for the Obama on the ACA and can’t really blame him for prioritizing it.

  15. Gravatar of ssumner ssumner
    31. August 2018 at 07:10

    Burgos, Monetary policy is not about interest rates. It determines the path of NGDP, which is very important in the short run.

    Powell, Yes, I understand why ACA was the priority. But the corporate tax cut could have been done right after.

  16. Gravatar of mpowell mpowell
    31. August 2018 at 08:19

    Yeah, I’d agree they probably could have gotten a corporate tax cut done. But even there, remember how unwilling the Republican caucus was to cooperate. They might not have been willing to pass anything that also included a broadening of the base, which would have absolutely been needed to get through the Democratic half of congress.

  17. Gravatar of Christian List Christian List
    31. August 2018 at 09:33

    Okay, then it was a surprisingly easy win considering that he was a nobody (at that time) compared to her. My impression is that Hillary could run against a broomstick and she would still lose. I assume she rigged those primaries as well, nevertheless back then I never had the impression that it was close or that she could actually win.

    how unwilling the Republican caucus was to cooperate.

    Mpowell, I know this is an extremely popular meme but is there an actual example for it? All the “compromises” and legislative proposals that I saw from Obama were not compromises, but basically 85-100% democratic content, followed by a theatrical lament that republicans reject the supposedly balanced bill.

  18. Gravatar of BC BC
    31. August 2018 at 19:52

    “Of course if he’d had that ideology then he never would have gotten the Democratic Party nomination.”

    Others have already commented, but I’m not sure if this claim is true. Back then, democratic socialists had not yet taken over the party. No one was talking about $15/hr minimum wages, “Medicare for all”, free college, etc. That’s why when Obama became president, he could still choose a centrist like Geithner as Treasury Secretary. I thought the main difference between Hillary and Obama was on the Iraq War (in addition to Obama’s much superior charisma). Obama guessed correctly early to oppose the war, while Hillary didn’t know to oppose the war until after seeing the results (like many others).

  19. Gravatar of Rein Rein
    1. September 2018 at 07:24

    If the ECB wants to target NGDP, should it target NGDP of the whole eurozone or could it target each and every country separately

  20. Gravatar of Philo Philo
    1. September 2018 at 17:35

    “Of course if he’d had that ideology then he never would have gotten the Democratic Party nomination.” But, after all, one can act contrary to his expressed ideology, and politicians often do so (though perhaps not as often as they should!).

  21. Gravatar of Philo Philo
    1. September 2018 at 17:55

    Your main point seems to be merely verbal: You complain that “people wrongly think of monetary policy [a]s a series of gestures, not a regime.” The point is well taken, since the word ‘policy’ is appropriate only for a planned sequence of actions over a considerable stretch of time, not for a momentary “one-off” measure. But it is not necessary to follow you in refraining from evaluating these “gestures” except by how well they fit the monetary authority’s announced regime. There is nothing wrong with complaining that what the Fed did on a particular day, while calculated to fulfill the regime it had embraced, was likely not to fulfill the regime it should have embraced. Such Fed behavior is, after all, a failure of a sort.

  22. Gravatar of Benjamin Cole Benjamin Cole
    2. September 2018 at 03:45

    Scott Sumner recently asked for column fodder, so here goes:


    Kocherlokata makes this statement near the end:

    “Yet the staff paper downplayed and Powell ignored what I see as the most important risk: that the U.S. economy could face a recession in the next couple years. As then-chair Janet Yellen’s speech at Jackson Hole two years ago revealed, the Fed lacks tools to deal with such a contingency. The best way to prepare is to ensure that the economy is as strong as possible when the downturn hits. And that requires keeping interest rates lower than the Fed is currently planning to do.”

    I wonder what Kocherlokata means by the above paragragh, in some ways.

    I think he means the Fed is already near ZLB and would be reluctant to go back to QE (and the effectiveness of QE is in dispute and some say minor anyway).

    Sumner has pointed out negative interest rates are possible, but again one cannot force banks to lend when a recession is brewing—and bank lending is how much new money enters the economy (lending on real estate is a about one-half o commercial-bank lending).

    The Fed can also lower IOER, but again, banks do not lend into property slumps. Property slumps are a self-feeding.

    Okay, if Kocherlokata is right, we have a Fed raising rates, as they have in the past, usually until they cause a recession (Greenspan something of an exception). But we are right on ZLB in the first inning of any recession, and then also the Fed wants to pay down its balance sheet, not start adding to it.

    Interesting topic.

  23. Gravatar of ssumner ssumner
    2. September 2018 at 18:35

    Rein, The entire eurozone.

    Philo, The point I was trying to make is that the Fed’s regime is not at all clear. Is it 2% inflation, on average? Or is it countercyclical policy?

  24. Gravatar of Christian List Christian List
    3. September 2018 at 08:23

    @Benjamin Cole

    Kocherlokata sounds quite tautological in this post. Keeping the economy strong is the best defense against recession? Oh really??? Reminds me of: In order to not become poor and ill, stay rich and healthy.

  25. Gravatar of Benjamin Cole Benjamin Cole
    3. September 2018 at 21:30


    Well, yes, he does sound tautological.

    Still, his points merit review.

    Does the Fed have a robust plan for a recession? No. My guess is the Fed “plan” is to lower rates, and if that does work and recessions deepens, then reluctantly go to QE.

    Is it too much to ask that the Fed have a recession-prophylactic in mind?

    Aggressively lowering rates and hard into QE at the early signs of a recession?

    Is QE+deficit spending effectively a helicopter drop? Michael Woodford seems to say yes.

    But why not straight chopper drops?

    I suspect Kocherlakota is right on one score: The Fed will enter the next recession without any battle plans.

    You know, let’s just wing it.

  26. Gravatar of TravisV TravisV
    4. September 2018 at 05:39

    Gee, for some reason Nike’s stock fell a lot after the opening bell today…….

  27. Gravatar of Christian List Christian List
    6. September 2018 at 11:40


    Does the Fed have a robust plan for a recession? No.

    I think their plan is not so bad: Inflation target of 2%, combined with “whatever it takes”.

    The problem seems to be implementation, especially in times of crisis when 2% inflation is needed the most.

    Don’t they have enough ink? No. Is the FED mute? No. So the problem is implementation, it’s a pure “power of will” scenario.

  28. Gravatar of Tom G Tom G
    8. September 2018 at 15:59

    Thanks for what I’m sure is right:
    “In retrospect, Obama’s biggest policy mistake was not cutting the corporate income tax sharply in early 2009, instead of enacting the actual stimulus bill. ”
    << tho that really smart Krugman you like to read was hugely against this.

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