What’s the most pragmatic good advice that we could give the Fed?

[I wrote this last week with the intention of posting right before the Fed meeting.  But since Frank McCormick just sent me a very similar proposal by Christina Romer, I thought I’d better post it now.]

With a key Fed meeting coming up, it’s worth thinking about the advice we’d give the Fed if for some bizarre reason they actually asked you or I for advice.  Suppose we just had one shot, and we put zero weight on our own ego and 100% on the well-being of the public.  Then what?  Here’s what I would not do:

1.  I would not recommend NGDP targeting.

2. I would not recommend level targeting.

Oh I would mention as an aside that I still think those are the two keys, but I see both as being politically impossible right now.  The Fed just made a big deal about their commitment to an official 2% inflation goal, and they aren’t about to tear that up because of some outside advice.  Even I can see that they’d look silly.  That’s an issue to work on for the next recession.  If smaller countries adopt it, maybe it will catch on internationally as inflation targeting did after New Zealand first adopted it.

It’s kind of an interesting challenge to think of the most aggressive policy stance that actually has a prayer of being adopted.  Something that would not be viewed as being inconsistent with the past actions and comments of Fed officials, especially Bernanke.  I’ll give you my thoughts, but I’d also like to know what commenters think.  I see the need for a three-pronged attack:

1,  Weekly QE as the policy instrument/communication device.

2.  Target the forecast using internal Fed forecasts of core PCE inflation and unemployment

3.  Emphasis on equal weights in the dual mandate, with inflation averaging 2% over the cycle.

First let me explain why this is politically feasible.  The Fed has already done several QEs, so nothing radical there.  They’ve lost their normal communication device (fed funds targets) and could use another.  Bernanke has admitted that they’d cut rates if they could, which suggests a need for a new instrument.  My commenter Benjamin Cole used to always recommend a given level of monthly QE until the targets were hit.  Tim Duy recently mentioned it as well.

Target the forecast is also a respected procedure.  The Fed’s never formally adopted it, but it has distinguished academic support (including Bernanke’s colleague Lars Svensson) and the Fed has informally nodded in this direction.  When they cut rates after the 1987 stock crash, or 9/11, they were basically doing a forward-looking policy.  The recent pattern of publicizing both the expected instrument paths (for short term rates) as well as expected paths for inflation and unemployment, is obviously extremely close to targeting the forecast.  So why not just go all the way?  Remember, I’m not asking the Fed to change its 2% inflation goal.  But its short term inflation forecast may have to rise to fulfill the dual mandate.

And finally the dual mandate, which is widely misunderstood.  Bernanke has often said that the Fed takes both sides equally seriously.  Nonetheless many people seem to wrongly assume that the Fed is targeting inflation at 2% each and every moment in time.  IF THEY DID THAT THEY’D HAVE A SINGLE MANDATE, AND THEY’D BE VIOLATING THE LAW.  Sorry for all the caps but the Fed needs to make it really clear that if the dual mandate means anything, they can’t aim for 2% inflation at each moment in time.  Rather inflation should average 2% over the cycle.  It also means that any deviations from 2% inflation must help achieve its unemployment objective.  Now even if we take the most conservative assumption, which is a vertical long run Phillips Curve, the Fed can hit the dual mandate with an inflation rate that average 2% over the cycle, but is allowed to rise above 2% when unemployment is above average, and run below 2% when unemployment is below average.  (And recall that Krugman recently argued the Phillips Curve is not vertical at low inflation, with some evidence to back up his claim–so I’m actually making a highly conservative assumption in this post.)  BTW, my approach would reverse the slope of the Phillips Curve—the dual mandate requires the Fed to aim for a positively sloped PC.

Let’s summarize.  QE is not at all radical.  It’s been used already.  Why not use it systematically for the communication device that even Bernanke admits the Fed has lost and wishes he still had?  “Target the forecast” is no longer radical.  The Fed’s been clearly moving in that direction, step by step.  And Bernanke has repeatedly emphasized that the dual mandate is taken seriously, and that the needs of the unemployed require the Fed to occasionally miss on inflation for part of a business cycle.  Put it all together as follows:

The New York Fed will be instructed to buy $30 billion a week in T-securities of various maturities, until the Fed’s forecasting department is able to forecast a path of unemployment and inflation over the next 5 years that minimizes the sum of the deviation of inflation from 2% and unemployment from its long run average (or estimated natural rate.)  At that point it will stop.  If forecasts of inflation and unemployment change in such a way as to under or overshoot the previous expectation, the New York Fed will either buy or sell T-securities, as appropriate.

Any better ideas, which aren’t politically infeasible?


Tags:

 
 
 

59 Responses to “What’s the most pragmatic good advice that we could give the Fed?”

  1. Gravatar of dwb dwb
    10. June 2012 at 05:53

    my only comment would be to aim for the gdp deflator, not PCE, allowing more flexibility on import price shocks. not much the fed can do about oil prices, no matter who complains, except by tightening and reducing demand through unemployment.

    great post!

  2. Gravatar of Robert Robert
    10. June 2012 at 06:15

    Maybe they could target the TIPS spread in the same fashion as a Taylor rule. SPREAD = 2% + a*inflation_gap + b*output_gap.

  3. Gravatar of Bill Woolsey Bill Woolsey
    10. June 2012 at 07:08

    Why 30 billion?

  4. Gravatar of Major_Freedom Major_Freedom
    10. June 2012 at 07:36

    Here’s what I would not do:

    1. I would not recommend NGDP targeting.

    2. I would not recommend level targeting.

    Oh I would mention as an aside that I still think those are the two keys, but I see both as being politically impossible right now.

    and then

    Any better ideas, which aren’t politically infeasible?

    So only market monetarists are allowed to advance ideas that aren’t politically feasible?

    A better idea, given the central banks must exist, is for their subsidiary banks to cease engaging in fractional reserve credit expansion. Milton Freidman was in favor of a proposal that would have seen the banks gradually increase their reserves for demand deposits to 100%. That can be done without closing the Fed’s doors.

    Secondly, the Fed should cease targeting price inflation, and avoid targeting aggregate spending. Hayek was in favor of the world’s central banks setting policy as if there was a world central bank with a world currency and world NGDP stabilization. That means world central banks have to accept country level fluctuations in aggregate spending, as investors readjust their world portfolio by removing capital from some countries and investing in other countries, according to fluctuating world supply and demand conditions. Hayek recommended that central banks should not try to manage country level money and spending, for it will cause international instability.

    So how would a population of many independent central banks set their respective policies, so as to get as close to a world monetary order as possible? They would have to coordinate with each other and target a global rate of money supply growth, as close as possible to the rate of global precious metals discovery (since precious metals would almost certainly be the money of choice in a free market in money production).

    Combining this with the 100% reserve, a global synchronized rate of money supply growth, that allows for country level fluctuations in money supply and hence aggregate spending, is the optimal monetary policy for central banks, given that they exist.

    It will enable recently depressed country economies to quickly recover in the global marketplace, as their localized money supplies fall, which puts downward pressure on local prices, which then makes their output more competitive in the world market, and by the same token, it will also enable recently booming country economies to expand only as much as world market conditions allow, as money will only be released from a country when relative competition abroad increases.

    This will finally enable the US to “compete” with China’s rapid growth, as the more money leaves the US for China, the lower the money supply in the US becomes relative to China, and the lower our prices will be, which will make the US more and more competitive with China the more that money goes from the US to China.

    There will be a world balance, unlike today where there are incredible world level imbalances created by independent central banks looking out for their own, preventing investors from allocating capital efficiently.

    The same exact reason why it would be destabilizing for the US economy to have city level or state level central banks ensuring that localized “spending” rises at a target rate, is why the world market would be destablized by country level central banks targeting country level spending growth. When money leaves one country for another, there is a good reason for it. It would be absurd to believe that the country’s central bank should replace this “lost” money. That lost money is a part of the price system; it is part of the system of demand signals that tells investors where resources are to be most efficiently allocated.

    If my firm had it’s own “central bank”, and I always turned the printing presses on whenever demand for my products fell, such that my revenues increased at 5% each and every year, then how in the hell can investors know how my firm stacks up with other firms? How will they know if they should invest more or less in my company, considering what I am doing, considering the dynamics of the US economy, let alone the world economy? The signals investors require in order to know what to do with the means of production at my firm, would be lost. My firm would be the cause of destabilization in the US economy. Here I am receiving 5% revenue growth, no matter what I do, no matter what I invest in, no matter who I hire, no matter what my choices are!

    Investors NEED to know country level demand and supply conditions, and in order for them to know this, country level money supply and aggregate spending MUST BE FREE TO FLUCTUATE according to world supply and demand conditions.

    Market monetarists are as crazy calling for constant country level aggregate spending growth no matter what happens in that country, as my firm is when calling for a firm level central bank to ensure the revenues of my firm’s output grows 5% each year.

  5. Gravatar of Tommy Dorsett Tommy Dorsett
    10. June 2012 at 08:03

    How about eliminating IOR at the same time so that less QE is absorbed by falling base velocity?

  6. Gravatar of Negation of Ideology Negation of Ideology
    10. June 2012 at 08:10

    I’m not sure why you consider NGDP targeting politically infeasible. Maybe controversial, but whatever they do is controversial these days. Would Volker’s embrace of money supply targeting have seemed feasible before he did it?

    Anything Bernanke does will cause one group of people to accuse him of sabotoging Obama, and another group to charge him with “treason” for “printing money” to try to reelect Obama. So maybe he should just do what’s right for the country and let people say what they want.

  7. Gravatar of 123 123
    10. June 2012 at 08:34

    30 billion is peanuts. An open-ended commitment is needed to achieve the Chuck Norris effect.
    Three year LTROs with full allotment repeated every two months would do wonders.

  8. Gravatar of dlr dlr
    10. June 2012 at 08:55

    Unfortunately the optimal, suboptimal solution is still probably impossible: Change the interest rate forecast language from the current string of meaningless words (we promise to keep rates low for 30 months unless of course something changes in the economy) to saying they expect to keep rates exceptionally low as long as they believe the benefits from increasing demand and reducing unemployment outweigh the costs from inflation temporarily rising above their target, as per their dual mandate. This is the version of promising to be “irresponsible” that doesn’t tie them down to a particular conditional path or switch to a level target, which they clearly won’t do. Of course, it ironically increases the risk that inflation expectations become unhinged relative to a level target or less discretion, but seems a very small risk relative to the potential benefit there really is a better equilibrium to be had at a higher nominal plane.

    If that is still too utopian for this post I would want them to at least be more explicit about their downside reaction function. They should emphasize the if their inflation forecast falls below their target they will extend OMOs to foreign and municipal bonds as permitted under the Federal Reserve Act and continue to do so until their inflation forecast is at its target.

  9. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 08:58

    I think ending IOR and then level inflation targeting is a nice starting point.

    Set it at 2% a year, and every month as need raise or lower rates.

    Sooner then later we’ll hit the upside of 2%, and it’ll be time to raise rates.

    But since you’re all so sure that inflation is under 2% right now, we’d get a small bump for your troubles.

    MF, you sound like Mundell.

  10. Gravatar of Andy Harless Andy Harless
    10. June 2012 at 09:01

    I don’t see why NGDP targeting would make the Fed look silly. The 2% inflation target is a long-term target. One way to aim for that target over the long horizon is to estimate the potential growth rate and target the path of NGDP at a rate that is 2% higher than the estimated potential growth rate. Moreover, the Fed must recognize that it has a dual mandate, so, given that we are, by most estimates, still far below potential, it would be appropriate to make the target path retroactive.

  11. Gravatar of Saturos Saturos
    10. June 2012 at 09:03

    If you can get this Fed to let inflation persistently above 2%, you’ve already won the war.

  12. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 09:32

    2% Level Targeted Inflation

    A liberal struggles to be “pragmatic”:

    “Imagine, if you will, the domino effect that would ensue if liberals and moderates simply tuned out the demagogues. Yes, they would still be able to manipulate their legions into endorsing cruel and self-defeating policies. But their voices would be sealed within the echo chamber of extremism and sealed off from the majority of Americans who honestly just want our common problems solved. They would be marginalized in the same way as activists who rant about racial purity or anarchy.

    Rush Limbaugh would be a radio host catering to a few million angry commuters, not the alpha male of conservatism. Fox News would be a popular fringe network, not the reliable conduit by which paranoid hogwash infects our mainstream media.

    In this world, it would be much harder to mislead people because media outlets would shift their resources to covering the content of proposed legislation, the exploding role of corporate influence in our affairs of state and the scientifically confirmed predicaments we face as a species.

    Liberals and moderates would no longer be able to mollify themselves by watching Jon Stewart mock conservative wack jobs. They would be forced to consider their own values and the sort of actions necessary to reify those values in the world. They might even consider breaching our artificially inflated partisan divide.

    This last measure, I realize, hasn’t worked for President Obama. But he’s up against a cohort of politicians underwritten by special interests. We citizens can’t use that excuse. We all have the same basic interests: to provide for our families, to worship as we see fit, to pursue happiness. We live in a country of unimaginable abundance. It shouldn’t be so hard to find common ground.”

    http://www.nytimes.com/2012/06/10/magazine/liberals-are-ruining-america-i-know-because-i-am-one.html?pagewanted=all

    The cultural lie that certain liberals tell themselves, that Obama tried to “reach out” to the Conservatives DOOMS THEM.

    Cory Booker, Bill Clinton, Harold Ford, Lanny Davis are only correct by half, but that way they are at least half right.

    These center-right Dems AT LEAST know that the once we reach the upper boundaries of US Debt, Dems must side with either:

    1. The A power Main Street Tea Party SMB owners

    2. The B power: Fortune 1000 management

    The mistake they make is that they do not credibly play the A and B powers off one another, and this is where the structural issue with jobs comes from.

    To foster a truly healthy free market, we ought to architect for new business creation the same way our US Constitution favors states rights…. and dump barrels of favored tax status all over Main Street SMB owners.

    Instead and by mistake, center-right Dems side only with the B power.

    Meanwhile progressives, the institutional left, they wish to day dream that somehow A and B are one team vs. the the left’s rag tag band of losers.

    Nothing stops center-right Dems from winning Ta Party Favor at the expense of the Wall street Journal.

    A TRULY pragmatic liberal should be offering bill after bill that gives to small businessmen and takes from large ones.

    By giving up keeping any spoils for themselves in the short term, progressives establish themselves as king makers between the two real warring factions.

    This policy doesn’t allow progressives to keep public employee unions around, but WHO NEEDS THEM?

    What matters is, once you run the government as efficiently as the private sector, there is no self-interested government in the equation…

    So, progressives can focus on which of the two warring sides, will generate more growth and reduce income inequality.

    Distributism is the best use case for progressive Liberalism

  13. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 09:36

    Still rooting for Portman / Rubio, but Mitch Daniels would be a great VP.

    http://www.huffingtonpost.com/2012/06/10/mitch-daniels-unions-public-sector-unions_n_1584396.html

  14. Gravatar of Justin Irving Justin Irving
    10. June 2012 at 09:56

    I second Robert on the TIPS spread. Weekly QE adjustments to keep the 5 year TIPS spread between 1.9 and 2.1%. The range could be adjusted to reflect the dual mandate, a higher ceiling when unemployment is high, a lower ceiling when it is low.

    The problem with any sort of market forecast however is that it doesn’t give the fed anything to do. It is a direct attack on the egos of macroeconomists, so perhaps it fails your criteria of being something they would actually undertake.

  15. Gravatar of Mike Sax Mike Sax
    10. June 2012 at 10:10

    Within what’s politicall the one thing that ocmes to mind hss already been mentioned-taking away IOR or making it negative.

    NGDPLT and Wallace Neutrality http://diaryofarepublicanhater.blogspot.com/2012/06/ngdplt-wallace-neutrality-and-related.html

  16. Gravatar of Mike Sax Mike Sax
    10. June 2012 at 10:10

    Within what’s politicall the one thing that ocmes to mind hss already been mentioned-taking away IOR or making it negative.

    NGDPLT and Wallace Neutrality http://diaryofarepublicanhater.blogspot.com/2012/06/ngdplt-wallace-neutrality-and-related.html

  17. Gravatar of Mike Sax Mike Sax
    10. June 2012 at 10:15

    Within what’s politicall the one thing that ocmes to mind hss already been mentioned-taking away IOR or making it negative.

    NGDPLT and Wallace Neutrality http://diaryofarepublicanhater.blogspot.com/2012/06/ngdplt-wallace-neutrality-and-related.html

  18. Gravatar of Mike Sax Mike Sax
    10. June 2012 at 10:15

    Within what’s politicall the one thing that ocmes to mind hss already been mentioned-taking away IOR or making it negative.

    NGDPLT and Wallace Neutrality http://diaryofarepublicanhater.blogspot.com/2012/06/ngdplt-wallace-neutrality-and-related.html

  19. Gravatar of DonG DonG
    10. June 2012 at 11:03

    I too like the idea of globally coordinated action. US, ECB, BOJ (plus the countries that peg to them) all doing QE. I don’t know the math, but I feel that gives more AD for the buck. Also scrap IOR, which is nothing more than a handout to big banks.

  20. Gravatar of ssumner ssumner
    10. June 2012 at 11:13

    dwb, I agree, but they won’t accept that because they’ve already committed to the PCE. This is a pragmatic post.

    Robert, The TIPS spread is useful, but must be interpreted with caution–as it’s distorted by oil price swings.

    Bill, Large enough to impress markets, small enough that they won’t run out of eligible assets for a long time.

    MF, You said;

    “Milton Freidman was in favor of a proposal that would have seen the banks gradually increase their reserves for demand deposits to 100%.”

    Haven’t we done that?

    Tommy, I like that, but I don’t think I could sell the Fed.

    Negation, I think it’s politically feasible in the long run, just not right now. I hope I’m wrong.

    123, It is open-ended, it’s repeated weekly. It’s nearly $5 trillion over three years.

    Saturos, Just when unemployment is high, not always.

    dlr, Why not do both?

    Morgan, Level targeting of prices starting from July 2008.

    Andy, I agree, that was poorly worded. I don’t think it would make them look silly. What I meant to say was the Fed feels it would look silly if right after finally deciding on 2% inflation as an explicit goal, they switched to NGDP. But the Fed and the financial press would both think it looks silly, and that (unfortunately) is what matters.

    Justin, Not a bad idea, but see my reply to Robert.

    Mike, Such a good idea it was worth repeating 4 times!

  21. Gravatar of ssumner ssumner
    10. June 2012 at 11:14

    DonG, Good idea, but politically difficult.

  22. Gravatar of Lars Christensen Lars Christensen
    10. June 2012 at 11:47

    Scott, I am with Andy. NGDP targeting is fully compatible with the Fed’s dual mandate. See here: http://marketmonetarist.com/2012/02/26/ngdp-level-targeting-and-the-feds-mandate/

  23. Gravatar of Shane Shane
    10. June 2012 at 11:50

    Negative interest on excess reserves should be the policy instrument, with targeting of internal forecasts to determine proper rates. It’s both new and radical and yet also a kind of back to basics move–the Fed could return to the comfort zone of speaking about “lowering rates,” while preempting both the “if this guy prints more money…” and the “QE 1 and 2 didn’t work” lines of attack. If they framed it as “the time for extraordinary measures to create liquidity is over, now let’s return to conventional policy” it could simultaneously come across as both contractionary to the dullards and expansionary to the canny.

  24. Gravatar of ssumner ssumner
    10. June 2012 at 12:13

    Lars, I’ve made that argument many times, but unfortunately it’s not politically feasible right now. The Fed just committed to 2% inflation a few weeks ago. To suddenly change that commitment would expose them to withering ridicule in the press.

    Shane, I’m not opposed, but I see little evidence the Fed would be willing to try that.

  25. Gravatar of Lars Christensen Lars Christensen
    10. June 2012 at 12:38

    Scott, but they could of course also just formulate their mandate as a rule for the money base based on the Mankiw rule. That would be pretty close to a NGDP rule and far better than a Taylor rule with interest rates or what they are doing now (whatever that is…)

  26. Gravatar of Andy Harless Andy Harless
    10. June 2012 at 13:04

    …the Fed feels it would look silly if right after finally deciding on 2% inflation as an explicit goal, they switched to NGDP

    But my point is that it’s not a switch; it’s a refinement. 2% inflation is a long-term goal, so great, they decided it’s 2% rather than 1% or 3% (or 1.875%, which sort of seemed like where they might be heading), glad we’ve settled that. Now how do you implement that? And specifically, how do you implement it in a way that’s consistent with the dual mandate (because the obvious ways of implementing it would be apparently inconsistent with the dual mandate)? And how do you implement it in a way that is consistent with the dual mandate and not subject to being thrown off course by unanticipated changes in the NAIRU? It seems to me that NGDP level path targeting is the obvious choice.

  27. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 13:07

    Scott,

    Politically feasible is not LT since 2008.

    And you know it.

    What is feasible is 2% inflation LT, it is a small deviation from their 2% decision.

    And it immediately puts a lower boundary on the economy.

    FOR SURE inflation will be 2%…

    Which then puts the animus ON CONGRESS / POTUS to deliver deflationary fiscal…. since they are now sure they will still get 2% inflation.

  28. Gravatar of Tom Grey Tom Grey
    10. June 2012 at 13:17

    Get rid of IOR (interest on reserves) — was silly to NOT have it during the 2002 (1995?) – 2006 asset bubble(s), is worse than silly and clearly counter productive whenever inflation is “high”.

    The minimum of the 5-year or 10-year unemployment rate should be used as the “target unemployment rate” (TUR). Current rate – TUR should be the excess unemployment in any unemployment formula.

    I like the 1-main street vs 2-wall street idea–the Fed was willing to buy commercial paper. The Fed should be willing to buy corporate bonds/small loans of all businesses who increased their employment over the last two years and who are at their maximum employment over the last 10 years. The max loan should be the amount of tax the company paid in the last 2 years, up to some maximum (100 years of prior avg wage? i.e. 100 * $45k = 4.5 million.)

    The rate should be 1% more than the Fed rate.
    I call these “Tax Loans”, where companies are sort of borrowing back their own previously paid taxes, rather than Other People’s Money.

    We need more government by formula, not discretion, and work towards optimal formula.

  29. Gravatar of Major_Freedom Major_Freedom
    10. June 2012 at 13:40

    ssumner:

    “Milton Freidman was in favor of a proposal that would have seen the banks gradually increase their reserves for demand deposits to 100%.”

    Haven’t we done that?

    Not even close.

    Not by law, and certainly not by practice.

    Reserves make up only a small portion of total demand deposit liabilities.

    A 100% reserve requirement would see a bank’s reserves coming to equal their total demand deposit liabilities.

  30. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 13:43

    Quoting myself:

    “Which then puts the animus ON CONGRESS / POTUS to deliver deflationary fiscal…. since they are now sure they will still get 2% inflation.”

    I think there is a formal way to say this is true.

    Since we assume generally that govt. spending is basically by some deviation less growth oriented than private market spending…

    THEN, under a LT (say inflation at 2%), every dollar NOT SPENT by government IS LIKELY to have some multiplier of growth as it is forced to show up on the private side of the ledger by the LT.

    —–

    Under a level target, deflationary effects ARE ALWAYS GOOD. They are a sign of productivity gains.

  31. Gravatar of Major_Freedom Major_Freedom
    10. June 2012 at 13:44

    Morgan:

    MF, you sound like Mundell.

    In what way? I am not very familiar with Mundell.

  32. Gravatar of Major_Freedom Major_Freedom
    10. June 2012 at 13:54

    Morgan:

    Under a level target, deflationary effects ARE ALWAYS GOOD. They are a sign of productivity gains.

    Only if the growth in productivity exceeds the growth in the quantity of money and volume of spending.

  33. Gravatar of Mike Sax Mike Sax
    10. June 2012 at 16:08

    oops-it’s been acting up lately when I press submit. Usually doesn’t let you doulbe submit though.

    It wasn’t that great an idea-LOL

  34. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 16:13

    MF,

    When I talk about deflationary effects, I’m talking about no increase in money.

    I’m talking about firing 50% of the teachers, moving to video course work and a positive effect on educational outcomes.

    If that happens during a LT regime, there is no slow down in the economy from all those teachers being fired.

    Normally, we have to suffer through the pain of decreased demand, now instead, the cost of borrowing decreases as the NGDP Futures market prints money and hand it to the retail investors who bet that NGDP would come up light.

    Suddenly they are flush with printed money, and they need to park it somewhere.

    The idea here is that there are still winners and losers, BUT we’ve used printed money to make strangling the public employee unions possible AND we’ve bypass Goldman-Sachs – so they don’t touch the printed money first.

  35. Gravatar of Morgan Warstler Morgan Warstler
    10. June 2012 at 16:17

    Mundell did Reaganomics and then did the Euro, and now advises China.

    His basic end game is a single global currency, where capital is mobile and no govt. has authority over it.

    Basically, the end of Macro.

  36. Gravatar of libfree libfree
    10. June 2012 at 16:34

    Scott,

    I second the comments about ending IOR or possibly negative IOR.
    1. No one knows that the Fed is paying IOR (General public obviously)
    2. Most people wouldn’t think it’s fair if they did learn about it.
    3. Public opinion rules

    This seems very politically feasible. I’m surprised that Christina Romer didn’t mention it. No one likes big banks and the idea of handing money to them isn’t all that popular right now.

  37. Gravatar of 123 123
    10. June 2012 at 19:58

    Scott, 30 billion per week is too little when there are macro shocks, like Grexit, so the risk of the ZIRP trap remains. It looks too much during calmer weeks, raising the political pressure for premature exit. Markets should tell the quantity.

  38. Gravatar of dwb dwb
    10. June 2012 at 20:07

    on a slightly different topic, i find PK’s cognitive dissonance on the Fed a little weird – after reading this, i would expect to find an equally disparaging column about the Fed holding rates steady from Sept 2008:

    “Most notably, last week the European Central Bank declined to cut interest rates. This decision was widely expected, but that shouldn’t blind us to the fact that it was deeply bizarre. Unemployment in the euro area has soared, and all indications are that the Continent is entering a new recession. Meanwhile, inflation is slowing, and market expectations of future inflation have plunged. By any of the usual rules of monetary policy, the situation calls for aggressive rate cuts. But the central bank won’t move. ”

    http://www.nytimes.com/2012/06/11/opinion/krugman-another-bank-bailout.html?ref=opinion&comments&gwh=9B3B67E9F4F353E8FB383F0654545F00#commentsContainer

  39. Gravatar of J.V. Dubois J.V. Dubois
    11. June 2012 at 01:13

    There would be several problems here:

    1) Nowhere did you put what variables would they target. They would basically have to make public the model that they use for internal forecast so that markets may anticipate what they are after. This is one of the two pillars of Market Monetarism named “expectations” and it is also the answer for endless “show me the transmission mechanism” debates from other economists. And I do not see it there.

    And inability to clearly communicate this is (in my opinion) also the reason why FED sticks with just inflation mandate – it makes them more accountable. Adding unemployment into the mandate makes their policy more discretionary, it would be harder to communicate they chose this mix of employment/inflation and not that one.

    Of course they already sort of did it – they decided to abolish unemployment part of their mandate – but then they did not face any political repercussions for doing that so why should they change it?

    2) Just a small but important distinction – target employment/population ratio or average net jobs created in some specific timeframe. There is already a lot of people that dropped out of labor force voluntarily, making unemployment number less useful. Or better target NGDP growth – but that you discounted right away

    My advice what FED should do is the same thing that Fisher does in bank of Israel. That is – target the stable NGDP growth and mask it in your usual centralbankgibberish with inflation accent, something like “We know that core inflation was 3% last quarter but we perceive increased risks of of downward pressure stemming from Eurozone crisis, or whatever”

    Let the markets figure what you are really after by trial-and-error. This will cost everyone in the world some needles suffering, but hey – our EGO is worth it.

  40. Gravatar of J.V. Dubois J.V. Dubois
    11. June 2012 at 01:23

    Scott: “Even I can see that they’d look silly [switching to NGDPLT]. That’s an issue to work on for the next recession.”

    According to the NBER our current recession ended in July 2009. So technically speaking, with imminent dissolution of Eurozone and mad Calvinist managing the European monetary policy I think we are heading into another round of recession. I already lost all faith in my home region and I braced myself against what is comming.

    How America will fare in this second global terrorist attack by central bankers is yet to be seen.

  41. Gravatar of Robert Robert
    11. June 2012 at 04:09

    Robert, The TIPS spread is useful, but must be interpreted with caution as it’s distorted by oil price swings.

    Shouldn’t transitory swings average out over a sufficient time period, say 2 years, so that the spread reflects expected underlying inflation? Even if the shocks are highly persistent, doesn’t the Fed target 2% headline PCE anyway, not core? Or do you mean PCE puts much less weight on oil prices than the CPI or something?

  42. Gravatar of ssumner ssumner
    11. June 2012 at 06:08

    Lars, You said;

    “Scott, but they could of course also just formulate their mandate as a rule for the money base based on the Mankiw rule. That would be pretty close to a NGDP rule and far better than a Taylor rule with interest rates or what they are doing now (whatever that is…)”

    Again, I agree there are lots of good options, but I’m focusing here on what’s politically feasible. And that includes very few options for stimulus. Maybe none.

    Andy, You are preaching to the converted. I’ve made the exact same argument in earlier posts. But in this post I’m trying to focus on what is politically possible. The unfortunate truth is that most people don’t agree with us, they’d see it as the Fed abandoning their recent commitment to keep inflation near 2%.

    I think both you and Lars are underestimating the EXTREME conservatism of the Fed. They are very reluctant to do anything that might look even a tiny bit controversial. The considered NGDP targeting at a meeting last fall, and rejected it. On the other hand I do believe the Fed will eventually go for NGDP targeting, as I believe in the power of good ideas to win in the long run.

    Morgan, I agree that LT is not politically feasible right now–that’s the problem.

    Tom Grey, I agree we should get rid of IOR–but it won’t happen.

    Everyone, Please open up the link that MF provides, if you want to see someone who thinks M2 measures “demand deposits.”

    libfree, I agree the public wouldn’t like it, but it’s not politically possible within the Fed, that’s the problem.

    123, You said;

    “Markets should tell the quantity.”

    I agree, but am focusing on what’s politically possible. In any case because of the expectations channel the exact weekly number is much less important than the expected final number.

    And the Fed would reserve the right to do more during a Greek crisis period.

    dwb, Thanks, that’s worth a post.

    JV, You said;

    “Nowhere did you put what variables would they target.”

    Yes I did, read it again. I mentioned PCE core inflation and unemployment.

    You said;

    “Adding unemployment into the mandate makes their policy more discretionary, it would be harder to communicate they chose this mix of employment/inflation and not that one.”

    I am not proposing that the Fed add unemployment to the mandate, it’s already there, as the Fed frequently acknowledges. And when they cut rates in 2007-08 despite very high inflation they are obviously doing so due to the employment mandate. So there’s nothing new there.

    I agree with many of your suggestions, but in this post am focusing on what’s politically feasible. NGDP targeting is not.

    Robert. You said;

    “Shouldn’t transitory swings average out over a sufficient time period, say 2 years, so that the spread reflects expected underlying inflation?”

    Not at all, oil prices swings can cause the 2 year TIPS spread to move by 100 basis points.

  43. Gravatar of dwb dwb
    11. June 2012 at 07:10

    dwb, Thanks, that’s worth a post.

    well, according to Krugman defenders he has been critical of the Fed… but i can’t find a single blog or column where he was critical of the Fed’s decision in sept 2008 (the minutes say the FOMC was worried about inflation). In fact, in his last column I recall he was laudatory of the Fed during 2008 for being aggressive during the 2008 period. I think he has been critical of more recent non-actions, thats true.

    But if the Fed was aggressive in 2008. Isn’t the ECB “aggressive” for LTRO, etc etc?? If someone can find a post where krugman was critical of the sept 2008 FOMC meeting, i will stand corrected.

  44. Gravatar of Negation of Ideology Negation of Ideology
    11. June 2012 at 07:48

    Would this be politically feasible?

    1. Use QE as the policy tool and communication device, but make it permanent. Completely and permanently eliminate interest rate targeting. Simply auction off whatever quantity of dollars necessary to hit the target in rough proportion to the outstanding Treasuries. So let’s say it’s $30 Billion for a particular week, or $6 Billion per weekday. For simplicity, let’s pretend the publicly held debt is held equally in 30 day T-Bills, 2 Year Notes, 5 Yr, 10 Yr, 30 Yr and TIPS. Then every day the Fed buys in a Dutch auction $1 Billion of each from anyone who signs up for a free online Fed Direct site (similar to Treasury Direct).

    When the Fed needs to reduce the base, it starts by buying less than comes due, and if that’s not enough, simply reverse the process and auction bonds for dollars. Interest rates on each security are of no concern to the Fed.

  45. Gravatar of J.V. Dubois J.V. Dubois
    11. June 2012 at 08:34

    I wen through old Krugman blogs and actually he was consistently warning against deflation prior to Sep 2008. Look in these posts:

    Before FOMC Meeting in September 16th: http://krugman.blogs.nytimes.com/page/259/

    After: http://krugman.blogs.nytimes.com/page/258/

    But then there was this and it seems that Krugman was already focused on fiscal stimulus so he played a role of monetary apologetics (Ben could not do more, we are in a liquidity trap and all this): http://krugman.blogs.nytimes.com/2008/09/22/the-humbling-of-the-fed-wonkish/

    So yes, in the end I would say that Krugman’s role in all this is also a negative one. He sort of tries to come around into monetary area, but then only halfheartedly – especially now when he has a book out there he has much more in stake for the discussion. He turned out to be the same as politics and public figures – he invested too much into some ideas (like fiscal stimulus) and he cannot exactly retreat from his position or he can lose face. And there is very few publicly known people that can do this. That is the basis of saying “Progress moves forward one death (even political one) at a time”

  46. Gravatar of Max Max
    11. June 2012 at 08:48

    Is the Treasury supposed to issue more long term bonds, so the Fed’s operations don’t change the maturity of the debt? (In past exchanges Scott has said that QE is fiscally neutral, which implies that the Treasury will undo whatever the Fed does).

    Next question is, is increasing the quantity of bank reserves at the zero bound really a “policy instrument”? Or is it just smoke and mirrors that is supposed to work via self fulfilling expectations, even if the expectations aren’t rational?

  47. Gravatar of J.V. Dubois J.V. Dubois
    11. June 2012 at 09:55

    DWB: Just to be fair I skimmed for MM blogs to check what they did say on FED keeping rates at 2% in September 2008. And i did not find any blog entry – Scott’s “The Money Illusion” and Lars Christensen’s “The Market Monetarist” are relatively new. WCI blog was there in 2008 but I could find only posts from Stephen Gordon during that time, it seems that Nick Rowe joined later.

    Did I miss some major MM blog that warned about this?

  48. Gravatar of Lorenzo from Oz Lorenzo from Oz
    11. June 2012 at 10:12

    Never waste a crisis. Use the claim that the Eurozone crisis is a gamechanger and announce that, in order to stop any serious contagion effect, the Fed will protect Americans by keeping spending, and thus incomes, up so that the US financial system and households can weather the crisis. The inflation target becomes a long term target incorporated in the new incomes target.

  49. Gravatar of dwb dwb
    11. June 2012 at 10:23

    @J.V. Dubois

    Did I miss some major MM blog that warned about this?

    Scott and Lars (and Marcus Nunes others) have done many posts on this (after the fact of course tho).

    My point is that while Krugman is scolding the ECB for holding rates constant, he did not similarly scold the Fed for hold rates at 2%, instead insisting that the Fed “preemptively eased” in Jan 2008 and that it was aggressive.

    The Fed held rates steady in sept 2008 because it was afraid of inflation, not watching the TIPS spreads. Krugman is now pointing out the German breakeven inflation rates (but i dont recall him mentioning them in the context of the sept 2008 meeting).

    This is like, example 247 zillion why you cannot determine the stance of monetary policy from interest rates. my point of course is that Krugman is consistently inconsistent on this.

  50. Gravatar of dwb dwb
    11. June 2012 at 10:26

    can someone tell me what Lockhart means:

    “He added that an adjustment to the way the U.S. central bank communicates, as opposed to asset purchases, is a possible easing tool if needed.”

    http://www.reuters.com/article/2012/06/11/usa-fed-lockhart-policy-idUSL1E8HB6GZ20120611

  51. Gravatar of 123 123
    11. June 2012 at 10:27

    Scott: “I agree, but am focusing on what’s politically possible. In any case because of the expectations channel the exact weekly number is much less important than the expected final number.

    And the Fed would reserve the right to do more during a Greek crisis period.”

    It is already a Greek crisis period. Money supply is expanding in these central banks where it is determined by markets (ECB, Swiss central bank).

    The problem with the expectations channel is that it does not work when a large expansion of money supply is needed because of some macro shock (Lehman, Grexit, etc.)

    I am sure that it is politically possible to have a system where money supply expands and contracts according to the market. Switzerland has done it with the euro peg, and the ECB has done it in the Dec ’11 – Mar 12 period with impressive results. You just have to call it with a suitable long and vague name so it would sound very boring. Imagine if Bernanke took a page from Trichet’s and Draghi’s playbook and announced:
    “We have decided to conduct our three-year discount window operations on a monthly basis as fixed rate tender procedures with full allotment for as long as necessary, and at least until the end of the 12th maintenance period of 2016 on 15 January 2017. The rates in these three-year discount window operations will be fixed at the average rate of the IOR plus 75 basis points over the life of the respective discount window operation. Interest will be paid when the respective operation matures. Moreover, we decided to increase collateral availability by reducing the rating threshold for certain asset-backed securities (ABS). In addition to the ABS that are already eligible for discount window operations, ABS having a second best rating of at least “single A” in the USA harmonised credit scale at issuance, and at all times subsequently, and the underlying assets of which comprise residential mortgages and loans to small and medium-sized enterprises, will be eligible for use as collateral in discount window operations. Keeping in mind that all our non-standard monetary policy measures are temporary in nature, we will monitor further developments closely and ensure medium-term macroeconomic stability for the USA by acting in a firm and timely manner.”
    Similar boring words have saved the world from Lehman 2.0 last December when Greece defaulted.

    During the latest ECB press conference, Draghi said:
    “On the first question – whether the situation is like it was at the time of Lehman Brothers’ collapse – the answer is no. The answer is no. We are rightly alarmed that there has been stress in the markets, and some of the indices that seemed to point to the stabilisation of financial markets until, say, three weeks ago, are now increasing again. But I would say that we are still a long way from that situation. From a long-term perspective, if I had to define the main difference between then and now: that episode was a major banking failure coupled with a pre-existing financial crisis of global proportions and, frankly it took us a while to understand, how it was spreading and what were the main causes. So, it took us time to understand the financial crisis, and it took us time to understand how to manage a failure as big as Lehman Brothers’. The situation now is different in a sense because, to a large extent, we know exactly what the problems are. I think that’s the main difference between now and then, so I don’t think the situation is nearly as bad as it was.”
    That is a good thing – Draghi is promising a proper policy response after Grexit that was lacking after Lehman.

  52. Gravatar of Major_Freedom Major_Freedom
    11. June 2012 at 10:36

    Morgan:

    When I talk about deflationary effects, I’m talking about no increase in money.

    I’m talking about firing 50% of the teachers, moving to video course work and a positive effect on educational outcomes.

    If that happens during a LT regime, there is no slow down in the economy from all those teachers being fired.

    Sure, I agree, but that won’t be because the “demand was replaced” elsewhere.

    Normally, we have to suffer through the pain of decreased demand, now instead, the cost of borrowing decreases as the NGDP Futures market prints money and hand it to the retail investors who bet that NGDP would come up light.

    Decreased demand? Or a failure of the economy to be physically sustained without accelerating inflation, which you intepret as a “decreased demand”?

    Suddenly they are flush with printed money, and they need to park it somewhere.

    The idea here is that there are still winners and losers, BUT we’ve used printed money to make strangling the public employee unions possible AND we’ve bypass Goldman-Sachs – so they don’t touch the printed money first.

    Goldman Sachs is a registered primary dealer. They do get to touch the printed money first. It’s from Goldman Sachs (and the other dealers) whom the Fed sends its checks in exchange for overpriced securities (due to the Fed standing ready to buy them).

    Mundell did Reaganomics and then did the Euro, and now advises China.

    His basic end game is a single global currency, where capital is mobile and no govt. has authority over it.

    Hahaha, a global central bank, which requires a global state to protect it and enforce its currency as the only legal tender, would restrain itself from intervening in capital movements? He’s out of his mind. He needs to just look at how many capital controls there are within individual states that face at least some competition with other states.

    Basically, the end of Macro.

    Macro was abolished in 1912 with Mises’ “Theory of Money and Credit.” Macro-economists have been flapping around like marooned fish ever since.

  53. Gravatar of ssumner ssumner
    12. June 2012 at 09:00

    Negation, Yes, it could be permanent—the interest rate should definitely be dropped as a policy instrument.

    JV, Thanks for those links.

    Max, I don’t have a strong opinion on whether the Fed should issue short or long term bonds.

    And I don’t favor the Fed trying to increase the amount of bank reserves, so I don’t follow your second comment.

    JV, I wasn’t blogging yet, but I was highly critical of the Fed’s tight money policy in late 2008.

    Lorenzo, Good point.

    dwb, That Lockhart quote sounds promising.

    123, If you are right, then I’m all for the Fed being even more aggressive than what I proposed. I see this as a sort of minimum.

  54. Gravatar of Major_Freedom Major_Freedom
    14. June 2012 at 11:45

    ssumner:

    JV, I wasn’t blogging yet, but I was highly critical of the Fed’s tight money policy in late 2008.

    Almost every mainstream economist was yammering for crack from the Fed in late 2008.

    The better question is who was highly critical of the Fed’s loose money pre-2008.

  55. Gravatar of TheMoneyIllusion » A spectrum with only one end TheMoneyIllusion » A spectrum with only one end
    18. June 2012 at 14:20

    […] rest of Greg Ip’s essay makes many of the same points I made in a recent post outlining a pragmatic stimulus policy that might be acceptable to the […]

  56. Gravatar of TheMoneyIllusion » The Fed edges closer to monetary stimulus TheMoneyIllusion » The Fed edges closer to monetary stimulus
    23. July 2012 at 16:19

    […] month I did a post describing a program that was far from optimal, but the best I thought we could hope for given the current make-up of […]

  57. Gravatar of Is it time for the Fed to launch a pro-growth monetary policy? | AEIdeas Is it time for the Fed to launch a pro-growth monetary policy? | AEIdeas
    7. August 2012 at 07:22

    […] actually sounds a lot like what NGDP targeting proponent Scott Sumner has suggested as one option for central bank: Let’s summarize. QE is not at all radical. It’s been used already. Why not use it […]

  58. Gravatar of Is it time for the Fed to launch a pro-growth monetary policy? | AEIdeas Is it time for the Fed to launch a pro-growth monetary policy? | AEIdeas
    7. August 2012 at 07:22

    […] actually sounds a lot like what NGDP targeting proponent Scott Sumner has suggested as one option for central bank: Let’s summarize. QE is not at all radical. It’s been used already. Why not use it […]

  59. Gravatar of TheMoneyIllusion » One down, two to go TheMoneyIllusion » One down, two to go
    13. September 2012 at 09:55

    […] June I proposed a “pragmatic” plan for the Fed.  It wasn’t my first choice, far from it.  But it was something […]

Leave a Reply