In his latest post Scott Sumner (avowedly engaging in some MM ‘counterintuitive cleverness’) writes:
But first a bit of history. When I was younger the recovery from recessions was quite rapid. Both RGDP and NGDP grew far more rapidly in the initial recoveries from recessions of the 1920s through the 1980s, than during the recoveries from 1991 and especially 2001. Indeed if you’d like the Fed to be cautious, if you’d like for a slow rate of demand growth during the recovery, so that the recovery can last longer, then 2001-07 is your model. It was one of the slowest recoveries I’ve ever seen. So slow that the unemployment rate in early 2003 was still going up, despite the fact that the recession trough was in November 2001.
If we use the Bernanke/Sumner benchmark for the stance of monetary policy (NGDP growth and inflation) then monetary policy was unusually contractionary during these last two recoveries. So if you want a slow recovery to prevent the buildup of bubbles, then 2001-07 is close to an ideal.
It must be remembered, however, that the 1990-91 and 2001 recessions happened during the “Great Moderation”. That´s the period where “booms” and “busts” were much more contained. Just as the recoveries (booms) in NGDP and RGDP were ‘slower’, the drops (busts) were much ‘shallower’. In 2001 RGDP growth never even turned negative on a year over year basis.
The charts illustrate. In the first we see the NGDP gap, the percent difference between the NGDP trend level and actual NGDP. In 1991 – 93, there´s not much oscillation, with NGDP remaining very close to trend. At this time there was a ‘conscious decision’ by the FOMC to bring inflation (PCE-Core) more closely to 2%. Interest rates were kept ‘high’ for a while after the recession began. RGDP growth contracted a bit and inflation was lowered. Unemployment increased and stayed high for a while. But that, I think, was the ‘script’ favored by the Fed.
From the NGDP Gap chart above, note that something very different happened in the 2001 recession. Previously, NGDP had increased a bit much (following Fed reaction to the Russian crisis and LTCM). The ‘monetary brakes’ were pulled too strongly (given the other demand shocks taking place at the time, like the terrorist attacks and corporate shenanigans) so NGDP undershot the trend considerably. Note, however that RGDP growth remained positive and unemployment went up by much less than in the 1990/91 recession although it ‘lingered’ for longer (remember that NGDP was far below trend). For the whole time, inflation remained below the implicit 2% target. Early on in the second half of 2003 the Fed adopted ‘forward guidance’. “Miraculously”, NGDP began moving towards trend, RGDP growth picked up and inflation (not shown) also went up to remain close to 2%. Unemployment began to fall.
To put things in perspective, the following is a quote from Greenspan in the November 17, 1992 FOMC meeting:
“Let me put it to you this way. If you ask whether we are confirming our view to contain the success that we’ve had to date on inflation, the answer is “yes.” I think that policy is implicit among the members of this Committee, and the specific instruments that we may be using or not using are really a quite secondary question. As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions. I would say in that context that on the basis of the studies,we have seen that to drive nominal GDP, let’s assume at 4-1/2 percent, in our old philosophy we would have said that [requires] a 4-1/2 percent growth in M2. In today’s analysis, we would say it’s significantly less than that. I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that. And I don’t see any change in our view…and we will know they are convinced (about “price stability”) when we see the30-year Treasury at 5-1/2 percent.”
Apparently 8 or 9 years later he had ‘forgotten’ about this. Maybe he was distracted by the New Keynesian assault and the increasing number of central banks pursuing explicit inflation targets that began to take hold in the early 1990s, when monetary policy became synonymous with interest rates and the New Keynesian “bible” dropped money altogether and was named “Interest and Prices”.
The counterfactual would be that, had the Fed been explicitly doing NGDP-LT, quite likely the over and under reactions observed in 1998-02 would not have occurred and interest rates likely wouldn’t have been so drastically reduced. Likely, also, that despite higher interest rates, asset bubbles would have occurred anyway. The causes of those were elsewhere.
PS I interpret the “Great Recession” after mid-2008 as a ‘magnified’ experience of 2001-03. The ‘magnification’ came about because this time around, under Bernanke, the Fed was perceived as being much closer to a ‘strict’ inflation targeter and targeting “headline” inflation to boot! This time around, ‘forward guidance’ came ‘too late’ and was seen as wishy-washy.