If you don´t have a target, don´t bother “wrestling with communication”

We hear that the Fed is set to spend a lot of time Tuesday and Wednesday “wrestling with communication policy”.

In a fun to read post Nick Rowe has done a great job in “dissecting” the subject. David Beckworth has succinctly summarized the issue:

There is no way programs like QE2 or Operation Twist will have lasting power if there is no explicit and well understood target assigned to them.

So, instead of “wrestling” with communications policy, the Fed should “wrestle” to establish a TARGET. I would go further and say that if it doesn´t have a (explicit) target, it should not bother “wrestling with communications policy”. That would likely make things worse!

Why do I say that? Just look at the Greenspan record. In terms of the Fed´s mandate (stable prices and maximum employment) he was the most successful Fed chairman.

And these quotes perfectly reflect Greenspan´s “communications policy”:

  • Since becoming a central banker, I have learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said.(Speaking to a Senate Committee in 1987, as quoted in the Guardian Weekly, November 4, 2005)
  • I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said. (1988 speech, as quoted in The New York Times, October 28, 2005)

Obviously they are one and the same. And Greenspan must have lied when he said “since becoming a central banker” because he only became a central banker in mid 1987. No way he could have developed that “communication strategy” in just a few weeks. It must have always been in his “DNA”.

But the markets adapt quickly. Soon a bunch of intelligent and handsomely paid people – Fed watchers – were hard at work endeavoring to translate into lay teems Greenspan´s “incoherent mumbles”.

And please don´t say that Greenspan had an “easy time”. The economy was buffeted by several shocks, some quite big, during his 19 year tenure (the second longest, losing by a narrow margin). Just to mention a few:

  1. The stock market crash of October 1987. The Dow dropped 22% in one day.
  2. The fall of the Berlin wall and breakup of the Soviet Union.
  3. The Mexico, Asia and Russia crisis that bunched up between 1995 and 1998
  4. The launch of the Euro
  5. The bursting of the tech “bubble”
  6. Terrorist attacks
  7. Wave of accounting scandals in 2001-02
  8. Oil shock following the invasion of Iraq in 2003

On the opposite side of the “communications pole” there is Bernanke. At least six years before becoming Fed chairman his mind was made up about the “communications” issue:

We think the best bet lies in a framework known as inflation targeting, which has been employed with great success in recent years by most of the world’s biggest economies, except for Japan. Inflation targeting is a monetary-policy framework that commits the central bank to a forward-looking pursuit of low inflation—the source of the Fed’s current great performance—but also promotes a more open and accountable policy-making process. More transparency and accountability would help keep the Fed on track, and a more open Fed would be good for financial markets and more consistent with our democratic political system.

As our research on the use of this approach around the world documents, successful inflation targeting requires that the central bank and elected officials make a public commitment to an explicit numerical target level for inflation (usually around 2%), to be achieved over a specified horizon (usually two years). Equally important, the central bank must agree to provide the markets and the public with enough information to evaluate its performance, and to understand its reasoning when policy and inflation deviate from the long-run goal–as they inevitably will at times.

Not only did it not work but made things worse because he did not (or was not able to) make his preferred target explicit. While just a few years earlier, following the 2003-05 oil shock, Greenspan “mumbled” about “appropriate monetary policy”, Bernanke tried to “be clear” about his intentions. But that proved to be an impossible feat given there was no explicit target to assign his actions to. Even worse, Bernanke implied the FOMC was “eyeing” headline inflation. That was akin to “throwing salt into the wound”. The consequences were terrible, with the economy “rehearsing a replay of the 1930´s”.

The next question is: which target? Market Monetarists have been clear about their preference for a nominal spending level target. In a very recent post Scott Sumner explains and contrasts NGDPT with the alternative of a “NGDP futures contract price targeting”. On the other hand, Bernanke is a big fan of inflation targeting.

I hold the view that inflation targeting, if chosen, would be a bad choice. Without going into details (see here for a discussion) I just mention the fact that inflation cannot be a good target, once it has been brought down, because if it were we would not observe the gatherings in myriad seminars and the dozens of papers written in the last 10 or 12 years, coinciding with the “conquest” of inflation in many countries, on the subject of “How to conduct monetary policy in a low inflation environment”.

To me this implies that when inflation has been brought down somehow monetary policy has to be “adapted”. But since monetary policy is clearly determined by its goal or target, the target has to change. The reason for the discussion on MP in a low inflation environment has to do with the problem of the ZLB on the policy “instrument” – the FF rate. This point is consistent with the suggestions made by some (Blanchard, Rogoff, for example) that the Fed should rise, even it temporarily, the inflation target.  Again, the problem is the US does NOT have an explicit target!

And that, folks puts the Fed in a situation akin to the “dog running in circles to grab his own tail”. It´s going nowhere!

Update: While I was engrossed in writing I got an e-mail from David Levey linking to this NYT comment by Christina Romer!

Mr. Bernanke needs to steal a page from the Volcker playbook. To forcefully tackle the unemployment problem, he needs to set a new policy framework — in this case, to begin targeting the path of nominal gross domestic product.

Nominal G.D.P. is just a technical term for the dollar value of everything we produce. It is total output (real G.D.P.) times the current prices we pay. Adopting this target would mean that the Fed is making a commitment to keep nominal G.D.P. on a sensible path.

I see that Lars Christensen has also linked.

One thought on “If you don´t have a target, don´t bother “wrestling with communication”

  1. Hello! Let me just say I enjoy your blog. I am quite interested in this whole recent phenomonen of “Market Monetarism.” Full disclosure I myself am a Keynseian. However I can’t help but notice that there has been a meeting of the minds lately between the “Market Monetarists” and the “New Keynesians.”

    The main obvious disagreement I have with the MM school would be on the fiscal side; on monetary policy what they have been suggesting-Sumner, et al-is very intriguing. A nominal GDP target sounds to me a major improvement on the inflation targeting that Beranke talks of here.

    I do have to push back a little on what you say about Greenspan: “look at the Greenspan record. In terms of the Fed´s mandate (stable prices and maximum employment) he was the most successful Fed chairman.”

    I don’t know that I would agree that in his term we had a record of maximum employment. In saying this I am thinking in particular of the 2001 recession. Remember the “jobless recovery” that followed. In reading his Age of Turbulence published in 2007 it is clear that he greatly understates how tough the 2001 recession was. Ultimately the record of job creation during the Bush Administartion-for which Greenspan was chairman 6 out of 8 years-was abysmal.

    In the recovery from 2001 we seemed to bounce back only very superfically. While most of the 3 million jobs lost were eventually gotten back, the new jobs created were very poorly paid service jobs. You had many people with a white collar background and education joining the world of burger flippers.

    So I don’t agree that he gave us maximum employment. More importantly to your point, yes I would dearly love to see the Fed move from it’s one dimensional inflation targeting. NGDO certainly sounds to me as a marked improvement.

    Having said that when Bernanike spoke of the success of inflation targeting, was this not in full agreement with Greenspan? Wasn’t Greenspan as well about inflation targeting above all?

    What I find interesting about the proposal of Sumner, et al, for NGDP is it might even appeal to James Galbraith-haven’t seen what he has to say about it. But going back to his 1997 book “Created Unequal” he has argued that the Fed-according to him this is staring with 1970-has been too preoccupied with inflation targeting. According to him, prior to this the Fed was committed to Full Employment.

    Now I don’t know how you-or Sumner, et al- as a monetarist feel about Full Employment but NGDP sounds like something that someone who does support Full Employment as a Fed mandate would see as at the minimum a major improvement.

    Finally I will offer this observation about inflation fighting. Since 1913 with the Federal Reserve Act, we really have had very few years that have shown seriously high inflation-certainly very few years with double digit inflation.

    Here is the historical data http://inflationdata.com/inflation/Inflation_Rate/HistoricalInflation.aspx

    Really the 70s is the only period we have seen sustained high ifnlation during peactime. Arguably the cause of this was more about exogenous shocks-Opec, the Iranian Revolution-that may have taken care of itself without the gruesome work Volcker did to the economy, giving us a 11.3 percent unemployment rate that even factoring in the current Lesser Depression is the highest we have seen since the 1930s.

    As inflation is not an ongoing problem in the American economy, it sometimes feels like the Fed is a physocsomatic instiution.

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