“Measuring Misery”

The misery index was initiated by economist Arthur Okun, an adviser to President Lyndon Johnson in the 1960’s. It is simply the unemployment rate added to the inflation rate. It is assumed that both a higher rate of unemployment and a worsening of inflation both create economic and social costs for a country. A combination of rising inflation and more people out of work implies a deterioration in economic performance and a rise in the misery index.

A very simple concept. Maybe it should be weighted, but that would bring in a lot of subjectivity. I bring this up because Christy Romer just suggested to Ben Bernanke that it was time for his “Volcker moment”. But what exactly was the Volcker moment? You could say it was the decision to bring the misery index down after it had climbed all through the 1970s under Burns and Miller.

Under Greenspan the misery index was further reduced and stayed down. Unfortunately, under Bernanke it has gone up and worse, stayed up

The pictures illustrate:

To do that, Volcker introduced “monetary targeting” after announcing that without monetary restraint inflation would not be brought down. The interest rate targeting “gimmick” just wasn´t helping anymore. But don´t think Volcker was a “monetarist” (just ask Friedman). In fact, on October 11, 1979, just a few days after the new policy was launched the WSJ quoted “a Fed official”, widely believed to be Volcker himself, who warned that “the central bank will continue to be unpredictable”. This Fed “official” was also quoted as saying: “Anybody looking for a rule of thumb is going to be frustrated…the central bank isn´t going to trap itself by following a rule”.

Note that that´s more blunt (Volcker after all is big) but not otherwise different from what Greenspan laid out as his “communication strategy”: “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said”.

Nevertheless, despite their peculiar “communication strategy” they succeeded. Volcker in bringing the misery index down and Greenspan in keeping it down!

Maybe that tells us that without an explicit target the more “clear” or “transparent” your “communication strategy” the worse the outcome will be (see here). That´s probably why Krugman wrote:

You see, the early Volcker years were the period when the Fed at least claimed to have become monetarist, to be setting targets for monetary aggregates like M1 and M2 rather than interest rates. It didn’t last long; by the summer of 1982 the Fed had more or less thrown out the monetarist playbook.

Yet the monetarist interval served a purpose: it gave the Fed a usefully euphemistic way to talk about its inflation-fighting strategy. Officials didn’t have to say, “We’re going to push the economy into a deep recession, and keep it there until inflation cries uncle.” Instead, they could talk in terms of M1 growth rates and credible long-run strategies and whatever, while in fact what they were basically doing was pushing the economy into a deep recession and keeping it there until inflation cried uncle.

Nominal GDP targeting is quite a lot like that. To be sure, NGDP is a much better target than M1, which (it turns out) is subject to wide swings in velocity. And the Fed’s goals, if frankly stated, wouldn’t be nearly as politically explosive as what it was doing in 1979-82. Still, NGDP is arguably mainly a relatively palatable way to state a strategy that’s ultimately about something else.

As I see it — and as I suspect many people at the Fed see it — the basic point is that to gain traction in a liquidity trap you must either engage in huge quantitative easing, raise the expected rate of inflation, or both. Yet saying this is very hard; people treat expansion of the Fed’s balance sheet as horrible money-printing, and as for the virtues of inflation, well, wear your body armor.

But say that we need to reverse the obvious shortfall in nominal GDP, and you’ve found a more acceptable way to justify huge quantitative easing and a de facto higher inflation target.

Don’t call it a deception, call it a communications strategy. And as I said, I’m for it.

With regards to NGDP targeting Krugman is being a bit too cynical, but I won´t quibble with that here.

Unfortunately, according to Fed followers like Calculated Risk, there´s not much hope for change:

There will be a two day meeting of the Federal Open Market Committee (FOMC) this coming Tuesday and Wednesday. I expect no changes to the Fed Funds rate, or to the recently announced program to “extend the average maturity of its holdings of securities” (scheduled to end in June 2012), or to the program to “reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities”.

There might be some other minor upgrades, but overall the statement will probably be pretty similar to the September statement.

I expect the focus will be on the press briefing and the FOMC forecasts.

Does anyone see an academic like Bernanke saying the things Volcker or Greenspan said? I don´t!

2 thoughts on ““Measuring Misery”

  1. I fear Marcus Nunes is right; Bernanke was brave when seated in cloistered comfort of the Ivory Tower. Put him in the pilot’s seat, and he freezes.

    We can only hope that the Market Monetarists win the day in public debate (I think we have already), and eventually Bernanke sees pitiful results from what he is doing, and so he gingerly moves to NGDP targeting. This could take another year or two.

  2. Pingback: Link roundup « Negative Interest

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