Yes, the Fed finally made its implicit 2 percent inflation target explicit in January 2012. But policy makers have been more explicit about the need to reduce unemployment, even if it means a modest overshoot on inflation. Setting a 6.5 percent unemployment rate threshold for contemplating a funds rate increase hardly qualifies as a rule. What it is, is a case-by- case study.
Think how much simpler it would be to adopt a nominal GDP target, which encompasses real GDP plus inflation. That’s what the Fed cares about. It even incorporates the Fed’s dual mandate of stable prices and full employment. (The road to full employment goes through strong growth.) It’s a lot better than the current mishmash of a threshold for unemployment, an inflation forecast (the Fed’s) that’s no higher than 2.5 percent, and a market-based indicator of inflation expectations.
A nominal GDP target might not have prevented the housing bubble, but it would have mitigated the fallout from the collapse, according to market monetarists, a group of economists who advocate an NGDP target. If the Fed had made it clear it would keep nominal income on a steady path — if it had applied “whatever it takes” to an explicit goal — it could have gotten a bigger bang for its buck, or a higher turnover rate (velocity) for each dollar of quantitative easing, according to Scott Sumner, a professor of economics at Bentley University in Waltham, Massachusetts.
No rule is perfect or can replace the gold standard of rules, which happens to be the gold standard, with its convertibility of a dollar into gold at a fixed price. Still, with the Fed’s balance sheet at $3.2 trillion and counting, and unwinding those purchases as the next hurdle, policy makers might find themselves wishing they had heeded Sumner’s claim that less is more.
Update: Scott Sumner is pleased!