Recent developments in monetary thought

Bloomberg has an interesting story on the recent developments in monetary thought. Michael Woodford is the ‘centerfold’.

I first backtrack to last year´s Jackson Hole conference. In his presentation at that conference, Woodford proposed forward guidance:

Standard New Keynesian models imply that a higher level of expected real income or inflation in the future creates incentives for greater real expenditure and larger price increases now but in the case of a conventional interest-rate reaction function for the central bank, short-term interest rates should increase, and the disincentive that this provides to current expenditure will attenuate (without completely eliminating) the sensitivity of current conditions to expectations. If nominal interest rates instead remain unchanged, the degree to which higher expected real income and inflation later produce higher real income and inflation now is amplified. If the situation is expected to persist for a period of time, the degree of amplification should increase exponentially. Hence it is precisely when the interest-rate lower bound is expected to be a binding constraint for some time to come that expectations about the conduct of policy after the constraint ceases to bind should have a particularly large effect on current economic conditions — to the extent, that is, that it is possible to shift expectations about conditions that far in the future.

And now (from Bloomberg):

While saying that the Fed’s current guidance on interest rates is a “significant improvement,” Woodford sees problems with tying the policy to progress on reducing joblessness. As unemployment falls toward 6.5 percent, the Fed will be forced to explain what it will do, especially if, as Woodford suspects, it doesn’t want to raise rates at that time.

He says the Fed should adopt a broader goal: returning total economic output — nominal gross domestic product, in economist parlance — back to the trend it would have been on if the recession hadn’t occurred.

Nice, but this was Carney´s argument in December 2012:

To “tie its hands,” a central bank could publicly announce precise numerical thresholds for inflation and unemployment that must be met before reducing stimulus. This could reinforce the central bank’s commitment to stimulative policy in the future and thus enhance the stimulative impact of its policies in the present, helping the economy escape from the liquidity trap.


Further Enhancing Guidance May Require a Change in Framework

From our perspective, thresholds exhaust the guidance options available to a central bank operating under flexible inflation targeting. If yet further stimulus were required, the policy framework itself would likely have to be changed. For example, adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP.

For more than 20 years discussion on NGDP targeting had been dormant in academia, and never reached the policymaking corridors. Almost 5 years ago Scott Sumner revived it…

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