While promoting his book on the Larry Kudlow Report:
Kudlow: You’ve got a school of thought, Alan, they call themselves market monetarists, who believe the mistake the Fed has made is that they should be targeting nominal GDP and that would give us the [economic] uplift. What do you think of that?
Greenspan: None of these mechanisms work. We’ve tried them all. I was there for 18 1/2 years. We looked at them all. The difficulty is that the markets are driven by forces which central banks only have a limited amount of capability of controlling. And what concerns me mostly is that when you start talking about maneuvering the inflation rate, it’s very difficult. And as you point out, the central bank has flooded the economy with liquidity. What has happened to the liquidity? It’s gone nowhere. Just look at the balance sheets. You have a very significant increase in central bank expansion, and a very large increase in commercial banks holding of excess reserves. But they’re holding those excess reserves with no capital charge, and they’re getting 25 basis points free for holding something which is hypothetical on their balance sheet. …
Maybe age is making him forgetful. During the December 1992 FOMC meeting there was a detailed discussion of NGDP targeting. An excerpt:
MR. JORDAN. This question of when the time is going to come to change the [funds] rate–especially in an upward direction–and the criteria for doing so has been on my mind a lot, and I’m sure it has been in everybody’s thinking. This is my seventh meeting, and I thought it was time to go back and review the last year and to look at what actually has happened in terms of all kinds of economic indicators–monetary as well as economic indicators, nominal and real indicators–and Committee actions to see if I could deduce an implicit model. I read the newsletters, as I’m sure everybody does; and [unintelligible] and I don’t see it in the numbers, it’s certainly not inflation. It’s not the various money measures: Ml, M2, the base, or bank reserves. I don’t even think its real GDP. I put together a table–a big matrix of every forecast for as many quarters out as the Greenbook does it–for every meeting for the last year. What struck me was that it looked as if we were on a de facto nominal GNP target. When nominal GNP is at or above expectations, the funds rate is held stable; but when nominal GNP comes in below what has been expected, we cut the funds rate. Do you want to comment?
MR. PRELL. I’d like to establish that in the past the Federal Reserve has shied away from enunciating a view about potential GDP growth, remaining agnostic and being prepared presumably to accommodate any positive surprise. If the positive surprise on nominal GDP could be discerned to be a favorable supply shock, then accommodating it would be a more natural thing to do than if you felt it was a demand shock which tightened up markets and had inflationary consequences down the road. But viewing nominal GDP targeting as your basic approach takes some things as given, as being relatively stable. You may view this [approach] as a way of having an automatic stabilizer over time so that it would be natural to react if you’re overshooting, with the thought that you would end up with some price pressures later [if you don’t react].
MR. PARRY. Jerry, in the discussion about nominal income targeting it’s clear to me that there are some problems associated with it. But what is perhaps more relevant is whether the problems associated with nominal income targeting are greater or lesser than those associated with interest rate targeting. I’m afraid a lot of the academic literature would suggest that we probably would reduce the chance of making the kinds of mistakes that we make with interest rate targeting if we followed a nominal income target.
MR. ANGELL. Well, nominal GDP targeting is really not as bad as it might seem in that it does have a heavy price level direction to it. That is, the advantage of using nominal GDP as a target versus using real GDP is that we are saying to other policymakers that if they in some sense gear up activities that tend to cause wage rate pressures or other price pressures to take place, then they are voting for lower real GDP. So, nominal GDP targeting is not that far away from what I think is price level targeting. I think price level targeting is better, but we’ll see.
MR. KOHN. But in the case of a supply shock, a lot of people have advocated nominal GDP targeting. We discussed this actually in August of 1990 in the face of supply shocks. It is supportive, as Governor Angell said, because it has some of these automatic stabilizer-type properties that Mike was talking about; you can’t overshoot too badly on one side or another and you bring about corrective actions, particularly when you’re unsure with prices going one way and quantities going the other way.
In closing the discussion Greenspan says:
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 this is how things worked out for the rest of Greenspan´s ‘reign’. Sure, all was not perfect. The Fed made some mistakes, causing instability, but the important thing to note is that they were corrected (funny how many at present say that correction was an important cause of the crisis!).
HT James Pethokoukis