Recently, as I cast list here, there has been a back and forth between Keynesians (Old & New) and Market Monetarists.
David Beckworth, very smartly, revived a year-old proposal that brings both parties closer and which he titled “Insure Against Central Bank Incompetence”:
So what is needed is a better way to do macroeconomic policy. One that would allow monetary policy to close the output gap and, in its absence, allow fiscal policy to do the same. I have a proposal that does just that. It is a two-tiered approach to NGDP level targeting:
First, the Fed adopts a NGDP level target. Doing so would better anchor nominal spending and income expectations and therefore minimize the chance of ever entering a liquidity-trap… [I]f the public believes the Fed will do whatever it takes to maintain a stable growth path for NGDP, then they would have no need to panic and hoard liquid assets in the first place when an adverse economic shock hits.
Second, the Fed and Treasury sign an agreement that should a liquidity trap emerge anyhow [say due to central bank incompetence] and knock NGDP off its targeted path, they would then quickly work together to implement a helicopter drop. The Fed would provide the funding and the Treasury Department would provide the logistical support to deliver the funds to households. Once NGDP returned to its targeted path the helicopter drop would end and the Fed would implement policy using normal open market operations. If the public understood this plan, it would further stabilize NGDP expectations and make it unlikely a helicopter drop would ever be needed.
Simon Wren-Lewis responded to DB´s “proposal” with a post entitled “Synthesis?!”:
In fact I like it so much that Jonathan Portes and I proposed something very like it in our recent paper. There we acknowledge that outside the Zero Lower Bound (ZLB), monetary policy does the stabilisation. But we also suggest that if the central bank thinks there is more than a 50% probability that they will hit the ZLB, they get together with the national fiscal council (in the US case, the CBO) to propose to the government a fiscal package that is designed to allow interest rates to rise above the ZLB.
If I understood it correctly, outside the ZLB, monetary policy is “king” (so NGDP targeting is fine and good). But SWL says that “if the central bank thinks there is more than a 50% chance that they will hit the ZLB…”.
But the beauty of NGDP level targeting is that, as DB argues, it would “make it unlikely a helicopter drop would ever be needed”. That´s because hitting the ZLB would just not happen.
Australia, for example, who kept NGDP close to the target path all through the crisis, never came close to the ZLB!
The Fed and Treasury could easily agree to that proposal because that would likely be the cheapest social insurance the government could provide, given that the likelihood of a “pay-out” would be microscopically small. Why? Because if the central bank allowed it to happen it would be a testament to its incompetence so they would work diligently not to let it come to pass!