Missing the point

That´s, I think, what Simon Wren-Lewis does in “Unconventional Monetary Policy versus fiscal policy”:

One way of stimulating demand when interest rates are stuck at zero is to promise a combination of higher than ideal inflation and higher than ideal output in the future. (This can be done either explicitly or implicitly by using some form of target in the nominal level of something like nominal GDP. For those not familiar with how this works, see here.) The cost of this policy is clear: higher than ideal future inflation and output. Once again, these costs can be worth it because of the severity of the current recession, which is why nominal rates are stuck at zero. Whether these costs are greater or less than the cost of changing government spending is debatable: a paper by Werning that I discussed here suggests optimal policy may involve both.

The concept of ideal real output is elusive, to say the least. And we have no precise idea of how a rise in nominal spending (NGDP) will break down between real growth and inflation.

For 20 years the US economy was moving along a stable level path, with inflation close to target and real output growth close to “potential” (at least close to its long term trend).

That environment of nominal stability began to be lost soon after Bernanke took over as head of the BoG. In mid-2008 it was completely lost!

A NGDP level target is not something to do so as to have any particular break-down between inflation and growth, but to maintain nominal stability. Sometimes, for reasons unrelated to monetary policy (supply shocks), inflation might go up and real growth down. The best monetary policy can do in those situations (helping to avoid financial crises, for example), is to “keep the nominal boat on a steady course”.

The problem is that having veered so far off course for such a long time, we have no precise idea of the new right course to “place the boat on”. We know we are below the “ideal” course, but how far below? But that should not discourage policymakers and make them feel good with “this is the new normal” view that is becoming widespread.

Instead of stating numerical objectives for the rate of unemployment (a real variable) the Fed could set a target for the level of nominal spending and keep adjusting the target depending on how the economy behaves. We´ll know when the “ideal” level has been reached because market variables will tell us. From then on nominal growth will proceed in such a way so as to be consistent with the best view for potential output growth and level of desired inflation. In other words, nominal stability will have been regained.

Missing point

Fiscal policy? That should concentrate on providing the most friendly environment for long term growth.

2 thoughts on “Missing the point

  1. Pingback: TheMoneyIllusion » To QE, or not to QE, that is NOT the question (Reply to Simon Wren-Lewis)

  2. I’m not sure that we should even have a “fiscal policy”. Instead, we should focus our concerns on “what should government be spending money on and how much?” Then we tax to pay for those decisions as people will allow. I.e., fiscal policy should not be either pro- or counter-cyclical. Why make spending hostage to “macroeconomic policy”? Especially when monetary policy has all the tools that it needs to do the macro job.

    While we can have a fun argument about what government should be paying for, that’s a separate question from macro stability. We should celebrate the fact that the two can be made independent (if they weren’t always…)

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