Michael Belongia and Peter Ireland have an interesting article in e21: “The Fed Should Forget About Forward Guidance”:
Mainstream monetary economics posits that the Federal Reserve influences economic activity by shaping expectations about the future. According to theory, when the Fed provides “forward guidance” about the future course of monetary policy, consumers and producers adjust their spending, hiring, and investment decisions accordingly. Forward guidance, in turn, can be communicated to the public via statements from Fed officials or public understanding of a policy rule that leads the Federal Open Market Committee to adjust its target for the federal funds rate.
This theory might, or might not, be an accurate description of how Federal Reserve actions are transmitted to aggregate spending and prices. But, for the time being, it is useful to examine the nature of forward guidance that the Fed is delivering to the public.
Because this overview suggests that the Fed may be confusing rather than enlightening the public, the practices and performance of other central banks may be worth examining. For example, the Bank of Canada has a Governing Council but, once its deliberations have concluded, only its consensus views are revealed to the public. The Bank of England makes decisions based on input from members of its Monetary Policy Committee and these individuals, like members of the FOMC, are free to offer to the public their own views on economic conditions and a preferred path for the future course of monetary policy.
It might be interesting to ask Mark Carney, who has served as the Governor of both the Bank of Canada and the Bank of England, which institutional arrangement makes monetary policy easier to implement and produces better policy outcomes. It might be useful, as well, to investigate and evaluate further the reasons why Stephen Poloz, the new Governor of the Bank of Canada, recently decided to abandon his Bank’s practice of offering forward guidance on its policies.
If the Fed wants to offer forward guidance, it should go to the trouble to make it more accurate. Otherwise, the Fed might as well abandon it altogether.
And how could they do that? Certainly not following Simon Wren-Lewis´suggestion that they target the output gap!
My parallel universe idea illustrates two points. First, over the last six years, the Divine Coincidence has been distinctly unholy. Second, as a result it is terribly misleading to focus on inflation (and consumer price inflation in particular) rather than the output gap. I suspect in thirty years students will look back on this period with the same disbelief that we look back on the 1930s. How could they have allowed the recession to continue for so long, they will ask, when they had the tools to do much better? Part of the answer will be inflation targeting.
Much better to consider an NGDP Level Target! In fact, one of the takeaways from the crisis was that it revealed which countries were practicing de facto inflation targeting and which de facto practiced NGDP-LT.
Australia or Israel, among a very few, where NGDP remained close to trend are more likely to have been following an NGDP-LT targeting regime than Canada or the U.S., who were formally or de facto implementing an IT regime. In those countries (larger in number) NGDP dropped well below trend. Not surprisingly to market monetarists, economic outcomes in Australia and Israel were order of magnitude better than in the US and Canada (or UK and EZ).
Update: Scott Sumner has a new paper at The Adam Smith Institute: “The real problem was nominal“:
So why do people always assume the Great Recession was caused by a financial crisis? Because it looks that way? Well, what would have it looked like it if was caused by central bank policy failures that allowed NGDP to fall at the sharpest rate since the Great Depression during a time where banks were already stressed by the subprime fiasco in the US, and when resources for repaying nominal debts come from nominal income? What if the subprime mortgage crisis was the cold, and the NGDP collapse was the pneumonia? What would you expect to happen? If my view is right, and central banks are to blame, then the policy implications are obvious: stop targeting inflation and switch to the clear, simple rule of NGDP targeting.
Much more intuitive than SWL´s “RGDP Gap targeting”!