Two Low Volatility Regimes: The Importance of Level Targeting

In my last post, I ‘contradicted’ James Bullard´s “monetary policy is regime dependent” assertion. I tried to show that the opposite is true, with regimes being monetary policy dependent.

The panel portrays three regimes – Great Inflation, Great Moderation and Great Stagnation. The associated monetary policy is described by the behavior of NGDP. To facilitate comparison, each line in the panel has the same scale, while each column depicts a different regime.

Wandering Regimes2

If you want rising inflation and a high volatility regime, just choose high/rising NGDP growth. Stable NGDP growth will provide nominal stability and low volatility. Note the “greatest inflation” in the UK going hand in hand with “fantastic” NGDP growth. Differences in RGDP growth are relatively minor.

However, nominal stability and low volatility can also give you the Great Stagnation! Therefore, it is important to get the LEVEL of nominal stability right. That´s why market monetarists push for NGDP Level Targeting.

As the charts show, central banks in the US, UK (and also in the Eurozone), through a misguided focus on headline inflation, let the “ball drop” and never tried to bring the LEVEL of spending back up. The outcome has been a more fragile system, one that can be strongly affected by different shocks.

A case in point is Brexit and Italy.

Wandering Regimes2_1

 

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