NGDP Targeting and FOMC discussions

Curiously, at the end of 1982 at the high point of unemployment and the low point of growth, with inflation below 6%, the lowest level reached since 1974, the Fed discussed NGDP targeting:

MORRIS. I think we need a proxy–an independent intermediate target– for nominal GNP, or the closest thing we can come to as a proxy for nominal GNP, because that’s what the name of the game is supposed to be.

During the December 1992 FOMC meeting there was a detailed discussion of NGDP targeting. An excerpt:

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

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.

From Bernanke´s Book as tweeted by Neil Irwin:

The FOMC had a long, serious discussion of NGDP targeting in 2011. And soundly rejected it.


Bernanke is really an inflation targeting freak! Note than in 1982 or 1992, no one said that by targeting NGDP the Fed “had suddenly decided it was willing to tolerate higher inflation, possibly for many years”. And just two months after this discussion, in January 2012, the Fed made the 2% target official policy!

Notice that in 1992, Greenspan said: “I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal…”

That said, I think it is worthwhile to check if Greenspan´s words were meaningful. The panel below pictures what went on in the NGDP, inflation and unemployment fronts from then to the end of his tenure.


The next panel shows how those things continued into the Bernanke/Yellen era.


One could say: “so what”? Inflation has remained low, even below the now official target, and unemployment has come down to a “comfortable” level. Bernanke has said the “Fed saved the economy – full employment without inflation is in sight”!

But, according to Bernanke:

Congress is largely responsible for the incomplete recovery from the 2008 financial crisisBen S. Bernanke, the former Federal Reserve chairman, writes in a memoir published on Monday.

Mr. Bernanke, who left the Fed in January 2014 after eight years as chairman, says the Fed’s response to the crisis was bold and effective but insufficient.

“I often said that monetary policy was not a panacea — we needed Congress to do its part,” he says. “After the crisis calmed, that help was not forthcoming.”

In a few instances, Mr. Bernanke also acknowledges, the Fed could have done more. He writes that the decision not to lower rates in September 2008, immediately after the collapse of Lehman Brothers, “was certainly a mistake.” The Fed’s benchmark rate then stood at 2 percent; by the end of the year, it had been cut nearly to zero.

By “incomplete recovery”, I´ll take it he´s referring to the “gaping hole” that´s observed in the NGDP chart (the distance to the trend NGDP level). But that cannot be attributed to Congress. It refers to what Friedman said almost 50 years ago: “A second thing monetary policy can do is provide a stable background for the economy.”

Bernanke gave a narrow interpretation to “stable background”, defining it in terms of “low and stable inflation”. If instead of low and stable inflation he had pursued a stable growth path for nominal spending (NGDP) he would have avoided the crash.

Inflation is low, unemployment is back (almost) at “full employment”. So what´s missing, allowing the gap to remain wide open?

As the charts show, the unemployment rate has a different “meaning” in the two periods!


And the last chart provides a “summary statistic”.


In the 2001 recession, NGDP growth slumped, but was brought back up so that the trend level of NGDP was regained.

In the 2007-09 recession, NGDP growth “caved” and has remained far below the trend growth, implying that there has been no “recovery”, with the economy remaining “depressed”!

And that´s no fault of Congress, but the result of Bernanke´s (and the Fed´s) obsession with inflation!

“Don´t reason from an employment change”


Federal Reserve Bank of Boston President Eric Rosengren said Saturday that his confidence that the U.S. central bank can raise rates soon has diminished in the wake of underwhelming employment data.

“The jobs report was disappointing; it seems to validate the decision” of Fed officials to hold off on lifting interest rates off near zero levels at their meeting last month, Mr. Rosengren said in an interview with The Wall Street Journal. The performance of the September jobs data, released Friday, “highlights that we need to continue to monitor how the data is coming in to determine when it is appropriate” to boost the cost of borrowing, he said.

That´s in clear violation of how Milton Friedman said monetary policy should be conducted:

The first requirement is that the monetary authority should guide itself by magnitudes that it can control, not by ones that it cannot control. If, as the authority has often done, it takes interest rates or the current unemployment percentage as the immediate criterion of policy, it will be like a space vehicle that has taken a fix on the wrong star. No matter how sensitive and sophisticated its guiding apparatus, the space vehicle will go astrayAnd so will the monetary authority.

What many of those highly paid policymakers do not realize is that by harping on the employment cord they are in fact tightening monetary policy, thus obtaining the ‘fantastic’ result of tight monetary policy at ‘zero’ interest rate!

Bernanke´s Failure!

Bernanke´s book Courage to Act was released today. I´m not much curious about the backstage discussion of how best to rescue the financial system or the “excitement” about Lehman because I fear that much of that was a consequence of monetary policy mistakes, so I will mostly want to read about his views on the monetary policy the Fed was pursuing.

I have the feeling he forgot about Friedman´s first and second dictum about what monetary policy can do.

The first and most important lesson that history teaches about what monetary policy can do-and it is a lesson of the most profound importance-is that monetary policy can prevent money itself from being a major source of economic disturbance.

When a Governor of the Board in 2002, Bem Bernanke made a speech at a conference honoring Milton Friedman on the occasion of his 90th birthday. He concludes thus:

For practical central bankers, among which I now count myself, Friedman and Schwartz’s analysis leaves many lessons. What I take from their work is the idea that monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful. The best thing that central bankers can do for the world is to avoid such crises by providing the economy with, in Milton Friedman’s words, a “stable monetary background–for example as reflected in low and stable inflation.

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

I think Bernanke gave a too narrow interpretation of what was Friedman´s second dictum:

A second thing monetary policy can do is provide a stable background for the economy.

If instead of low and stable inflation he had pursued a stable growth path for nominal spending (NGDP) he would have avoided the crash.

And it´s not that Bernanke did not know that the level of the FF rate (“low” at the time) was not a good indicator of the stance of monetary policy. In 2003 he wrote on the Legacy of Milton and Rose Friedman:

As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as wellThe real short-term interest rate, another candidate measure of policy stance, is also imperfect, because it mixes monetary and real influences, such as the rate of productivity growth

The absence of a clear and straightforward measure of monetary ease or tightness is a major problem in practice. How can we know, for example, whether policy is “neutral” or excessively “activist”?

Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation

Unfortunately, he preferred to concentrate on inflation, and worse, the headline variety, which was being buffeted by the oil and commodity price shocks!

In looking at this

Courage to Act_1

He missed this

Courage to Act_2

And harvested mayhem!

BB makes me sick!

On the day that his book “Courage to Act” will be released, he writes an op-ed at the WSJ “modestly” titled How the Fed Saved the Economy – Full employment without inflation is in sight. The central bank did its job. What about everyone else?

For the first time in nearly a decade, the Federal Reserve is considering raising its target interest rate, which would end a long period of near-zero rates. Like the cessation of large-scale asset purchases in October 2014, that action will be an important milestone in the unwinding of extraordinary monetary policies, adopted during my tenure as Fed chairman, to help the economy recover from a historic financial crisis. As such, it’s a good time to evaluate the results of those measures, and to consider where policy makers should go from here.

He chooses to compare with Europe:

It is instructive to compare recent U.S. economic performance with that of Europe, a major industrialized economy of similar size. There are many differences between the U.S. and Europe, but a critical one is that Europe’s economic orthodoxy has until recently largely blocked the use of monetary or fiscal policy to aid recovery. Economic philosophy, not feasibility, is the constraint: Greece might have limited options, but Germany and several other countries don’t. And the European Central Bank has broader monetary powers than the Fed does.

Europe’s failure to employ monetary and fiscal policy aggressively after the financial crisis is a big reason that eurozone output is today about 0.8% below its precrisis peak. In contrast, the output of the U.S. economy is 8.9% above the earlier peak—an enormous difference in performance. In November 2010, when the Fed undertook its second round of quantitative easing, German Finance Minister Wolfgang Schäuble reportedly called the action “clueless.” At the time, the unemployment rates in Europe and the U.S. were 10.2% and 9.4%, respectively. Today the U.S. jobless rate is close to 5%, while the European rate has risen to 10.9%.

And wraps up with a bromide:

It is encouraging to see that the U.S. economy is approaching full employment with low inflation, the goals for which the Fed has been striving. That certainly doesn’t mean all is well. Jobs are being created, but overall growth is modest, reflecting subpar gains in productivity and slow labor-force growth, among other factors. The benefits of growth aren’t shared equally, and as a result many Americans have seen little improvement in living standards. These, unfortunately, aren’t problems that the Fed has the power to alleviate.

Today, Bullard was the lunch attraction at the SOMC!

That´s the “Shadow Open Market Committee”. The title of his talk: Three Challenges to Central Bank Orthodoxy. His opening:

The current monetary policy debate in the U.S. is at a crossroads. Since 2007-2009, the Federal Open Market Committee (FOMC) has pursued a very aggressive monetary policy strategy. This strategy has been associated with a significantly improved labor market, moderate growth, and inflation relatively close to target, net of a large oil price shock. A key question now is how to think about monetary policy going forward.

And concludes:

In this address, I have outlined an interpretation of current events in U.S. monetary policy that I called the orthodox view. This view stresses the currently stark difference between FOMC objectives, which are arguably nearly attained, and FOMC policy tools, which remain on emergency settings. A simple and prudent approach to current policy would be to begin normalizing the policy settings in an effort to extend the length of the expansion and to avoid taking unnecessary risks associated with exceptionally low rates and a large Fed balance sheet. This would be done with the understanding that policy would remain extremely accommodative for several years, even as normalization proceeds, and that this accommodation would help to mitigate remaining risks to the economy during the transition.

What Bullard and many others call “very aggressive” monetary policy just reflects the mistaken view that monetary policy (MP) is synonymous with interest rate policy (IRP). The same large group also likes to appeal to unspecified “risks” that supposedly flow from  “excessively” low rates so that “prudent” policy would be to begin to “normalize policy” (another reference to MP=IRP). As Jeremy Stein famously said halfway through his short tenure at the Board, “interest rates get into all of the cracks”. Anyway, the FOMC objectives are nearly attained!

The Fed is getting exactly what it wants…

…And they must be pretty dumb if they think otherwise! They talk about “normalizing” monetary policy as if there could be any other understanding that they want to put rates up. What does the market do? It pushes longer rates down!

For more than one year, ever since “the time is coming talk” began, the economy has been weakening. In that sense, the “TT” (“Tightening Tune”) strategy is working.

This is another example showing that the level of the FF rate does NOT define the stance of monetary policy. As seen in the chart, NGDP growth has been trending down for more than one year, which defines the stance of monetary policy much more precisely.

Converging on 3

So I find it surprising that people who should know better feel baffled:

Chairperson Yellen’s remarks on September 24 mentions again that they could (expect to?) raise rates by the end of the year:

Most FOMC participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter. But if the economy surprises us, our judgments about appropriate monetary policy will change.

The last sentence in the Yellen quote once again provides an out for the Fed not to do anything.

The bigger question is whether the economy is in a sustained recovery or have we hit a rocky spot giving the Fed further pause? That said, a return to normal monetary policy that begins to eliminate some of the distortions caused by several years of zero interest rates would seem to be beneficial and it is surprising that the FOMC did not see it that way.

Man, what do you mean by “not doing  anything”? As I just argued, the Fed is in “tightening mode”. By actually raising rates they will be in “economy strangulation mode”!

Scott Sumner says:

Get ready for the new normal—3.0% NGDP growth—it’s coming soon.

As the chart above shows, we may be there already! Worse, if the Fed continues with the “TT” Strategy, it will bring it even lower.

PS Remember, in the “limit”, if there´s no labor force, there´s 0% unemployment!

Jeffrey Lacker, a “serial dissenter”

With his vote on Thursday, Mr. Lacker becomes tied for seventh place in the number of dissents among Fed officials during the central bank’s century-long existence, according to information from the St. Louis Fed. He has voted no 14 times, matching Darryl Francis, the St. Louis Fed president, from 1966 to 1976. [Note: Considering only Regional Fed Presidents, who vote much less often, he and Francis are # 2]

Lacker has been a FOMC participant since 2004. Although he´s tied with Darryl Francis, their inflation environment couldn´t be more different!

Lacker serial dissenter

Maybe his goal is to be #1! In the pursuit of that goal he´s already setting-up another dissent:

The Federal Reserve could get enough new information by its late October policy meeting to spur officials to raise short-term interest rates then, Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, said in an interview with The Wall Street Journal on Wednesday.

NGDP not less reliable than RGDP (or inflation), but it’s not relevant anyway

A James Alexander post

There is growing debate about the potential introduction of NGDP targeting or, rather, a debate that had quietened down seems to building up steam again in Europe  and in the press.

Back in 2012 it was discussed in central bank circles. This was probably due to the recovery seemingly stalling in many countries and central banks were reluctant to do more QE and cast about for alternatives.

As the global recovery began to pick up in 2013 the NGDP train itself thus stalled. In the UK semi-secret discussions led nowhere and some semi-public inquiries opted for the status quo. The cloak and dagger nature of the debates was because of the sensitivity of the subject, evidenced by the wonderfully positive response to Mark Carney raising the issue when he was still head of the Bank of Canada, but on his way to the Bank of England.

The major confusion about the actual target of monetary policy and the direction of US and UK interest rates has brought NGDP targeting back on the agenda. Headline inflation, core inflation and the central bankers’ preferred measure of the GDP deflator, are all flat on their backs. Long term market-implied inflation, or as the Fed likes to belittle it “inflation compensation” (ie the US TIPS spread) is also very low. Why not look at NGDP expectations instead?

The weakest criticism of NGDP Targeting

A lot of the smart set like to dismiss NGDP because they think it gets revised a lot more than RGDP or inflation. This is simply false for the US as I showed here.

In any case it is theoretically impossible for NGDP to be revised more than RGDP, given equal resources to the production of the data. RGDP is merely a derivative of NGDP deflated by inflation, another set of data that is prone to revision, as shown for the US by Mark Sadowski here.

Yesterday’s revisions to UK GDP by the Office for National Statistics provided an opportunity to do a similar test of RGDP vs NGDP revisions. It’s a bit hard to compare apples with apples as UK RGDP estimates bizarrely come out in what the ONS calls Month 1 (M1), 3-4 weeks after the quarter end, while NGDP only comes out in Month 2 (M2) with the first revisions of RGDP. There is then a Month 3 final release. However, there are also at least three further reviews “Blue Book 1” (BB1) after a year and “BB2” after two years, plus a more final review after a period of 3 years (Y3). Yesterday’s revisions showed some very large changes to the history of RGDP,  in particular for the 2012 quarters.

Looking over a long period the quarterly YoY revisions for the UK come out like this:

JA NGDP Revisions_1

The revisions more or less cancel themselves out over long periods. The UK RGDP and NGDP has been shown to be much worse than first feared during the Great Recession, but the recovery has been shown to be more robust too.

The average revision excluding the direction of the revision is somewhat greater for NGDP than for RGDP, although the Standard Deviations aren’t that different.

So much for NGDP being far worse than RGDP for revisions, and with equal work they will be smaller revisions.

Inflation: CPI, RPI or the GDP Deflator?

Some have pointed out that inflation in the UK never gets revised, but this is just the Consumer Price Index and its predecessor, the Retal Prices Index. The “no revision” stance is a political one, not a statistical one. And something so political should not be an object of serious monetary policy, or even serious economic research. The ONS themselves more or less admit this:

Consumer price inflation statistics are important indicators of how the UK economy is performing. They are used in many ways by individuals, government, businesses, and academics. Inflation statistics impact on everyone in some way as they affect interest rates, tax allowances, benefits, pensions, savings rates, maintenance contracts and many other payments.

 “The uses to which consumer price inflation statistics are put (notably indexation) means that it is imperative that every effort is made to ensure all data are included in the first release of any month’s figures. This is reflected in the revisions policies below.

“CPI indices are revisable although the only time the CPI all items index has been revised was when the index was re-referenced to 2005=100, which took place with the publication of the January 2006 indices.

And the Retail Prices Index before it:

The policy for the RPI is that once the indices are published they are never revised. This was re-affirmed in the 1986 RPI Advisory Committee report (Command 9848 p86, para 183) which states:

“it has always been the practice not to revise the RPI once it has been published, as doing so would create serious problems for some users, particularly in connection with index-linking, and we have no wish to see this practice changed.”

There are no perfect macro indices. The notion that it is a political stable index is shown by the number and size of revisions to the GDP deflator, the professional central bankers measure of choice.

The ONS also helpfully released its “revision triangles” for the GDP deflator this week which make a colourful chart that reveals some incredibly wild revisions to the GDP deflator from any particular quarter. Many are revised by quite substantial amounts several years after the initial releases.

The lines in the chart show the “life” of each YoY quarterly deflator, from birth a few weeks after the period end to the current day. The most ill-behaved child is the 3q12 deflator, going negative at one point in its 3 year life to date. Not coincidentally, the quarterly RGDP numbers have been ill-behaved too.

The volatile lives of YoY quarterly deflators

JA NGDP Revisions_2

The average revisions for the quarters from 1q00 to 1q06 are 0.1 including the sign, 0.9 excluding the sign with a standard deviation of 0.6. The latter two quite a bit worse than either RGDP or NGDP. So much for NGDP being less reliable than a reliable inflation index.

It is slightly comical, but also deadly serious. Historic data cannot be relied upon. Medium term expectations are what really matters as they drive actual behaviour. People do not drive by looking in the rear view mirror. Steering current and future behaviour is what will avoid recessions and excessive booms.

The Stein legacy

If you want to understand why economic growth has been “shrinking” for more than one year

Quantitaty Change

Read Leaning, then toppling (by Ryan Avent, March 2014):

IF YOU want to know why the Federal Reserve is undershooting both its inflation target and its maximum employment mandate, cast your eye toward Jeremy Stein. Mr Stein is a Harvard economist and Fed governor. And since assuming his role at the Fed in 2012, he has led the intellectual charge within the Federal Open Market Committee to place more emphasis on financial stability as a monetary policy goal. For a glimpse of Mr Stein’s handiwork, have a look at his most recent speech, where he says:

I am going to try to make the case that, all else being equal, monetary policy should be less accommodative–by which I mean that it should be willing to tolerate a larger forecast shortfall of the path of the unemployment rate from its full-employment level–when estimates of risk premiums in the bond market are abnormally low. These risk premiums include the term premium on Treasury securities, as well as the expected returns to investors from bearing the credit risk on, for example, corporate bonds and asset-backed securities. As an illustration, consider the period in the spring of 2013 when the 10-year Treasury yield was in the neighborhood of 1.60 percent and estimates of the term premium were around negative 80 basis points. Applied to this period, my approach would suggest a lesser willingness to use large-scale asset purchases to push yields down even further, as compared with a scenario in which term premiums were not so low.

Mr Stein is effectively taking ownership of the Fed’s move toward tapering. Long-term unemployed Americans should address their letters accordingly.