“If you can’t hit the 2% target why introduce a harder one? Because …”

A James Alexander post

I was pleased to report some traction in the Market Monetarist campaign to see inflation targets substituted by, or added to, an NGDP growth target.

One common pushback I’ve received recently is if the central bank can’t hit a 2% target how can it hit a tougher target? It’s a reasonable question.

First, central banks in the US, UK, Euro Area and Japan, don’t want to hit their 2% targets. An odd claim, I know. But on closer inspection they now actually operate a 2% medium term target, crucially based on their own forecasts of inflation. Any time their medium term forecast approaches 2%, or worse moves above it, the noise level about interest rate paths gets very loud. The Fed even raised rates!

This targeting a target has been discussed before here, and is very depressing to economic activity, real and nominal. It ends up with actual inflation consistently below the 2% target. It is rather like most people’s two year out plans, they never seem to quite come off.

Shoot higher, achieve more

Second, moving to a 4% inflation target and missing it by 1-2% is far less damaging than missing a 2% target by 1-2%. Modest 2-3% inflation is consistent with 5% nominal growth, i.e. trend nominal growth. Stable nominal growth is the proper target for central banks, agreed by most people, even central banks.

Central banks wouldn’t have to hit 4% but turning it into a target would enable the market to believe the central banks were happy with 2-3% inflation now. Even four percent inflation, if achieved, would not be terribly damaging either. Market Monetarists are not crazy inflationists, just dull-sounding moderate inflationists, and very hostile to missing lowflation targets. The truth of the matter is that they don´t like the word “inflation”.

Third, simply moving the target obviates the need for the sort of oxymoronic “responsibly promise to do something irresponsible” thing Paul Krugman again suggests in a response to a Tony Yates blog post. No one in markets takes such nonsense seriously.

Central banks do not operate like that, and if they did markets would be worried about other stuff pretty quickly. Just change the target to something more ambitious, but still credible and responsible. It would also end the ridiculously unnecessary, frankly idle, chatter about helicopter drops.

Last an NGDP growth target is a different animal to an inflation target. NGDP is simply aggregate demand or aggregate income. It is what the central banks have almost exact control over. Inflation is a terrifically hard to calculate residual of the difference between easy to calculate nominal demand and terrifically hard to calculate real demand.

The exact balance of any nominal growth between real and inflationary growth is very difficult to divine in real time. It is, nevertheless, very important to understand and to fix if the balance is too much inflation and not enough real. That debate is no concern of the central bank. Inflation is simply the wrong target for them. They control money and therefore the other half of all economic transactions, not output. It’s a powerful tool, use it!

Tony Yates on Kocherlakota

In his further comments on Stan Fischer´s presentation at the AEA meeting, Kocherlakota writes:

Why has r* fallen so much and stayed so low, despite signs of improvement in the economy?  One reason is the diminished credibility of central bank objectives.

The Fed (and other central banks) have fallen short of their inflation and employment goals for many years, and are expected to do so for several more years to come.  The public’s beliefs about Fed long-run capabilities and objectives are evolving in response to these misses.  It should not be surprising that the Fed’s extended misses with respect to its objectives are fueling expectations of similar future extended misses – and are one factor that is pushing down on r*.

This analysis seems like yet another argument against the plan to continue to tighten monetary policy.  Doing so only serves to prolong the Fed’s long undershoot with respect to inflation and (more arguably) with respect to employmentThe additional erosion of credibility will create still more downward pressure on r*. (Note: r*   stands for the neutral rate of interest).

To which Tony Yates responds:

On Twitter last night, commenting on Stanley Fischer’s contribution to a panel at the American Economic Association meetings in San Francisco, outgoing FOMC member Kocherlakota expressed his scepticism about the wisdom of raising the inflation target.

However, credibility worriers also need to remember [and here I don’t finger Prof Kocherlakota for failing to] that in some respects raising the inflation target may improve the credibility of monetary policy and reduce inflation uncertainty.

By persisting with the current 2 per cent target, the Fed and other central banks risk further long episodes at the zero bound, and further protracted periods in which inflation is substantially below target [in the UK headline inflation has been about 0 for a year now], and corresponding uncertainty about whether the central bank can ever regain control over inflation.  If setting a higher target means reduced time at the zero bound, then it most surely means better inflation control, and enhanced ‘credibility’, in the sense of the reputation for competence and inflation forecasts that would follow from inflation turning out to be closer to the new, higher objective.

Nowhere does Kocherlakota mention a higher inflation target. That´s TY´s pet project. In any case, if the Fed does not seem to be able to hit the 2% target, how can we presume a 4% target is not only achievable but also enhances credibility!

Inflation is determined by monetary policy. If instead of associating monetary policy with interest rate policy (which becomes “ineffectual” at the ZLB) you associate monetary policy with NGDP growth relative to a stable trend path, you get nominal stability. In that case you not only avoid the ZLB but you get stable (and credible) inflation and stable RGDP growth.

Over more than 20 years prior to 2008, the Fed succeeded in obtaining nominal stability. That comes out clearly in the chart below where, particularly between 1993 and 2007 NGDP growth is quite stable (low growth dispersion). That stability (around a trend growth path) was lost in 2008 and the appropriate level path has not been regained.

Kocherlakota-Yates_1

Core inflation, which particularly during the 1993 – 2007 period had remained close to 2%, fluctuating due to real (productivity) shocks, since 2008 has mostly been below the 2% target.

Kocherlakota-Yates_2

Just like the 1970s showed that a rising NGDP growth path is inflationary, the last several years have shown that too little inflation results from too low NGDP growth (at a low trend path).

What that tells me is that it is high time to stop talking and worry about inflation and try to regain the lost nominal stability that the US economy enjoyed prior to 2008. Best way to achieve that is for the Fed to set an NGDP Level Target.

Central bankers on target with their targets

A James Alexander post

There has been an illuminating exchange between Scott Sumner and Nick Rowe with John Handley who has been defending bravely New Keynesian models. New Keynesians wonder why QE at the ZLB hasn’t been effective in raising inflation. To me the best the reply is: central banks don’t want to raise inflation.

The central banks seem to define inflation as inflation two years out, that is expected inflation, based on their own “official” expectations. And, therefore, central bankers are on target with their own targets.

The evidence is clear in the charts and tables below, unanimously modelling a return of inflation.

So they just patiently, or often impatiently, wait for near term inflation to behave as their models predict so they can move rates as they plan: up in the US and the UK, hold flat in Japan and the EuroZone.  And the central bankers are slaves to these models.

The markets understand all this: that it is the two-year out inflation outlooks that drive monetary policy. For the Fed and the BoE monetary policy may even be a little too loose, certainly if they don’t raise rates in line with their guidance. The Bank of Japan seems to think it can just stand pat. And that maybe the EZ is a little worried that its two year out projection is a bit too low, and so is muttering about using some more tools.

All four central banks use mainstream New Keynesian models. So what is wrong? Inflation never seems to rise to the two-year out expectations. We have been there many times over the last several years as “inflation” keeps disappointing these determinedly mainstream models. So the market is really asking: at what point will the mainstream economics realise there is something wrong with their models? While the markets wait to find out, nominal growth will continue stalling, fearing that these New Keynesian slaves wont’ change their models but find a reason to raise rates – see our very last chart from the Bank of England desperately searching for an inflation pickup.

Market Monetarists understand that it is the two year out inflation targets that keep depressing near term inflation, and depressing nominal and real growth as a result. The answer is to target nominal growth expectations not strict inflation targets.

Flexible inflation targets would be better, but inflation is a poor economic measure. No one really knows when overall prices rise or fall, it is too difficult to observe. And there is total confusion about individual or particular baskets of goods and services price changes being due to quality changes or not, to mix changes or not.

Just target total nominal incomes, spending or output and forget about inflation. Five percent nominal growth will give enough flexibility for economies to ride the real economy cycles and not cause real economy mayhem due to downwardly sticky wages.

The Federal Reserve Board of Governors forecast in September 2015: PCE “inflation” will be at 2% in late 2016, assuming it raises rates in line with its guidance.

JA IT_1

Federal Reserve “guidance” on rates from the same report

JA IT_2

The ECB staff projection in September 2015 forecast  HICP “inflation” will be at 2% in late 2016, assuming it raises rates in line with its guidance.

JA IT_3

ECB “guidance” on rates from the same report.

JA IT_4

The Bank of Japan’s macroeconomic model in October 2015 forecast  (All Items Less Fresh Food) “inflation” will be at 2% in late 2016, assuming it raises rates in line with its guidance.

JA IT_5

The Bank of England’s macroeconomic model in August 2015 forecast CPI “inflation” will be at 2% in late 2016, assuming it raises rates in line with its guidance.

JA IT_6

Bank of England interest rate “guidance” from the same report.

JA IT_7

Evidence of just how watchful central banks are about inflationary pressures coming up on the blind side and biting in the back is the chart from the same BoE August 2015 inflation report. The chart heading reveals a lot about the thinking at the BoE. A “slight pickup in consumer goods inflation” is evidenced by a “rise” from an actual negative rate of 0.25% to a positive 0.05%. Whereby the official CPI projection has some appropriately wide fan charts to show the degree of error, when it comes to spotting future pressures the error charts disappear.

JA IT_8

 

Clive Crook should have looked at his notes!

Today:
My Bloomberg colleague Michael McKee asked a really good question at Janet Yellen’s press conference Thursday: If the Federal Open Market Committee expects below-target inflation for years, why do most its members think a rise in interest rates before the end of this year is called for?

The headline from the statement was that interest rates are staying at zero for the moment. But among the materials released with the announcement is the so-called dot-plot, which displays each FOMC member’s “judgment of the midpoint of the appropriate target range for the federal funds rate.” This shows that 13 of the 17 participants expect a first rise in interest rates to be warranted before the end of this year.

Turning to another page of the FOMC’s forecast, you see projected inflation remaining below the target rate of 2 percent for three more years — it eventually gets to 2 percent at the end of 2018. On the face of it, even allowing for lags in monetary policy, the prospect of three years of below-target inflation does not argue for an increase in interest rates by December of this year.

…If the Fed doesn’t want to publish a forecast showing inflation rising above 2 percent, it should perhaps acknowledge that its target is indeed a ceiling. And then, having done that, it should perhaps raise the ceiling to 3 percent. 

In 2011

Admittedly, the limits to the Fed’s efforts to stimulate the economy are partly prudential. At the recent meeting of its policy committee, dissenters questioned whether it was right to promise explicitly, as the central bank has, two more years of very low interest rates. Inflation hawks resist the idea of further QE. Here is the central point, however: this is a disagreement about whether further stimulus would be wise, not whether it is possible.

In my view, it is both possible and necessary. The recent revisions to the figures for growth make the economic argument so strong that I wonder if politics is not influencing the dissenters. The problem is that the Fed has to explain itself, both to Congress and to the public at large. Conditions demand what critics would call an “inflationary” monetary stimulus. The Fed’s vague mandate, which calls for both price stability and full employment, is not much help. It is a fight the Fed would rather avoid.

To make the case for new stimulus, the Fed needs better arguments. The past few weeks have settled, to my satisfaction at least, a long-running debate on this very topic. Rather than targeting inflation, central banks should keep nominal incomes growing on a pre-announced path: say 5 per cent a year. Nominal gross domestic product is the sum of inflation and growth in real output – and is the variable that monetary stimulus directly drives.

The Inflation Target “two-step”. It sure isn´t one of the world´s wonders

Central bankers are proving to be the gang that can’t shoot straight.

A quarter of a century since New Zealand opened the era of inflation targeting, policy makers from the U.S., euro area, U.K. and Japan are all undershooting their consumer-price goals. Of the Group of Seven, only Canada is currently meeting its mandate.

Rather than lowering their sights to make things easier, the misses are fanning calls for targets to be increased from the 2 percent most aim for to perhaps as high as 4 percent.

While a similar idea was pitched five years ago by International Monetary Fund economists led by Olivier Blanchard, and endorsed by Nobel laureate Paul Krugman, this time around it may be the central-banking community itself proposing a rethink.

Former Federal Reserve Chair Ben S. Bernanke last month suggested he would be open to an increase in the U.S. Federal Reserve’s 2 percent goal, saying there is nothing “magical” about that number.

Fed Bank of Boston President Eric Rosengren said the same month it could be the case “inflation targets have been set too low.” His colleague from San Francisco, John Williams, told the New York Times that if the future is one of weaker growth because of demographics and productivity then it’s worth asking “is the 2 percent inflation goal sufficiently high in that kind of world?”

But if they can’t hit 2 percent, why lift the targets?

……………………………………………………….

A better solution would be for future central bankers to be as worried when targets undershoot as they have been when they overshoot, said David Lipton, the IMF’s No. 2 official.

Standard Life’s Lawson is unconvinced.

One wonders how many more years of failure it will take before the consensus surrounding current inflation targets begins to rupture and more radical policy objectives are considered,” he said.

Now consider this paper from the NY Fed that recently came out: “Inflation Expectations and Recovery from the Depression in 1933: Evidence from the Narrative Record”.

The abstract reads:

This paper uses the historical narrative record to determine whether inflation expectations shifted during the second quarter of 1933, precisely as the recovery from the Great Depression took hold. First, by examining the historical news record and the forecasts of contemporary business analysts, we show that inflation expectations increased dramatically. Second, using an event-studies approach, we identify the impact on financial markets of the key events that shifted inflation expectations. Third, we gather new evidence—both quantitative and narrative—that indicates that the shift in inflation expectations played a causal role in stimulating the recovery.

That´s a very sensible conclusion. Does that mean the Fed could increase inflation expectations today by announcing a higher inflation target? Given that inflation has been way below target for a long time, that´s quite unlikely.

What happened in early 1933 to change expectations?

1 FDR announced a price level target

2 To get the price level up, spending had to increase. To get spending to rise, monetary policy had to be expansionary. To make monetary policy expansionary, FDR delinked from gold and devalued the dollar.

The outcome:

No need for higher IT_1

Today, a more “radical” policy objective would be a NGDP – Level Target! At least the economy wouldn´t have remained “splashing” far underneath the “surface”!

No need for higher IT_2

HT Becky Hargrove

“Forensic evidence that Bernanke drove the car off the road”

Since Bernanke began blogging I have complained that he doesn´t go to the “heart of the matter”. That is, recognize that the Fed, under his command, bungled.

In fact, the mess-up is likely due to his “love affair” with inflation targeting, with that “love” manifesting itself at the worst possible moment, because the rise in headline inflation that occurred at the time was the result of a negative supply shock, which should not have unduly worried the “lover”.

Bernanke has a deep knowledge of economic history, so he knew about the thought process on economic stabilization that evolved over the decades since the early 1970s. To recall, on becoming chairman of the Fed, Volker challenged the Keynesian orthodoxy which held that the high unemployment high inflation combination of the 1970´s demonstrated that inflation arose from cost-push and supply shocks – a situation dubbed “stagflation”.

Volker´s challenge placed inflation as the FOMC´s top priority. He also brought to the fore of policy discussions the ideas developed during the previous 12 years – since Friedman´s address to the 1967 AEA meetings – on the importance of inflation expectations.

To Volker, the policy adopted by the FOMC “rests on a simple premise, documented by centuries of experience, that the inflation process is ultimately related to excessive growth in money and credit”.

This view, an overhaul of Fed doctrine, implicitly accepts that rising inflation is caused by “demand-pull” or excess aggregate demand or nominal spending.

Now, why is this new “doctrine” consistent with the observed increase in economic stability?

Given the cost-push “doctrine” on the inflation of the 1970´s, the Fed would compensate the fall in AS with an increase in AD, an expansionary monetary policy. This followed from the perceived flatness of the SAS curve below potential output. Since this was a flawed doctrine, over time we should observe trend growth in AD (or nominal expenditures).

Volker, on the other hand, believed that inflation was the result of excessive AD. So nothing more natural than to assume that the Fed should increase its responsiveness to the growth in nominal spending. How would this change in “doctrine” (from regarding inflation as a “cost-push” to “demand-pull” phenomenon) show up in the data?

Recall that under the cost-push “doctrine” the Fed would react vigorously to negative output gaps making policy expansionary, so nominal spending would grow. Under the new “doctrine” the Fed doesn´t react much to supply shocks since a negative supply shock, for example, would decrease real output an increase prices with little effect on nominal spending, but would react vigorously to AD or nominal spending shocks.

Therefore, under the new “doctrine”, policy would make AD growth stationary, in which case AD growth will not show a rising trend as under the cost-push “doctrine”. The chart illustrates.

Forensic Evidence_1

The main difference between the two “doctrines” is not the change in the Fed´s responsiveness to inflation as argued by, among others, John Taylor and Bernanke, but the changed responsiveness to aggregate demand or nominal income growth. A collateral effect of the change in “doctrine” shows up in the reduction and stabilization of inflation and decreased volatility in real output.

The Fed never explicitly targeted anything – inflation or nominal income (AD) growth – but implicitly you could say it targeted nominal AD along a 5.5% growth path growth with Volcker and Greenspan.

The chart below provides, to my mind, compelling evidence about the change in doctrine and its stabilizing consequences. One implication is that during all this time, “Inflation Targeting” was just a red herring!

Forensic Evidence_2

And the biggest victim of the “red herring” was Bernanke himself. Since forever he has been a great defender of the “IT modus operandi”, and exactly when he put it in practice he “pushed the car off the road” and got a “depression” as the result. Later, by making the “red herring” @2% official policy target, he showed he was clueless about the true cause of the monetary policy foul-up!

It appears there will never be a R.I.P. for Inflation Targeting!

Benyamin Appelbaum has a survey in “2% Inflation Rate Target Is Questioned as Fed Policy Panel Prepares to Meet:

The cardinal rule of central banking, in the United States and in most other industrial nations, is that annual inflation should run around 2 percent.

But as the Federal Reserve prepares to start raising its benchmark interest rate later this year to keep future inflation from exceeding that pace, it is facing persistent questions about the wisdom of the rule and the possible benefits of significantly increasing its target.

Higher inflation could disrupt economic activity, but it also would enhance the Fed’s power to stimulate the economy during recessions. And some experts say the struggles of the Fed and other central banks to provide enough stimulus since the Great Recession suggest they could use more room for maneuvering.

“Most developed countries’ central banks have experienced difficulty in providing sufficient monetary stimulus to spur a robust recovery in their economies,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said in a recent speech in London. “This may imply that inflation targets have been set too low.”

IT has been “dead” for seven years but a “burial ceremony” is never planned! Instead, applying “CPR” is the “solution” most discussed.

IT RIP

When “theory” placed inflation targeting at the “center” and interest rate targeting as the “mechanism” to accomplish it, they simultaneously took money out of the equation.

Give IT the R.I.P. it deserves, and bring out “nominal stability” to centerfold. Money will naturally become the “accomplishing mechanism”.

Ben (“Blade Runner”) Bernanke

The “Blade Runner” comes from his talk in the IMF´s “Monetary Policy in the Future” panel.

Scott Sumner wrote that

this is the post we’ve all been waiting for, isn’t it?  Ben Bernanke has a post discussing options for monetary reform. As you’d expect, it’s a really well thought out post—first rate.  And as you’d expect, I am still able to find a few points where I disagree. “

That was certainly not the post I was waiting for. I think Patrick Sullivan is more on “target” when he writes in Bernanke? … Bernanke?:

So, finally, the most authoritative scholar/policy expert on monetary policy–in a blogpost titled Monetary Policy for the Future–is going to get around to answering the Market Monetarists? No, that was just a feint;

Some of these approaches have the advantage of helping deal with the zero-lower-bound problem, at least in principle. My colleagues at the Fed and I spent a good deal of time during the period after the financial crisis considering these and other alternatives, and I think I am familiar with the relevant theoretical arguments.

Yes…yes…

 Although we did not adopt one of these alternatives, I will say that I don’t see anything magical about targeting two percent inflation.

What he thinks was (and is) magical is Inflation Targeting (2% is just the conventional point number or, in some cases the mid-point of a narrow band). A little over 15 years ago, long before becoming a Fed Governor and after editing the “Inflation Target Bible”, Bernanke (with Mishkin and Posen, his co-editors in the “Bible”) wrote an op-ed called “What Happens when Greenspan is Gone?”:

U .S. monetary policy has been remarkably successful during Alan Greenspan’s 121/2 years as Federal Reserve chairman. But although President Clinton yesterday reappointed the 73-year-old Mr. Greenspan to a new term ending in 2004, the chairman will not be around forever. To ensure that monetary policy stays on track after Mr. Greenspan, the Fed should be thinking through its approach to monetary policy now. The Fed needs an approach that consolidates the gains of the Greenspan years and ensures that those successful policies will continue; even if future Fed chairmen are less skillful or less committed to price stability than Mr. Greenspan has been.

We think the best bet lies in a framework known as inflation targeting, which has been employed with great success in recent years by most of the world’s biggest economies, except for Japan. Inflation targeting is a monetary-policy framework that commits the central bank to a forward-looking pursuit of low inflation; the source of the Fed’s current great performance; but also promotes a more open and accountable policy-making process. More transparency and accountability would help keep the Fed on track, and a more open Fed would be good for financial markets and more consistent with our democratic political system.

As our research on the use of this approach around the world documents, successful inflation targeting requires that the central bank and elected officials make a public commitment to an explicit numerical target level for inflation (usually around 2%), to be achieved over a specified horizon (usually two years). Equally important, the central bank must agree to provide the markets and the public with enough information to evaluate its performance, and to understand its reasoning when policy and inflation deviate from the long-run goal–as they inevitably will at times.

What I really want is for him to explain the reasoning behind, not the deviation of policy and inflation from the long-run goal, but the complete failure of policy in keeping inflation anywhere near close to the long-run goal, and the utter loss of the nominal stability that had characterized the previous 20 years!

Update: After accepting a position as adviser to Hedge Fund Citadel, it´s unlikely Bernanke will “explain” anything:

Former Federal Reserve Chairman Ben Bernanke, a key architect of the federal government’s rescue of the financial system, is joining Chicago hedge fund Citadel LLC as a senior adviser.

Mr. Bernanke will consult on developments in monetary policy, financial markets and the global economy, Citadel said in a release. “His insights on monetary policy and the capital markets will be extremely valuable to our team and to our investors,” said Citadel founder and chief executive Ken Griffin in the statement.

 

A long-time Fed economist discusses NGDP favorably

Robert Hetzel, of the Richmond Fed writes “Nominal GDP: Target or Benchmark?”  I highlight two passages.

First:

Previous work by the author in 2008 and 2012 argues that former Fed chairmen Paul Volcker and Alan Greenspan followed a nonactivist rule during the period known as the Great Moderation, the years following the Volcker disinflation through the Greenspan era. Although the FOMC does not explain the rationale for its policy actions within the framework of a rule, since this era, policymakers have recognized the need to behave in a consistent, committed way to shape the expectations of financial markets.

The chart provides the view of NGDP growth and inflation for the last 60 years.

Hetzel Benchmark_1Hetzel Benchmark_2

Initially NGDP growth is highly volatile (but trendless). From the mid-60s to 1980, NGDP growth trends up, and so does inflation. The Volcker adjustment was a period when NGDP growth was strongly reduced with inflation being brought down significantly.

Note that from the start of Greenspan´s Great Moderation, NGDP growth is stable, but inflation continues to come down, only reaching the (implicit) 2% target in the mid-90s.

As Hetzel notes, the Fed, particularly Greenspan, never explained the rationale for its policy actions within the framework of a rule. As such, the Taylor-rule was an attempt by John Taylor to describe (guess, make-up) a “rule” that was consistent with what the Fed was doing. With time, given the highly successful monetary management of that period, Taylor and his followers want us to believe that the “rule” was responsible to the period´s success!

From the chart, it appears much more likely that the “success” (defined by inflation falling and remaining low and stable) was mainly due to NGDP growth remaining stable.

The chart on RGDP growth tends to corroborate that view.

Hetzel Benchmark_3

Throughout the 1954-2007 period, RGDP growth averaged 3.4% (we´ll see below that is true since 1870!). Before the mid-60s, the volatility of RGDP growth is due to the volatility of NGDP growth. During the “Great Inflation”, RGDP growth volatility derives from the inflation volatility of the period (caused by the rising and “chopped” growth in NGDP). During the “Great Moderation”, low NGDP growth volatility translates into low inflation and real growth volatility!

Which leads me to the second passage of Hetzel´s essay I want to highlight:

If trend real GDP growth is stable and policy is credible so that the expectation of inflation is aligned with the FOMC’s inflation target, as it was for most of the 1990s, these procedures translate into stable trend nominal GDP growth. Note, however, that this fact does not imply that the FOMC had a target for nominal GDP.

It would seem that a stable NGDP growth is the outcome, or result, not the driver! That´s the reason for him to suggest that NGDP may be a good benchmark (although not a target).

My first observation is that trend real growth has been stable since the 19th century! It´s not a characteristic of the 1990s. The top chart shows RGDP and trend from 1870 to 2011 (yearly data). Trend growth is 3.4%. The bottom chart, based on quarterly data from 1954 to 2014, shows that trend growth is also 3.4% (up to 2007). Note that following the Great Depression, RGDP reverted to trend. Will the post 2007 period become known in 50 years’ time as “the Bernanke Break”?

Hetzel Benchmark_4

Hetzel Benchmark_5

My second observation is that during the 1990s, since the US did not have an explicit inflation target, policy credibility cannot be defined as the “alignment of inflation expectations with the FOMC´s inflation target”. The FOMC´s “target” was “low” inflation, something vague. In the course of the 1990s, the Fed gained credibility because inflation remained “low”. My conjecture is that that´s the outcome of NGDP growth evolving stably along a level trend path.

The panel below indicates my conjecture has some validity. From the early 90s to early 2008, you could say the Fed “targeted” inflation, not at 2% but in a band of 1% – 2%. You could also say it targeted the price level (PLT) close to a 2% trend growth, but you could also say the Fed targeted NGDP along a 5.5% trend level path.

Hetzel Benchmark_6

The “Bernanke Break” serves to show that what “held everything together” was keeping NGDP evolving stably along a level path. In 2008 it wasn´t inflation or the price level that indicated something was wrong. The “dog that barked” was NGDP dropping significantly and “permanently” below the trend path!

But by all means, if there are reservations to a formal NGDP level targeting, use it as a benchmark. If the Fed had done so in 2008, things would be much less dire in 2014, and we would not be having ridiculous discussions about “GSG”, “SS” or about “June”, “September” or “whatever”! Or see things go topsy-turvy as suggested by this piece by Binyamin Appelbaum ( HT Peter Ireland):

At a hearing in February, Representative Scott Garrett, a New Jersey Republican, complained that Congress and the Federal Reservehad traded places.

During previous periods of high unemployment, members of Congress pressed the Fed to print more money even as the Fed remained wary of the inflationary consequences of such efforts.

After the Great Recession, by contrast, the loudest criticism has come from politicians demanding that the Fed shut down its printing press and raise interest rates.

Atlanta Fed Says Q1 U.S. GDP At Standstill; Nation Below Target-Inflation, Interest Rates Falling; Fed Ponders Rate Hike

A Benjamin Cole post

The Atlanta Fed, usually a quiescent bunch, just X’ed out growth in its Q1 forecast GDPNow index.

Of course, headline inflation is at 0% and rates on 10-year Treasuries are skidding below 2%. Hiring is seizing up, the Dow is stutter-stepping, and unit labor costs have not risen in six years.

And the Fed?

The Fed is endlessly jibber-jabbering about raising rates and getting back to normal.

I have some advice for the Fed: From the clues I detect, raising rates will not get you back to normal. My other advice to the Fed is to send reconnaissance teams to Europe and Japan. It you think now is not normal, wait ‘till you see what comes next.

Back to The Future: QE

I have been tooting all along that the Fed should stay with QE, adding my kazoo to the cacophonic, conductor-less global orchestra of macroeconomic e-pundits.

But, perhaps it wouldn’t matter if I had Gabriel’s Trumpet, and not a kazoo.

I suspect Janet Yellen is marching to the Fed’s own drum, and the beat goes on. And on. And on. And on