The Phillips Curve still lurks underneath FED thinking

Minnesota Fed Neel Kaskari published today “Why I dissented”, to explain the reasons for his dissent in the latest FOMC Meeting. His dissent has a dovish slant, but does not differ materially from the consensus view. In short, the relationship between inflation & unemployment, known as the Phillips Curve, is still very much alive in the Fed´s decision-making process:

“I strongly support the new Statement on Longer-Run Goals and Monetary Policy Strategy¹ that the Federal Open Market Committee has adopted. It incorporates the lessons we have learned from the prior recovery and gives the Committee sufficient flexibility to make up for periods of low inflation in order to achieve our dual mandate goals.

However, I voted against the FOMC’s September 16, 2020, policy statement because, while I believe the statement is a positive step forward in putting those lessons into practice, I would have preferred the Committee make a stronger commitment to not raising rates until we were certain to have achieved our dual mandate objectives.

The 2015 tightening cycle

To explain my rationale for seeking stronger forward guidance, I first must review what I learned from the recent tightening cycle that began in 2015. That policy tightening was predicated on the Committee’s view that the labor market was reaching maximum employment and therefore inflation was around the corner.

When I first became an FOMC voter, I dissented against all three of the Committee’s rate hikes in 2017 because, as I wrote then: “We are still coming up short on our inflation target, and the job market continues to strengthen, suggesting that slack remains.” ²

Recently, Governor Brainard commented: “had the changes to monetary policy goals and strategy we made in the new [monetary policy strategy] been in place several years ago, it is likely that accommodation would have been withdrawn later, and the gains [to the labor market] would have been greater.” ³

We misread the labor market and, as a result, the tightening cycle that we embarked upon was not optimal to achieving our dual mandate goals of maximum employment and stable prices.”

In recent years, we have repeatedly believed we were at or beyond maximum employment only to be surprised when many more Americans reentered the labor market or chose not to leave, increasing the productive capacity of the economy without causing high inflation. To me, maximum employment is the point at which the labor market is just tight enough to deliver 2 percent inflation in equilibrium.”

The highlighted segments indicate the close connection the Fed, even its more dovish members, see continue to exist between unemployment and inflation.

This is not surprising. In March of this year, Marco Del Negro, from the New York Fed, and coauthors presented a paper for discussion with reference to the New Statement on Longer-Run Goals titled “What´s up with the Phillips Curve:

Inflation has been largely disconnected from business cycle ups and downs over the past 30 years.  This puzzling observation is one more reason why the Federal Reserve should consider adopting a systematic monetary policy strategy that reacts more forcefully to off-target inflation—whether too high or too low.”

In What’s Up with the Phillips Curve?, the authors note that inflation in the United States has remained remarkably stable since 1990, even in the face of pronounced cycles in economic activity.  For example. the unemployment rate has fallen from a 25-year high of 10 percent in 2009 during the Great Recession to near 50-year lows of at or under 4 percent over the past two years.  But U.S. inflation hasn’t responded much to the steep drop in joblessness and remains somewhat short of the Fed’s 2 percent inflation target.

They don´t think monetary policy has been the major factor:

Changes in the conduct of monetary policy appear to have played some role in inflation stability in recent decades, but they cannot be its principal explanation, the authors suggest.

Their leading candidate for the driver of inflation stability is a reduced sensitivity of inflation to cost pressures—such as those associated with wage movements—or, in economic parlance, a decline in the slope of the Phillips curve.  This could be due to many structural forces—such as the increased relevance of global supply chains, heightened international competition, and other effects of globalization.

So, they recommend Average Inflation Targeting (AIT):

A flat Phillips Curve requires the monetary authority to work harder to stabilize inflation:  Unemployment needs to get lower to bring inflation back to target after a recession,” the authors write.  They use an econometric model to explore how monetary policy should adapt, examining, for example, a strategy known as average inflation targeting—one of several strategies the Federal Reserve has been evaluating during a public review of its monetary policy framework.

It´s a pity the Fed ignored much better advice, some from people advocating NGDP Level Targeting.

The panel below, covering the post Great Recession “Longest Expansion” provides interesting pointers.

  1. A stable NGDP growth is associated with falling unemployment (and stable inflation)
  2. When NGDP growth falls (below its average growth), unemployment stabilizes (stops falling) and when NGDP growth rises above its average growth, unemployment falls faster.
  3. The Fed´s juggling of the FF rate does not seem to connect to either inflation or unemployment (with unemployment falling “faster” during the period the FF was on the rise). That was more likely because NGDP was growing more.

FOMC members would do well to read and reflect on a recent paper by Alan Cole of the Senate´s Joint Economic Committee titled “A stable monetary policy to connect more americans to work”:

“The best anchor for monetary policy decisions is nominal income or nominal spending—the amount of money people receive or pay out, which more or less equal out economy-wide. Under an ideal monetary regime, spending should not be too scarce (characterized by low investment and employment), but nor should it be too plentiful (characterized by high and increasing inflation).

While this balance may be easier to imagine than to achieve, this report argues that stabilizing general expectations about the level of nominal income or nominal spending in the economy best allows the private sector to value individual goods and services in the context of that anchored expectation, and build long-term contracts with a reasonable degree of certainty. This target could also be understood as steady growth in the money supply, adjusted for the private sector’s ability to circulate that money supply faster or slower.

Bottom Line:

The Fed´s new strategy may just be a tweak on its old strategy in order to “accommodate” a belated realization that the Phillips Curve is (or has become) flat!

When danger looms, the NGDP-LT dog barks, the other dogs stay silent

David Beckworth brings attention to this interview with James Bullard where it he implies that the new AIT framework is equivalent, or approximates NGDP-LT.

That´s not true. The Great Recession was the result of the Fed “downgrading” the NGDP target level, and then continuing to practice NGDP-LT at a lower trend path (accompanied by a lower growth rate). However, AIT (or IT, or PLT) continued on the same trend path as before.

The charts illustrate. Until 2006, all those “targets” were “observationally equivalent”. You wouldn´t know if the Fed was targeting the average PCE core inflation, the PCE core price level or PCE core inflation. It could also be targeting NGDP at a particular level and growth rate.

From that point on, the NGDP-LT dog began barking to remind the Fed that it was being “derailed”. The other dogs remained on the path so the Fed, who never imagined that the overall nominal stability it had successfully attained (Great Moderation) was due, not to targeting inflation, average inflation or the price level, but to targeting NGDP at a particular trend path, was stunned by the depth of the recession.

A “new” and lower trend path for NGDP was followed after the shock, and that´s why the economy has been nominally stable since the end of the GR. Unfortunately, it is a “depressed” level of nominal stability. Given the new AIT framework, we risk, as I argued here, to “depress” the economy further following the Covid19 shock!

Irony alert: The Fed has been doing AIT for three decades!

As I will show, it has also been doing NGDP-LT, albeit with a “variable” Level Trend. It´s amazing that it took them one and a half years to come up with a framework that had been in place for so long!

The chart below shows that the core PCE has closely followed the trend (estimated from 1992 to 2005). The trend reflects a 1.8% average inflation, not the 2% average target, but close.

To illustrate the fact that the Fed has effectively been practicing AIT, I zoom in on two periods (outside the estimation interval) to show an instance of adjustment from above and one from below.

Even now, after the Covid19 shock, it is trying to “make-up”!

The “other Policy framework” the Fed has been “practicing” with for over three decades is NGDP Level Targeting.

The set of charts below show how NGDP has evolved along the same trend during different periods.

The following chart zooms in on 1998 – 2004 and shows that the Fed first was excessively expansionary (reacting to the Asia & Russia +LTCM crises) and then “overcorrecting” in 2001-02 before trying to put NGDP back on the level trend, which it did by 2004. Many have pointed out that the Fed was too expansionary in 2002-04, blaming it for stoking the house bubble and the subsequent financial crisis. However, the only way the Fed can “make-up” for a shortfall in the level of NGDP is for it to allow NGDP to grow above the trend rate for some time!

As the next to last chart shows, 2008 was a watershed on the Fed´s de facto NGDP-LT framework. As shown in the chart, in June 2008 the Fed “gave up” on the strategy, “deciding” it would be “healthier” for aggregate nominal spending (NGDP) to traverse to a lower level path and lower growth rate.

If you doubt that conjecture, read what Bernanke had to say when summarizing the June 2008 FOM Meeting.

Bernanke June 2008 FOMC Meeting:

“I’m also becoming concerned about the inflation side, and I think our rhetoric, our statement, and our body language at this point need to reflect that concern. We need to begin to prepare ourselves to respond through policy to the inflation risk; but we need to pick our moment, and we cannot be halfhearted.”

He certainly got what he wished for.  As the next chart indicates from the end of the Great Recession to just prior to the Covid19 shock, NGDP was spot on the new lower trend path alongside a reduced growth rate.

The Covid19 shock tanked NGDP. This was certainly different from what happened in 2008. Then, it was a monetary policy “choice”. Now, it was virus related. The other thing is that at present, instead of being worried about inflation being too high or risking getting out of control, the fear is with inflation being too low.

That worry, which has been evident for some time, led that Fed to unveil a new monetary policy framework, AIT, for average inflation targeting. As I argued before, this framework has been in place for decades!

The last chart above indicates that monetary policy is “trying” to make-up for the drop in NGDP from the “Great Recession Trend” it was on. We also saw that the Core PCE Index is on route to get back to its decades-long trend.

Given that inflation is a monetary phenomenon, these two facts are related. For inflation to go up (as required to get the price level back to the trend path) NGDP growth has to rise. However, many FOMC members are squeamish. We´ve heard some manifest that they would “be comfortable with inflation on the 2.25% – 2.5% range”.

The danger, given the presence of “squeamish” members, is there could come a time when the Fed would reduce NGDP growth before it reached the target path. Inflation would continue to rise (at a slower, “comfortable”, rate) and reach the price path while, at the same time, the economy remains stuck in an even deeper “depressive state” (that is, deeper than the one it has been since the Fed decided in 2008).

That is exactly what happened following the Great Recession. NGDP growth remained stable (at a lower rate than before) and remained “attached” to the lower level path the Fed put it on.

These facts show two things:

  1. To focus on inflation can do great damage to the economy. For example, imprisoning it in a “depressed state”.
  2. Since the Fed has kept NGDP growth stable for more than 30 years, and freely choosing the Level along which the stable growth would take place, the implication is that it has all the “technology” needed to make NGDP-LT the explicit (or just de facto) monetary policy framework. As observed, that framework is perfectly consistent with IT, AIT or PLT!

A “simple solution” to the Fed´s new AIT framework

The first thing to note is that inflation is not a price phenomenon (don´t reason from a price change is relevant here), but a monetary phenomenon.

For example, changes in relative prices (due to an oil price shock, for example) will only turn into inflation (a continued increase in all prices), if monetary policy allows it to happen (as we´ll see contrasting the 70s with the last 30 years.

Another point I´ll make is that the price index the Fed should target is the PCE Core index. Why? Because the headline index is much more volatile and, like in 2008, will lead the Fed astray.

The first chart shows that over a long period (60 years in this case) both the Core & Headline index show the same thing.

If you break the 1960 – 2020 period by decades, you´ll note that the core index functions as an “upper bound” to the headline index. The next chart shows two examples. The first from the high inflation 1970s and the second from the low inflation 1990s.

The next charts show the two in the form of year over year rate of change – inflation – and the corresponding behavior of nominal spending (NGDP) growth. Note that rising inflation (both for the headline & core indices) only happens when monetary policy, as gauged by NGDP growth, is on a rising trend. Relative prices do change but only with overall prices going up.

During the low and stable core PCE inflation period, the headline PCE inflation wonders up and down, buffeted by the price shocks (mostly oil). For this low inflation period, the average headline PCE inflation is 1.8, with a standard deviation (volatility) of 0.86. The average for core PCE inflation is the same 1.8, but with a standard deviation less than half that (0.41). So it´s much better to target the low volatility index.

What does the Fed face at present? The next chart shows that the core PCE index has hugged closely to a 1.8% trend path since 1993. This trend path was established from the data to 2006, before the upheavals of the Great Recession. Fourteen years later, even after the effects of the Covid19 shock, the index hasn´t deviated from the path.

If the Fed manages to keep the core PCE index following this path going forward, in ten years’ time, the index will reach Scott Sumner´s “magic number” of 135 (Ok, he means the headline index, but I´ve argued that´s a bad index to target and anyway, the core index is an upper bound on the headline index).

How to do that? Basically, don´t invent new benchmarks. Take what you have and do the best with it. Moreover, the best the Fed can do is what has been proven adequate for a long time, to wit, keep NGDP growth stable. The Fed can improve on that by not making the mistakes it made in 2001 and particularly in 2008, as the charts below indicate.

Now, NGDP is still far below the trend path it followed from the end of the Great Recession. The Fed´s first order of business is to make monetary policy expansionary enough to take NGDP back to that trend path. Once (if?) that´s done, the Fed should pursue a monetary policy that allows NGDP to grow close to the 4% rate it averaged from 2010 to 2019.

With that, the core price level will be close to 135 in 10 years’ time.

Contrasting Inflation Targeting with NGDP Level Targeting

Given the recent increase in the number of articles or blog posts on NGDP level targeting (see, for example, here, here, here or here), I thought it would be useful to post an essay I wrote at the end of 2014 that compared NGDP-LT to inflation targeting. The piece is empirical, but I think the visual evidence is compelling,

Which is more reliable-1

Tyler Cowen and Fiat-Money Independent Central Banks

A Benjamin Cole post

The globe’s major fiat-money central banks are considered “independent,” those being the Bank of Japan, the U.S. Federal Reserve and the European Central Bank.

The ostensible reason for the independent status is so that central bankers can “do the right thing” and not cave in to political or popular demands, almost invariably described as “printing money.”

But if inflation everywhere and always is a monetary phenomenon, then so too must be disinflation and deflation. After obtaining the former in the 1980-1990, the major central banks have obtained the latter in the late 2000s over much of the globe, and the U.S. is but one recession away from deflation also.

Tyler Cowen

Tyler Cowen, the brilliant blogging polymath from George Mason, recently posited it is politics and the labor class that is pushing the Fed to chronic tight-money, in his recent and welcome endorsement of nominal GDP level targeting by central banks, or NGDPLT.

By Cowen’s reckoning, the central banks are independent, except they are cowed by a working class that does not want to see wage cuts through inflation.

Does the AFL-CIO stand athwart of Fed desires for NGDPLT, and the attendant moderate rates of inflation?


I rather suspect it is strident right-wing academia, think-tankers, punditry and bloggers, and related party politics that have contorted an eagerly compliant Fed into a supine posture now conducive to a deflationary perma-recession.

It is rare to see true happiness in this world, but the beam on a central banker’s face when announcing a rate-hike is the best place to look.

The Fed has leaned to deflation for decades, and is on the doorstep now. It is benighted, second-rate mythology that the Fed has been “easy” or “held rates low.” If the Fed has been easy, how to explain the 35-year decline in inflation and interest rates?


Glad we are to accept a Tyler Cowen into the NGDPLT camp. Maybe for politesse, Cowen must identify the anti-inflation zealots as laborites. So be it.

There is still a real danger to American prosperity, even if the Fed adopts NGDPLT, and that is the Fedsters will select a straitjacket tight version of NGDPLT, or chronically miss LT on the low side, as they do with the IT (inflation targeting).

The idea of an independent fiat-money central bank may be proving a bad one. In the modern-era, such institutions generally asphyxiate economic growth.

Someone has been listening

And that someone is in far-away Australia, a country that has avoided recession for a quarter century. Things started going wrong for the past few years, when it ignored its NGDP level target and started worrying about home prices.

Read this: The new RBA governor should target [nominal] growth, not inflation:

If you had told Australians 10 years ago that official interest rates would fall to 1.5 per cent, many would have jumped for joy.

Aside from homeowners, Australians are not feeling much joy these days. This is despite the lowest interest rates in 70 years, low inflation, economic growth close to normal and the unemployment rate – though not ideal – still lower than it was during the Sydney Olympics.

So why are we feeling so miserable? The reason is that most Australians’ incomes are going nowhere.

Wages are growing at recessionary levels, profits for small and medium-sized businesses are flat and the budget deficit constrains government spending.

Overall, Australia’s “nominal” growth rate –  the growth in actual money in our pockets – has fallen from 7 per cent per annum in the decade before the GFC to only 2 per cent today.

A large part of it is also due to the out-of-date inflation target that the Reserve Bank of Australia has been tasked with hitting.

A better option would be for the RBA to target a reasonable rate of growth in Australia’s nominal GDP.

In other words, we should replace the RBA’s existing inflation target with a nominal GDP target.

Stronger growth in nominal GDP would provide workers and businesses with greater means to pay their debts, hire more staff and invest in new plant and equipment.


HT Virgílio

The Fed has more than just “some explaining” to do

Narayana Kocherlakota writes “The Fed Has Some Explaining to Do”:

My forecast is that the Fed will remain reluctant to raise rates until inflationary pressures are much stronger, at which point it will feel compelled to move at a faster pace than four times per year. This is similar to Chicago Fed President Charles Evans’s suggestion that the central bank should wait to raise rates until core inflation reaches 2 percent. If prices start rising at that rate, the Fed will be right to put a lot more weight on inflationary concerns than on downside risks.

Charles Evans’ suggestion has been practiced in the past.

Back in mid-2003, when inflation was far below 2%, the Fed adopted forward guidance (“FG”). In the Minutes of the August 2003 meeting we read:

The Committee judges that, on balance, the risk of inflation becoming undesirably low is likely to be the predominant concern for the foreseeable future. In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period.

In January 2004, the message changed to:

With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.

In May 2004, in the meeting before the first rate hike, the message became:

With underlying inflation still expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.

The chart illustrates the period:


The FF Target rate started moving up when core inflation reached 2%, just like Charles Evans suggests at present.

However, note that at the time, NGDP was somewhat below the trend level path. The chart indicates that forward guidance was sufficient to take it back to trend, with core inflation at 2%


Unfortunately, at present, the environment is very different. Today, NGDP is way below the original trend level, in which case, even if (big if) inflation is brought closer to 2%, the level of nominal spending will still remain far below any reasonable trend path.


To “ignite” the economy, and lift it from the depressed state it´s in, the best alternative is not to keep “fiddling” with interest rates, but to change the target to an NGDP Level target.


The Independent Fed And NGDPLT

A Benjamin Cole post

“I agree that a credible NGDP level target would go a long ways in addressing this problem (of weak economic growth). I am, however, becoming less convinced the Fed could politically do something like NGDP level targeting….”

David Beckworth, Kentucky scholar and new podcaster, makes the fascinating statement above in the comments section of his excellent blog, Macro And Other Market Musings.

At first, Beckworth’s observation is something of a shoulder-shrug. Yes, the U.S. Federal Reserve Board operates within political limits.

Independent? What For?

But on second look, Beckworth’s comment is thought-provoking. Wait a minute—isn’t the Fed an independent agency?

Central bank independence, one of the most–gloried and cartouched escutcheons in the modern macroeconomics parade, is why the Fed does what is right, not bowing to short-term political demands, or so the story goes. No printing money around election time, for example.

But in watching the current presidential campaign antics, the question arises of what minute fraction of the voting population has the slightest idea of what is NGPDLT, or that the Fed has a 2% inflation target (on PCE no less), or that Janet Yellen is the Fed Chair?

Frankly, it does not seem likely that if the Fed switched the NGDPLT that the vast public would know, and if they did know, would care.

Even the perennial tight-money crackpots have been fading into the background, having cried wolf a few thousand times too many, most notably and loudly after 2008.

So who would take umbrage of Fed switch to a NGDPLT policy? A few academics and eccentric radio talk-show loonies?


More probably the Fed, or Fed staffers truly believe that keeping inflation as measured by the PCE under 2% is the only way to conduct monetary policy. Abundant Fed literature shows no embrace of NGDPLT. The vast sea of Fed Phd’s (in sinecures) appear comfortable with recent macroeconomic results, as does the FOMC, while lurking inflation is ever the potent bogeyman in Fed reports and regional bank websites.

The most recent Fed-bash in Jackson Hole featured four panels, all on inflation, and no other panels. This monomania on inflation exists in a prolonged era of microscopic inflation rates, but weak economic growth.

Marcus Nunes has documented that central banks often appear dissolute and chronically ineffective when faced with serious economic contractions. The short story may be the U.S. got out of the Great Depression, but only thanks to WWII, which forced Fed accommodation. That accommodation extended through the worst of the Cold War, and into the late 1960s.

But in the decades since, that concept of central bank independence has become enshrined high in the pantheon of macroeconomic totems, and other nations and regions, such as Europe and Japan have adopted similar institutions. There is a book out, “The Rise of the People’s Bank of China,” that suggests the PBOC is able to muster a degree of independence in recent years, as the Chinese Communist Party, like pols everywhere, is uncertain as to the intricacies of financial systems and central banking and so defers to the PBOC.

It is worth noting that in recent years Chinese inflation and growth rates have slowed.


More likely, it is not political constraints but rather central bank independence and ossification that is a barrier to the Fed adopting NGDPLT, or even to merely tilt to the growth side of policy-making, through more QE, or lower interest on excess reserves.

The Fed is independent and that is the problem.


Clive Crook should have looked at his notes!

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.