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.

The Fed Can Suffocate The Economy Under NGDPLT Too

A Benjamin Cole post

Recently there has been a hubbub in Market Monetarist circles that prominent Democratic economist Larry Summers, generally a Keynesian type, tipped his hat to nominal GDP level targeting, or NGDPLT.

Well, at least in preference to inflation targeting or IT.

Said Summers at latest report, “I didn’t quite endorse NGDP targeting. I said that I would prefer a shift to NGDP targeting to a shift up in inflation targets.”

Why The Summerian Reservation?

That Summers endorsement of NGDPLT was hesitant and oblique may not be surprising. He is, after all, a Keynesian, and believes in federal deficit-spending.

But Summers may also have entirely human and sensible reason for his backhanded support of NDGPLT—that is, a central bank can just as well suffocate an economy under NGDPLT as under IT.

Indeed, the U.S. Federal Reserve has kept the U.S. economy growing at a fairly steady nominal rate since 2008. The problem is, the economy is blue in the face from monetary asphyxiation.

Remembering Milton

Forgotten today is the Milton Friedman of October 1992, when CPI inflation was 3.2%, and real GDP was expanding at about 4.0%.

Yet the title of Friedman’s October 1992 op-ed in The Wall Street Journal, after the Fed had dropped interest rates from 10% to 3%? It was: Too Tight For A Strong Recovery

That 1992 Friedman op-ed speaks worlds about the inflation-obsessed state of modern economists.

Market Monetarists of 2015

Yet some Market Monetarists recommend straitjacket nominal growth rates, succumbing to the present-day peevish fixation that inflation—even moderate inflation—cannot be endured.

We can hope someone will further flesh-out Summers’ sentiments regarding NGDPLT. But whatever Summers’ take, I hope Market Monetarists  do not mimic the inflation-nutters.

It doesn’t really matter if inflation is 1% or 4%.

What matters is robust real growth.

A “solution” to DeLong´s “back-propagation induction-unraveling” problem

Brad DeLong has a (way too) long post. But the end gives the gist of his argument:

The problem is that the macroeconomics that Paul Krugman learned at Jim Tobin’s knee wasn’t just 1930s-style Hicks-Hansen Keynesianism. It was the 1970s adaptive-expectations Phillips Curve neoclassical synthesis–nearly the same stuff that I first learned at Marty Feldstein and Olivier Blanchard’s knees in the spring of 1980.

That is the framework that Marty is using now, and that generates his puzzlement. That framework had a short run of 1-2 years, a medium-run transition-dynamics phase of 2-5 years, and a long run of 5 years or more baked into it. You cannot–or at least I cannot–just throw away the medium run transition dynamics* and the declaration that the long run Omega Point is five years out, and say that mainstream economics does well. You need to explain why the back-propagation induction-unraveling worked at its proper time scale in the 1970s and the 1980s, but is nowhere to be found now.

And so I am much less confident that I have solid theoretical ground under my feet than Paul Krugman does.

The “solution” (or “explanation” for the absence of the “back-propagation induction-unraveling”), towards which even Brad´s pal Larry Summers is warming up to is….NGDP-Level Targeting. In fact, the Fed has (implicitly) established a much lower level target for NGDP, a level that is consistent with Summers´ “Great Stagnation” thesis.

So I hope that when Summers says “I didn’t quite endorse NGdp targeting. I said that I would prefer a shift to NGdp targeting to a shift up in inflation targets”, I also hope he has a level target at the back of his mind!

HT Scott Sumner

The Depression´s “Great Moderation”

It´s always interesting to see that not many perceive the low growth of this ‘recovery’ as clear evidence that the economy is in a depression (not a “Great” one, but one nevertheless).

The chart provides an illustration:

Depressions´ Great Moderation_1

At the WSJ Jon Hilsenrath writes about his (and the markets´) befuddlement in Why the Economy—and the Fed—Keeps Getting Knocked Off Track:

The peril of a slow-growing economy is that even small disturbances can knock it off stride, a reality now bedeviling the U.S.

A slew of soft economic reports in recent days has led Wall Street analysts to again reduce their estimates of U.S. growth. It now looks possible U.S. output will nearly be flat for the first half of 2015, and might even contract on average over the first half. J.P. Morgan economists see a growth rate of just 0.5% for the first half.

This softness, which is likely to constrain the Federal Reserve as it eyes when to raise short-term interest rates, is befuddling many economists who just months ago pointed to signs the U.S. economy was kicking into a higher gear. Many of the economy’s underlying fundamentals still look strong: companies are hiring, and incomes and wealth are rising. Interest rates are low and supportive of growth while government fiscal policy—a drag early in the recovery—has become neutral.

A variety of indicators, though, tell a different story. The Federal Reserve on Friday reported U.S. industrial production contracted in April for the fifth straight month, down a seasonally adjusted 0.3% from the month before. A University of Michigan index of consumer sentiment also droppedSoft April retail-sales data and dismal trade numbers, both on Wednesday, had already led analysts to reduce their estimates of growth.

“Economies, like bicycles, are more stable when growing at moderate speed than when growing slowly,” said Lawrence Summers, a Harvard University economics professor and former Obama administration economics adviser, in an interview. A slow-growing economy “is one moderate sized shock away from recession.”


The U.S. economy has actually been less volatile than normal since the recession ended in mid-2009, according to James Stock, a Harvard University economics professor who coined the term “Great Moderation” to describe the steady growth rates of previous decades.

Deviations in growth from one quarter to another have been no larger in this recovery than they were in the three recoveries preceding the past recession, he said. Moreover, deviations in growth from one year to the next in this recovery have actually been half as large as they were during the three previous recoveries.

Yet he sees a risk if economic turbulence grows.

“If you are growing at a low level, you are going to be more vulnerable to those major shocks than you would be if you were growing at 3.5% or 4%,” he said. “This is a major challenge for policy.”

Because interest rates are already near zero—in part because of the slow growth rate—the Fed doesn’t have room to cut them in response to a downturn if one actually does occur.

The thing is that most talk about “Great Moderation” as something only pertaining to growth, forgetting about the associated level.

The chart below illustrates why the ongoing “Great Moderation” is consistent with a depressed economy. The chart describes in ‘phase space’ the degree to which growth ‘spreads out’ (is volatile).

Depressions´ Great Moderation_2

It is clear that real growth volatility is significantly lower during the ongoing ‘recovery’, than it was during the original “Great Moderation”. If you discard the low growth of the 2001 recession, real growth at present has been far lower than real growth in 1992 -07.

If you look at the first chart above, you see why we are in a depression. During the “Great Recession”, real output contracted and extremely low growth thereafter has not directed it back to trend.

The next chart describes in ‘phase space’ the behavior of nominal growth (NGDP or nominal spending growth). It is even more stable now than before, but note that at present, the growth rate is not much different from the nominal growth rate observed during the 2001 recession.

Depressions´ Great Moderation_3

The big question is; if the Fed has the ability (and note that for decades nominal growth was very volatile) to provide nominal growth stability (that translates into real growth stability), why can´t it also do it at a non-depressed level?

In other words, if it can keep nominal growth chugging along at a ‘constant’ rate, why can´t it temporarily increase that rate so that the economy will climb out of the ‘hole’ it´s in?

It´s certainly not because interest rates are at the ZLB. As Watson puts it, rates are near zero in part because (nominal) growth has been so low. For goodness sake, then, increase the nominal growth rate!

Unfortunately, Janet & Friends prefer to speak about “policy normalization”, meaning increasing the FF target rate. They would do much better if they switched to a target level for nominal spending.

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

“Three coins in the fountain” of the monetary policy stance. Unanimously, they say interest rate does not define the stance!

First Milton Friedman:

The Federal Reserve cannot and does not control interest rates, though its actions clearly have an effect – but in a more complex way than would justify the identification of easy money with low interest rates and tight money with high interest rates.

Followed by Bernanke:

The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman  . . . nominal interest rates are not good indicators of the stance of policy . . .  The real short-term interest rate . . . is also imperfect . . .  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.

Then Mishkin:

What I’d like to spend some time on—because I feel this is sort of my swan song, but maybe because I’m a classy guy, I’ll call this my “valedictory remarks”—are three concerns that I have for this Committee going forward. I’m not going to be able to participate, but I have a chance now to lay them out.

The first is the real danger of focusing too much on the federal funds rate as reflecting the stance of monetary policyThis is very dangerous. I want to talk about that.

So what best defines the stance of monetary policy? Let´s check Bernanke´s alternatives. The charts show NGDP relative to trend, Inflation and the FF target rate for different periods.

In 1992, Friedman wrote about monetary policy being tight with reference to money supply (M2) growth. Unfortunately, that´s not a good measure of the stance. He should have said monetary policy had been tight, because at that moment the Fed was just getting it right given NGDP was fast converging to trend, despite the falling/low FF target rate and falling inflation.

MP Stance_1

The 1993-97 period describes what a “perfect” monetary policy looks like.

MP Stance_2

NGDP hugged the trend, the FF target rate initially low, was subsequently raised (does that mean it was initially “easy” and then “tightened”?) and inflation fell throughout (does that mean the stance of policy was “tight”?).

The end of the decade describes what an “easy” stance of monetary policy looks like. Despite the increase in the FF target rate and inflation remaining below the “desired” (2%) level, the fact that NGDP rose above the trend level accurately describes the easy stance of monetary policy.

MP Stance_3

The subsequent period includes John Taylor´s “too low for two long” level of the FF target rate. According to the deviation of NGDP from trend, monetary policy was initially too tight, only becoming stimulative in the second half of 2003, when forward guidance was introduced, even though the FF target rate soon began to rise.

MP Stance_4

The following period accurately describes what a very tight monetary policy looks like, despite an initially constant and then falling FF target rate and inflation. Soon after taking the Fed´s helm, Bernanke proceeded to tighten monetary policy, and the “screws” turned until NGDP “crashed”! It looks like Lehman was a consequence and not the trigger.

MP Stance_5

And monetary policy, despite all the “highly accommodative” talk, has in fact remained pretty tight ever since!