Does the “Monetary Theory of Nominal Income” stand scrutiny?

Fifty years ago, Milton Friedman published in the JPE “A Monetary Theory of Nominal Income”. I highlight two passages from the paper.

Correspondence of the Monetary Theory of Nominal Income with Experience

I have not before this written down explicitly the particular simplification I have labelled the monetary theory of nominal income—though Meltzer has referred to the theory underlying our Monetary History as a “theory of nominal income” (Meltzer 1965, p. 414). But once written down, it rings the bell, and seems to me to correspond to the broadest framework implicit in much of the work that I and others have done in analyzing monetary experience. It seems also to be consistent with many of our findings.

One finding that we have observed is that the relation between changes in the nominal quantity of money and changes in nominal income is, almost always, closer and more dependable than the relation between changes in real income and the real quantity of money or between changes in the quantity of money per unit of output and changes in prices.

This result has always seemed to me puzzling, since a stable demand function for money with an income elasticity different from unity led us to expect the opposite. Yet the actual finding would be generated by the monetary approach outlined in this paper, with the division between prices and quantities determined by variables not explicitly contained in it.

…On still another level, the approach is consistent with much of the work that Fisher did on interest rates…In particular the approach provides an interpretation of the empirical generalization that high interest rates mean that money has been easy, in the sense of increasing rapidly, and low interest rates that money has been tight, in the sense of increasing slowly, rather than the reverse.

A few pages later in Short-Run Adjustment of Nominal Income, Friedman writes:

For monetary theory, the key question is the process of adjustment to the discrepancy between the nominal quantity of money demanded and the nominal quantity of money supplied…The key insight of the quantity-theory approach is that a discrepancy will be manifested primarily in attempted spending, thence in the rate of change in nominal income.

Put differently, money holders cannot determine the nominal quantity of money, but they can make velocity anything they wish.

What, on this view, will cause the rate of change in nominal income to depart from its permanent value? Anything that produces a discrepancy between the nominal quantity of money demanded and the quantity supplied, or between the two rates of change of money demanded and money supplied.

In symbols, the equation of exchange (in growth form) says that M+V=P+y, with M being money supply growth, V velocity growth, P inflation and y real output growth.

By “ignoring” the division between prices (P) and quantities (y), we are only concerned with aggregate nominal spending growth (or NGDP). In this way, an “appropriate monetary policy” is one that maintains nominal stability (or a stable growth of nominal spending). In other words, an “appropriate monetary policy” is one in which money supply growth offsets changes in velocity to keep NGDP growth stable.

As I´ll show later, it is not just the stable growth rate of NGDP that matters, but also the Level Path of spending along which that growth takes place. That´s the reason Market Monetarists favor NGDP-Level Targeting as the central bank´s framework.  

Before going ahead, I think it is useful to put the Monetary Theory of Nominal Income in context.

Traditional versions of monetarism, still followed today, assume velocity is stable. With that assumption, the equation of exchange in growth form is written (to an approximation) as M=P+y or M-P=y so that statements such as:

“In a large body of work with a number of colleagues Friedman demonstrated that inflation was “always and everywhere a monetary phenomenon”, meaning that it arose over extended periods only when the quantity of money increased more rapidly than the quantity of goods and services.

Are not valid.

When Friedman concluded that money holders cannot determine the nominal quantity of money, but they can make velocity anything they wish, he was led to the view that the relation between changes in the nominal quantity of money and changes in nominal income is, almost always, closer and more dependable than the relation between changes in real income and the real quantity of money or between changes in the quantity of money per unit of output and changes in prices.

The other contender, New Keynesianism, is a way of analyzing the economy with a mere three equations, none of which refers to the quantity of money. A “two line summary” would be:

In New Keynesian analysis, monetary policy (interest rate policy) determines real GDP, which in turn determines inflation via a Phillips curve.

[Notes: In what follows, for the money supply, I consider the Divisia M4 index, a very broad measure of the money supply. The data are available at the Center for Financial Stability and a good discussion of the indices construction and usefulness for monetary policy is “Getting it Wrong”, by William Barnett. For inflation, I consider the headline PCE in order to take account of supply shocks such as oil prices. For unemployment, I use the Core version, which does not consider “temporary layoffs”. That´s a fixture of the “Covid19 pandemic”, with the two measures, core & headline unemployment, showing little difference for all other periods. For details, see here.]

To check if the Monetary Theory of Nominal Income stands up to scrutiny, I analyze several periods over the last 30 years. For each period, the top chart shows the “outcome” of M+V=P+y(NGDP), while the bottom chart shows what happened to “pieces” of the economy; RGDP(y), Inflation(P) and unemployment.

The first chart covers the 1990s.

Monetary policy was quite good. In the top chart, we observe nominal income (NGDP) growth was stable, with some sign of instability occurring when money supply growth did not adequately offset velocity changes.

In the bottom chart, RGDP growth “mimicked” nominal income growth. The unemployment rate fell almost continuously and inflation remained low (close to “target”). Towards the end of the period, inflation falls. That´s due to the occurrence of two positive supply shocks; the fall in oil prices following the Asia crisis 0f 1997/98 and the rise in productivity growth from 1997.

It appears that a monetary policy geared to keeping NGDP growth on a stable path gives out “good results”.

The second chart illustrates the more “confusing” follow-up period.

When the Asia crisis and Russia crisis (remember LTCM?) were “solved”, oil prices began to rise. In 1999 and for most of 2000, monetary policy kept NGDP growth stable. For that interval, RGDP growth remained stable and robust and unemployment still fell somewhat.

The combination of low unemployment and rising inflation signaled red flags to the Fed. Velocity fell significantly while money supply growth was “timid” in offsetting it. NGDP growth fell strongly, from about 5.5% to close to 2%. The effect on RGDP growth of the negative supply shock was magnified and unemployment rose.

 With monetary policy succeeding in stabilizing NGDP growth (around 4%), unemployment remains higher but stable. Around mid-2003, the Fed becomes more expansionary adopting “forward guidance”. Velocity rises (and money supply growth does not offset it). NGDP growth climbs to the 5% range, RGDP growth picks up and unemployment begins to fall. The end of the oil surge and the recession of 2001 had brought inflation down, and it remained low & stable after that.

The next chart covers the last years of the Great Moderation”, the last two years of Greenspan´s and the first months of Bernanke at the Fed´s helm

Contrary to many that view this period as an example of “bad” (expansionary) monetary policy, I believe monetary policy was close to “perfect”, especially given the fact that it coincides with the first leg of a persistent negative oil shock that extended to mid-2008.

The Dynamic AS/AD model tells us that, because of a negative supply shock, real growth falls and inflation rises. That´s exactly what happens as observed in the lower chart. In the top chart, however, monetary policy remains geared to providing nominal stability (stable NGDP growth).

With that, unemployment remains on a downtrend. I bet Claudia Sahm felt excited by that outcome shortly before she joined the Fed in 2007.

Unfortunately, in early 2006, Bernanke took over from Greenspan, and Bernanke has a “visceral” fear of inflation. The next chart shows that soon after, NGDP growth drops a notch and unemployment stops falling.

With inflation rising and unemployment low, in early 2008 the Fed tightens monetary policy (reflected in monetary expansion falling short of the fall in velocity). Unemployment begins to increase and the fall in RGDP growth is magnified.

At the closing of this period, it´s almost as if the Fed realizes its mistake and loosens monetary policy somewhat. The unemployment rate, however, does not have time to react because the Fed, scarred of inflation due to oil price increases tightens massively, as seen in the chart below.

The evidence for that comes from Bernanke himself:

Bernanke June 2008 FOMC Meeting (page 97):

“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.”

The Great Recession of 2008/09 is on. NGDP growth and RGDP growth sink while inflation goes from 4% to -1% and unemployment shoots up from 6% to 10%.

The next chart, in my mind, is the most compelling evidence for the monetary theory of nominal income approach.

By early 2010, NGDP growth was back to 4% YoY, with NGDP growth averaging 4% over the next 10 years. That was not due to interest rates remaining at the ZLB until December 2015, but to the fact that money supply growth adequately offset velocity changes to maintain stable NGDP growth.

The bottom chart shows that with nominal stability consolidated, the unemployment rate enters a long period of decline going from 10% to less than 4% before the pandemic began. RGDP growth was very stable around the average of 2.2% and headline inflation remained low and stable, averaging 1.6%.

But, and there´s always a “but”, those 10 years comprise a vivid example of the importance of the level path along which nominal stability occurs.

The chart below illustrates, showing that after the Great Recession, the economy evolved very stably along a much lower nominal income level.

Over the years, the rate of unemployment has become not just a gauge of the health of the labor market but the most common yardstick policymakers use to assess the health of the economy as a whole.

Some have argued that the historically low rate of unemployment attained is testament to the strength of the economy. Unfortunately, that´s not so. When you look at the determinants of the unemployment rate, the employment population ratio and labor force participation, you see that the post Great Recession economy is much “weaker” than the pre GR economy.

Labor force participation provides a measure of the “excitement” conveyed by the labor market. The “low” level of nominal income has “muted” that “excitement”.

Almost one year ago, the pandemic hit. The next chart shows the steep & deep fall in velocity (remember, money holders can make velocity whatever they wish). This time, monetary policy reacted quickly to stop the bleeding.

As the next chart shows, however, monetary policy still falls short of what´s needed, so that the level of NGDP remains below, and even distancing itself from the already low level that prevailed after the Great Recession.

As the pandemic withers with mass vaccination, the demand for money will fall (velocity will rise). The Fed will have to offset this rise in velocity in order to stabilize the growth of nominal income (NGDP). It will also have to choose a level path, hopefully higher than the one it travelled for the 10 years to early 2020!

As the NGDP growth rises to reach a higher-level path, some of that rise could reflect (temporarily) higher inflation. Despite the Fed having adopted Average Inflation Targeting (AIT), a higher inflation will most likely cause “nervousness” at the Fed. That´s probably why, more than 10 years ago, Scott Sumner wrote:

I don’t propose to abolish the phenomenon of inflation, but rather the concept of inflation.  And to be more precise, price inflation, which is what almost everyone means by the term.  I want it stripped from our macroeconomic theories, removed from our textbooks, banished into the dustbin of discarded mental constructs.

Independent Fiat-Money Central Banks and ITs: A Toxic Combination

A Benjamin Cole post

The woeful record of independent fiat-money central banks and inflation targets is one of nearly universal economic asphyxiation. Everywhere on the globe where a central bank has an IT, one sees inflation below targets, deflation and anemic growth.

Right to it:

  • The Reserve Bank of Australia has an inflation target of 2% to 3%, but with inflation at 1% the RBA is below target. Growth is subpar—and this is the best of the lot.
  • Thailand has a1.5% inflation band around 2.5% IT, and has no inflation and subpar growth.
  • The People’s Bank of China has a 4% IT, and a 1.8% inflation rate. The nation is about at half of real growth rates when inflation was close to target.
  • The ECB has a 2% IT, and is in deflation perma-gloom
  • Japan has a 2% IT, and is in deflation perma-gloom.
  • The Bank of England has a 2% IT, and a 0.3% inflation rate. Growth is subpar.
  • Singapore has exchange-rate target on currencies that are ruled by ITs. The city-state nation most recently posted 0.3% QoQ growth and is in deflation.

Calling Inspector Clouseau

I see a pattern!

For that matter the Fed has a 2% IT on the PCE, often misperceived as a 2% ceiling on the CPI (perhaps even by FOMC officials). The Fed is below target and real growth in the U.S. microscopic. What a surprise!

Should not the macroeconomic topic of the day be,  “Why are global central banks nearly universally falling below their ITs while mired in slow growth?”

At this late date, why does anyone think an IT is a good idea? Where has an IT worked (with the possible exception of the RBA’s IT-band, a slightly less worse idea than an strict IT).

The sooner fiat-money central banks kill off ITs the better. They have not worked. Is that not reason enough?

Yes, NGDPLT’s would be better.

The oddity: For decades, there has been long-winded sermons on the risks of fiat-money central banks, one reason they were made independent. The premise, even in present-day literature, is that central banks have been loose, are loose, and want to be loose, to serve sinister statist-inflationist goals and populist madmen.

The reality? Independent fiat-money central banks have universally asphyxiated commerce through tight money.

How else to explain gathering global deflation and slow growth?

When will macroeconomic orthodoxy accept the reality?

Blissful Ignorance

Janet Yellen:

And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course. Our ability to predict how the federal funds rate will evolve over time is quite limited because monetary policy will need to respond to whatever disturbances may buffet the economy. In addition, the level of short-term interest rates consistent with the dual mandate varies over time in response to shifts in underlying economic conditions that are often evident only in hindsight.

For these reasons, the range of reasonably likely outcomes for the federal funds rate is quite wide–a point illustrated by figure 1 in your handout. The line in the center is the median path for the federal funds rate based on the FOMC’s Summary of Economic Projections in June.1 The shaded region, which is based on the historical accuracy of private and government forecasters, shows a 70 percent probability that the federal funds rate will be between 0 and 3-1/4 percent at the end of next year and between 0 and 4-1/2 percent at the end of 2018.2

The reason for the wide range is that the economy is frequently buffeted by shocks and thus rarely evolves as predicted. When shocks occur and the economic outlook changes, monetary policy needs to adjust. What we do know, however, is that we want a policy toolkit that will allow us to respond to a wide range of possible conditions.

The range of reasonably likely outcomes for the FF rate is so wide it´s useless.

Blissful Ignorance

One property NGDP targeting (in fact NGDP LEVEL Targeting) is that it is the appropriate framework for “all seasons”, i.e. you don´t need to keep tinkering with monetary policy. In addition to keeping the central bank from mishandling supply shocks, it keeps the central bank from generating demand shocks, which throws both inflation and real growth in the same direction, up as during the “Great Inflation” and down as in the “Great Recession”.

How long is “too long”?

Diana Furchtgott-Roth writes “Why the Fed Should Raise Rates”

Practically no one believes that the Fed will raise interest rates after its July meeting this week, but some Federal Reserve officials, such as Atlanta Fed President Dennis Lockhart and Dallas Fed President Robert Kaplan, are suggesting that rates could go up in September.

With Fed Chair Janet Yellen constantly putting off rate increases, no one can be sure what will happen in the fall — even if the jobs reports for July and August are as rosy as the 287,000 June jobs increase.

The unemployment rate stands at 4.9 percent, and the latest inflation data show that the Consumer Price Index rose by more than 2 percent over the past year.

The Fed should not depend on employment data, which will be revised several times, to decide when to raise rates. Rates have been too low for too long, and it is time for them to rise — regardless of what the jobs report shows.


The longer the Fed leaves rates low, the greater the danger of inflation. Levels of inflation depend not only on interest rates set by the Fed, but on the willingness of banks to lend. It is difficult for the Fed to forecast a precise level of inflation and stick to it because its models are imprecise across a multitude of economic measures. The Fed and the IMF regularly overpredict GDP growth, and in 2007 their models did not forecast the recession.

Western economies’ experience of inflation in the 1970s and 1980s showed that eliminating inflation is no easy feat. The world does not need another bout of stagflation.

Interestingly, to a New Fisherian such as Steven Williamson, the danger of rates too low for too long is deflation!

We know that, for almost eight years, while interest rates have been extremely low, inflation has been locked inside the 1%-2% range, and shows no sign of “escaping”, either to the “north” or to the “south”!


What´s behind the low inflation AND low real growth is the low LEVEL and low growth of NGDP!


Brexit is noise in the bigger picture of monetary strangulation

A James Alexander/Marcus Nunes post

Independent of Brexit, the bigger issue remains that all three currency blocs – USD, Euro and British Pound – are seeing low NGDP growth, too low for comfort. Small real shocks like Brexit (let´s call them, à la Robert Higgs, actual and/or potential institutional discontinuities) cause market mayhem precisely because NGDP growth is too low and thus rather fragile and easily knocked lower.

Why is NGDP level and growth so low? Because central banks seem to like it that way. Their 2% inflation targets dominate their discourse and all their internal projections show them on course to meet their targets in two years’ time – and to hell with NGDP growth. The result is slow monetary strangulation; Brexit is mere noise in this bigger picture.

Nevertheless, given the nature of Brexit, that mixes Supply and Demand shocks, some clarification is in order.

  1. Brexit caused a (global) fall in velocity (AD shock). This requires an offsetting rise in money supply
  2. Brexit caused a (less global) fall in trend real growth (AS shock). Given that monetary policy is synonimous with interest rate policy, this requires a fall in interest rate (because the neutral rate has fallen), which at the ZLB is not forthcoming. In that case, a negative AS shock automatically turns into a negative AD shock.

Solution: Forget interest rate targeting and concentrate on nominal stability (NGDP-LT)


If the negative AS shock is permanent, for nominal stability to be maintained you require a lower trend growth in NGDP.


Permanent AS shocks tend to be rare!

Japan doesn´t need a higher inflation target, but a sufficiently high NGDP Level Target

In his Bloomberg View article today, Narayana Kocherlakota writes “A Possible Cure for Japan’s Low Inflation”:

Suppose, for example, that the Bank of Japan had announced a target of 4 percent in March 2013. Actual inflation over the past three years would probably have been higher — teaching wage-setters and price-setters that if they want to avoid costly mistakes, they’d better pay attention to what the central bank says will happen. Having built up that credibility, the central bank could then more easily guide expectations to its long-run goal of 2 percent.

Before Abe, Japan had an implicit 0% inflation target. By establishing an explicit 2% target, things should have worked out as Kocherlakota argues. But they didn´t! Does that mean that if you really want 2% inflation you should target 4%? Doesn´t sound reasonable.

As the chart indicates, Japan´s problems began when the BoJ allowed NGDP to stagnate. It appears it would be much more effective for Abe/Kuroda to stipulate that the BoJ would “not rest” until nominal spending (NGDP) had reached the stated level, from which it would henceforth grow at a specified rate.


Thoughts converging on bad ideas

Jared Bernstein in the WAPO:

Simply put, in a period with very low interest rates, fiscal policy may well pack more punch than monetary policy and thus becomes that much more important, especially in recession. I don’t know when the next downturn will hit, but between now and then, I’ll be trying to help policy makers understand this reality.

Greg Ip in the WSJ:

Research by John Williams, president of the Federal Reserve Bank of San Francisco, and Fed economist Thomas Laubach suggests the equilibrium rate could be as low as 2%, or zero when adjusted for inflation. This means the Fed may have only two percentage points of interest-rate cuts available to fight the next recession (compared with 5.25 points in 2007).

“I am worried that a very low equilibrium rate makes it harder for monetary policy to do the full job of counter-cyclical stabilization policy in downturns,” Mr. Williams said in an interview. That, he said, means fiscal policy will need to play a bigger role.

It appears even central bankers are giving up on monetary policy!

That´s a dangerous attitude because it increases the likelihood of a recession creeping in. Why? Because if you think of monetary policy as interest rate policy, even with extremely low interest rates monetary policy can be tight (or being tightened) and you will be blindsided!

Update: Scott Sumner posted “Who’s afraid of level targeting?”. From the chart below, it appears that you should be afraid if you don´t level target!

Level Target

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.


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.


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.

Santa, it´s not more inflation we want. It´s more Nominal Spending

Bloomberg tells us “A Little More Inflation Would Be Good for Everyone”:

Thirty years ago, any policy maker would have welcomed a run of inflation below 2 percent. But the less inflation there is, the lower central-bank rates will be, making a return trip to zero more likely. That would force officials to resort, once again, to unconventional tools such as bond-buying that can be politically unpopular and less effective in restoring jobs and growth.

“We’re not saying goodbye forever to the zero lower-bound and the problems that it causes,” former U.S. Treasury Secretary Lawrence Summers told Bloomberg on Dec. 15. “When we get to recession, we usually need 300 basis points or more of Fed easing, but there’s simply not going to be room for that.”

Those are not good arguments. The charts show that:

1 There´s not much difference in the behavior of inflation in 1996-04 and 2010-15. In both instances they were mostly below “target”. But no one worried about “too low” inflation 10 or 20 years ago!

2 The big difference is in the behavior of nominal spending (NGDP) growth and its level


It seems, therefore, logical to root for an increase in the level of spending followed by a stable growth rate (open for discussion are the establishment of both the target level of nominal spending and its stable growth rate)

And as the charts also indicate, that´s a job the Fed can do if it sets its mind to!

Long and Variable Lags

A Benjamin Cole post

There is a great escutcheon carried by the tight-money crowd, that actions taken by central banks have “long and variable lags.”  Behind this shield, the tighties always see inflation as a threat on the horizon, and thus always central banks should be tighter. As no one can with certainty project prices two years out, there is always a measure of plausibility in “inflationary threats,” and thus always a case for tightening.

So, let’s look back two years.

Then, as now, the U.S. Federal Reserve had an inflation target of 2% on the PCE deflator, and that is an average. On paper, the Fed should be targeting inflation in the 1.5% to 2.5% range.

So what did the Federal Open Market Committee say two years ago—that is, a long and variable lag ago—about inflation?

They said: “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.”

At that time the Fed was engaged in quantitative easing. But the Fed announced it would scale back QE, known as tapering, the start of tightening up monetary policy.  Yes, the Fed was below IT, but it would tighten policy. “Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month.” Of course, the Fed phased out QE in October 2014.


The Fed undershot its IT. The PCE deflator as of September 2015 is running at 0.2% above year ago levels, and 1.3% on the PCE core. However, both PCE measures include housing, the supply of which is restricted at local levels through property zoning. Thanks to insights of blogger Kevin Erdmann and others, a very game question is how a central bank can keep inflation (as measured) at microscopic levels and yet support robust growth.  It may be a null set.

And Now?

The Fed is presently predicting 2% PCE inflation will be obtained in 2018. And yet at any gathering of central bankers, we see Topic A through Topic Z is inflation—as we saw at the recent Jackson Hole confab, in which six panels addressed the topic of inflation. There were no other panels. It was literally a monomania.

The far more important topic or how to support robust economic growth is still off the central banker agenda.


The Fed remains unable to adjust to the modern economy, or to migrate to nominal GDP level targeting as a good policy choice. Even an IT band, say of 2% to 3%, is a bridge too far for the ossified Fed. Ever fearful of inflationary boogiemen hiding in thickets of long and variable lags, the Fed suffocates the national economy.

For Americans, the timid, dithering Fed translates into trillions of dollars of lost output every year, and greater political support for non-market safety valves for employees and others.