The Fed Will Fail

A Benjamin Cole post

House prices feed heavily into U.S. inflation rates as measured, and as pointed out by Kevin Erdmann of the excellent blog Idiosyncratic Whisk, there is hardly inflation at all but for housing costs.

The matters little for U.S. Federal Reserve officials or the gaggle of inflationistas who monomaniacally jibber-jabber about prices. At every juncture, monetary policy is about the perils of inflation and the need to raise rates.

But, as noted by many, from here the Fed cannot tighten its way to higher long-term interest rates. The United States is in that monetary zone long ago noted by Milton Friedman: Interest rates are low as a consequence of tight money.

The present-day reality is this: Easy money for years on end does not lead to sub-2% 10-year US Treasuries, which we see in the market now.

And Fed policy gets more confounding.  If the Fed raises rates, it will only succeed on the short-end of the curve. As money is already tight, long-term rates will sag, and that includes long-term mortgage rates.

Okay, so lower long-term mortgages rates, ceteris paribus, lead to higher house prices and thus higher rents, as rents are tried to house prices.

Of course, the real solution to high housing costs in the United States is twofold, involving aggressive upzoning or dezoning of property in high-cost cities, and a looser money policy and extension of credit to home-building industries and buyers.

An aggressive pro-growth monetary policy might actually result in prosperity and higher long-term rates. Oddly enough, the higher mortgage rates might somewhat depress house prices and related rents, which feed into reported inflation.

As it stands, there is little the Fed can do about property zoning, which is a local prerogative. At the last Fed shindig in Jackson Hole, every panel discussion was about inflation, but none mentioned property zoning. I would call this a blind-spot, but that would suggest the Fed has eyes.

In any event, the U.S. property-owning class in each city seems content to zone out competition, and is politically powerful. In the real world, prosperity in the United States will incur moderate inflation, in large part due to housing costs.

The Fed’s chosen solution is to prevent prosperity, but that is a central banker’s fix and not a good one. The Fed’s better recourse from here is to shoot for higher long-term growth and interest rates, and moderate inflation, by any means necessary, including helicopter drops.

Of course, the best course is targeting NGDPLT.

The Fed is likely to enter the next recession with interest rates near the zero-bound and inflation dead. Then what?

A “Taylor Rule” For Chopper Drops?

A Benjamin Cole post

The British monetary thinker Lord Adair Turner contends that helicopter drops, at least those designed as money-financed fiscal programs (MFFPs), will work to counter recessions and slow growth, and macroeconomists know they will work.

Turner says the usual objection to chopper drops is political—a fear the money-printers will gain the upper hand, rout common sense, and charge to hyperinflation. Turner may be too kind; some people oppose chopper-drops due to sheer dogma.

So, why not a “Taylor Rule” to guide or restrict MFFPs?

The Taylor Rule

Here is one version of the Taylor Rule:

i = r* + pi + 0.5 (pi-pi*) = 0.5 (y-y*)

Where i is the nominal federal funds rate, r asterisk is the real federal funds rate, pi is the rate of inflation, p asterisk is the target inflation rate, y is a logarithm of real output, and y asterisk is a logarithm of potential output.

True, the Taylor Rule makes less sense when deflation becomes the norm, and there seems to be no provision for quantitative easing (QE), although Taylor has gushed about the use of QE in Japan.

And as even with Market Monetarism NGDPLT, there can be agendas hidden in the little numbers of the Taylor Rule.  For example, a tight-money fanatic could praise NGDPLT—as long as the target was a 2% increase for every year.

Marcus Nunes would add that monetary rules should target results, not process. Still, when it comes to helicopter drops, some rules might provide comfort.

Chopper Drop By Code?

So let’s listen to Marcus and target 6% NGDPLT.

How should a chopper drop code or formula read?

How about this: For every 1% below a target of 6% increase in annual NGDPLT, then $100 billion of money-financed fiscal policy is induced, preferably through cuts in payroll taxes.

In this plan, payroll taxes would be cut by $100 billion for every 1% deficit from target, and the Federal Reserve would print up $100 billion and turn it over to the Social Security-Medicare Trust Funds.

No doubt some readers will have a great deal of uneasiness with this proposal.

But does the current Rube Goldberg arrangements of the Federal Reserve, working through the 22 primary dealers, prosecuting the buying and selling of Treasuries on the open market, and the passing through of interest but not principle from the Fed to the U.S. Treasury, really make sense? Would anyone design such a system from scratch?

Furthermore, the present-day claptrap system relies on major extent on private-sector but extraordinarily regulated commercial bank lending to expand economic output. But banks are loath to make unprofitable loans, and the bulk of bank loans are on property. In other words, the Fed is trying to stimulate the economy through property markets, or (more usually) apply the monetary noose. The noose we saw in 2008, btw.


As noted by many, the targeting of interest rates and inflation is off-center. The target should be expansion of GDP, also called nominal GDP, and preferably the NGDPLT.

Surely, any rules that apply to helicopter drops could be tweaked, although the more simple, the better.

And in the end, it does not matter if inflation is 1.4% or 2.1%, though the current FOMC, and cult of central banking, seems to regard such trivia of Titantic importance.

What matters is sustained growth of NGDPLT, and a nation that consistently pursues pro-business policies.

PS I wonder if federal agencies, including the Federal Reserve, are collecting data as they could. With the advent of bar codes, many national retailers know daily sales. National hotel chains and airlines at any moment know their room and seat counts. Many traffic-monitoring systems exist. Is it not possible to generate a fairly accurate, timely picture of NGDP, and adjust helicopter drops accordingly?

Unintentionally, Kocherlakota makes a strong case for NGDP Level Targeting

In “Blackouts and the Burden of Uncertainty”, he writes:

From the mid-1980s through 2008, central banks had the tools, the will, and the knowledge to protect the economy from sharp swings in the demand for goods and services. They raised interest rates to head off surges, and lowered rates to prevent severe slumps. As a result, households and businesses could count on an economy in which aggregate demand grew relatively steadily. Nobody had to think about, or plan around, the possibility of persistent shortfalls in prices and employment.

That has changed. Since 2008, central banks haven’t been able or willing to defend against a sharp and highly persistent fall in aggregate demand. They have used much of their toolkit, and seem reluctant to employ the tools that remain. As a result, the flow of demand has become uncertain.  Market participants and others are focused on what could go wrong, and how central banks might — or might not — respond.

Before 2008, global aggregate demand was like electricity in the U.S. — just something in the background that everyone could count on. After 2008, it became like electricity in India — desperately needed, but subject to random and persistent shortages. Just as the uncertainty of electricity provision hobbles India’s economy, the uncertainty of aggregate demand impairs the global economy. To reduce uncertainty and promote higher growth, both systems need overhauls.

How should the world overhaul its system for providing aggregate demand? To me, this is the key question facing macroeconomists today. Answering it will require a big change in the discipline. Before 2008, most macroeconomists studying the U.S. and Europe largely ignored the possibility of long-lasting shortfalls in demand. This may (at least arguably) have been appropriate for most questions of interest before 2008. Now, however, they need different models and approaches to understand the effects of aggregate-demand uncertainty, and figure out how best to eliminate it.

The chart gives a visual of Kocherlakota´s ‘allegations’.

Note that during 1985 – 2007, NGDP (Aggregate Demand) growth was very stable (comparatively). In other words, “Before 2008, global aggregate demand was like electricity in the U.S. — just something in the background that everyone could count on.”


But note, after 2007 NGDP growth was initially quite unstable, “running off at high speed” through the Southwest corner of the “stability compound”. Contrast that with NGDP “running off at high speed through the Northeast corner of the “stability compound” in 1970 -84. While the 1970s defined the “Great Inflation”, the 2008-09, by symmetry, characterized a strong disinflation period. In 1985 – 07, aggregate demand growth is contained wholly within the “stability circle, and we had the “Great Moderation”.

Again note that contrary to Kocherlakota´s musings, after the “recovery” from the Great Recession was established in early 2010, what we observe is a very stable aggregate demand growth and not random and persistent shortages”.

However, given the low level of NGDP and it´s rather low average growth, the post 2010 period could be called “Depressed Great Moderation”!

From that perspective, again contrary to Kocherlakota, there´s no need to “overhaul the system for providing aggregate demand”, and also no “big change in the discipline” is required.

It is clear that the Fed can target NGDP growth at a stable rate. After all that´s what it did from 1985 to 2007 and from 2010 to 2015. What´s missing now is the definition of an adequate NGDP level and the most promising growth rate along that level path.

If that´s done the economy will, once again, prosper in a state of nominal stability.

Come on George, stand up for NGDP Targeting

A James Alexander post

It has been noted already by Market Monetarists and others that George Osborne and his UK Treasury team are concerned about the low level of expected Nominal GDP growth in the UK. The latest January 2016 CPI figures showing just 0.3% YoY growth will only worry them more. The correct inflation number for policy should be the GDP Deflator, not CPI, but it is also pitifully low and dragging down both RGDP and NGDP.


But whose responsibility is NGDP growth? It is no good Osborne worrying about it and then doing nothing. The Treasury sets the targets for Bank of England monetary policy.

Monetary Policy Framework: The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment. The Government’s inflation target is announced each year by the Chancellor of the Exchequer in the annual Budget statement.

Is Mark Carney concerned by low NGDP growth? Not at all by the sound of it. He is still obsessed by managing to the Bank’s own forecast for CPI two years out, and keeping that forecast below 2%. He has UK the monetary policy set firmly for tightening. The evidence was crystal clear in this exchange  at the February press conference:

 Sam Nussey, Nikkei: Governor, with the BOJ having joined the ECB Switzerland, Sweden, Denmark, and having used negative rates, do you see negative rates as part of the BOE’s arsenal and could you envisage a situation in which they would be used?

 Mark Carney: Well let me start that discussion we had at the MPC was whether now was the right time to raise interest rates. And the judgement, as you’ve seen nine to nil, was that now was not the right time to raise interest rates, but we had a forecast – we have a forecast – which requires some increases in interest rates in order to sustainably achieve the inflation target.

And the markets understand this tightening bias, just look at UK stock markets and UK government bond yields. Sterling has been relatively weak vs the even tighter USD, and on rising trend vs the EUR although weak just recently.

The result is both lower and lower NGDP growth and lower and lower NGDP growth expectations.

Something has to change and it has to be led by Osborne and the Treasury. Central bankers change little once in office.

Osborne wants to follow his instinct and balance the budget by 2018 despite the most vocal mainstream macro-economists urging him not to. It’s sad that most are crypto-Corbynites, but that is social science academia for you, there are no jobs for free-marketers. It’s an increasingly closed shop for anyone not a socialist. Fortunately, students, and more importantly voters, aren’t so dogmatic. Our university social science departments will become like old theology colleges, with the professors just chatting amongst themselves.

Yet when Osborne ordered an inquiry into possible changes to the inflation target mandate he meekly accepted the macroeconomic consensus that there was no need to change, in fact it would be a bad thing. To his credit the crypto-Corbynites are amongst the most sympathetic to NGDP Targeting, but he shouldn’t let that worry him – they much still prefer big deficits over monetary policy.

Osborne needs to show some leadership about NGDP Targeting and not just the deficit. He should keep the CPI target if he has to, but combine the price stability and growth and employment targets into one NGDP Target. It really isn’t that difficult to understand.  He and his advisers can read some of the answers to the very weak mainstream macro criticisms here and here .

The ONS might need to raise its game a bit, but calculating NGDP really should be easier, faster and more reliable than RGDP. They should relegate the very tricky Output method of calculating GDP to the third choice (like in the US) and promote either the easier Expenditure method to first place (like in the US) or Income. The Output method was preferred once upon a time when advanced economies grew, dug or made stuff (i.e. agriculture, mining, manufacturing). The output of the dominant services sector cannot be so easily measured.

Michael Woodford Endorses A Tax-Cuts-And-QE-Regime

A Benjamin Cole post

Since becoming a devout Market Monetarist, I have pondered not the goal but the how—how does the U.S. Federal Reserve and federal government meaningfully target nominal growth in GDP at an appropriate level, i.e. NGDPLT?

It may be that plain-vanilla QE, without the straitjacket of interest on excess reserves, would be effective. It appears QE was effective in the United States, especially the open-ended QE 3, even when hamstrung by interest on excess reserves.

But I have also been curious about marrying QE to tax cuts, such as a tax holiday on Social Security and Medicare taxes (the FICA taxes), with the lost revenues supplanted by the bonds obtained through QE. The FICA tax cut scheme has the additional benefit of lowering the cost of employment (remember, employers pay half of FICA taxes) at the very time that unemployment is a problem.

Michael Woodford

I had assumed my tax cuts+QE scheme would never appeal to serious economists, as it is suspiciously close to monetizing the debt, if not outright money-printing to run the federal budget.

But it turns out the highly regarded and deferred to Michael Woodford, the Colombia University professor, also backs tax cuts+QE!  Woodford has accolades too numerous to mention, and gets invited to the Kansas City Fed’s annual Jackson Hole confab as a speaker.

In a 2013 interview for VOX, the policy portal for the Center for Economic Policy Research, Woodford said of a QE-and-tax-cuts regime:

“I believe that one could achieve a similar effect, with equally little need to rely upon people having sophisticated expectations, through a bond-financed fiscal transfer, combined with a commitment by the central bank to a nominal GDP target path (the one that would involve the same long-run path for base money as the other two policies).

The perfect foresight equilibrium would be exactly the same in this case as well; and as in the case of helicopter money, the fact that people get an immediate transfer would make the policy simulative even if many households fail to understand the consequences of the policy for future conditions, or are financially constrained. Yet this alternative would not involve the central bank in making transfers to private parties, and so would preserve the traditional separation between monetary and fiscal policy.”

True, Woodford leaves open whether the “fiscal transfer” is tax cuts or direct spending. But I think most economists would concur that leaving money in the private sector is better than public spending, and so we can say, ceteris paribus, Woodford endorses tax-cuts+QE.


Back when the U.S. space program was in the early and televised days, NASA did not refer to the Atlas or Gemini or Mercury rockets as “blasting off.” Too cartoon-y. So, NASA used the words “lift off” to describe a launch, even though “blast off” is more correct.

Woodford appears the very epitome on erudition and intellect, deeply committed to his craft. But obscurantism is everywhere.

What Woodford is saying is, “Print money and finance federal deficits with it.”

He also says no promise should be made to unprint the money.

So…why is Michael Woodford not the Chairman of Federal Reserve?

Fortunately, some learn!

From Bloomberg:

Market participants have been coalescing around the view that the Federal Reserve’s liftoff from near-zero interest rates will be a “one and done” affair.

That is, market metrics suggest that monetary policymakers will likely hike rates once, then wait a considerable time to assess how financial markets and the real economy digest this less stimulative stance.

But in an appearance on Bloomberg Surveillance, Kenneth Rogoff, Harvard professor of economics and public policy, questioned the rationale of this view.

“What is the logic of doing it, also?” he said in response to a question on the merits of a rate hike followed by a long pause. “It’s very asymmetric. If we see inflation, they can start raising rates, and if you go in the wrong direction, it’s harder to do something about it.

“The models have not been very good for a long, long time since the financial crisis, and why you would want to rely on that and not be more on seeing inflation I don’t understand,” said Rogoff. “After your models have been so off for so long — your ship’s been thrown around in a storm and you don’t know where you are when you land — you kind of want to see the inflation more than usual.

He´s getting better with age. In July 2008 he was adamant:

Of course, today’s mess was many years in the making and there is no easy, painless exit strategy. But the need to introduce more banking discipline is yet another reason why the policymakers must refrain from excessively expansionary macroeconomic policy at this juncture and accept the slowdown that must inevitably come at the end of such an incredible boom. For most central banks, this means significantly raising interest rates to combat inflation. For Treasuries, this means maintaining fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies. In policymaker’s zealous attempts to avoid a plain vanilla supply shock recession(!), they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater and more protracted downturn.

So, the “capsizing” of the economy that was just beginning when he wrote was the fault of “too easy” monetary (and fiscal) policy!

But just a few months later, in February 2009, he turned into an “inflation lover”:

Excess inflation right now would help ameliorate the problem. For that reason, it would be far better to have 5pc to 6pc inflation for a couple of years than to have 2pc to 3pc deflation,” he told the Central Banking Journal

Which just goes to show that we should stop talking about inflation. It´s a tricky and inneficient target to have. Concentrate, instead, on pursuing Nominal Stability (through level targeting NGDP, for example)

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.

Ben´s blogging has generated more heat than light so far

So far the former and wannabe Fed Chairmen crossed swords over the irrelevant and misguided concepts of GSG & SS. (I´ve given those things some thought here and here).

With big dogs growling at each other, Krugman simply could not help butting in (really to show he had been there before). And for very obvious reasons he ends up giving each a “bone”:

There’s been a really interesting back and forth between Ben Bernanke and Larry Summers over secular stagnation. I agree with most of what both have to say. But there’s a substantive difference in views, in which Bernanke correctly, I’d argue, criticizes Summers for insufficient attention to international capital flows – but then argues that once you do allow for international capital movement it obviates many of the secular stagnation concerns, which I believe is wrong.

As it happens, the role of capital flows in the logic of liquidity traps is an issue I tackled right at the beginning, back in 1998; and I’ve been trying to work out how it plays into the discussion of secular stagnation, which is basically the claim that countries can face very persistent, quasi-permanent liquidity traps. So I think I may have something useful to add here.

Start with Bernanke’s critique of Summers. The most persuasive evidence that the US may face secular stagnation comes from the lackluster recovery of 2001-2007. We experienced the mother of all housing bubbles, fueled by a huge, unsustainable rise in household debt – yet all we got was a fairly unimpressive expansion by historical standards, and little if any inflationary overheating. This would seem to point to fundamental weakness in private demand. But one reason for the sluggish growth in demand for U.S.-produced goods and services was a huge trade deficit, the counterpart of huge reserve accumulation in China and other emerging markets. So Bernanke argues that what Summers sees as evidence of secular stagnation actually reflects the global savings glut.

The 2001-2007 recovery is not evidence, let alone persuasive, of secular stagnation. Krugman is on the right track when he says this “would seem to point to fundamental weakness in private demand.” But at the last minute he veers off in the wrong direction by making the fundamental mistake of “reasoning from a (GDP) component change” (a close cousin of “reasoning from a price change”).

A huge trade deficit somewhere is always the counterpart of a huge reserve accumulation elsewhere. The important reasoning is to discover why this came about when it did and if it might be related to other stuff (such as the US housing boom). For an explanation, read here (below the fold).

If “movements in GDP components” had not distracted Krugman he would probably have found out that the post 2001 recession recovery was slow up to mid-2003, being due to the tightness of monetary policy, despite fast falling interest rates.

When the Fed made monetary policy more expansionary in mid-2003 by adopting forward guidance (FG), despite interest rates remaining put, the recovery took off, with nominal spending rising back to trend. Interestingly, many see this strong growth in nominal spending as reflecting a “loose/easy” monetary policy. Grave mistake. Faster NGDP growth was necessary to take nominal spending to trend. Monetary policy was “just right”!

At that point, unemployment begins to fall and core inflation rise towards the “target” level.

Bernanke had the bad luck to take over almost concomitantly with the peak in house prices. Initially house prices fell only a little, increasing the speed of fall after financial troubles erupted in some important mortgage finance companies.

Unfortunately, the Fed was exceedingly focused on headline inflation, fearful of the oil price rise. Interest rates remained elevated, only being reduced after August 2007, when three funds from Bank Paribas folded. However, the pace of interest rate reduction was deemed too slow by the market. In the December 11 2007 FOMC Meeting, for example, the markets were negatively surprised by the paltry 25 basis points reduction in the FF rate. On that day the S&P fell 2.5% and the 10 year TB yield dropped 17 basis points.

Rate reductions stopped in April 2008 (only resuming in October, after Lehman!). In the June 2008 FOMC, it came out that the next move in rates was likely up!

With all this monetary tightening, nominal spending decelerated and then fell at an increasing rate. One casualty was Lehman! The rest is history!

Give me a break and let´s stop talking “Gluts” and “Stagnations”. Bernanke would do much better if he starts shinning some light and blog about how monetary policy could really have been much better! Will he be daring?

The charts illustrate the story

Gluts & Stagnations_1

Gluts & Stagnations_2

Gluts & Stagnations_3


Matt O´Brien thinks it´s the opposite in “Larry Summers and Ben Bernanke are having the most important blog fight ever

The “(Stan) Fischer Effect”

In 1995, while a managing director of the IMF, Stanley Fischer wrote an essay titled: “Modern Central Banking”, where he ardently defends “Inflation Targeting” (The NBER version is here):

…The issue of a target price level (PLT) versus target inflation rate (IT) nonetheless remains. Compare the goal of being close to a target price level that is growing at 2% per annum from a given date, say 1995, with the goal of achieving a 2% inflation rate each year from 1995 on.

With a target price path (PLT), the monetary authority attempts to offset past errors, thus creating more uncertainty about short-term inflation rates than with an inflation target (IT). The gain is more certainty about the long-term price level.

My present view is that the inflation target with its greater short-term inflation rate certainty is preferable, despite its greater long-term price level uncertainty.

I thought that view was “narrow-minded”, in particular given that important firm and individual decisions tend to be longer term ones. Does Fischer still hold those views from 20 years ago?

By 2011 he had come to favor a flexible IT regime:

“A central bank should aim to maintain price stability and support other goals, particularly growth and employment. So long as medium-term price stability — over the course of a year or two or even three — is preserved.”

Price stability means 2% inflation. But for at least six years inflation (as measured by PCE Core prices) has been well below target except for a fleeting moment in early 2012, coinciding with the moment the 2% target was made official. Barring people like Bullard who think the “Core is rotten”, most people think core prices provide a better indication of the inflation trend. (The chart indicates how fickle the Fed would be if it targeted headline inflation at 2%!)

Stan Fischer Preferences_0

So by Fischer´s own definition we haven´t experienced “price stability” for several years, implying a lot of uncertainty about “short-term inflation rate certainty”.

In fact, “long-term price level uncertainty has been lower than short-term inflation uncertainty”, especially if you associate the price level with the core measure of the PCE.

As the panel below shows, core prices evolved very close to trend until 2012, after which they fall a little short. The headline price level was impacted by the persistent oil shocks during 2003-08. More recently, the negative oil shocks have brought it back to trend. Meanwhile, core inflation has spent most of the time below the target (initially implicit) level.

From a PLT perspective, the Fed is doing OK. From an IT perspective, it is doing a pretty awful job. But note that trying to “correct” inflation (bring it to target) will likely “disturb” the PLT (at least the headline price level). But the Fed doesn´t target the price level!

In 2008 the Fed botched the job because it became “afraid” of the increase in headline inflation that was rising on the heels of oil prices. That shows the main deficiency of both IT and PLT. Both are sensitive to real or supply shocks. Since the Core measure of the price level is much less sensitive to supply shocks, the fall in the core price level below trend over the past few years is an indication, contrary to FOMC conventional wisdom, that the drop in inflation is due to more than recently falling oil prices! Would that be related to a monetary policy that is implicitly tight?

On that score, the panel also shows that the major factor behind both the depth of the recession and the weak recovery was the Fed letting nominal spending drop way below trend and then not allowing it to climb back towards trend, i.e. keeping monetary policy too tight!

The NGDP & Trend chart is also evidence that the prevalent view that monetary policy was “too easy” in 2002-05 is misguided. With the FF rate at 1%, in August 2003 the FOMC decided to undertake forward guidance. All measures of inflation were below the target, and so was the NGDP level. It was effective in bringing both NGDP and core inflation back to target (headline was impacted by oil, and that shouldn´t concern the stance of monetary policy).

Bernanke took over with a “clean slate”! And proceeded to botch the job!

Stan Fischer Preferences

Unfortunately, those responsible for monetary policy simply won´t recognize the need for an overhaul in how monetary policy is conducted. Simply “endowing” the inflation target with more flexibility, imposing interest rate rules (aka “Taylor-type” rules) or even adopting a PLT won´t cut it. One of the consequences of this “hard-headedness” will be increasing claims for the use of distortionary fiscal policies (“stimulus”).

Unfortunately as he has made abundantly clear over the years, Stanley Fischer is quite against it, although he left a door open in a 2011 speech called “Central Bank Lessons from the Global Crisis”:

During and after the Great Depression, many central bankers and economists concluded that monetary policy could not be used to stimulate economic activity in a situation in which the interest rate was essentially zero, as it was in the United States during the 1930s – a situation that later became known as the liquidity trap.  In the United States it was also a situation in which the financial system was grievously damaged.  It was only in 1963, with the publication of Friedman and Schwartz’s Monetary History of the UnitedStates that the profession as a whole1 began to accept the contrary view, that “The contraction is in fact a testimonial to the importance of monetary forces.”

In this lecture, I present preliminary lessons – nine of them – for monetary and financial policy from the Great Recession.  I do this with some trepidation, since it is possible that there will later be a tenth lesson: that given that it took fifty years for the profession to develop its current understanding of the monetary policy transmission mechanism during the Great Depression, just two years after the Lehmann Brothers bankruptcy is too early to be drawing even preliminary lessons from the Great Recession.  But let me join the crowd and begin doing so.


The ninth:

In a crisis, central bankers (and no doubt other policymakers) will often find themselves implementing policy actions that they never thought they would have to undertake – and these are frequently policy actions that they would prefer not to have to undertake. Hence, some final advice for central bankers :

Never say never

India, a missed opportunity

From Free Exchange: “Lights, action, cut”:

LIKE most other central banks, the Reserve Bank of India (RBI) has a schedule for its monetary-policy meetings—firm dates on which its top brass gathers to consider changing interest rates. But much of the important action is now taking place between such meetings. On March 4th, the RBI cut its main interest rate by 0.25 percentage points, to 7.5%, the second such reduction in three months. Like the previous cut, in January, it was made outside the bank’s normal cycle of meetings. Is anxiety about the economy making the RBI trigger-happy or does something else explain this?

The previous interest-rate cut in January came days after figures showing consumer-price inflation had risen by less than expected in December, to 5%. That left the RBI comfortably on track to meet its self-imposed goal of bringing inflation below 6%. So it decided to act quickly. The second unscheduled cut two months later seemed as if it might have been a thumbs-up for the budget presented on February 28th by Arun Jaitley, India’s finance minister. The RBI’s governor, Raghuram Rajan, had said before that further interest-rate cuts would depend on the government’s fiscal rectitude [I´ll offset you]. But on this occasion action was spurred by the publication a day earlier of a three-page framework agreement with the government that set the RBI a formal inflation target.

Instead of an inflation target, India could have “innovated” and chosen an NGDP level target!

The chart shows that it´s not too far “off target”.


Actually, it wouldn´t have to bring NGDP down to the original trend level, because it´s quite likely India´s trend level has risen somewhat. In the next chart, you can glean that real trend growth shifted up after 2003, which would increase the “optimal” nominal spending level.


With the recent drive for reforms contemplated in the latest budget, it is likely India´s trend real growth could remain for a long time in the 7%-8% range. Therefore, NGDP growth of around 11% is consistent with inflation at or below 4%, which is the desired target:

The RBI said in a statement on March 4th that it needed to act outside the normal policy-review cycle for two reasons. First it ought to quickly offer guidance on how it would go about its new task now that the remit was public. It said that its aim was not to get inflation to 4% by the start of 2016-17 but rather to reach that target two years hence. In other words, it is pursuing a gentle glide-path to the 4% target so as to minimise the output costs getting inflation down.