My paper at the monetary rules conference
By Scott Sumner
Today I will be presenting a paper at a Mercatus/Cato conference on monetary policy rules. Here I’d like to summarize my key themes:
1. The past 10 years have destroyed the pre-2008 consensus on monetary policy. Everything is up in the air. Tools, targets, and even the extent to which monetary policy can hit its targets.
2. The “puzzle” of ultra-low rates for an extended period of time has led to a number of heterodox theories:
a. The return of old Keynesianism
b. The view that the Fed should also focus on asset prices, not just inflation
d. Market monetarism.
The new old Keynesians claim that monetary policy is mostly ineffective at zero interest rates, and favor fiscal stimulus. Many conservatives at places like the BIS worry that low interest rates will lead to asset bubbles and financial imbalances, and favor raising rates even if it would cause central banks to miss their inflation target. NeoFisherians suggests that the combination of low rates and low inflation provides support for their claim that a policy of low rates for an extended period of time can cause low inflation. And the market monetarists claim that low rates don’t mean easy money, and hence there is no puzzle to explain.
Then I suggest that market monetarism represents a return to pre-2008 mainstream beliefs, many of which have been abandoned by much of the profession. I list 7 such beliefs:
1. Low interest rates don’t mean easy money. (Friedman, Mishkin, Bernanke)
2. Monetary policy highly effective at zero bound. (Friedman, Mishkin, Bernanke)
3. Fiscal policy is not an effective stabilization tool, even at zero bound. (Krugman)
4. Level targeting is more effective at the zero rate bound. (Eggertsson, Woodford)
5. Central banks should target the forecast (Lars Svensson)
6. Expectations are rational and asset markets are efficient. (Lucas, Woodford, Fama)
7. NGDP level targeting (Bennett McCallum, Michael Woodford, Christina Romer)
I know of nothing that has occurred in the past decade that would lead someone to change their views on any of these points. Nonetheless, I have good reason to believe that some of these people (and indeed most of the profession) no longer believe the pre-2008 conventional wisdom on at least some of these points. Whether or not my supposition is correct, I for one still believe that low rates (and/or QE) don’t mean easy money, that monetary policy is still highly effective at zero rates, that fiscal policy is mostly ineffective, even at zero rates, that level targeting is especially beneficial at the zero bound, that central banks should target the market forecast, that markets are efficient, and that NGDPLT is the optimal policy.
I end up calling for the “guardrails” approach to NGDP futures targeting, with the Fed announcing that it is willing to go long on unlimited NGDP futures contracts at a price of 3% growth, and go short on unlimited NGDP futures contracts at a 5% growth price. This would be equivalent to an exchange rate band in a fixed exchange rate regime. This type of futures targeting still allows some policy discussion, but not enough to do any significant harm. And it is clearly not subject to market manipulation, which some critics have (wrongly in my view) suggested that a purely automatic NGDP futures regime is subject to.
PS. The conference will be livestreamed at mercatus.org/live.