David Beckworth recently interviewed Gauti Eggertsson, who is an important member of what I called the Princeton School of Macroeconomics. (He currently teaches at Brown University.) In the interview, Eggertsson made a number of astute observations about monetary policy.
Here he pushes back against the “Fiscal Theory of the Price Level”, which blames the recent inflation on the increase in the national debt:
I don’t think the Fed was interpreting this stimulus as a license to, or a mandate to, keep interest rates low in order to keep the debt burden lower. I think it was more just the fact that that increased demand to a degree that people were not quite expecting. Additionally, and maybe more importantly, and this was one of the rationales for the framework and why it was asymmetric, was that people thought that the cost of employment going above its maximum… the risk of inflation was very low.
The large fiscal stimulus might have played some role in the recent inflation, but the Fed could have and should have offset enough of the stimulus so that the average inflation rate stayed close to 2%. Unfortunately, the Fed had an asymmetric interpretation of its flexible average inflation targeting policy. Eggertsson suggests that this was probably a mistake:
And I think that the average inflation target is a valuable tool, I don’t think it played a role here, but I think it may be relevant in the future, and I would keep that there. But, maybe this asymmetry, I think, is a bit problematic.
Eggertsson suggests that it might be hard to explain nominal GDP targeting to the general public, but then correctly notes that the important audience is the financial markets, which are perfectly capable of understanding the concept:
I guess one aspect of it that I suspect would make the Fed quite reluctant [to go] down that route is just the communication element of it, that it might be more difficult to communicate to people, “Well, we are targeting nominal GDP, not something we have been talking about,” and everybody understands, which is the price level. Although, I’m not particularly sympathetic to those kind of objections, in the sense that I think that the people you’re mostly communicating to are really the financial markets.
I would go even further. The Fed could simply call NGDP level targeting by the name “Flexible Average Inflation Targeting”, as it fits that name far better than the policy the Fed has actually adopted over the past 4 years. Then tell the financial markets that NGDPLT is the Fed’s preferred interpretation of Flexible Average Inflation Targeting. After all, any “flexible” policy rule needs a specific interpretation to become meaningful.
In other words, don’t change the name, just change the policy to match the current name.
READER COMMENTS
John Hall
Feb 2 2024 at 11:00am
If they adopt a new policy framework, it will have a new name. They don’t want to tar the new policy with the name of a failed policy.
Scott Sumner
Feb 3 2024 at 11:10am
How about FAIT 2.0?
Bobster
Feb 2 2024 at 11:40am
Scott, thoughts on todays’ report? Looks like wage growth is accelerating.
Scott Sumner
Feb 3 2024 at 11:07am
I’m planning a post on that. Yes, the wage growth is worrisome.
steve
Feb 2 2024 at 12:28pm
I think it is fairly large change, making it hard to sell. However, I think if they commit to it we will get a lot of people then taking on the chore of explaining the concept, people who excel at communications. I dont think that economists in general do a very good job, sorry Scott, of explaining NGDP targeting in layman’s terms. It’s mostly economists or finance people talking to each other. Without good explanations that laypeople can understand, or at least think they understand, this is going to get demagogued by one or both political parties.
Steve
Scott Sumner
Feb 3 2024 at 11:08am
That’s why they should call it flexible average inflation targeting, so that the public doesn’t get confused.
Todd Ramsey
Feb 6 2024 at 10:04am
I believe you are overthinking what the general public will understand. The “Nominal” in “Nominal GDP” is superfluous. Pharmacy assistants and truck drivers don’t reflexively think in terms of “real” and “nominal”; the simple term for “Nominal GDP” is “GDP”. Likewise, “Flexible Average Inflation Targeting” is several layers too complicated for the way the general public thinks about the economy.
I suggest “GDP targeting” or better yet, “National Income Targeting”. The financial markets will more easily adapt to terminology the general public can understand than vice versa.
The media would likely explain that if the Fed sets the National Income Target too high, we don’t get wealthier, we just get more inflation. That’s more understandable to the general public than current media explanations of Fed policy, which treat the Fed Funds Rate as a precise dial whereby the Fed chokes off the economy or dials up inflation, and cause belief that interest rates are the Fed’s only tool.
Michael Sandifer
Feb 2 2024 at 3:27pm
Short of the Fed developing a subsidized NGDP futures market, what’s your best recommendation for the data to be used to level target NGDP?
Scott Sumner
Feb 3 2024 at 11:09am
Any data that provides information on market expectations of future NGDP, including TIPS spreads, stock prices, wages, payroll employment, interest rate futures, etc.
Thomas L Hutcheson
Feb 2 2024 at 10:06pm
I think you are right about offsetting the “stimulus,” (which was spread pretty widely and dis not create a lot of relative rice changes that needed to be accommodated) but that still left the need to accommodate the supply chain effects of the shift of consumption from service to goods and (somewhat) back and the energy and grain price effects of Putin’s invasion. How much over target inflation and for how long was necessary to allow relative prices to adjust and how much was just pure error?
Thomas L Hutcheson
Feb 3 2024 at 7:35am
In practice it is hard to see how flexible NGDP targeting would be different from FIAT. In both cases the issue is how “flexible” for how long to you engineer the target outcome when it is away from target? And THAT depends on the size of the shock that the temporarily over-target outcome was designed to accommodate.
Scott Sumner
Feb 4 2024 at 12:13am
I’m not proposing flexible NGDP targeting, I’m proposing NGDP level targeting.
spencer
Feb 3 2024 at 12:22pm
N-gDp has been a stark outlier, too high for too long. Yet the FED still manages the economy through interest rate manipulation and not legal reserves.
Lorie Logan gives a prime example of this delusion: “But in an efficient system, the costs of liquidity should be similar for banks and non-banks.”
Never are the banks intermediaries between savers and borrowers. The NBFIs are the DFI’s customers.
bill
Feb 4 2024 at 4:04pm
I listened to that podcast a few days ago. Hopefully my memory is correct on this. I think an idea that was discussed related to under and over shoots in NGDPLT (if I heard this elsewhere, sorry for bringing it up). That not only should the Fed try to return to the Level, but that the Fed should try to spend as much time above the level as below. What do you make of that suggestion?
Scott Sumner
Feb 5 2024 at 1:32am
I guess I would just focus on returning to trend, once an error occurs. But you’d hope the errors were symmetric, and that we spend roughly equal time on each side
Comments are closed.