I can’t find the quote, but I recall reading that Milton Friedman was once asked about his plan for school vouchers. The reporter wanted to know how the education provided by voucher schools would differ from the education provided by public schools. Friedman relied something to the effect (my words, not his) “If I knew the answer to that question I would not favor school vouchers, I’d instruct public schools to provide that sort of education.” (Hopefully, the anecdote is not apocryphal.)
People sometimes ask me where the Fed should set interest rates. I’m tempted to respond, “If I knew the answer I wouldn’t be a market monetarist, I’d be a new Keynesian.” I suppose this requires a bit of explanation:
1. I believe that monetary policy is most effective when markets set interest rates. The appropriate interest rate can change quite rapidly during a period of turmoil. The Fed should set policy at a level where markets expect roughly 4% NGDP growth. Whatever interest rate results from that policy is appropriate. Whatever price of zinc results from the policy is also appropriate.
2. There are times when I’ve argued that monetary policy is too easy or too tight. But even then I don’t have strong opinions on interest rates. An easier monetary policy might result in lower interest rates (Keynesian effect) or higher interest rates (Fisher effect.)
3. The Fed does (foolishly) use interest rates as a policy instrument, and also a signaling device. In most cases, a sudden and unexpected increase in interest rates represents a tightening of monetary policy relative to a day earlier. But it does not necessarily represent a tightening of policy relative to a month earlier, even if the target rate previously had not changed for several months. This is very hard for most people to grasp.
4. During the Great Recession, policy was clearly too tight. Today, policy seems roughly on target, so I have no opinion on how the Fed should adjust its interest rate target today.
More broadly, market monetarism is not a method for determining where interest rates should be set, it’s a method for discovering where other people (the market consensus) think interest rates need to be set in order keep the macroeconomy stable.
Most importantly, the Fed urgently needs to set up and subsidize a highly liquid NGDP futures market. I am currently not anticipating a recession in the next couple of years, but the risk seems to be increasing. It’s imperative that the Fed stops “flying blind”. Congress should immediately authorize funding for a highly liquid NGDP futures market. Something on the order of $20 million/year would be more than adequate, but the more the better. The subsidy could take the form of above market interest paid on the margin accounts of the NGDP futures traders.
In the future, economists will look back on the current lack of a highly liquid NGDP market in utter disbelief. Like, why would you not care to learn the market forecast?
Here’s are some recent Hypermind NGDP prediction markets. Divide by 10 to get the expected growth rate for NGDP:
READER COMMENTS
Kevin Erdmann
Dec 19 2018 at 1:45pm
Great post.
Will there be a Hypermind Q1 2020 market? It would be very interesting to see what the price would be on that market.
Brian Donohue
Dec 19 2018 at 2:47pm
“Today, policy seems roughly on target, so I have no opinion on how the Fed should adjust its interest rate target today.”
OK, I think conditions are a bit tight and risks are significantly on the side of too tight versus too loose, but I won’t rehash the data on the subject.
Anyway, the first line of Powell’s statement was interesting: “Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate.”
Hmm. The November jobs report was ok, and we’ve known about 3rd quarter GDP for a while. It sounds like the Fed is hinting at some positive recent inside information here…
This seems wrong: “Indicators of longer-term inflation expectations are little changed, on balance.”
30-year TIPS spreads have fallen more than 0.20% since the November meeting. Judging by historical movements, this is not “little changed”.
The 30-year bond has fallen 0.4% since then (that’s a big move!), dashing hopes that future FFR increase will push up long-term rates.
Markets view reducing expected 2019 hikes from 3 to 2 as weak tea, which it is. I’d be willing to bet against two hikes next year. Stupid box plot, stupid idea of “normalization” persists.
Brian Donohue
Dec 19 2018 at 3:15pm
30-year continues to crater, now yielding 3.00% versus 2.50% FFR. This is the dialogue between the Fed and the market. Listen up, Jerome.
Brian Donohue
Dec 19 2018 at 4:23pm
30-year TIPS spreads closed down another 7bps today at 1.83%. Hard to imagine Fed pays more than lip service to 2% PCE target.
Translation: markets interpret today’s comments as “tighter” than pre-meeting expectations, i.e. Powell fell short of what markets expected in terms of forward guidance, i.e. enough is enough Jerome.
LK Beland
Dec 19 2018 at 4:24pm
Interestingly, while Scott Sumner argues that we should look at ngdp rather than interest rates, and likely bases his assessment of Fed policy based on this, many commentators point to yield curves to criticize Fed policy.
Personally, I’d bet that 2019 ngdp growth will be above 4 percent and that U-3 stays under 4 percent.
Brian Donohue
Dec 19 2018 at 5:07pm
@LK, Scott has preferred metrics, which tell him “Today, policy seems roughly on target, so I have no opinion on how the Fed should adjust its interest rate target today.”
I interpret this as Scott saying whatever Powell did today was no big deal one way or the other. It’s funny to obsess over Fed policy all the time, but when the big day comes, it’s just a shoulder shrug.
Clearly SOMETHING happened today, if you think listening to the market is part of the Fed’s job, which I think Scott does. SOMETHING that wasn’t expected yesterday.
I have my own metrics, such as the TIPS spread and shape of the yield curve. I think policy is a bit tight, and Powell made a misstep today with unduly hawkish forward guidance. Unforced error.
You seem content with making predictions that should easily come true under any non-awful scenario. Good for you.
Scott Sumner
Dec 19 2018 at 8:57pm
Kevin, I hope someone sets it up, it would very interesting right now.
Brian, I think the rate increase was fine, but I also think the Fed should have provided more dovish forward guidance, emphasizing the willingness to adjust the rate path vigorously as new information comes in. If you look closely at the market response, the guidance seemed to hurt more than the rate increase itself, a point I believe you emphasized in another comment section.
Comments are closed.