The Fed repeatedly makes policy mistakes by ignoring erratic swings in nominal GDP. Today, two important media outlets published persuasive arguments in favor of NGDP targeting. Here’s Clive Crook in the Washington Post:
The Fed delayed raising interest rates until now because it wasn’t sure why inflation had spiked and whether the pandemic-driven contraction of the labor force would reverse. An excess of demand over supply is driving prices up — but how much of this excess is due to high demand and how much to temporary interruptions in supply?
A central bank that watched NGDP can be agnostic about this. It would compare actual NGDP to its target, and aim to keep it growing on track. Changing supply conditions would then determine what happens to inflation and output. . . .
The chart compares actual NGDP with a benchmark Beckworth calls “neutral NGDP” — a steadily rising level of demand consistent with medium-term growth and low average inflation, which is neither expansionary nor contractionary. Following the pandemic-induced shock in 2020, demand had recovered to this benchmark level by the second quarter of 2021. Had the Fed been watching, it would have seen a strong signal to start tightening no later than last summer — and would have been equipped with a simple explanation for lift-off.
And here is a similar suggestion, from Bryan Cutsinger and Alexander Salter in the National Review:
Monetary policy affects total spending, and hence aggregate demand. To fight recessions, it’s appropriate for the Fed to push back when demand collapses, stabilizing both labor markets and the dollar’s value. You can’t have one without the other. How much employment is full employment depends on supply, over which the Fed has no power. All the central bank can do is pick the level of demand, and hence the purchasing power of money.
This doesn’t mean the Fed is unimportant. On the contrary: Stable demand is a boon for the economy. Instead, it means the employment component of the mandate is superfluous at best and dangerous at worst. By keeping nominal income on a steady path, the Fed creates a solid foundation for labor markets to flourish. No micromanaging needed.
READER COMMENTS
Thomas Lee Hutcheson
Apr 9 2022 at 8:18am
The dollar’s value? 🙂 I take this to mean a concern with the trade gap, but that is a fiscal problem.I’m still skeptical that NGDP targeting is superior to PL targeting which can be guided by TIPS. If the Fed created an NGDP futures market, things would be different.
Don Geddis
Apr 9 2022 at 12:40pm
No, the “dollar’s value” has nothing to do with any “trade gap”. The value of a dollar is what you can exchange it for in the domestic economy: how much concrete, cars, houses, phones, haircuts, hamburgers, etc. The purchase of real goods and services in exchange for the money. That is what the purchasing power of the dollar is. (And inflation is an approximate measure of the change in the purchasing power.)
Michael Rulle
Apr 9 2022 at 9:58am
It is surprising to see WAPO and NR move in the same direction. That’s optimistic I believe.
But I still do not know how one keeps NGDP on target——-of course, I don’t need to know——but the Fed does. One bad sign is they never heard of FAIT either—-once they realized they had no idea how to do it.
So the cynic in me says—-“X is a great policy, if only we knew how to do it”. I know Scott believes we know how to do it—-and he probably does—-. Powell has truly disappointed me. As did Bernanke——and Greenspan, and Miller too. Volcker knew how to do one thing——and it was a good one—-then he was clever enough to get out quick.
Scott Sumner
Apr 9 2022 at 10:35am
” is they never heard of FAIT either—-once they realized they had no idea how to do it.”
Oh they know how to do it, they simply decided not to.
Spencer Bradley Hall
Apr 9 2022 at 5:26pm
Aren’t the FED’s nowcasts surrogates for a futures market? The FED doesn’t even respond to their own forecasts.
Targeting N-gDp implies that recessions are not self-correcting. A recession, a drop in AD, is a manufactured response to higher inflation. Higher inflation is a policy mistake generated by the Keynesian macro-economic persuasion that maintains a commercial bank is a financial intermediary (see George Selgin’s error “Yes, I hold that commercial banks are credit intermediaries and not just credit creators”).
Lending by the Reserve and commercial banks is inflationary, through several transmission channels (increases the volume and turnover of new money). Whereas lending by the nonbanks is noninflationary (is strictly a velocity relationship), ceteris paribus.
Bernanke’s contraction in N-gDp was no erratic swing. It persisted for several years. Today’s erratic swings, though less pertinacious, are nevertheless self-destructive.
Andrew_FL
Apr 10 2022 at 10:12am
Putting aside that it is not Keynesian and not an “error” to say that banks are financial intermediaries, let’s start with the fact that you don’t seem to know what “intermediary” means. Direct lenders are not “intermediaries”. They are not intermediate parties between would be lenders and would be borrowers in direct lending, so there are no intermediaries. There cannot be a middle man between two people, only three or more.
Jon Murphy
Apr 10 2022 at 10:38am
To the extent that they get their loanable funds from other savers (e.g., they lend out of deposits), then they are intermediaries. Most banks work that way. When you deposit money at the bank, they keep some on hand but loan out the rest. Thus, they act as a financial intermediary between you (the saver) and the borrower.
Andrew_FL
Apr 10 2022 at 2:58pm
But then they are not direct
Spencer Bradley Hall
Apr 11 2022 at 9:48am
A superfluous distinction. Commercial banks acquire earning assets through the creation of new money. When commercial banks make loans to, or buy securities from, the nonbank public -new money, demand deposits, are created — somewhere in the commercial banking system.
From the standpoint of the forest, and not the trees, the commercial banks do not loan any existing deposits, demand or time; nor do they loan out the equity of their owners, nor the proceeds from the sale of capital notes or debentures or any other type of security. It is absolutely false to speak of the commercial banks as financial intermediaries not only because they are capable of “creating credit” but also because all savings held in the commercial banks originate within the banking system.
The non-bank public includes every institution (including shadow-banks), the U.S. Treasury, the U.S. Government, State, and other Governmental Jurisdictions, and every person, etc., except the commercial and any of the District Reserve banks. The commercial banks create credit endogenously.
The aggregate lending capacity of the payment’s System is determined by the monetary policy directives of the FOMC (the Fed’s policy making arm). It is in no way dependent on the savings practices of the public. People could cease to hold any savings in the commercial banks and the lending capacity of the payment’s System would be left unimpaired.
Spencer Bradley Hall
Apr 9 2022 at 5:49pm
Re: “The Fed has some control over aggregate demand, but not aggregate supply”
That’s not true. The FED has always contracted supply at the same time it reduced AD, whenever it fought inflation. An interest rate inversion subverts the channeling of finite savings into real investment outlets (where S = I ). This destroys velocity.
If savings are not expeditiously activated, put back to work, then a dampening economic impact is generated. Then, AD, predominately R-gDp, is surreptitiously reduced. Hence a recession is artificially produced.
Spencer Bradley Hall
Apr 9 2022 at 6:05pm
It’s virtually impossible for the DFIs to engage in any type of activity involving its own non-bank customers without an alteration in the money stock. Deposits are the result of lending and not the other way around.
Banks don’t lend deposits. Ergo (Eureka!), all bank-held savings are lost to both consumption and investment. This is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw nonsense. As the volume of savings deposits increase, velocity decreases. Link: “The Riddle of Money Finally Solved” by Dr. Philip George.
The riddle of money, finally solved (philipji.com)
Alex S.
Apr 9 2022 at 10:43pm
Scott,
I have been hearing more concerns linking the current burst of inflation to the unsustainable path of the federal debt, which Covid-related spending exacerbated. When — if at all — does fiscal policy override the ability of monetary policy to determine the path of NGDP? Can monetary policy monetary policy tie fiscal policymaker’s hands by credibly committing to an NGPLT?
Relatedly, to what extent does Wallace neutrality fit within market monetarism?
Scott Sumner
Apr 10 2022 at 12:19pm
Wallace neutrality does not hold in the US because monetary policy is in the dominant position and fiscal authorities must adapt to that policy regime.
That might change in the future, but right now we are a very long way away from fiscal dominance.
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