Let’s start with the most obvious example, the annual spike in NGDP around the Christmas shopping season. I hope it’s obvious that the Fed should not try to smooth out this NGDP seasonality with monetary policy.

On the other hand, the fall in NGDP during 2008-09 was clearly undesirable. So what about the coronavirus?

In my view, the Fed should aim for on-track nominal spending one, two and three years out, not in April and May of this year. If virus fears cause many businesses to shut down, and/or if retail spending is temporarily depressed (as seems likely to me), the Fed probably could not and should not try to prevent that, as long as expectations for 2021 NGDP remain on track.  Here the Christmas analogy holds.

The further out in the future you go, the more it becomes like 2008-09 and the less it becomes like the spike in NGDP at Christmas.  I haven’t given much thought to this issue, so I won’t try to pick a dividing line. But certainly the argument for the stabilization of NGDP growth expectations becomes stronger the further out you look.

I don’t know what’s going to happen to the economy this year, as we’ve never had a shock quite like this except during August 1918 – March 1919, when there was a very short (7 month) recession and a very quick recovery before and during the Spanish flu epidemic.  Friedman and Schwartz don’t even mention the flu, instead pointing to the end of WWI.  (A similar short recession occurred in 1945).  And this current epidemic will likely be much less severe than the one in 1919.  On the other hand, we are far more risk averse today, so the economic effects could easily be far larger.

Here’s something to look for.  Suppose we have a mini-recession; would that tell us anything about the business cycle?  I think it would.  Previously I speculated that our total lack of mini-recessions (at least since WWII) is due to the fact that business cycles have been caused by monetary policy failures, where policy reacted too slowly to the onset of recession.  This failure was sort of built into how the Fed operates—interest rate targeting with inertia, and also a lack of level targeting.  If the first “real” recession of my lifetime (except arguably 1974) is also a mini-recession, that would tend to provide support for the hypothesis that our lack of mini-recessions reflects the nature of demand shocks and monetary policy in the US.

PS. When I say “real recession” I don’t mean “actual” recession, I mean supply-side recession.

PPS.  I define a mini-recession as a period where unemployment rises by a total of less than 2% during the contraction and early recovery, but by more than 0.8%.

Here’s a picture from the Spanish flu: