Shoot to kill: Power, precision, sufficiency and the appropriate target
By Scott Sumner
Over at MoneyIllusion I have a new post advocating reforms that would boost the power of monetary policy. Here I’d like to put this in context, especially given that the Fed is planning to revisit its policy strategy this summer. A successful monetary policy has four elements:
1. An appropriate target: I favor NGDP level targeting, but the Fed’s current target (AD set at a level that leads to 2% PCE inflation and minimizes the employment/output gap) is not that bad, if done right.
2. Power: The Fed needs policy tools that they are comfortable using, and that are powerful enough to hit the target. There are many possible reforms, some of which I’ve discussed in other posts. In a technical sense, it’s an easy problem. The Fed needs to decide which among the many feasible options it prefers, to insure that it never runs out of ammunition. Options include a higher inflation target, level targeting, allowing the Fed to buy any asset, negative IOR, having the Treasury take over the Fed’s balance sheet, etc. At MoneyIllusion I offer another possible reform to give the Fed more power.
3. Precision: I’ve previously mentioned numerous possible reforms to boost precision. Within the current discretionary framework, you could have the fed funds target adjusted daily, set at the median vote of the FOMC. Changes would be to the nearest basis point, with no presumption as to direction of change.
Even greater precision would result from adding market guidance. The beauty of my “guardrails” system is that it can be adjusted to fit any preferred approach. Make the guardrails very wide and you have almost unlimited discretion. Make them very close—say 2 basis points apart—and you have a policy tightly controlled by the market. Allow the Fed to take on a net short or long position in NGDP futures and you boost discretion. Force the Fed to take a roughly balanced long and short position, and you have a strict policy rule. Every feasible monetary regime can be seen as a variation of my guardrails proposal, with suitable parameters.
4. Sufficiency: Even if you have the appropriate target, a powerful tool, and a precise aim, you still might fail. Imagine a big game hunter who is aiming his gun at the correct animal, has enough power to kill the animal, and a scope accurate enough to get the bullet on target. He still might suffer a loss of nerve and fail to pull the trigger. Monetary policy should never be set in a position where it is expected to fail because of a loss of nerve. Target the forecast.
Every three months, the Fed should tell Congress how much growth in AD it believes is necessary to hit its goals, according to the dual mandate. It should also tell Congress how much growth in AD it actually expects to occur. If these two growth rates differ, Congress should instruct the Fed to go back and do its job properly. If monetary policy lacks sufficient power to achieve the goals, then the Fed should tell Congress what additional tools are needed. Under no circumstance should the Fed ever ask for assistance from fiscal policy.
The Fed needs to view (demand-side) recessions as like a rhino charging directly at the hunter. Get a powerful gun and SHOOT TO KILL.
PS. I’m not advocating rhino hunting; they are an endangered species.