George Selgin is the most frequent guest on David Beckworth’s Macro Musings podcast and listens to the recent interview it’s easy to see why. I’d be hard-pressed to find one point I disagree with. I see Selgin as a more eloquent and knowledgeable version of myself.
While much of the podcast discusses issues like Bitcoin and debanking, I will make a few comments on the final part, which covers the Fed’s upcoming review of monetary policy. Here’s Selgin:
[A]All this stuff, from just having a plain old 2% inflation target, to having a flexible average inflation target, to having God knows what they’re going to come up with next, an acronym with inflation in it. All of this is just a way to achieve what really works, which is targeting nominal GDP.
But they can’t say that. They don’t even want to talk about it because it doesn’t sound like the dual mandate. And this is really a shame, because NGDP targeting is a good way to get good behavior of both inflation and employment. It is a way to prevent serious unemployment. It is a way to prevent overheating of the labor market. It is a way to achieve inflation of around 2% in the longer term, but at the same time make prices behave differently during supply shocks, in a way that again best preserves stability in the labor market, and that is exactly what you want too.
It achieves all these things. The only point against the NGDP is that it is not clearly the same as stable prices or high employment. It doesn’t sound like a double mandate. So we need to find out that, I think, the Fed has moved toward a strategy language that sounds like the dual mandate, but is actually a stable NGDP. They would save a lot of time, and perhaps who knows how many more strategic reviews, if they would just acknowledge what they’ve been up to and at least talk, in secret, about stabilizing spending.
Unfortunately, David Beckworth indicates that the Fed is unlikely to move toward an NGDP target.
This is a good illustration of what concerns me about where I think the framework review is going, and that is that Jay Powell sat down with Catherine Rampell from The Washington Post. They did a little interview. She asked him about the framework revision, and he said, “I consider this a base case: these are his words: “A response function where you don’t overcompensate or overlook past mistakes.” So basically he says, “I see that in the base case we have a no makeup policy.”
After 2008, the Fed messed up by not having any makeup policy. In 2021, they went in the exact opposite direction, applying way too much makeup, exceeding the previous NGDP trendline by 11%.
So if you’ve made a serious mistake by going too much in one direction, and another serious mistake by going too much in the opposite direction, isn’t the conclusion you should aim for somewhere in the middle? -upwards? Instead, it appears the Fed plans to return to the policy regime that led to the Great Recession. How can we explain that?
The following is just speculation on my part, but it’s the only explanation I can think of. The Fed may assume that the zero interest rate problem has disappeared, and that for various reasons the (nominal) natural interest rate will remain above zero. Why could that be so? Perhaps a combination of slightly higher trend inflation than in the 2010s, slightly stronger real growth thanks to AI, and much larger budget deficits, as far as the eye can see. The bond market is certainly not predicting a return to the zero lower bound.
The second calculation might be that level targeting isn’t really necessary if you’re not at the lower bound of zero. They may think that Alan Greenspan’s policy approach worked quite well when rates were positive, and that they can safely return to the inflation target in a positive interest rate environment.
I don’t think that kind of reasoning is that crazy, but ultimately I don’t agree with it. First, NGDP targeting works better than inflation targeting, even in “normal times.” More importantly, macro history is full of unforeseen developments and you therefore need them a policy for all seasons. I have no doubt that my students in the 1990s were bored when I told them about what happened in the 1930s, when there was a serious banking crisis and interest rates fell to zero. That had never happened in their lifetime, or even in my (much longer) lifetime. “Why do we have to learn this old stuff?” I hope they saw the value of my teaching when they worked on Wall Street in 2008.
You never know what changes will occur in the macroeconomy. Rather than taking policy shortcuts, adopting a policy regime that might work in “fair weather,” isn’t it the more responsible course of action to adopt a regime that works under virtually all conditions? Isn’t this approach more responsible, even if it is a little more difficult to explain NGDP-level targets to Congress than it is to explain inflation targets?