George Selgin is the most frequent guest on David Beckworth’s Macro Musings podcast, and after listening to his recent interview, it’s easy to see why. You’d be hard-pressed to find a single point you disagree with. I consider Selgin a more eloquent and more knowledgeable version of myself.
Many of the podcasts discuss issues like Bitcoin and debanking, but I’ll make some comments on the last segment, which covers the Fed’s upcoming monetary policy review. This is Selgin.
[A]From the run-of-the-mill 2% inflation target, to the flexible average inflation target, to God knows what we’ll come up with next, to inflation-inclusive acronyms, it’s all just that. This is how we arrive at a method that actually works, targeting nominal GDP.
But they can’t say that. They don’t even try to talk about it because it doesn’t seem like double duty. This is a real shame because NGDP targeting is a good way to keep both inflation and employment in good shape. This is the way to avoid severe unemployment. This is a way to avoid overheating the labor market. This is a way to achieve an inflation rate of about 2% in the long run, but also allows prices to behave differently during supply shocks, which is also another objective you want to achieve in the labor market. This is the method that best maintains the stability of
It accomplishes all that. The one thing NGDP is against is clearly not the same thing as price stability or high employment. I don’t think it’s double duty. So we need to understand that what the Fed has been doing so far is stumbling on the way to a strategic language that sounds like a dual mission, but is actually stable NGDP. I think so. If they just acknowledged what they’ve been doing and at least privately talked about stabilizing their spending, doing this could save them a lot of time, and perhaps how much more strategic review. No one knows.
Unfortunately, David Beckworth suggests that the Fed is unlikely to move in the direction of targeting NGDP levels.
This is a good indication of my concerns about where I think the framework review will go. In other words, Jay Powell spoke with Katherine Rampel of the Washington Post. They did a little interview. When she asked him about reviewing frameworks, he replied, “I think of it as a base case.” This is the phrase “reaction function that does not overcompensate or overshoot past mistakes.” So, in effect, he’s saying, “As a base case, we don’t have a makeup policy.”
After 2008, the Fed made a mistake by not taking any compensation measures. In 2021, we made the exact opposite mistake by wearing too much makeup, exceeding the previous NGDP trend line by 11%.
So, once you’ve made a critical error of going too far in one direction, and once you’ve made a critical error of going too far in the other direction, the conclusion is that you should aim for somewhere in the middle, that is, apply just the right amount of makeup. Isn’t it? -above? Rather, the Fed appears to be planning a return to the policy regime that caused the Great Recession. How do I explain that?
The following is just my guess, but it’s the only explanation I can think of. The Fed may assume that the zero interest rate problem will disappear and that the (nominal) natural rate of interest will remain above zero for various reasons. Why is that? Probably a combination of slightly higher inflation trends than in the 2010s, slightly stronger real growth due to AI, and larger fiscal deficits as far as the eye can see. The bond market certainly does not expect a return to the zero lower bound.
In the second calculation, if the zero lower bound is not reached, level targeting may not actually be needed. They may believe that Alan Greenspan’s policy approach worked fairly well when interest rates were positive, and that they could safely return to their inflation target in a positive interest rate environment.
I don’t think that kind of reasoning is crazy, but ultimately I don’t agree with it. First of all, even in “normal times” NGDP targeting works better than inflation targeting. More importantly, macro history is full of unexpected developments and requires policies for all seasons. In the 1990s, I’m sure my students were bored when I taught them what happened in the 1930s, when there was a severe banking crisis and interest rates dropped to zero. That had never happened in their lives or in my (longer) life. “Why do I need to learn this old stuff?” I hope they understood the value of my teachings when they were working on Wall Street in 2008.
We don’t know what changes will occur in the macroeconomy. Rather than taking policy shortcuts, adopting a policy regime that is likely to work in “good weather” may be the most responsible course of action, adopting a regime that works under almost all conditions. . Indeed, even if it is slightly more difficult to explain NGDP level targets to Congress than it is to explain inflation targets, wouldn’t that approach be more responsible?
