A recent post by Marcus Nunes pointed out that the Fed doesn’t seem to be interested in NGDP growth, and instead is merely trying to prevent deflation.
Now I get Bernanke
He´s an inflation targeter through and through! And an inflation targeter wants, at all costs, to avoid deflation! That´s all folks! He has no understanding of the benefits from stabilizing nominal spending growth along a target path. He only thinks in terms of inflation/deflation.
I don’t think that’s exactly correct (for reasons I’ll explain later), but he may be close to the truth.
The implications of this are very simple, and easily explained with an AS/AD diagram. Draw a horizontal line for a given price level. The Fed won’t let prices fall below that level, or rise above that level. That means if fiscal stimulus tries boost AD the Fed will offset the effect with tighter money, or perhaps a failure to do QE when needed. But if Obama tries to shift AS to the right, output will increase as the Fed will be forced to shift AD equally far to the right to prevent prices from falling. How might Obama try to shift AS to the right?
- A cut in the employer portion of the FICA tax, perhaps offset with budget saving elsewhere. That would reduce labor costs (due to sticky wages), without generating any deflationary side effects (due to the Fed inflation targeting policy.)
- Boost oil supply, by allowing more drilling, or releasing oil from the emergency reserves.
- Cut the minimum wage and the length of extended UI benefits.
Given that #1 is being discussed and #2 has already been enacted, I’d say it’s a pretty good bet that Obama understands the problem he faces. (Although he obviously has a weak understanding of monetary policy.)
Part 2: Is the Fed actually targeting inflation?
The first thing we need to remember about the Fed is that it isn’t a person, it lacks a mind. It doesn’t have a well thought out policy goal. It responds to many factors, and probably represents some sort of consensus view. Recent statements by Fed officials suggest that they have felt pressure from opponents of QE2, who are much more vocal than supporters. And they’re not just more vocal, probably more numerous as well. A recent survey showed 36 out of 38 economists opposed further monetary stimulus. Even if the survey was biased, that’s a pretty impressive figure. The Fed rarely moves far outside the mainstream, so rather than asking what the Fed believes we should think about what the profession believes.
As far as I can tell, the profession believes many different things, most of which are complete bunk:
- The view of the quasi-monetarists, and also Krugman/DeLong/Duy/Yglesias/Harless/etc, that we need faster NGDP growth, which means we need more monetary stimulus. Tyler Cowen should also be included in this group, despite the fact that he puts more weight on structural factors than do the others.
- The typical progressive view that either the Fed can do nothing, or that Fed stimulus merely aids asset holders.
- The typical conservative view that more AD is not needed, rather we need supply-side reforms.
- Then there are those who think fiscal stimulus boosts real growth and monetary stimulus boosts inflation.
As far as I can tell, group 1 is a tiny minority within the economic profession. Indeed I think it quite possible that the FOMC is actually more pro-stimulus than the overall profession. QE2 was arguably ahead of the consensus. Actual Fed policy is a weighted average of FOMC views, and the views of the broader profession. This makes it very difficult to talk about the Fed’s objective function. There is probably a reasonable consensus for aggressive stimulus when deflation threatens, as in mid-2010. Many economists focus on core inflation, but many others become frightened by a sharp uptick in headline inflation due to rising commodity prices and a falling dollar, as in early 2011. And real growth matters at least a little bit. Some economists think AD suddenly ceases to matter when there is some other highly visible problem, like banking distress or real estate collapse. Some don’t want to “bail out” Obama, hoping he’ll fail.
Mix all these views into the pot of boiling stew, and you get some sort of consensus policy objective. No single description can do justice to that complex mixture of strange models, dubious morality, and confused reasoning. It is what it is. Our job as bloggers is partly to persuade the FOMC, but more importantly to persuade our colleagues that they are thinking about these issues in the wrong way. If 36 out of 38 economist surveyed favored more monetary stimulus, I absolutely guarantee the Fed would already have QE3 underway.
PS. Don’t tell me that Bernanke always gets his way. He’s a cautious person. “His way” is partly a reflection of what he perceives as the views of other FOMC members and the broader profession.