Last year Christina Romer argued that Fed chairman Ben Bernanke needed a Volcker moment. What she meant is that like Paul Volcker in the early 1980s, Bernanke needs to rise to the occasion and adopt a new monetary regime radical enough to solve the big economic problem of the day. For Paul Volker the problem was ever increasing inflation and the new monetary regime was targeting bank reserves. For Ben Bernanke the problem is an ongoing aggregate demand slump and the new monetary regime would be nominal GDP (NGDP) level targeting. As someone who believes in NGDP level targeting, I too have been hoping the Ben Bernanke will have a Volcker moment. After all, it would not be too much of a stretch for him given his work on Japan. But he has not and therefore continues to keep Fed policy effectively tight as it has been since mid-2008. Fed vice-chairwoman Janet Yellen acknowledges as much. Tim Duy considers this to be maddening monetary policy, Karl Smith views it an utter policy failure, and Ryan Avent is banging his head in frustration over it.
Maybe it is time for us to admit that Bernanke will never have his Volcker moment. He has had many opportunities and whether because of groupthink at the Fed, political power of savers, or a failure by him to read Scott Sumner’s blog, Bernanke cannot seem to find his Volcker moment. It is not clear he ever will. So instead of hoping Bernanke has a Volker moment, maybe we should be hoping for President Obama to have a FDR moment.
The FDR moment occurred in 1933 when FDR took the reigns of monetary policy from an ineffective Fed and sparked a robust recovery in aggregate demand. The Fed had allowed aggregate demand to collapse for three years when FDR responded. He signaled that he wanted the price level to return to its pre-crisis level (i.e. increased expectations of higher nominal spending) and acted upon it by having the Treasury Department devalue the gold content of the dollar. This dramatically increased the monetary base and spurred a sharp increase in aggregate demand.
So how could President Obama have his FDR moment? Like FDR, he should signal his intentions for higher level of nominal spending and follow through on it by having the Treasury Department take take the reigns of monetary policy from the Fed. President Obama could do this by announcing a NGDP level target that would be implemented by the Treasury Department creating large-denomination platinum coins that would be deposited at the Fed and used to fund checks to the public. The Treasury Department would keep making these coins until the the NGDP level target was hit. If NGDP went above the target the Treasury Department would issue bonds to withdraw the excess money.
Okay, that is a radical idea coming from me. It is a mongrel mix of Market Monetarism and Modern Monetary Realism. It is not my first choice of the Fed adopting a NGDP level target, but it should work. It makes use of expectations management which should minimize the number the actual number of platinum coins needed and if used as a threat it might even cause Bernanke to suddenly discover his Volcker moment.
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Volcker never had his moment & neither did FDR usurp FED policy.
Monetary policy objectives should be formulated in terms of desired roc’s in monetary flows (MVt) relative to roc’s in real-gDp (but the FED’s technical staff is incapable of steering real-gDp).
So, contrary to economic theory, & Nobel laureate, Dr. Milton Friedman, monetary lags are not “long and variable”. The lags for monetary flows (MVt), i.e. the proxies for (1) real-growth, and for (2) inflation indices, are fixed in length (a mathematical constant).
The upcoming 2 month downswing is almost on top of us. This particular period would make a good case for targeting nominal-gDp. Real-gDp will fall (for 2 months), but inflation will not change much (i.e., it looks like stagflation).
In order to smooth out the upcoming disruption (change in job creation), the FED should target nominal-gDp in the next 2 months. Any blip in inflation will later be erased (be transitory as Bernanke says), as the FED targets the roc in nominal-gDp — because the constant (time lag), for inflation is longer than the constant (time lag), for real-output.
Thus the longer-term constant (time lag), for inflation will serve to reduce any short-term injection of liquidity by the FED (an injection accompanied by the resultant short-term increase in inflation’s rate-of-change (roc)).
This is just because both the longer-term average (roc) for inflation (as well as its historical ratio to real-output), is mathematically lower, than the longer term (roc) in real-gDp (given that real-gDp is allowed to recover & the inflation component of nominal-gDp reverts-to-mean).
I.e., it extremely unlikely by targeting nominal-gDp — that the (roc) in inflation will grow faster in the longer-run than the (roc) in real-output.
This process (concept), is more pronounced coming out of a recession. The FED can boost real-gDp (with a larger injection of liquidity), for up to 3 qtrs, & then apply the brakes (dis-inflation). Real-gDp will then increase at a faster (roc) than re-flation does during this period. And later inflation will subside as the FED shifts to a “tighter” (de facto), money policy (nominal-gDp target).