This interview is required listening for anyone interested in the Fed. A few comments:
1. Michael starts off with some interesting anecdotes about how Fed chairmen often abuse their powers. In one case he discusses how Greenspan used to do an end run around the FOMC, so that he could get his preferred fed funds target (and make it look almost unanimous), even if a number of FOMC members were initially opposed. Another example involves Volcker vetoing the choice of monetarists like Lee Hoskins and Jerry Jordan for the position of regional Federal Reserve Bank presidents. The view from the inside is not pretty.
2. He then does a really nice job of explain why fed funds targeting often ends up being procyclical, pouring fuel on the fire.
3. Much of the piece has a political economy slant, which I think will appeal to people who lack knowledge of and/or share my disinterest in highly technical monetary theory. In these areas Russ Roberts also does very well. He is more sympathetic to Belongia’s views than he is to my views, and this allows for a very smooth conversation where Russ is able to contribute a lot of insights into the public choice aspects of Fed. I won’t summarize all of Michael’s views on what the Fed should be doing differently, they link to one of his papers, and I also have this earlier post that discusses some of his views.
4. I was especially interested in his discussion of the flaws in the current monetary aggregates. I admit to not paying a lot of attention to this issue, as I prefer futures targeting to any form of monetary aggregate targeting. However most economists favor some sort of backward-looking Taylor Rule, and Michael points out that all of the arguments raised against the monetary aggregates in the 1980s, equally well apply to the Taylor Rule (or rules, since its proponents can’t even agree on what version is best.)
5. Not surprisingly, the one area I disagreed was the NGDP target discussion. But first let me indicate where I agree, and then where I diverge.
a. I agree that the Fed cannot hit two targets with one instrument.
b. I agree that the current mandate of stable prices and full employment causes great mischief. As I argued a couple days ago, it leads to a situation where at some times the hawks have the upper hand and at other times the doves dominate policy. This leads to an erratic policy. It also gives the Fed a ready-made excuse for their failures. Like a magician using sleight of hand, whenever one policy goal is doing poorly, they can say “but look over here, we need to loosen or tighten because of this other objective.” They need a single goal.
So where do we disagree? I have the feeling that Michael thinks NGDP is still implicitly straddling two goals, as the NGDP growth rate is the sum of inflation and real growth. A couple responses:
a. NGDP is still a 100% nominal variable, fully under Fed control. The Fed can (in principle) move NGDP over a range of zero to infinity, just like the price level.
b. The problems associated with inflation volatility (Michael’s preferred target is inflation) are more accurately described as problems that arise from NGDP instability. What are those problems? Inflation instability is alleged to create business cycles. For instance, if wages are sticky it may lead to suboptimal real wage movements. But this is even more true of NGDP instability. Inflation instability is alleged to distort financial markets, to redistribute wealth between lenders and borrowers. But George Selgin has argued (and I agree) that this argument better fits NGDP instability. (Although Selgin uses a slightly different target from NGDP.)
c. Michael mentions an example where Milton Friedman once asked (when someone proposed a 6% NGDP target) what would the Fed do if inflation was 7% and real growth was 1%? The implication was that the high inflation showed that we needed to tighten policy, but the NGDP target would be signaling “all is well.” Surprisingly, I think the Fed should and would pay more attention to NGDP than inflation, even in that case. The NGDP target would keep wage growth and core inflation well behaved, and the transitory supply shock would not have any long run impact on inflation, and wouldn’t have any impact at all on long run inflation.
d. This italicized point is of course debatable, but I am pretty confident in making this assertion. If the long run real growth rate is 3%, then (under a 6% NGDP target) for every year with 7% inflation and -1% real growth, there would have to be another year with 7% real growth and -1% inflation. Surprisingly, those sorts of fluctuations in inflation would not cause any of the problems that inflation is alleged (correctly) to cause. It would cause less RGDP instability than an inflation target, and it would be fair to lenders and borrowers.
e. What about Michael’s concerns about how unanticipated inflation can disrupt long term decisions? After all, in theory you might get a decade or two of 7% inflation and -1% RGDP growth. In theory yes, but not in practice. Even the worst decades for supply shocks have shown surprisingly steady RGDP growth rates. I seem to recall that even the 1970s saw close to 3% RGDP growth. Now I happen to think that for all sorts of reason the current decade may be the worst in my lifetime. But that could occur even with 2% RGDP growth.
So I have two basic arguments, the problems we typically associate with inflation instability are better described at reflecting NGDP instability, and second, that over any extended period of time NGDP targeting will deliver a fairly stable inflation rate, as higher than desired inflation during one or two years will be offset by lower than desired inflation in the following few years.
Despite my quibbles about NGDP targeting, I agree with 90% of what Michael Belongia has to say. And he says it very well. He has worked at the Fed and you almost immediately sense that this is someone who knows what he is talking about. With no disrespect to Mississippi, it really bugs me that people this knowledgeable in both monetary theory and the real world practice of monetary policy are not more highly valued at the elite schools any longer. At the margin he would add far more value to an Ivy League program than some young hotshot that will churn out more DSGE models that no one will pay attention to in another 10 years (or in many cases even 10 months.)