No, she didn’t quite say that, nor does she quite believe that. But . . . well you’ll see. Janet Yellen recently gave a very interesting speech on monetary policy:
Importantly, resource utilization rates have been so low since late 2008 that a variety of simple rules have been calling for a federal funds rate substantially below zero, which of course is not possible. Consequently, the actual setting of the target funds rate has been persistently tighter than such rules would have recommended. The FOMC’s unconventional policy actions–including our large-scale asset purchase programs–have surely helped fill this “policy gap” but, in my judgment, have not entirely compensated for the zero-bound constraint on conventional policy. In effect, there has been a significant shortfall in the overall amount of monetary policy stimulus since early 2009 relative to the prescriptions of the simple rules that I’ve described.
David Beckworth pointed to one obvious implication:
What Yellen and Bernanke both need to embrace is a NGDP level target. This approach would allow the Fed to make up the cumulative shortfall created by the Fed’s passive tightening while at the same time keeping long-term inflation expectations anchored.
Interestingly, in the very next paragraph (after the one quoted by David), Janet Yellen hints that there are people at the Fed who see the logic of level targeting:
Analysis by some of my Federal Reserve colleagues suggests that monetary policy can produce better economic outcomes if it commits to making up for at least some portion of the cumulative shortfall created by the zero lower bound–namely, by maintaining a highly accommodative monetary policy for longer than a simple rule would otherwise prescribe. This consideration is one important reason that the optimal control simulation generates a more accommodative path than the Taylor (1999) rule.
That’s exactly my view. At this late date it would be appropriate to make up for only a portion of the policy shortfall since 2008. Yellen continues:
Risk-management considerations strengthen the case for maintaining a highly accommodative policy stance longer than might otherwise be considered appropriate. In particular, the FOMC has considerable latitude to withdraw policy accommodation if the economic recovery were to proceed much faster than expected or if inflation were to come in higher. In contrast, if the recovery faltered or inflation drifted down, the Committee could provide additional stimulus using its unconventional tools, but doing so involves costs and risks. Given the unprecedented nature of the current economic situation and the limits placed on conventional policy by the zero lower bound on interest rates, these issues of risk management take on special importance.
These three paragraphs form a devastating critique of Keynesian monetary policy. Keynesians have lots of arguments for using interest rates as a policy tool (or instrument, or target, depending on your perspective) but none of them hold much water. Yellen is basically admitting that the Fed is allowing hundreds of thousands of workers to remain unemployed because the Fed’s preferred policy tool is stuck at zero. And they don’t like unconventional tools (which contrary to her assertion are not “risky.”)
The Fed really needs to move away from using any policy rules with a zero bound. Some non-zero bound tools include Bennett McCallum’s policy rule for adjusting the money supply to offset changes in velocity, exchange rate targeting, CPI futures targeting, Divisia monetary index targeting, and NGDP futures targeting. I’m sure there are many other options. But interest rate targeting (which underlies all of New Keynesian economics) has been an unmitigated disaster for American workers. And given that rates are likely to frequently hit the zero bound in future recessions (as trend productivity growth and population growth both slow) NK policy will fail us again and again in future recessions, i.e. when we most need it to be effective. Our current monetary regime is roughly like a car with a steering wheel that works fine—except when driving on twisting mountain roads with no guard rail.