In a previous post I showed graphically how one could view the history of U.S. monetary policy through the changing trends in the growth rate of nominal spending. One of the striking features from this figure was the stabilization of the nominal spending growth rate around 5% during the Great Moderation period. This figure, therefore, indicates the Fed may have had an implicit nominal spending or nominal income target of 5% during this time. That interpretation is now confirmed in a new paper by fellow blogger Josh Hendrickson:
An Overhaul of Fed Doctrine: Nominal Income and the Great Moderation
Abstract: The Great Moderation is often characterized by the decline in the variability of output and inflation from earlier periods. While a multitude of explanations for the Great Moderation exist, notable research has focused on the role of monetary policy. Specifically, early evidence suggested that the increased stability has been associated with monetary policy that responded much more strongly to rising inflation. Recent evidence casts doubt on this change in monetary policy. An alternative hypothesis is that the change in monetary policy was the result of a change in doctrine; specifically the rejection of the view that inflation was largely a cost-push phenomenon. As a result, this alternative hypothesis suggests that the change in monetary policy beginning in 1979 is reflected in the Federal Reserve's response to movements in nominal income rather than inflation as previously argued. I provide evidence for this hypothesis by estimating the parameters of a monetary policy rule in which policy adjusts to forecasts of nominal GDP for the pre- and post-Volcker eras. Finally, I embed the rule in two dynamic stochastic general equilibrium models with gradual price adjustment to determine whether the overhaul of doctrine can explain the reduction in the volatility of inflation and the output gap.Take a look at this important paper. I believe targeting nominal spending would go a long way in shoring up macroeconomic stability and hope that one day it is explicitly adopted as the policy goal for the Fed.