Thursday, March 3, 2011

Christina Romer and John Taylor Agree on Something

This may surprise you, but Christina Romer and John Taylor both agree on an important issue.  They both see the need for an explicit monetary policy rule that would provide more transparency and  predictability of the Fed's actions.  Here is Christina Romer in a recent article:
 [The Fed] could set a price-level target, which, unlike an inflation target, calls for Fed policy to take past years’ price changes into account. That would lead the Fed to counteract some of the extremely low inflation during the recession with a more expansionary policy and lower real rates for a while. All of these alternatives would be helpful and would retain the Fed’s credibility as a defender of price stability.
So Romer wants a price level rule that would keep the price level growing according to some target  rate.  This would not only commit the Fed to long-term price stability, but it would also create more certainty for the markets.  John Taylor makes the same point in his critique of Bernanke's recent testimony before congress:
[T]he exchange between Chairman Bernanke and Senator Toomey suggests that the Fed is unclear about what monetary policy strategy it is using for the interest rate. Is it the Taylor Rule, as in the first response? Is it the rule incorrectly attributed to me in 1999, as in the second response? Is it some estimated rule, as in the third response? Or is it something else? It would be useful to know what the strategy is. Greater transparency about the strategy would add greatly to predictability and would help markets understand whether quantitative easing will be extended or when the interest rate will break out of the 0-.25 percent range.
I agree with both of them.  We desperately need a rule-based approach to monetary policy that would provide more certainty. Instead of a price level rule or a Taylor rule, though, let me suggest another alternative: a nominal GDP level target. If congress is serious about narrowing the mandate of the Fed, they should could consider this option too. 


  1. I think one reason for the confusion alluded to by John Taylor might be that there are two types of rule being discussed here. A rule like the Taylor rule is effectively a guide for HOW to conduct monetary policy; an objective like price level or NGDP targeting is rule governing WHAT monetary policy should aim to achieve.

    While I can see the appeal of price level or NGDP targeting, now is not the time. At the moment, either of them would justify easier monetary policy, so the introduction of either would reduce monetary policy credibility. I doubt that the prospect of price level or NGDP targeting prompting tightening in some future boom would carry much credibility if the change that introduced (whichever of) them avoided an unpleasant tightening, because there would be grounds for suspicion that the target would simply be changed again if it proved inconvenient. As Christina Romer probably does understand, far more credibility is gained by paying a price to keep a promise than by making one which is not binding for the foreseeable future.

  2. You say "Romer wants a price level rule that would keep the price level growing according to some target rate. This would not only commit the Fed to long-term price stability, but it would also create more certainty for the markets."

    I am all for "price stability" and "more certainty for the markets." What I am struggling to understand is why our Federal Reserve focuses narrowly on US price stability, and other "US stuff" when the US dollar is the reserve currency for the world.

    I have been following bubbles around the world for many years and wonder how the US can escape blame for many, perchance all of these bubbles, not only due to poor regulatory structures in banking and finance, but also due to our monetary/fiscal policies.

    I also know that the FED has promised to keep a better eye on emerging bubbles. But is it only to keep an eye on bubbles as they emerge on US soil?

    Can you help me better understand?

  3. Followup from previous comment: After reading your Feb. 21 post on Bernanke's Savings Glut Hypothesis, and thinking through my earlier questions, I'm beginning to wonder whether we've got a Jack Nicholson moment: "Maybe this is as good as it gets!"

    Maybe we have to stumble through for now with nation states -- even gi-normous ones like the US -- acting as if they only have to protect domestic interests when setting monetary policy. They leave broader-scale coordination to things like the G20, that Roubini recently called the Gzero, as I recall.

    Until there can be some better coordinating mechanisms for world finance, maybe this indeed is, pretty much, "as good as it gets."

    In the meantime, we can all try to better understand whether your nominal GDP targeting is better than Taylor's inflation targeting, and how both compare to Bernanke and Co.'s moves.

    Thanks for helping those of us who only watch from the sidelines.