Monday, September 19, 2011

Who Needs Professional Wrestling When There is the FOMC?

Via Jon Hilsenrath we learn this about the FOMC members:
Fed Chairman Ben Bernanke has asked Philadelphia Fed President Charles Plosser and Chicago Fed President Charles Evans, two intellectual adversaries, to work with Vice Chairwoman Janet Yellen on how the Fed can better explain its economic goals to the public. One issue high on the agenda: Detail what changes in unemployment and inflation it would take to make the central bank veer from its low interest rate target...
Mr. Bernanke and many other officials dismiss the idea that he’s confronting a rebellion inside the Fed. They argue that internal disagreement is a sign of strength because it shows officials are wrestling earnestly with hard questions and have their eyes wide open to the challenges they face. “My attitude has always been: if two people always agree, one of them is redundant,” Mr. Bernanke said earlier this month in Minneapolis.
This would be fun to watch if the Fed's internal divisions were not such a serious issue.  Maybe the Evans-Plosser assignment is Chairman Bernanke's way of letting the inflation hawks be heard while still pushing through additional monetary stimulus.  That seems to be Hilsenrath's interpretation of these developments.  The only problem is that the options the Fed seems most likely to adopt--shrinking the average maturity of publicly-held national debt (i.e. Operation Twist II) and/or lowering interest paid on excess reserves--are not brazen enough to meaningfully change nominal spending expectations.  The public needs a sharp expectation shock, a bold slap to the face to wake it up from its economic lethargy.  Instead the Fed looks ready to place a mild kiss on the check that will only add to the economic stupor.  These half-measures are the product of political compromise not unified leadership at the Fed.

So what would a bold policy change look like? Charles Evans knows the answer.  In a speech he noted the following:
There are other policies that could give clearer communications of our policy conditionality with respect to observable data. For example, I have previously discussed how state-contingent, price-level targeting would work in this regard.  Another possibility might be to target the level of nominal GDP, with the goal of bringing it back to the growth trend that existed before the recession. I think these kinds of policies are worth contemplating—they may provide useful monetary policy guidance during extraordinary circumstances such as we find ourselves in today 
In other words, the Fed would allow faster-than-normal growth in nominal spending (and by implication the price level) until there was no longer insufficient aggregate demand.  That would be a bold shock and might even freak out many people about future inflation.  Money demand would be sure to drop.  But that is the point: implement a policy that would catalyze rapid nominal spending by household and firms.  Nominal GDP level targeting would do just that.  And, at the same time, such a level target would actually anchor long-term nominal expectations by restricting nominal spending to its long-term trend growth path after catch-up period.

Unfortunately, not everyone on the FOMC appreciates level nominal GDP targeting like Charles Evans.  Thus, we end up with the half measures the FOMC is most likely to adopt this week.  These half-measures are not likely to spur a robust recovery, but are likely to attract further political criticism of monetary stimulus.  The Fed is digging its own grave.

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