Wednesday, August 1, 2012

The FOMC's Decision in a Parallel Universe

The FOMC continues to disappoint.  Other than acknowledging the economy is getting worse, the FOMC decided to sit on its hands and hope the aggregate demand slump disappears on its own.  As I have noted before, this failure to act by the Fed when money demand is elevated and growing amounts to a passive tightening of monetary policy.  Caroline Baum in her latest Bloomberg column agrees. Can anyone say Lords of Finance 2.0?

I have been disappointed for so long that sometimes I feel the need to believe in parallel universes where somewhere out there a FOMC actually does its job.  In that universe, the FOMC responds forcefully to the aggregate demand slump and does so using a nominal GDP level target.  Below is what the FOMC statement in that parallel universe would look like.  (It is an update on a similar post I did for the April FOMC.  I plan to update and post it every FOMC meeting the Fed fails to do its job.)
Release Date: August 1, 2012

For immediate release

Information received since the Federal Open Market Committee met in June suggests that economic growth remains anemic. Labor market conditions are weakening and the unemployment rate continues to remain elevated.  Household spending and business fixed investment appears to be slowing down. Inflation has moderated in recent months. Long-term inflation expectations remain well anchored.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a sluggish pace of economic growth over coming quarters as the crisis in Europe, the slowdown in Asia, and the uncertainty over year-end fiscal austerity plans are creating significant headwinds for the economy.  These developments along with the economy  operating below its full-employment level indicates that further action is warranted by the Committee.
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to begin a new conditional asset purchasing program tied to an explicit growth path for nominal GDP.  The Committee believes that nominal GDP should expand to $16 trillion dollars and grow at a 5% annual pace thereafter.  To this end, the Committee intends to purchase Treasury and Agency securities every week until this target is hit.  
This program should raise expectations of future nominal GDP growth and cause a rebalancing of portfolios that will facilitate a rise in current aggregate nominal spending.  The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Sarah Bloom Raskin; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen. Voting against the action was Jeffrey M. Lacker, who does not anticipate that economic conditions are likely to warrant a new conditional asset purchase program.


  1. Assistant professor:
    Monetizing debt does not create GDP growth. It may help the government run even larger deficits (which in your obviously Keynesian views is a good thing) but which, according to commons sense, will only borrow growth from future periods.
    How is real GDP going to grow if real incomes are stagnant at best? What is the purpose of inflating nominal GDP via inflation without any benefit for real GDP growth? If central banksters achieve their goal in creating inflation, interest rates should rise, making elevated debt even more hurtful. If they do not achieve their goal, the real burden of elevated debt will weigh even more on a weak economy.

  2. Lords of Finance 2.0 indeed. Yglesias also had this book on his mind and like him, now I believe it was my favorite on this whole mess.

  3. i feel like this IS the surreal parallel universe. today Draghi talked about how EU inflation was running at 2.2% but was expected to go down due to declining oil prices. Can we PLEASE make the current incarnation of Bernanke and co go back and read Bernanke and Gertler's earlier work on how high oil prices are contractionary due to the monetary response... What planet to i live, where the EU and Fed can influence WORLD DEMAND on oil, except through unemployment???

  4. Gloeschi,

    Nominal spending and nominal incomes are inordinately depressed. Given sticky nominal debt and sticky prices this means real growth is far below its potential. Correcting this mistake is not does not borrow growth from the future nor does it only lead to higher inflation. See FDR in 1933.

  5. Becky,

    I think Ryan Avent would be well suited to write the 2.0 version. He had some epic posts recently on the failures of central banks. They would make great chapters in the book.

  6. dwb,

    Yes, this universe does feel surreal. And most people take it for granted this is way it has to be. I can only conclude that the economics profession has failed to fully learn the lessons of the Great Depression. I hope future economic historians come to realize the true nature of this Little Depression.

  7. I don't quite follow: in which part of the world is nominal spending depressed?
    If the government spending = income, then we could "spend" our way to riches? The multiplier on $1 additional debt to GDP is currently 0.43 in the US. So you have debt going up 2.3x faster than GDP. And you are advocating spending more? Wasn't that the problem in the first place?
    The output gap cited by academics is an ill-thought out invention without much justification. Why would GDP have to revert back to "trend"? Trends change.

  8. Gloeschi,

    You are obviously late to the conversation. Money demand is elevated, money supply has fallen, and by implication nominal spending is artifically depressed. No trends are needed, but they do illustrate the point. See the following for some catch-up reading:

    1. Money demand has sharply risen: here and here. (Should be self-evident from insatiable appetite for safe assets.)

    2. Money supply has fallen: here and here.

    3. Nominal spending/income collapse the real problem: here.