George Selgin is the most frequent guest on David Beckworth’s Macro Musings podcast, and listening to the recent interview it’s easy to see why. I would have trouble finding a single point on which I disagree. I see Selgin as a more eloquent and better-informed version of myself.
While much of the podcast discusses issues such as Bitcoin and debanking, I’ll provide a few comments on the final portion, which covers the Fed’s upcoming monetary policy review. Here’s Selgin:
[A]ll this stuff, from just having a plain old 2% inflation target, to having a flexible average inflation target, to having God knows what they’re going to come up with next, some acronym with inflation in it— All of this is just a way of getting to what really works, which would be targeting nominal GDP.
But they can’t say that. They don’t even want to talk about it because it doesn’t sound like the dual mandate. And this is really unfortunate, because NGDP targeting is a good way to come up with good behavior of both the inflation rate and employment. It’s a way to avoid severe unemployment. It’s a way to avoid overheating the labor market. It’s a way to gain a long run inflation rate of around 2%, but while also allowing prices to behave differently during supply shocks in a way that, again, best preserves stability in the labor market, which is the other thing you want.
It accomplishes all of those things. The one thing NGDP has going against it is it is not obviously the same thing as stable prices or high employment. It doesn’t sound like the dual mandate. So, we have to figure out, I think, what the Fed has been doing has been stumbling its way towards strategy language that sounds like the dual mandate but is actually stable NGDP. They would save a lot of time doing this, and, maybe, who knows how many more strategic reviews if they would just acknowledge what they’ve been up to and at least, secretly, talk about stabilizing spending.
Unfortunately, David Beckworth indicates that the Fed is not likely to move in the direction of NGDP level targeting.
This is a good illustration of what concerns me about where I think the framework review is going, and that is, Jay Powell sat down with Catherine Rampell from The Washington Post. They did a little interview. She asked him about the framework review, and he said, “I see as a base case,” these are his words, “A reaction function where you don’t overcompensate or you don’t overshoot for past misses.” So, effectively, he’s saying, “I see as a base case, we don’t have makeup policy.”
After 2008, the Fed screwed up by not trying to do any make-up policy. In 2021 they screwed up in exactly the opposite direction, by doing far too much make-up, overshooting the previous NGDP trend line by 11%.
So when you’ve made one serious error going too much in one direction, and another serious error going too much in the opposite direction, isn’t the conclusion that you should aim for somewhere in the middle—do just the right amount of make-up? Instead, it seems as though the Fed is planning to return to the policy regime that led to the Great Recession. How can we explain that?
The following is just speculation on my part, but it’s the only explanation that I can think of. The Fed may be assuming that the zero rate problem is gone, and that for various reasons the (nominal) natural rate of interest will remain above zero. Why might that be? Perhaps some combination of slightly higher trend inflation than during the 2010s, slightly stronger real growth due to AI, and much bigger budget deficits for as far as the eye can see. The bond market is certainly not forecasting a return to the zero lower bound.
The second calculation may be that level targeting isn’t really necessary when you are not at the zero lower bound. They may be thinking that Alan Greenspan’s policy approach worked pretty well when rates were positive, and they can safety return to inflation targeting in a positive interest rate environment.
I don’t view that sort of reasoning as crazy, but in the end I do not agree. First of all, NGDP targeting works better than inflation targeting even during “normal times”. More importantly, macro history is full of unforeseen developments and thus you need a policy for all seasons. I have no doubt that during the 1990s my students were bored when I taught them about what happened in the 1930s when there was a severe banking crisis and interest rates fell to zero. That had never happened during their lives, or even in my (much longer) life. “Why do we need to learn this old stuff?” I hope that they saw the value of my teaching when they were working on Wall Street in 2008.
You never know what sort of changes will occur in the macroeconomy. Rather that take policy shortcuts, adopting a policy regime that might work in “fair weather”, isn’t the more responsible course of action to adopt a regime that works under almost all conditions? Indeed, isn’t that approach more responsible even if it is slightly harder to explain NGDP level targeting to Congress than it is to explain inflation targeting?
