3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

When I was working in the Treasury in 1993, I was struck by how much it was the case that President Bill Clinton was still the ex-Governor of Arkansas, and that arguments that would have been powerful and important when directed at a Governor of Arkansas still resonated in his mind much more strongly than they perhaps should have if they were evaluated purely on technocratic grounds.

Arkansas, remember, was a small, poor state, heavily dependent on coupon-clipping from the Walton family and on the ability of Tyson Chicken to export to other states as its engines of economic growth. Those put constraints on Arkansas and make certain factors salient for Arkansas in ways that do not apply to the country as a whole.

Donald Trump has been a real estate developer–and a failed casino manager. The same where-he-comes-from-determine-which-arguments-resonate should apply here.

There thus ought to be an elective affinity between Donald Trump and proper technocratic fiscal policy: he ought to be very responsive to the very strong case for a real and substantial infrastructure construction-led fiscal expansion–and remember that investing in the human capital of twelve year olds is a very durable piece of infrastructure indeed. The math that shows that at current interest rates borrow-and-build is indeed a no-brainer for the economy is math that ought to be very familiar to Donald Trump.

And he ought to be very responsive to the Yellen caucus in the Federal Reserve. Very much like Reagan in 1980, Donald Trump has been told and from personal experience knows very different things about the Federal Reserve. by some that we need rigid Taylor Rules and has been told by others that we need a Gold Standard, but he also knows that high interest rates kill real estate values, real estate deals, and the solvency of real estate developers. Reagan’s goldbug and loose-money staffers fought each other to a standstill, and Volcker was left alone to manage the economy as best he could. There is a potential fight between the Donald Trump who develops real estate and the Donald Trump who wants to be a good Republican fighting for Republican causes he doesn’t really resonate with. My bet is that, if the issue can be properly framed, the valid technocratic arguments for loose money will prevail inside Donald Trump’s head, given the natural elective affinity with his past career.

And there is much to be done here…

One of my proudest moments was when, back in 1992, Larry Summers and I egged each other on to tell the Federal Reserve at Jackson Hole that, given the magnitude of recessionary shocks and the vulnerability of an economy to the zero lower bound, it was too hazardous to try to push the average inflation rate much below 5%/year. Great call. Completely correct. Totally ignored. One that I am very proud of.

But a 2%/year inflation target was set in stone for the U.S. by Alan Greenspan in the 1990s. Thereafter the Federal Reserve system fell in line and coalesced around finding reasons why that target was a good thing–not analyzing whether it was in fact a good thing.

It is now clear that it is not a good thing: shocks are too large. Perhaps the 2%/year target was appropriate if the Great Moderation was permanent. It wasn’t. We have radical uncertainty of many kinds, and a 2%/year target will have us slam into the zero lower bound appallingly often. The target inflation rate should be raised to 4%/year.

The only argument for keeping the 2%/year inflation target is that it helps build the Federal Reserve’s credibility. But the credibility that comes from doing stupid things consistently and persistently is not the kind of credibility you want to build or have, is it? It is important that people trust your promises. But the promises that you want to make and that you want credibility for are promises that you will do the right and smart thing–not the wrong and dumb thing–and thus that you will correct policies that turn out to have been clearly mistaken.