Tag: Inflation Targeting

My Sections: As Delivered: Fed Up Rethink 2% Inflation Target Blue-Ribbon Commission Conference Call

Posted on by Brad DeLong

Opening Statement (as Delivered): I digress from my job here to say that I agree with everything that Jason and Josh have said. They do not speak just for themselves. They speak for me as well.

And let me also digress by trumping both Jason and Josh.

They both said “if you thought a 2% inflation target was appropriate a decade ago”. A decade ago I did not think a 2% inflation target was appropriate.

It was twenty-five years ago this summer that Larry Summers and I went to the Federal Reserve’s conference at Jackson Hole to say, among other things, that we thought it would be extremely risky and inappropriate to drop the Fed’s informal inflation target from its then-five percent to two percent. The 1990 savings and loan crisis was a small macroeconomic shock. Yet the Federal Reserve cut short-term interest rates by 600 basis points to respond to it. If there were ever a big shock, we said, the Fed would want all that much room to maneuver and more. It would not have that room to maneuver with a two percent inflation target.

So I’ve been beating this drum for twenty-five years off and on, and feeling very Cassandra-like for the past decade.

Now on to my job here. It is to get all medieval, in the sense of Thomas Aquinas, on you. It is to deal with the objections to our position, and then to provide what we believe are sufficient answers to those objections.

I hear four arguments for not changing the 2%/year inflation target, even though pursuing that target found us in a situation where monetary policy was greatly hobbled in its ability to manage the economy for a solid decade. And, as best as I can evaluate them, all four of these arguments seem to me to be wrong. They are:

The Federal Reserve, even at the zero lower bound, has powerful tools sufficient to carry out its stabilization policy tasks (Cf.: Mankiw and Weinzierl (2011) https://scholar.harvard.edu/files/mankiw/files/exploration_of_optimal.pdf), so moving away from 2%/year as a target is not necessary. This leaves begging the questions of why, then, employment has been so low over the past decade and why production is still so low relative to our circa-2007 expectations.

The problem is not the 2%/year target but rather pressure on the Federal Reserve: pressure from substantial numbers of economists and politicians practicing bad economics and motivated partisan reasoning. (As an example, somebody sent me a video clip this week of the very smart Marvin Goodfriend half a decade ago, arguing that faster recovery required the Fed to hit the economy on the head with a brick to make people more confident in its willingness to fight inflation http://www.bradford-delong.com/2017/06/on-the-negative-information-revealed-by-marvin-goodfriends-i-dont-teach-is-lm.html.) This ignores the Fed’s long institutional history of being willing to ignore outside pressure as it performs its standard monetary policy task of judging what appropriate interest rates are. Pressure only mattered when we got into “non-standard” monetary policies, which we needed to do only because the low inflation target had caused us to hit the zero lower bound.

At 2%/year, inflation is non-salient: nobody worries about it. A higher inflation rate would bring shifting expectations of inflation back into the mix, distract people and firms from their proper task of calculating real costs and benefits to worry about monetary policy, and make monetary policy management more complicated. But right now people and firms are “distracted” by the high likelihood of depressions that last longer than five years. That is a much bigger distraction than worrying about whether inflation will be 4%/year of 5%/year. And right now the zero lower bound makes monetary policy management much more complicated than it was back in the 1990s when the impact of Fed policy on inflation expectations was in the mix.

The Federal Reserve needs to maintain its credibility, and if it were to even once change the target inflation rate, its commitment to any target inflation rate would have no credibility. But the credibility you want to have is credibility that you will follow appropriate policies to successfully stabilize the economy—not credibility that you will mindlessly pursue a destructive policy because you think it somehow wrong to acknowledge that the considerations that led you to adopt it in the first place were wrong or have changed. As my friend Daniel Davies puts it in his One-Minute MBA Course: “Is a credible reputation as an idiot a kind of credibility really worth having?” http://crookedtimber.org/2006/11/29/reputations-are-made-of/

Over to you, Joe…

* * * *

Answers to Questions: There is no unemployment rate target right now.

The Federal Reserve thinks about what the non-accelerating inflation rate of unemployment might be. But they claim not to have any strong view. They claim to be guided by the data, in terms of assessing how much pressure the economy can take. By contrast, the Federal Reserve had an informal inflation target of four to five percent per year in the late 1980s and early 1990s. And it then shifted down first, in the mid-1990s, to an informal target of two percent per year for the core PCE index under Alan Greenspan. It then formalized that under Bernanke in the late 2000. If they did have an unemployment rate target to talk about, we would be talking about that as well. But they don’t.

The question is a very good one. When I come write the economic history of the 2010s, I think that both Ben Bernanke and Janet Yellen are likely to be judged quite harshly. Once the recession of 2008-2009 had reached its end, the Federal Reserve had one overwhelming first priority: to create a strong enough economy that it could sustain short-term safe nominal interest rates of 400 to 500 basis points, and still grow at potential, in order that the Federal Reserve would have room to deal with the next recessionary shock when it came by conventional interest rate policy. The Federal Reserve did not prioritize that objective. Now here we are, late in a recovery, with short-term safe interest rates at 80 basis points or so, and with substantial fear that the economy is not robust enough to support any substantial rise over the time before the next severe recessionary shock hits. Indeed, an attempt to push short-term rates higher in the near future might well be such a recessionary shock.

The Federal Reserve has wedged itself into a position where it has almost no conventional monetary policy ammunition to deploy.

Let me say that the housing bubble did not blow up the economy. Let me say that the deflation of the housing bubble did not blow up the economy. As of the start of 2008, the housing bubble had collapsed, and all of the excess workers who had
been employed in construction had moved out and overwhelmingly found jobs in other sectors without even a small recession or more than a trivial rise in the unemployment rate.

But there was left in the bowels of the financial system the fact that the big money center banks had been playing regulatory arbitrage—claiming that the mortgage-backed securities they were holding were true AAA assets when they were nothing of the sort. It was this concentration of overvalued and mischaracterized assets in the highly leveraged money center banks that got us into big trouble, not the collapse of the housing bubble.

You can see this if you recall that the collapse of the dot-com bubble in 2000-1 took down about five times as much in the way of investors’ wealth as the collapse of the housing bubble took down the wealth of subprime lenders. And yet the 2000-1 bubble collapse did not cause a big recession. Why not? Because the people who took the hit were the rich equity investors in Silicon Valley, rather than the highly overleveraged money center banks that had decided to get a little bit too clever with how they characterized the assets they were holding.

Note that there are people like Larry Summers and Olivier Blanchard who are right now much more on now on Team Expansionary Fiscal Policy than on Team Raise the Inflation Target, in substantial part because of a desire to keep inflation non-salient and because our understanding of how bubbles are generated and what role ultra-low interest rates and quantitative easing play in generating them is very poor.

Let me underscore Jason’s point: Marvin Goodfriend is a potential future nominee to the Federal Reserve Board. Marvin Goodfriend has a remarkable aversion to and suspicion of quantitative easing. But has been very comfortable with the Federal Reserve’s interest rate management role.

When I have pitched this idea of a blue-ribbon examination of the proper inflation target in the past, what I have believed was my cleverest thought was to make Ben Bernanke and Larry Summers co-chairs, and make them in charge of figuring out where the rough consensus of—once again getting Thomas Aquinas on you—the greater and wiser part of the informed community of thinkers about this is.

I have to run to two pointless bureaucratic meetings. If you have any more questions, please email me at delong@econ.berkeley.edu, and if I can hide my phone keyboard and use my thumbs I will answer during the meetings, and if not I will answer as soon as I can afterwards.

And one thing I did not say: We have had four pieces of bad news in the past decade, all of which strongly argue against preserving the two percent per year core PCE inflation target. They are:

  1. bad news about the value of the Wicksellian neutral interest rate.
  2. bad news about the public sphere’s understanding of what the non-interest rate macroeconomic policy tools are and how to deploy them.
  3. bad news about partisanship—the solid opposition of the Republican Party to the policies of South Carolina Republican Ben Bernanke because it was thought they might redound to the benefit of Obama.
  4. bad news about the strength of non-standard stimulative monetary policies.

More References:

Rethink 2%

Posted on by Brad DeLong
3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

Rethink 2% http://populardemocracy.org/sites/default/files/Rethink%202%25%20letter.pdf:

Federal Reserve Board of Governors
Constitution Ave NW & 20th Street Northwest
Washington, D.C. 20551

Dear Chair Yellen and the Board of Governors:

The end of this year will mark ten years since the beginning of the Great Recession. This recession and the slow recovery that followed was extraordinarily damaging to the livelihoods and financial security of tens of millions of American households. Accordingly, it should provoke a serious reappraisal of the key parameters governing macroeconomic policy.

One of these key parameters is the rate of inflation targeted by the Federal Reserve. In years past, a 2 percent inflation target seemed to give ample leverage with which the Fed could lower real interest rates. But given the evidence that the equilibrium interest rate had fallen substantially even prior to the financial crisis, and that the Fed’s short-term policy rate remained at zero for seven years without sparking any large acceleration of aggregate demand growth, a reassessment of this target seems warranted. Such a reassessment is particularly appropriate when the lack of evidence that moderately higher inflation would harm Americans’ standard of living is juxtaposed with the tremendous evidence that a tighter labor market would improve Americans’ standards of living.

Some Federal Reserve policymakers have acknowledged these shifting realities and indicated their willingness to reconsider the appropriate target level. For example, San Francisco Federal Reserve President John Williams noted the need for central banks to “adapt policy to changing economic circumstances,” in suggesting a higher inflation target, and Boston Federal Reserve President Eric Rosengren cited the different context in which the inflation target was set in emphasizing the need for debate about the right target.[1] [2]

In May, Vice Chair Stanley Fischer highlighted the Canadian system of reconsidering the inflation target every five years, saying, “I can envisage–say, in the case of inflation targeting–a procedure in which you change the target or you change the other variables that are involved on some regular basis and through some regular participation.”[3]

The comments made by Fischer, Rosengren, and Williams all underscore the ample evidence that the long-term neutral rate of interest may have fallen. Even if a 2 percent inflation target set an appropriate balance a decade ago, it is increasingly clear that the underlying changes in the economy would mean that, whatever the correct rate was
then, it would be higher today. To ensure the future effectiveness of monetary policy in stabilizing the economy after negative shocks–specifically, to avoid the zero lower bound on the funds rate–this fall in the neutral rate may well need to be met with an increase in the long-run inflation target set by the Fed.

More immediately, new, post-crisis economic conditions suggest that a reiteration of the meaning of the Fed’s current target is in order. In its 2016 statement of long-run goals and strategy, the Federal Open Market Committee wrote: “The Committee would be concerned if inflation were running persistently above or below this objective.” Some FOMC participants, however, appear to instead consider 2 percent a hard ceiling that should never be breached, and justify their decision-making on that basis. It is important that the Federal Reserve makes clear–and operates policy based on–its stated goal that it aims to avoid inflation being either below or above its target.

Economies change over time. Recent decades have seen growing evidence that developed economies have harder times generating faster growth in aggregate demand than in decades past. Policymakers must be willing to rigorously assess the costs and benefits of previously-accepted policy parameters in response to economic changes.

One of these key parameters that should be rigorously reassessed is the very low inflation targets that have guided monetary policy in recent decades. We believe that the Fed should appoint a diverse and representative blue ribbon commission with expertise, integrity, and transparency to evaluate and expeditiously recommend a path forward on these questions. We believe such a process will strengthen the Fed as an institution and its conduct of monetary policy, and help ensure wise policymaking for the years and decades to come.

Yours,

Dean Baker
Laurence Ball
Jared Bernstein
Heather Boushey
Josh Bivens
David Blanchflower
J. Bradford DeLong
Tim Duy
Jason Furman
Joseph Gagnon
Marc Jarsulic
Narayana Kocherlakota
Mike Konczal
Michael Madowitz
Lawrence Mishel
Manuel Pastor
Gene Sperling
William Spriggs
Mark Thoma
Joseph Stiglitz
Valerie Wilson
Justin Wolfers

[1] John Williams, “Monetary Policy in a Low R-Star World,” August 15, 2016

[2] Sam Fleming, “Inflation Goal May Be Too Low, says Fed’s Rosengren,” Financial Times, April 21, 2015

[3] Greg Robb, “Fed’s Williams Backs Changing Central Bank’s Strategy to Price-Level Targeting,” Market Watch, May 5, 2017

Why the Fed Should Rethink Its 2%/Year No-Lookback Inflation Target

Posted on by Brad DeLong

Conference call today at 9:00 PDT/noon EDT on why the Federal Reserve would be very smart to abandon its 2%/year no-lookback inflation target for a less destructive policy framework. The call is to be moderated Shawn Sebastian. Then Josh Bivens will summarize his short whitepaper: “Is 2% Too Low? Rethinking the Fed’s Arbitrary Inflation Target to Avoid Another Great Recession” http://www.epi.org/publication/is-2-percent-too-low/. Jason Furman will talk about the evidence for the fall in the equilibrium Wicksellian neutral rate of interest and the implications of that for optimal monetary policy. I come next. Joe Stiglitz wraps up. And then questions from reporters.

My task is to set out what the arguments on the other side are—and why we do not find them convincing:

I hear four arguments for not changing the 2%/year inflation target, even though pursuing that target found us in a situation where monetary policy was greatly hobbled in its ability to manage the economy for a solid decade. And, as best as I can evaluate them, all four of these arguments seem to me to be wrong. They are:

  1. The Federal Reserve, even at the zero lower bound, has powerful tools sufficient to carry out its stabilization policy tasks (Cf.: Mankiw and Weinzierl (2011) https://scholar.harvard.edu/files/mankiw/files/exploration_of_optimal.pdf), so moving away from 2%/year as a target is not necessary. The response is: This leaves begging the questions of why, then, employment has been so low over the past decade, and why production is still so low relative to our circa-2007 expectations.

  2. The problem is not the 2%/year target but rather pressure on the Federal Reserve: pressure from substantial numbers of economists and politicians practicing bad economics and motivated partisan reasoning. (As an example, somebody sent me a video clip this week of the very smart Marvin Goodfriend half a decade ago, arguing that faster recovery required the Fed to hit the economy on the head with a brick to make people more confident in its willingness to fight inflation http://www.bradford-delong.com/2017/06/on-the-negative-information-revealed-by-marvin-goodfriends-i-dont-teach-is-lm.html.) The response is: This ignores the Fed’s long institutional history of being willing to ignore outside pressure as it performs its standard monetary policy task of judging what appropriate interest rates are. Pressure only mattered when we got into “non-standard” monetary policies, which we needed to do only because the low inflation target had caused us to hit the zero lower bound.

  3. At 2%/year, inflation is non-salient: nobody worries about it. A higher inflation rate would bring shifting expectations of inflation back into the mix, distract people and firms from their proper task of calculating real costs and benefits to worry about monetary policy, and make monetary policy management more complicated. The response is: But right now people and firms are “distracted” by the high likelihood of depressions that last longer than five years. That is a much bigger distraction than worrying about whether inflation will be 4%/year of 5%/year. And right now the zero lower bound makes monetary policy management much more complicated than it was back in the 1990s when the impact of Fed policy on inflation expectations was in the mix.

  4. The Federal Reserve needs to maintain its credibility, and if it were to even once change the target inflation rate, its commitment to any target inflation rate would have no credibility. The response is: But the credibility you want to have is credibility that you will follow appropriate policies to successfully stabilize the economy—not credibility that you will mindlessly pursue a destructive policy because you think it somehow wrong to acknowledge that the considerations that led you to adopt it in the first place were wrong or have changed. As my friend Daniel Davies puts it in his One-Minute MBA Course: “Is a credible reputation as an idiot a kind of credible reputation one really wants to have?” http://crookedtimber.org/2006/11/29/reputations-are-made-of/

Over to you, Joe…

Macroeconomic Policy Reform: A Tentative Agenda

Posted on by Brad DeLong

It was 24 years ago this week that Larry Summers and I warned that if we were to push the target inflation rate much below roughly 5%/year, then, in the immortal words of Dr Suess’s the Fish in the Pot:

“Do I like this? Oh, no, I do not. This is not a good game”, said our fish as he lit. “No, I do not like it, not one little bit!”

As I see it, if we want good macroeconomic business-cycle stabilization policy over the next generation, we need to do one or more of four things. I think the more of them we do, the better. And I want Summers and Bernanke to chair a commission this fall and winter to establish the order in which we should attempt to do these four things, and to start building the political and technocratic coalition to get them accomplished:

  1. Raise the inflation target when the economy has any chance of hitting the zero lower bound on short-term safe nominal interest rates–either by nominal GDP or price-level catchup targeting, or by raising the inflation target to 4%/year or so. The way to sell this is to say that the Fed has a dual mandate, that dual mandate requires tradeoffs, and that those tradeoffs are best accomplished via targeting recovery too and growth along a 6%/year nominal GDP growth path.

  2. Give the Federal Reserve the tools that it needs in order to properly manage aggregate demand. That means such things as:

    • Deciding by itself how it is going to use its seigniorage revenue, rather than returning its profits to the Treasury as a matter of course. (Yes, this is helicopter money.)
    • Funding mechanisms to support what ought to be state-level automatic stabilizers in a downturn–states should not be cutting construction and education and public safety spending when the economy as a whole is in recession, and thus when there is plenty of slack in the labor market.
    • More aggressive use of regulatory asset-quality and reserve-requirement tools as countercyclical policy instruments.
  3. Act to substantially reduce the risk premium on safe highly-collateralizable assets, both to repair a significant microeconomic financial market failure and to raise the medium-run equilibrium short-term safe real interest rate–the r*–in order to provide the central bank with more sea room on the lee shore it finds itself on. This requires operating both on the side of boosting market risk tolerance and expanding the supply of safe assets. This means moving beyond “government debt and deficits are always bad!” to “under certain conditions, the national debt of those sovereigns with exorbitant privilege that create safe assets when they issue debt can be a global blessing.”

  4. Reintegrate macroeconomic policy. Return forecasting from three separate exercises–the White House’s Troika (CEA-Treasury-OMB), Congress’s OMB, and the Federal Reserve–back to the Quadriad (Federal Reserve-CEA-Treasury-OMB) or on to a Pentiad (Federal Reserve-CEA-Treasury-OMB-CBO), with the principals to whom it reports being not just the President and the FOMC, but also the Majority and Minority Leaders of the Senate and the Speaker and Minority Leader of the House.

The argument against (4) is, of course, that the Fed needs to be insulated from the broader policy-political world because (a) the Fed can do the job by itself, and (b) having its elbow joggled by the policy-political world would only bolix things up. Well, the past decade has proven to us that (a) the Fed cannot do the job by itself, and (b) Fed “independence” does not keep the policy-political world from bolixing things up. The moment the Republican Party decided in January 2009 to go all-in in root-and-branch opposition to Obama, it necessarily also decided to go all-in in root-and-branch to policies pursued by Obama–which meant root-and-branch opposition to the Federal Reserve as well.

And certainly if we are not going to do (2), we definitely need to do (4).

Some very recent background reading:

Larry Summers: A Thought Provoking Essay from Fed President Williams:

John Williams has written the most thoughtful piece on monetary policy that has come out of the Fed in a long time…. He stresses the desirability of raising r* by pursuing structural policies to raise growth and affirms the importance of fiscal policy. I yield to no one in my enthusiasm for improved education and educational opportunity, but I do not think it is plausible that it will change the neutral rate appreciably in the next decade given that the vast majority of the 2030 labor force will be unaffected.

If Williams is overenthusiastic on education, he is under enthusiastic on fiscal stimulus.  He fails to emphasize the supply side benefits of infrastructure investment that likely enable debt financed infrastructure investments to pay for themselves as suggested by DeLong and Summers and the IMF.  Nor does he note at current interest rates an increase in pay as you go social security could provide households with higher safe returns than private investments…. Nor does Williams address the possibility of tax measures such as incremental investment credits or expansions in the EITC financed by tax increases on those with a high propensity to save.  The case for fiscal policy changes in the current low r* environment seems to me overwhelming….

Williams’s comments on monetary policy have generated more interest…. If the Fed believed that a 2 percent inflation target was appropriate at the beginning of 2012 when it believed the neutral real rate was above 2 percent, I cannot see any argument for not adjusting the target or altering the framework when the neutral real rate is very plausibly close to zero.  The benefits of a higher target have increased and so far as I can see nothing has happened to change the cost of a higher target. I am disappointed therefore that Williams is so tentative in his recommendations on monetary policy…. Moreover even accepting the current framework, I find the current policy framework hard to comprehend.  If as it asserts, the Fed is serious about the 2 percent inflation target being symmetric there is an anomaly in its forecasts….

Finally there is this:  Everything we know about business cycle history suggests an overwhelming likelihood that there will be downturns in the industrial world sometime in the next several years. Nowhere is there room to cut rates by anything like the normal 400 basis points in response to potential recession.  This is the primary monetary and indeed macroeconomic policy challenge of our generation. I hope it will be very much in focus at Jackson Hole.

Greg Ip: The Case for Raising the Fed’s Inflation Target:

Six years ago, Olivier Blanchard, then chief economist at theInternational Monetary Fund, floated the idea that central banks should target 4% inflation instead of 2%. I remember giving a colleague countless reasons why he was wrong. It was I who was wrong….

Last week John Williams, president of the Federal Reserve Bank of San Francisco, made the case for a higher inflation target in a bank newsletter. The subject will almost certainly be in the air when Fed officials and their foreign counterparts meet next week at the annual Jackson Hole symposium…. The historical case for low inflation rested on the assumption that high inflation created damaging distortions and more frequent recessions. Low inflation or deflation was a trivial risk because central banks could easily drive inflation higher by promising to print more money. But in 2008, central banks around the world cut interest rates to nearly zero and printed copious amounts of money, and only lackluster growth followed….

Here are my original objections and how they have changed.

  1. Central banks have invested their credibility in a 2% target. If they raise it, the public will assume they’ll raise it again, and expectations will rapidly become unanchored…. If anything, central banks are too credible: Investors seem to believe 2% is a ceiling, not a midpoint.

  2. As inflation rises, individual prices become more volatile, which makes the economy less efficient and more prone to booms and busts. This is still true, but against that we can see the harm from not being able to lower real (inflation-adjusted) rates further is much larger than anticipated. Meanwhile, the microeconomic harm of higher inflation is elusive….

  3. Since inflation is below 2% now and there are no new tools to get it higher, it will undermine central banks’ credibility to raise the target. Japan’s success in getting inflation back above zero, albeit not to 2%, suggests adopting a higher inflation target can bring a shift in expectations, and actions, that help make it happen.

  4. A higher inflation target makes real interest rates more negative, which would spur reach-for-yield and other speculative excesses. This is true but the alternative may be worse….

  5. What happened in 2008 was unique. Why change the target for something that happens maybe twice per century? Interest rates have been near zero now for more than seven years, and there is every reason to think similar episodes are going to happen again…. Williams sees ample evidence that deep-seated structural forces have dragged down the real natural interest rate—which keeps the economy at full employment without stoking inflation—from around 2.5% before the recession to 1% now. It may be lower….

John Williams: Monetary Policy in a Low R-Star World:

The inflation wars of the 1970s and 1980s led to a broad consensus on two fronts among academics and policymakers….

[Larry Summers and I warned]:

First, central banks are responsible and accountable for price stability… often acknowledged through… formal adoption of… inflation targeting…. Second, monetary policy should play the lead role in stabilizing inflation and employment, while fiscal policy plays a supporting role through… automatic stabilizers…. Fiscal policy should focus primarily on longer-run goals such as economic efficiency and equity….

In the post-financial crisis world, however, new realities pose significant challenges…. A variety of economic factors have pushed natural interest rates very low and they appear poised to stay that way…. Interest rates are going to stay lower than we’ve come to expect in the past…. Juxtaposed with pre-recession normal short-term interest rates of, say, 4 to 4½%, it may be jarring to see the underlying r-star guiding us towards a new normal of 3 to 3½%—or even lower…. Conventional monetary policy has less room to stimulate the economy during an economic downturn, owing to a lower bound on how low interest rates can go…. In this new normal, recessions will tend to be longer and deeper, recoveries slower, and the risks of unacceptably low inflation and the ultimate loss of the nominal anchor will be higher…. If the status quo endures, the future is likely to hold more of the same—with the possibility of even more severe challenges to maintaining price and economic stability.

To avoid this fate, central banks and governments should critically reassess the efficacy of their current approaches and carefully consider redesigning economic policy strategies to better cope with a low r-star environment…. Greater long-term investments in education, public and private capital, and research and development…. Countercyclical fiscal policy should be our equivalent of a first responder to recessions, working hand-in-hand with monetary policy…. Stronger, more predictable, systematic adjustments of fiscal policy that support the economy during recessions and recoveries…. Monetary policy frameworks should be critically reevaluated to identify potential improvements in the context of a low r-star…. A low inflation rate… is not as well-suited for a low r-star era…. The most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target…. Second, inflation targeting could be replaced by a flexible price-level or nominal GDP targeting framework….

We’ve come to the point on the path where central banks must share responsibilities. There are limits to what monetary policy can and, indeed, should do. The burden must also fall on fiscal and other policies to do their part to help create conditions conducive to economic stability…

Simon Wren-Lewis: Helicopter Money: Missing the Point:

I am tired of reading discussions of helicopter money (HM) that have the following structure:

  1. HM is like a money financed fiscal stimulus
  2. HM would threaten central bank independence
  3. So HM is a bad idea….

These discussions never seem to ask… why we have independent central banks (ICB) in the first place. And what they never seem to note, even in establishing (1), is that ICBs deny the possibility of a money financed fiscal stimulus (MFFS)…. Creating an ICB means that a MFFS is no longer possible… [because] it could only happen through ICB/government cooperation, which would negate independence…. Proponents of ICBs say… macro stabilisation can be done entirely by using changes in interest rates, so a MFFS is never going to be needed. Then we hit the Zero Lower Bound….

To then say no problem, governments can do a bond financed fiscal expansion is to completely forget why ICBs were favoured in the first place. Politicians are not good at macroeconomic stabilisation…. Demonstrating (1) does not, I repeat not, imply that ICBs do not need to do HM. Implying that it does is a bit like saying governments could set interest rates, so why do we need ICBs. Most macroeconomists would never dream of doing that, so why are they happy to use this argument with HM?

Which brings us to (2)… never… examined with the same rigour as (1)… just mentioning ‘fiscal dominance’ is enough to frighten the horses…. Imagine the set of all governments that would refuse a request from an ICB for recapitalisation during a boom when inflation was rising–governments of central bank nightmares. Now imagine the set of all governments that, in a boom with inflation rising, would happily take away the independence of the central bank to prevent it raising rates. I would suggest the two sets are identical…. HM does not seem to compromise independence at all. So please, no more elaborate demonstrations that HM is equivalent to a MFFS, as if that is an argument against HM…

Paul Krugman: Slow Learners:

Larry Summers has a very nice essay that takes off from a new paper by John Williams at the San Francisco Fed…. Williams is the highest-placed Fed official yet to suggest that maybe the inflation target should be higher. It’s not a new argument… but seeing it come from a senior official is news. Yet as Larry says, the paper is still weak and tentative even on monetary policy, to an extent that’s hard to understand…. Furthermore, there’s basically no break with orthodoxy on fiscal policy, despite the evident importance of the liquidity trap, evidence that multipliers are fairly large, and basically zero real borrowing costs. Yet Williams is at the cutting edge of policy rethinking at the Fed…. Mainstream thinking about macroeconomic policy has changed remarkably little, remarkably slowly.

You might say that it is always thus. But, you know, it isn’t…. Stagflation emerged as an issue in 1974, after the first oil shock, and pretty much ended with the Volcker double-dip recession of 1979-82–a recession whose end implication was that monetary policy continued to work in a fairly Keynesian way. So it was well under a decade of experience; yet it utterly transformed how everyone talked about macroeconomics.

Then came the 2008 crisis…. The sheer persistence both of depressed economies and of low inflation/interest rates should by now have led to a big rethinking. Depression economics redux has now gone on as long as stagflation did. Yet rethinking has been glacial at best. People who warned about the coming inflation in 2009 are warning about the coming inflation in 2016. Orthodox fears of budget deficits still dominate a lot of discourse. And the Fed still clings to an inflation target originally devised in the belief that the kind of thing that has happened to our economy would never happen.

I’m not entirely sure why learning has been so slow this time. Part of it, I suspect, is that the anti-Keynesian backlash of the 1970s had a lot of political power, and behind the scenes a lot of money, behind it–which influenced even academics, whether they realized it or not. And these days that same power and money is deployed against any rethinking. Whatever the explanation, however, it’s taking a painfully long time for serious policy discussion to arrive at a point that should have been obvious years ago.

Must-Read: Paul De Grauwe and Yuemei Ji: Animal Spirits and the Optimal Inflation Target

Posted on by Brad DeLong

Must-Read: Paul De Grauwe and Yuemei Ji: Animal Spirits and the Optimal Inflation Target: “Low inflation targets can cause economies to hit the zero lower bound during deflationary periods caused by even mild shocks…

…In such circumstances, central banks lose their ability to stimulate the economy. This column assesses the risk of this happening using a model that endogenises self-perpetuating optimism and pessimism in the economy. Given agents’ intrinsic chronic pessimism during times of recession, central banks should raise their inflation targets to 3 or 4% to preserve their ability to stimulate the economy when needed.

Must-Read: Narayana Kocherlakota: There Goes the Fed’s Credibility

Posted on by Brad DeLong

Must-Read: By now we can no longer understand the Federal Reserve Chair as needing to maintain harmony on a committee that has on it many regional reserve bank presidents who have failed to process the lessons of 2005-2015. By now all the regional bank presidents are people whom the Federal Reserve Board has had an opportunity to veto:

There Goes the Fed s Credibility Bloomberg View

Narayana Kocherlakota: There Goes the Fed’s Credibility: “The Federal Reserve promised to keep its preferred measure of inflation…

…close to 2 percent over the longer run…. Some would say that central banks are out of ammunition…. Actually, though, the Fed has been deliberately tightening monetary policy over the past three years. Just last week, Chair Janet Yellen made a point of saying that the Fed intends to keep raising interest rates in the coming months….

Would it have started pulling back on stimulus in May 2013 if its short-term interest-rate target had been at 5 percent instead of near zero, and if it hadn’t been holding trillions of dollars in bonds? I strongly suspect that the Fed would instead have added stimulus by lowering interest rates…. The Fed’s current course is driven not by the state of the economy, but by a desire to get interest rates and its balance sheet back to what is considered ‘normal.’ Savers, bankers and many politicians agree with this objective…. The Fed, however, promised to focus on actual economic outcomes….

Investors’ doubts [about the Fed] aren’t surprising, given the Fed’s focus on ‘normalizing’ interest rates rather than on hitting its inflation target. Such concerns will create an extra drag on the economy if and when bad times do come. In other words, the Fed’s willingness to renege on its promises seems likely to make the next recession worse than it otherwise would be.

Monday DeLong Smackdown: Kevin Drum Asks a Question About the Attainability of a 4%/Year Inflation Target

Posted on by Brad DeLong

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A very effective smackdown, I must say:

Kevin Drum: 4%/Year Inflation: “Generally speaking, I’m in DeLong’s camp…

…But here’s my question: what makes him think that the Fed can engineer 4 percent inflation right now? And what would it take? I ask this because it’s conventional wisdom that a central bank can engineer any level of inflation it wants if it’s sufficiently committed and credible about it. And that’s true. But my sense recently has been that, in practice, it’s harder to increase inflation than it sounds. The Bank of Japan has been trying to hit the very modest goal of 2 percent inflation for a while now and has had no success. Lately it’s all but given up. ‘It’s true that the timing for achieving 2 percent inflation has been delayed somewhat,’ the BOJ chief admitted a few months ago, in a statement that bears an uncomfortable similarity to the emperor’s declaration in 1945 that ‘the war situation has developed not necessarily to Japan’s advantage.’

So I’m curious. Given the current state of the economy, what open market operations would be required to hit a 4 percent inflation goal? How big would they have to be? How long would they have to last? What other extraordinary measures might be necessary? I’ve never seen a concrete technical analysis of just how much it would take to get to 4 percent. Does anybody have one?

I think the answer is: We don’t know whether it is in fact possible for a central bank today to hit a 4%/year average inflation target via conventional ordinary quantitative easing. It might well require other tools. For example:

  • Miles Kimball’s negative interest rates.
  • Helicopter drops–that is, allowing everyone with a Social Security number to incorporate as a bank, join the Federal Reserve system, and borrow at the discount window, with the loan discharged by the individual’s death.
  • The Federal Reserve as infrastructure bank–an extra $500 billion/year of quantitative easing buying not government or mortgage bonds but directly-financing public investments.
  • Extraordinary quantitative easing–buying not the close substitutes for money that are government bonds but rather the not-so-close substitutes that are equities.

I say: If we could win the argument about what the goal is, we could then begin the discussion about what policies would be needed to get us there.

Morning Must-Read: Barry Eichengreen: It’s Not a Savings Glut, It’s a Tolerance for Holding Risky Investment Shortfall

Posted on by Brad DeLong

Barry Eichengreen: It’s Not a Savings Glut, It’s a Tolerance for Holding Risky Investment Shortfall: “The data show little evidence of a savings glut….

It is plausible that the wealthy consume smaller shares of their income…. But to affect global interest rates, these trends have to translate into increased global savings…. A second explanation for low interest rates is a dearth of attractive investment projects. But this does not appear to be the diagnosis of stock markets…. Capital expenditure has been insufficient to prevent rates from trending down for more than three decades…. If the disorder has multiple causes, then there should be multiple treatments… tax incentives for firms to hire the long-term unemployed; more public spending on infrastructure, education, and research to compensate for the shortfall in private capital spending; and still higher capital requirements for banks and strengthened regulation of nonbank financial institutions…. Finally, central banks should set a higher inflation target…