Townhall’s Kevin Glass gives the nickel tour of AEI’s panel from last Friday, “Mend it, don’t end it: Revamping the Fed for the 21st Century.” One reason I held the panel, as Kevin points out, is to try and shift center-right views on the Bernanke Fed (make it more like the hawkish ECB!) and monetary policy. From my intro:
Many on the right – and to be fair, some on Wall Street and at the Fed itself — fear the Fed’s — in their view — extremely loose monetary policy will eventually create much higher inflation or dangerous asset bubbles. They also view the Fed as enabling Washington’s out-of-control deficit spending. While many libertarians and followers of Ron Paul would like the end the Fed, many congressional Republicans would be happy merely changing the Fed’s legal mandate to one that focuses soley on keeping prices stable. The Fed’s job is to keep inflation at 2% or so — and nothing more. And right now, the Fed – as they say on Twitter – “is not doing it right.”
At this point let me quote Oliver Cromwell who in 1650 wrote the Church of Scotland, making the following plea: “I beseech you, in the bowels of Christ, think it possible that you may be mistaken.”
The humble purpose of this panel today is to explore the idea that the current … consensus … center-right on the Bernanke Fed — and how to conduct monetary policy in general — may indeed be mistaken.
And we will attempt to do this through the lens of market monetarism, perhaps the first economic theory birthed by bloggers, albeit ones with PHDs in economics. Market monetarism is actually an update of the monetary policy theories of Milton Friedman. To broadly generalize, market monetarists argue the following:
– An overly tight Fed in 2008 turned a period of economic weakness or a mild downturn into the Great Recession, a minor replay of the Great Depression;
– Low interest rates are likely a sign monetary policy is too tight rather than too easy;
– The Bernanke Fed’s bond buying program, unemployment targeting, and new communications strategy have actually moved the central bank in the right monetary direction, toward a strategy of targeting the level of nominal gross domestic product.
And it is NGDP targeting that is central to market monetarism. Instead of directly trying to keep inflation stable and unemployment low, the Fed should instead announce its intention of taking whatever action necessary to maintain a long-run nominal GDP growth rate target.
This rules-based approach would create long-run economic certainty for business, investors, and consumers – and make it less likely the US would again suffer another severe recession or financial crisis.
The headline on Kevin’s otherwise fine piece is “Conservatives for the Federal Reserve.” Well, that’s not quite true.
1. As I mentioned above, market monetarists tend to think the Bernanke Fed blew it in 2008. Not only did the Fed leave rates alone between April 2008 and October 2008 as the economy deteriorated, but the FOMC “effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members. In May 2008, federal funds futures had been predicting the rate to remain at 2% through November. By mid-June, that forecast had risen to 2.5%.
2. If the Fed had adopted NGDP level targeting — or even the current policy with a better communications strategy — the Fed balance sheet likely wouldn’t be nearly as big today. As it is, the Fed’s current bond buying policy would be more effective if the central bank indicated how quickly it would like to pass its unemployment thresholds.
3. Maybe a better headline would be “Conservatives for a Federal Reserve” since I have little interest in dissolving the central bank. Rather, by adopting NGDP level targeting along with a peg to NGDP futures contracts, it is possible to recreate the Fed as a rules-based, market-driven institution better able to ensure a more stable macro background.