Former Federal Reserve Chairman was on CNBC’s The Kudlow Report last night promoting his new book, The Map and the Territory. After Greenspan and host Larry Kudlow discussed whether the US economy needs more inflation, Kudlow asked Greenspan about market monetarism, which advocates the Fed target the level of nominal GDP as a way of better meeting its dual inflation-employment mandate — even if that means inflation sometimes rises above the Fed’s 2% target. Here is the exchange:
Kudlow: You’ve got a school of thought, Alan, they call themselves market monetarists, who believe the mistake the Fed has made is that they should be targeting nominal GDP and that would give us the [economic] uplift. What do you think of that?
Greenspan: None of these mechanisms work. We’ve tried them all. I was there for 18 1/2 years. We looked at them all. The difficulty is that the markets are driven by forces which central banks only have a limited amount of capability of controlling. And what concerns me mostly is that when you start talking about maneuvering the inflation rate, it’s very difficult. And as you point out, the central bank has flooded the economy with liquidity. What has happened to the liquidity? It’s gone nowhere. Just look at the balance sheets. You have a very significant increase in central bank expansion, and a very large increase in commercial banks holding of excess reserves. But they’re holding those excess reserves with no capital charge, and they’re getting 25 basis points free for holding something which is hypothetical on their balance sheet. …
And the question basically is how long [are those reserves] going to stay there? [They] will stay there so long as the economy remains in the doldrums. as soon as the economy starts picking up, then you get that – those excess reserves relent into the marketplace and the usual money multipliers begin to take hold. That’s your inflation. That’s your inflation risk, anyway.
1. As economist Scott Sumner has said frequently, “No fiat money central bank has ever tried to inflate and failed. And that includes the Fed.” You can’t believe both a) current Fed policy has huge inflation risks and b) that it can’t boost inflation. That is cognitively dissonant.
2. Greenspan obviously thinks his Fed tenure a successful one. Here are Fed minutes of Greenspan in 1992, where he seems to suggest that the Fed is targeting NGDP:
As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions. I would say in that context that on the basis of the studies, we have seen that to drive nominal GDP, let’s assume at 4-1/2 percent, in our old philosophy we would have said that [requires] a 4-1/2 percent growth in M2. In today’s analysis, we would say it’s significantly less than that. I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that.
I really can’t reconcile this evidence of what the Greenspan Fed did — or thought it was doing — with Greenspan’s CNBC statements. He also seems to ignore how clear NGDPLT rule could anchor inflation expectations.
3. Here is a paper from Josh Hendrickson suggesting the Greenspan Fed was implicitly targeting NGDP.
4. And as Sumner has pointed out, the actual growth in NGDP between 1990 and 2008 was just over 5%, only slightly above the 4.5% figure. And NGDP never strayed very fall from that 5% trend line until 2008. An interesting coincidence.
5. Greenspan doesn’t seem to think QE bond buying has had much effect given the high level of bank reserves. (At the same time, he doesn’t think the stock market bubbly.) But he ignores other transmission channels. QE — although it would be more effective if done is concert with an NGDP level targeting rule — might also boost growth through higher asset prices and through expectations. In addition, Greenspan ignores the counterfactual situation of no QE. Michael Darda, chief economist at MKM Partners:
… if banks want to hold reserves and households want to hold cash, the central bank has to satiate this demand to prevent a deflationary slump. That is basically what the Fed has done. Slow, steady growth is the result of the Fed only partially offsetting a huge velocity (demand for money) shock. Had they done less the slump surely would have been worse.
So I think the good chairman gets it wrong here, though I would love to explore further the issue with him. Maybe I will try and book him for my weekly Ricochet podcast.
Follow James Pethokoukis on Twitter at @JimPethokoukis