In one of my recent podcasts, I chatted with AEI scholar and former Federal Reserve economist Stephen Oliner. While we mostly talked about US productivity, I also hit him with a few monetary policy questions on Janet Yellen, inflation, and market monetarism:
You’ve been less worried than some about [new Federal Reserve Chair] Janet Yellen being a super-dove who’s going to cause a return to 1970-style, high inflation. What makes you so confident?
So I believe that both based on personal experience working with her and observing the arguments that she made in FOMC team meetings and also from reading the many speeches that she’s given, I think she really has very little tolerance for inflation, notably above the Fed’s 2 percent target as does essentially every member of the FOMC.
I mean, they all recognize that the continued loose policies in the 1970s paved the way for the inflation that we had during that period, which was brought back under control only at great cost through the economy by Paul Volker. And none of them want that to happen again on their watch.
I mean, if there’s anything that unites the people on the FOMC it’s that inflation needs to be kept relatively close to target. What they disagree about is whether the underlying conditions in the economy, as they perceive them, so just there’s a lot or little inflation risk at any given point in time. It’s really not about tolerance for inflation, just whether the risk is high.
And when you view the economy right now, does this economy look like we’re about to see an outbreak of inflation?
Well, I think price inflation as we conventionally measure it, which is the goods and services that people buy, I’d say no. There’s really no sign of inflation in this economy that price indexes that the Fed looks at and that are published regularly all show inflation rates below their 2 percent target, some of them way below their 2 percent target. And I think, overall, there aren’t wage pressures either that would be worrisome and would be driving inflation higher. A lot of that is just that the world economy is still relatively weak and there isn’t a lot of push on inflation coming from demand worldwide.
So, no, I’m not really worried about what the inflation trends are right now, but of course the Fed needs to remain vigilant because they do plan to keep policy very accommodative and they need to be careful about those pressures are starting to build.
One last question I want to talk about, market monetarism, which is an update of Milton Friedman monetarism. There’s been some economists, such as Scott Sumner and a few others, who have said that the Fed should run monetary policy by targeting the level of nominal gross domestic product, total spending in the economy, not separating out inflation. And if we did that, you would have a much better macro environment. I’d love to get your thoughts on that idea.
So I think as a theoretical idea, it has a lot of merit. And I think many economists who aren’t necessarily associated with market monetarism as a school thought would agree that, as a theoretical idea, it has a lot of promise. I think the problem is in the implementation. So if a central bank targets nominal GDP, it means they are not specifically targeting either prices, they’re not targeting inflation, and they’re not specifically targeting real GDP. So the focus on keeping inflation near a target rate gets pushed to the back of the bus in a sense. And so I think the Fed will not go to a nominal GDP target, nor has any other central bank to my knowledge in the world gone to a nominal GDP target because they see it as risky from the point of view of maintaining inflation near target and maintaining credibility that they’re going to do that.
Because there could theoretically be periods in which you would have, you know, 4 percent inflation to hit that 5 percent NGDP target …
You could have that. And if it were possible to have the public continue to believe that inflation – the inflation target is going to be a target that will –eventually inflation will return to so there’s no loss of credibility, then I think I would be OK.
The problem is that once inflation starts to move away from targets, say it gets up to 3 percent, 3.5 percent and it doesn’t appear that any control is being provided by the central bank to bring it back, then I think you do risk un-anchoring inflation expectations. And once that genie gets out of the bottle, it can be very hard to get it back in. So I just don’t think the Fed is going to take that risk.
Some people say that they felt that the Greenspan Fed was almost doing de facto targeting of nominal GDP. Does that sound right to you?
I would say that in the second half of the 1990s, Greenspan was one of the early observers to recognize that productivity growth in the economy was really picking up. And he allowed the economy to run hotter than most others would have because he felt that the real growth potential of the economy was much greater, so nominal GDP could be relatively high. The growth could be fast without endangering their inflation objective. It wasn’t an explicit target at that point, but they had an objective. And he was right.
So I think it could be viewed as kind of backdoor nominal GDP targeting, but it didn’t really have – it wasn’t sold that way internally at the Fed. I think basically it was just potential GDP is going faster than we had thought. Let’s not lean against the economy when it really has more growth potential.
To focus on the NGDP targeting stuff, I actually found Oliner’s comments fairly supportive. of the idea. It really sounds like the issue is one of effective, persuasive communication. Business, consumers, investors need to know and understand what the Fed is doing and why it is doing it. It would also be helpful, I guess, if some other, smaller economy — or several — were (a) explicitly targeting NGDP as as proof of concept, (b) successfully did so over an entire business cycle.