Great Post on Monetary Policy
Blog friend The Everyday Economist has a great post up yesterday that I would highly recommend.
It's a serious look at monetary stability and the plusses and minuses of different targets for Central Bankers. It is certainly accessible to any bright person irrespective of economics training and gets nicely to the heart of an under-discussed topic: what are the goals of central bankers?
EE got me hooked up with Bernanke's textbook, and I remain very comfortable with the idea of inflation targeting. I think the problem with the FOMC is the so called "dual-mandate" to target price stability and employment. I think a firm commitment to inflation would be sufficient. EE makes some good points for income targeting and I wouldn't object. But I think the problem is more the dual mandate which contains an intrinsic acceptance of the Phillips Curve rather than any difference between a price and income target.
Do yourself a favor and read the whole thing.
Economics and Markets
Posted by John Kranz at May 13, 2009 12:33 PM
Whew. I'm not sure that word "accessible" means what you think it means.
But consider this: "Scott Sumner believes that we could have avoided the recession and simply experienced a burst of the housing bubble had we followed a nominal income target. I actually think that we might not have even had a housing bubble if we had a nominal income target (that allows for falling prices)." Alternately, could we have avoided both the recession AND the housing bubble with JK's October 1, 2008 'first, do no harm' prescription of government anti-meddling? [Like anti-matter, we can imagine it but can't seem to find it.]
"If you get the time machine and can go back, Terminator style, to fix our current problems, I would suggest:
1. Rein in Fannie Mae and Freddie Mac. Set the way-back machine far enough to prevent their birth if you can, but at the very least pass the reforms that President Bush and (some) GOP legislators proposed in 2004 and 2005. Cut their leverage in half and you cut the current mess to a fourth.
2. Get Andrea Mitchell to dope Greenspan's tea and get him to raise rates to at least 2% before handing the reins over to Princeton Boy.
3. Strangle mark-to-market accounting in the crib. Bank regulation makes accounting a legal endeavor. These rules are too harsh and give short sellers too powerful a tool to take a bank down.
4. Laugh the Community Reinvestment Act out of Congress. Do not require banks to make bad loans, they seem to do pretty well on their own.
Get halfway there on all of those and there's no panic."
Whew. I'm not sure that word "accessible" means what you think it means.
But consider this: "Scott Sumner believes that we could have avoided the recession and simply experienced a burst of the housing bubble had we followed a nominal income target. I actually think that we might not have even had a housing bubble if we had a nominal income target (that allows for falling prices)." Alternately, could we have avoided both the recession AND the housing bubble with JK's October 1, 2008 'first, do no harm' prescription of government anti-meddling? [Like anti-matter, we can imagine it but can't seem to find it.]
Posted by: johngalt at May 13, 2009 1:42 PMjk,
Thanks for the link. Also, it is somewhat ironic that I got you hooked on Bernanke's inflation targeting book when I am now unconvinced with that approach. However, there are elements of inflation targeting that I like. For example, the explicit goal allows the market to understand what the central bank is going to do as well as giving it the ability to evaluate whether or not they are successful.
The reason that I favor the nominal income target is because an exclusive focus on inflation can be misleading (perhaps I should write a post on that). What's more the nominal income target also serves to satisfy the dual mandate -- and without the inflationary bias.
JG,
Sorry.
In all seriousness, Sumner's point is basically that we could have avoided the recession in spite of the bursting of the housing bubble. I am not convinced that this is the case.
I will echo your point that government policy has not been anywhere close to ideal (see here, here, here, here, and here).
[Shameless plugging!]
Posted by: EE at May 13, 2009 2:46 PMI'm a serious skeptic on that one too, EE. Not only is housing a high value segment of the economy, it was (necessarily) tightly coupled with financial markets and institutions.
I'll leave serious critique of inflation vs. income targeting to Perry but what irks me about inflation targeting - as I understand it, the Fed manipulates the money supply to maintain a small positive rate of inflation in order to promote stability and prevent recession - is that the rate of inflation acts as a fee for the priviledge of using the currency. The collector of the fee is the issuer of the currency (the Federal Reserve Banks) and it amounts to a profit at the expense of the entire dollar based economy.
Am I off base here?
I'm not opposed to private business making a profit, except when it is a government protected monopoly. How about "Federal Reserve Dollars" competing with "Halliburton Dollars" and "General Electric Dollars" and "Uncle Eric's Gold and Silver Backed Dollars" none carrying the backing of the United States government?
Posted by: johngalt at May 13, 2009 3:15 PMjg,
You are correct in your critique of central bank-issued currency in that it generates revenue for the monopolist issuer. However, I don't know whether that fee is substantial enough to be my primary concern. I would prefer zero inflation, or more appropriately falling prices in a growing economy. For an accessible, yet thorough discussion of this view, see here:
http://www.cato.org/pubs/journal/cj28n3/cj28n3-1.pdf
This type of outcome can be accomplished using a nominal income target or through the method that you proposed -- free banking. I think that there is much to like about free banking. If you have a keen interest in this topic, I would recommend George Selgin's text, The Theory of Free Banking, and also his recent interview with the Richmond Fed.
Posted by: EE at May 13, 2009 3:29 PMI feel a bit hoist on my own petard with JG's quote. I'll stand behind it as a way to avoid the panic. But I'd have to swap #2 with #1 and admit that Inflation Targeting generally allowed the Greenspan Fed to provide easy money without setting the trip wires.
On free banking: I'm sorry gents, but Mister Hamilton's train left the station a couple hundred years ago. Perry and Josh will laugh that I root for Taney and Jackson against Nicholas Biddle when I read history, yet I get less excited about "fiat money" than any other guy in the land with a subscription to Reason.
I'll have to read more on income targeting, but I am concerned that it would have squeezed the life out of the 1990s expansion. Near and dear to my geeky, technological heart is the belief that the Internet bubble was an unalloyed good. I'll trade a brief and shallow 2001 contraction for the fruits of the dot-com days any day of the week.
Posted by: jk at May 13, 2009 4:04 PMjk,
Jackson is the hero in that story.
I'm am not sure why you think that a nominal income target would have restrained the 1990s boom. If real GDP is growing because of changes in productivity as it was during the 1990s (which I know will come as a shock to those on this blog who think that it was the Clinton tax policy), prices would fall. Thus, suppose that the nominal target is 3%. If rising productivity causes output to rise and prices to fall, you could have real GDP growing above the nominal target rate.
Again, Selgin's work is excellent on this point. This monograph specifically.
Posted by: EE at May 14, 2009 3:01 PM | What do you think? [6]