A slightly off-center perspective on monetary problems.
One thing that drives me nuts about my fellow economists is that they are always taking about monetary policy like it’s some sort of “tool,” which can be used to fix economic problems. You can almost imagine policymakers rummaging through a toolbox, deciding whether to take out a tool labeled “MP” or a tool labeled “FP.”
That’s completely wrong. If there is some sort of policy that you think needs fixing via monetary policy, then you have the wrong monetary policy regime. You are targeting the wrong variable. Thus you might (wrongly) decide it’s a good idea to target headline inflation at 2%, and then suddenly notice that that target conflicts with your gut instinct that unemployment is too high because of inadequate AD. In that case the right decision is not to pull out the monetary policy tool, but rather to entirely abandon your inflation targeting regime. If you have the right regime, then YOU SHOULD NEVER, EVER, ADJUST MONETARY POLICY.
For instance, in 2003 Ben Bernanke said NGDP is a good indicator of the stance of monetary policy. Now suppose the Fed decides to target NGDP along a target path growing at 5% per year (i.e. level targeting.) In that case, under no circumstances should monetary policy ever be adjusted. It should always be set in exactly the same way, a policy stance expected to produce on target NGDP growth. If unemployment is too high despite that target, and you think the target is appropriate, then the solution is not to adjust monetary policy or to do demand-side fiscal stimulus, rather you’d want to do labor market reforms.
As we saw in the previous post (actually two posts back), if you do sensible monetary policy then the policy won’t look like a tool. You won’t see monetary policy fixing problems. If you see cases where policymakers seem to be using monetary policy as a tool, they are not fixing problems, they are using monetary policy in the way an arsonist uses gasoline–they are causing the problem that (from the perspective of outside observers) they seem to be trying to fix. Like that fireman who set fires so he could look like a hero putting them out.
Monetary policy should be boring, as it is in Australia; not exciting, as it is in the US and Japan. Most of my readers think I am advocating use of monetary policy as a tool. Most think I want it to be exciting. Nothing could be further from the truth.
PS. The Fed has been consistently coy about the question of whether they are missing their target, or whether 2% inflation is the wrong target. You can find plenty of Fed statements to support either interpretation. They create this ambiguity to deflect criticism, and they have successful fooled the press, Congress, and most economists.
PPS. I don’t doubt that I am guilty (in previous posts) of the same things I criticize others for here. I’ve probably referred to monetary policy as a “tool.”
PPPS. Off topic, but my “job-filled non-recovery” theme seems to have become trendy. Here’s Matt Yglasias:
The hot new topic to address this week is that in the early months of 2012 we appear to be witnessing the reverse of a “jobless recovery,” an economic growth cycle in which the increase in gross domestic product is not large enough to justify the quantity of net job creation.
Here’s a post I did on December 2nd, and another on February 3rd, on the same issue.
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14 Responses to “Monetary policy should NEVER be used to solve problems”
Scott, yes but this only works if you have the perfect regime, which will be true for any policy system.
We would never have to “fix” a foreign policy problem if we always had the right foreign policy regime. We would never have to fix a health care problem if we have the right health policy regime.
The precise reason one has problems – that is bad things for which effective corrective action can be taken – is because the regime does not automatically adopt the proper stance.
Now you may argue that an NGDP futures market with Fed targeting would be such a regime, but it is clearly not the regime we have now.
When will Scott Sumner break out the dreaded PPPPPPS
WINNER!!!!! Morgan WINS!!!!!
Finally, after two god damn years, Scott FINALLY writes a paragraph the furthers the debate in a way that liberals can no longer find solace in what Sumner writes….
“For instance, in 2003 Ben Bernanke said NGDP is a good indicator of the stance of monetary policy. Now suppose the Fed decides to target NGDP along a target path growing at 5% per year (i.e. level targeting.) In that case, under no circumstances should monetary policy ever be adjusted. It should always be set in exactly the same way, a policy stance expected to produce on target NGDP growth. If unemployment is too high despite that target, and you think the target is appropriate, then the solution is not to adjust monetary policy or to do demand-side fiscal stimulus, rather you'd want to do labor market reforms.”
Attention all ye children gather round and let Uncle Morgan clue you into what this means:
NOW we are down to one calculation / discussion point
What is the NGDP level target? And that is really just a short term question, in the end all roads lead to Rome.
BUT, starting with a lower one forever more, will put tighter immediate screws to liberals, and we like that.
BUT, since “opportunistic disinflation” onward, it has been 100% obvious, we have had a Fed that was determined to get inflation under 2% over the long term and keep it thtere.
They announced it, we knew it. Selah.
So we’re <2% on inflation with an expectation <3% RGDP, so we settle in on:
4 or 4.5% NGDP.
—-
Now that Scott has said that once we lock down, NGDP… "If unemployment is too high despite that target, and you think the target is appropriate, then the solution is not to adjust monetary policy or to do demand-side fiscal stimulus, rather you'd want to do labor market reforms."
We know what the Fed today REALLY means:
1. screw Obama 2. the government needs to crush public employee unions. 3. the government needs to drill baby drill. 4. and generally, the government need to act like my ilk are poking it with hot irons whenever it slows down on the path to becoming AntiDeKrugmanistan
It really does help to just think of what happens:
1. if in 2003 we adopt 4.5% level. 2. we follow Scott's very demanding paragraph.
It is unarguable. the effect is no houses for bad credit risks, and no raises for public employees – and that means everything today is FINE.
All blame flows to Democrats where it belongs.
Scott 1. I wonder what the hell all the conferences and papers on MP at low inflation were good for. In one of the very first Bernanke presented his now(in)famous “Self-induced paralysis” paper. 2. Ezra Klein in a Wonkbook piece today also discusses the “job-filled non recovery”. I´ve estimated a post (Korean) war Okun “Law”. Preliminary comments: (a) 1984 and 2009 are on the regression line in opposite extremes. (b) There´s nothing “special” about 2010 (very close to the regression line). (c) 2011 is what´s “bugging” Yglesias and Ezra. It´s far below the regression line (growth much lower than the “recommended rate”). An equivalent “error” was noticed in 1974 (first oil shock time). But unemployment rose quite a bit in 1975 (delayed effect?) and the “error” “symetrically” jumped to the other side of the regression line.
"Conventions around dead people are ridiculous. The world outlook is slightly improved with @AndrewBrietbart dead."-Matt Yglasias
Monetary policy should be boring, as it is in Australia
Ha, that’s a good one! Check out any Australian online newspaper at 3pm on the first Tuesday of each month (the RBA announces its rate decisions at 2:30pm). I guarantee you that the cash rate will be the top story. This is mainly because most people are on variable-rate mortgages and those rates vary closely with the RBA’s cash rate. The Fed’s decisions may be interesting to Fed-watchers, but the RBA’s decisions are followed by just about everyone in Oz.
“The Fed has been consistently coy about the question of whether they are missing their target, or whether 2% inflation is the wrong target. ”
I find quite a lot of people who think that the 2% inflation target is a ceiling, not a target. Do some on the Fed think that way?
Morgan,
I don’t know what drugs you’re on, but they are dangerous.
Rajat,
Knowing your comments over at ricardianambivalence.com, I suspect you know that Scott means by Australia having boring MP.
TBH all the hysteria re cash rate decisions is a bit, well, hysterical. The impact on average mortgage is so minor, that it should be irrelevant. To mix metaphors: at 25bps rise means fewer milkshakes, not less schooling for your kids. If someone finds themself in the latter situation, then they are too dumb to be prudent and deserve the pain.
This is a great post.
When I think about this issue, I take it a little farther to look at MV=PY like it isn’t just a monetary theory, just like Friedman wasn’t just an economist, although it can be viewed that way. In everything he did, he preached MV=PY even though he wasn’t saying it quite that way. I don’t know if you’ve ever seen the video of Friedman admitting that he was once a socialist, and he talked about why he felt that way and what changed his mind. It’s worth watching if you haven’t seen it. I will try to find the link for those who might be interested, otherwise I stumbled on it on YouTube if you feel like searching.
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