Some assorted macro musings from the week
A Monetary Correction
Ramesh Ponnuru and I have a new article in the National Review where we make the contrarian case that monetary policy was actually tight over the past decade relative to its own inflation target and past trends in the growth of aggregate nominal spending. We note the following:
The economy seems largely to have adjusted to the new, lower pace of spending growth. The problem now is not that monetary policy is erring on the side of tightness and thus holding back the economy’s potential. It’s that the Fed’s apparent bias against letting spending and inflation drift higher, even temporarily, makes it more likely that the next economic downturn will again be severe and the next recovery will again be sluggish.
As evidence for our claim on a trend decline in the growth of nominal spending, we show the following figure:
Asymmetric Inflation Fears
I often chastise the Fed for effectively having an asymmetric 2% inflation target. The truth is, though, that the Fed's undershooting of its inflation target is mild compared to the asymmetric inflation fears many of financial commentators. When the CPI hit 2.1% last week the financial pundits began to freak out like it was the 1970s all over again. The Wall Street Journal OpEd shown below is a good example of this thinking:
Where was this concern when inflation was undershooting for so long? Recall that the official target of the Fed, the PCE deflator inflation rate, has been running about 50 basis points below its target for almost a decade. (Yes, the Fed was implicitly targeting 2% before 2012 so it has been a decade.)
Comments on January's FOMC Minutes
The January FOMC minutes came out this week and I had a few things to say about them on twitter. Below is a screen shot of my first tweet. I also did a quick write up of these points at The Bridge.
Israel Monetary Awesomeness Update
In the past some of us have pointed to the Bank of Israel(BoI) as a central bank that does flexible inflation targeting right. We noted that the BoI allows for truly flexible countercyclical inflation that on average hits its inflation target. It does it so well that nominal demand growth has been relatively stable. Below are a few pictures to illustrate this point
Consider first Israel's inflation rate, as measured by the GDP deflator. Since 2007, this inflation rate has moved in a countercyclical fashion. The BoI officially targets inflation within a range of 1%-3%, but has allowed inflation to touch 5% two times over the past decade when real GDP decline. It also has allowed inflation to fall when GDP has soared. Over this sample period, the GDP deflator inflation rate has average just over 2%. Imagine that: a symmetric inflation target over the business cycle!
As a result of this inflation flexibility, nominal demand has been relatively stable. Well done BoI. Here's hoping that some at the Fed are taking notice.
This week on the podcast I interviewed George Selgin. We discussed the difference between a corridor and floor system and what that means for the Fed. Among other things, we discuss how a floor system can create a liquidity-trap like situation above the ZLB, what a car in neutral can tell us about a floor system, and what we know about the legality of IOER. Take a listen.