Friday, February 23, 2018

Assorted Macro Musings

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.

Floors vs Corridors: Fed Edition
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.


  1. And yet Israel's unemployment rate has been quite volatile (peaking at 11% in 2004) and, as best i can tell, returns on capital have been subpar (judging by the equity index). So what exactly does NGDP targeting get you other than bragging rights about "avoiding recessions" (while burdening your population with inflation instead).

    1. I am focusing on the period when Israel was "doing it right" in terms of FIT, which I note in the post was from mid-2000s. During that time unemployment been heading down and the OECD shows a slightly positive output gap over much of the past decade. So, yes, the BoI is doing a comparatively good job. Also, monetary policy is not a cure all for the structure of the economy. It can't change trend return on investments. It can minimize the business cycle and it appears BoI has done that well.


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  2. Great post.

    I contend in the next recession, the argument will move to instruments.

    Oh, maybe we will have a 2.0% inflation target. If we are smart a 1% to 3% band. But how to get there? We will hit zero bound nearly on Day One of a recession.

    Stuffing banks with reserves and hoping they lend it out seems futile. (Especially if you slap on IOER).

    So...maybe we do QE plus federal deficits, which looks an awful lot like money-financed fiscal programs.

    Until the 198s, the Fed could buy bonds directly from the Treasury…another option. This process avoids all the reserves, commercials banks and primary dealers claptrap.

    Should the Fed have authority to buy bonds straight from the Treasury? I think so.

    1. Ben, you're proposing helicopter drops. Even those need to be tied to a target to make a difference. But yes, on your more general point, it will be interesting to see how monetary policy handles the next recession.

  3. I'm really impressed by the BoI. I've long been persuaded that NGDPLT was the right target, but I thought that the LT component was the key because I had some doubts that steady NGDP growth was possible. I learned too much Philips Curve 3 decades ago in college. I'm very glad to see that this can work year in and year out, not just over time.