Is Monetary Regime Change on the Way?

by Reihan Salam

Drawing on the work of Laurence Ball, we recently discussed how the economist Vincent Reinhart, at the time the director of the Federal Reserve Board’s Division of Monetary Affairs, might have played a major role in convincing Ben Bernanke to take a more cautious approach to monetary stimulus in 2003. In a recent interview with Bloomberg Surveillance, however, Reinhart made the case for changing course:

“The Federal Reserve should provide a conditional commitment that says as long as it is short of its goals it is willing to expand its balance sheet,” Reinhart, a former head of the Fed board’s Division of Monetary Affairs, said today. “What you want to be is conditional, you want to be able to say as long as the economy is not performing relative to what the Congress told you to do, you’ll continue to act.”

The Fed chief should say he recognizes that “the Federal Reserve is failing in both of its goals, maximum employment and stable prices, and that we’ll have an open-ended commitment to expand the balance sheet,” Reinhart said.

There are new indications that the Federal Reserve might embrace monetary expansion if the economy continues to falter, as Joshua Zumbrun and Jeff Kearns report:

Policy makers, who said in their Aug. 1 statement that economic conditions “warrant exceptionally low levels for the federal funds rate at least through late 2014,” discussed extending the duration for how long they will keep the main interest rate low, the minutes showed.

“It was noted that such an extension might be particularly effective if done in conjunction with a statement indicating that a highly accommodative stance of monetary policy was likely to be maintained even as the recovery progressed,” according to the minutes. The Fed has kept the rate at almost zero since December 2008. [Emphasis added]

This reminded me of Evan Soltas’s Bloomberg View post on monetary expansion and employment levels:

The best hope for faster job creation lies in monetary policy. In 2010 and 2011, the Federal Reserve was able to sidestep calls for more aggressive action because of a declining unemployment rate amid what was ultimately a feeble recovery. As the unemployment rate stagnates, there will be more pressure for more monetary stimulus.

Contrary to the insistence of the Fed’s more hawkish governors, there is considerable room for further monetary policy action without levels of inflation that would violate the Fed’s dual mandate. Given high unemployment and low capacity utilization, monetary expansion is likely to be met by growth in real production rather than increases in prices. That would be particularly true if the Fed chose not to launch a third round of discretionary quantitative easing but rather a rule-based policy, such as targeting the pre-recession growth path of nominal GDP.

One wonders if the advocates of NGDP level targeting are finally making headway.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.