Alarmed by the enormous discretion the Federal Reserve has to set monetary policy, and often disagreeing with the way it has used that discretion, some congressmen want to pass new legislation to narrow its mandate. Right now it is empowered to do what it can to achieve both price stability and full employment — but how it makes trade-offs between these goals, and how it seeks them, are left unspecified. Setting a rule that both limits the damage that the Fed can do and establishes democratically determined guidelines for one of the government’s most important policies is undeniably attractive. But whether legislation would make the situation worse or better depends entirely on what rule it imposes.
The best rule would force the Fed to try to stabilize total current-dollar spending or nominal GDP around some targeted growth path. For example, it could target a 5 percent yearly growth rate in nominal GDP. That target would, on historical patterns, result on average in 3 percent real economic growth and 2 percent inflation each year. This approach, called nominal-GDP targeting, has become increasingly popular lately because of the economic crisis. Even the Federal Reserve discussed it during its September 2010 meeting.
Advertisement
The appeal of nominal-GDP targeting comes from its simplicity, its appropriate focus, and its ability to enhance long-term certainty.
The simplicity of this approach can be illustrated by considering how the Federal Reserve would have responded to the sharp downturn of 2008–09 had it been targeting nominal GDP. During this time, the financial system was in distress and, as a result, there was a rush for liquidity. The rise in demand for highly liquid assets meant less spending and a drop in economic activity. Had the Federal Reserve been targeting nominal GDP at this time, it would have provided enough liquidity to fully offset the spike in liquidity demand. Such a response would have stabilized actual and expected nominal-GDP growth in 2008–09 and prevented the collapse of the economy. It is that simple.
Some may object that nominal-GDP targeting could not have prevented the 2008–09 crisis, because it was the beginning of a deleveraging cycle. According to this view, such “balance-sheet recessions” simply are not amenable to monetary-policy fixes. This understanding, however, fails to recognize that for every debtor who is cutting back on spending there is a creditor receiving money payments. Creditors should have increased their spending to offset the decline in debtor spending. They did not, because their expectations of economic activity were allowed to worsen, something that would not happen with a nominal-GDP target that anchored spending expectations.
A nominal-GDP target focuses monetary policy appropriately because it responds to spending shocks only. To see this point and its importance, imagine that a new technology makes computers much faster. This productivity-enhancing supply shock would create disinflation. With a nominal-GDP growth-rate target of 5 percent, this shock might temporarily result in 5 percent real economic growth and 0 percent inflation. In contrast, a rigid inflation target of, say, 2 percent in conjunction with the 5 percent real economic growth would require 7 percent nominal-GDP growth, or a potentially destabilizing surge in spending. Better to ignore the supply shock and allow the temporary disinflation than to have a boom in spending.
Now consider a super-virus that temporarily shuts down most computer systems. This negative supply shock would decrease productivity and increase prices. This might, for example, result in 0 percent real economic growth and 5 percent inflation. Here, a 2 percent inflation target would require a tightening of monetary policy that would further constrict an already weakened economy. A Federal Reserve that was targeting nominal GDP would not face this dilemma. It would simply keep total current-dollar spending stable at 5 percent growth and allow the supply shock to work itself out.
Nominal-GDP targeting also enhances long-term certainty by communicating clearly to the public the long-run trend for spending. Thus, if spending actually falls by 2 percent one year, then the following year the Fed would have it grow by 12 percent to get it back on its 5 percent growth trend. This feature would create spending expectations that would automatically tend to keep nominal GDP on trend. Spending shocks like the ones in 2008–09 would therefore be less likely to occur.
The Fed could reasonably be held accountable for this policy, which asks it to pick one target. But that target is well chosen, since hewing to it provides a stabilizing influence on both inflation and real economic growth (which sum up to nominal-GDP growth). If Congress really wants to narrow the Federal Reserve’s mandate, it should consider nominal-GDP targeting.
— David Beckworth was formerly an economist with the U.S. Department of the Treasury and is currently an assistant professor of economics at Texas State University.
Monetary policy is nothing more than the tail trying to wave the dog. It does not work. The Fed should only respond to short term liquidity needs and work hard to keep the monetary supply stabilized. It shouldn't be trying to move the economy because it can't. It can only create bubbles -- and it's very good at doing that.
Inflation is a bane and it's mostly caused by our idiot government and the fed. Target GDP growth? Seriously? The Fed and government have nothing to do with real GDP growth. The both can only hamper that. The Fed shouldn't target anything of the kind because it has no bullets for that kind of game.
Go back to your university and prattle on to your like minded academics and leave the real world to people how actually live in it.
The Fed's mandate is to avoid deflation, that is why it was created. It's been very successful. Having eliminated the deflation half of the cycle has left us with chronic inflation. For over a century. And it hasn't eliminated the business cycle. Nor, obviously, financial busts. It's the FDIC that eliminated bank runs. So far. If a run on the dollar starts, though ...
Pull this lever, turn this knob, and prime that pump! Credit, credit, and more credit! Yes, more liquor in the punch bowl is what we need! After all, the party isn't wild enough with the strippers, cuban cigars, LSD, and cocaine, we must have more punch!
Monetarists are all the same Keynesian, yet just by another name. Neither understand John Maynard's true economic principles of government should save money in the good years, to be able to inject the savings in a downturn to take up the slack of spending by the private sector in a non-money fueled inflation like the one that Mr. Beckworth advocates for.
The mere fact that Mr. Beckworth would consider making the Fed's mandate to litterally manipulate the already manipulated GDP number, goes beyond anything that is liberty minded, and down and outright imposing of tyrannical control of the money supply. Carte blanche to actually cajole the money supply into a permanent "mark to fantasy" of the entire economy would enslave the entire country into a debt prostitute lifestyle. Strong words, I am aware, but nessecary when combating idiot wonks who think the right people and right policy will fix our problem.
Errrrnt, wrong! Sorry, no policy will work until the actual free market wins out, debt defaults happen, credit write-offs and write-downs occur, and we can actual figure out the non-manipulated price of goods, services, and commodities. Besides, with every expansion in the monetary base by the Federal Reserve, we have ALWAYS seen a dramatic rise in the price of oil, accompanied shortly thereafter by a prolonged recession / stagnation. Meaning, even the Fed can't fight the Austro-Hungarian economic cycle.
Meddlers work in Washington, because they only know how to meddle. Wonks work for meddlers because the wonks have the brains the meddlers wish they could have to provide the logistics to implement their ends. Of course, the means are one in the same, the people.
There is no such thing as a "business cycle". All booms and busts that are not caused by natural disasters or war are caused by the Fed.
Deflation is actually OK for those of us with savings. It really hurts the government and others with lots of debt though. The government wants to maintain inflation because it lowers the real value of what they have to pay back on the loans. It's a stupid policy, but is perpetuated by selling myths like inflation is
How can it be relied upon that the correct statistics will be gathered so the fed will grow the GDP at a five percent nominal rate? As Mises wrote in _Human Action_, economic analysis that relies upon econometric data like GDP that is nothing more than an arbitrary model and not reality is fundamentally flawed. Setting a fixed amount of dollars to grow would be much more prudent as it would not be subject to the manipulations of statisticians or economists.
The Fed is a for profit institution created outside real government control for the benefit of its stockholders. Who are the stockholders? The American people? No. The stockholders are the big Fed banks.
The reason we have so much debt is because our money system is debt - Federal Reserve Notes. All the incentives are aligned to create tons and tons of debt because ultimately it benefits the guys holding the debt. It is the perfect scheme.
I highly recommend readers watch Money as Debt 2 Promises Unleashed at : External Link If you want to understand why DC is so insane you have to understand the money system and the perverse incentives it creates to grow government and debt at every level.
If conservatives don't understand the money system, they are doomed to lose a grinding political war because the Fed and its protectors on the Left and Right can print the money it needs to pay off whoever it needs to buy the votes in Congress.
Why is it that Ron Paul is the only guy out there talking about the money system and everyone else just lays down and takes what is given? The root power of socialism is the power of the central bank and its ability to redistribute the wealth of the middle to the government and then to the bankers. If we don't take out the power source, we are doomed to lose.
