In a recent article for NR, David Beckworth and I looked back over the last ten years of monetary policy, arguing that the Federal Reserve has kept it too tight for most of that period. It should have kept the level of spending throughout the economy growing at a stable pace, as it had in the dozen or so years before the crisis, when spending grew at a relatively steady 5.3 percent per year. Instead spending fell during the crisis and then failed to recover to its previous trendline. Hitting the trendline would have required a few years of above-5.3 percent growth. Instead spending has risen by 3.7 percent per year.
In an informative post about the Fed’s latest meeting, Theodore Kupfer assumes that Beckworth and I want the Fed to pursue a looser policy now. We are actually agnostic on that question in the article, saying that it’s more important that the Fed commit to a sensible rule to guide its future policy than that it loosen or tighten policy now.
For much of the last ten years, any plausible rule would have counseled a looser policy. A Fed committed to a 2 percent inflation target, or to a dual mandate targeting both inflation and unemployment, or (as we’d prefer) to stabilizing nominal spending, would have followed a looser policy. But at this point, the case for more monetary expansion is a lot weaker than it was then. As we suggest in the article, it’s not clear that the Fed is holding the economy significantly below its potential by keeping monetary policy overly tight.
As we also comment, by this point the economy has largely adjusted to the new, lower rate spending growth. Spending growth during the recovery has been even more stable than it was pre-crisis. It no longer makes sense to try to return to the pre-crisis trendline. It would be better for the Fed to keep us on the current one, and commit to keeping us on it—and to getting back to it quickly in the event of a future dip.