George Schultz and John Cogan, two eminent scholars at the Hoover Institution, argue in the Wall Street Journal that the first criterion for a new Fed chairman is someone who recognizes that our economy is capable of higher growth:
The next leader of the Fed must recognize this potential for higher productivity and be willing to establish a monetary policy that accommodates a faster-growing economy. He must not mistake more-rapid economic growth for an overheated, inflation-prone economy that needs cooling off. A Fed that made such a mistake would only perpetuate the slow-growth, low-productivity, stagnant-wage economy of the past decade.
I assume that an example of what they have in mind is that the Fed should not see wage gains as a sign of incipient inflation that calls for higher interest rates, but instead see them as a sign of higher economic growth that does not require a monetary response at all. Similarly, higher-than-expected economic growth should be seen as an increase in our potential rather than as a sign of “overheating.”
One of the advantages of a monetary rule that seeks a stable growth path for nominal spending is that it has the properties Schultz and Cogan seek. Say the Fed is targeting 4 percent nominal-spending growth over a year, and expects 2 percent inflation and 2 percent real economic growth. If productivity rises, the Fed can stick to the 4 percent target — neither restraining the economic boom, as the authors say the Fed should avoid, nor trying to feed it. Only the composition of nominal spending will change. If the Fed hits its target, inflation will come in below 2 percent and real growth above 2 percent.
Even better, the Fed does not have to be able to predict whether the economy will be growing at 1, 2, or 3 percent in order to implement the rule. It does not have to determine exactly why wages are rising (when they are rising). It does not have to know whether inflation is falling because of productivity improvements or sagging demand. In that way, a nominal-spending target accounts for the knowledge problem that afflicts all monetary policymakers. And it makes for a monetary policy that is appropriate under many different sets of economic conditions.