Though I’m skeptical of some of his specific proposals, Scott Sumner has convinced me that nominal GDP targeting is the way to go. I’d like to propose the following law:
The Board of Governors of the Federal Reserve System shall conduct monetary policy in such a way as to increase the nominal gross domestic product to approximately $24 trillion in the year 2017.
I choose 2017 because it’s 10 years after the end of the last growth cycle, and I choose $24 trillion based on an approximate extrapolation of the growth rate from 1997 to 2007. (You get why I like the numbers 7 and 24, right?) This is essentially a retroactive 10-year plan for monetary policy, but it leaves all the details up to the Fed.
I’m proposing this as a law to be passed by Congress, because it’s a little bit easier for me to imagine Congress passing such a law than the Fed making such a radical change on its own. Moreover, it would have more credibility if it were written into law rather than merely an announced policy of the Fed. It does take away a little bit of the Fed’s independence, but, as Dr. Phil might say, “How’s that independent central bank thing workin’ out for ya?” It fully retains the Fed’s operational independence, and it mandates an objective based on what the Fed was already achieving over the 10 years up to 2007 (and very roughly for the prior 10 years as well).
The law would need some sort of enforcement provisions, too, but these need not constrain any specific Fed actions. The Chairman would simply have to explain to Congress, on a regular basis, how the Fed plans to get from here to there. If the plan misses in the early years, it obviously has to become more aggressive in the later years – which is the whole point: the worse things get, the more dangerous it should become for banks, businesses, and individuals to keep sitting on cash instead of investing it. (If you want to give the Fed governors a bonus based on how close they come to the target, I’m down with that, too.)
After 2017, the Fed would be free to go back to its discretion in setting long-range policy goals. But it will have an incentive to continue nominal GDP targeting. It may even ask Congress to pass another law. What incentive? To make up for the abysmal performance of 2008-2010, the 2017 goal will almost certainly require the Fed to allow an inflation rate greater than 2% – possibly much greater than 2% – as 2017 approaches. The Fed will then need a credible way to bring the inflation rate back down. What could be more credible than a promise to continue the nominal GDP pattern of the past 20 years? (Remember, the $24 trillion goal for 2017 was based on an extrapolation of the 1997-2007 trend.)
I would hope that the Fed would then elect to continue with nominal GDP targeting. In the longer run, it’s a policy that solves the problem I discussed when I wrote about inflation targets and financial crises. A financial crisis will (if history is any guide) reduce expectations of real growth. If the Fed is targeting nominal GDP, then inflation expectations should automatically increase when real growth expectations decline. This automatically gives the Fed more room to cut the real interest rate so as to clean up the economic fallout from the financial crisis. And nominal GDP targets should also help prevent such crises by reining in real growth that is driven by speculation rather than actual improvements in productivity. In such cases, inflation may not accelerate, but nominal GDP will, and this will automatically lead to an expectation of Fed tightening. Aside from the arbitrary connection with the numbers 24 and 7, nominal GDP targeting is a 24-7 solution in the sense that it reliably provides help in a variety of circumstances.
I’m hoping my law will receive bipartisan – or even tetrapartisan – support. Progressives can see it as a way to make up for the inadequacy of fiscal policy initiatives. Mainstream Democrats can see it as way to consolidate the gains of fiscal policy. Republicans can see it as an acknowledgment that Democratic fiscal policy initiatives were the wrong solution in the first place. And Tea Partiers can see it as a way to get the Fed out of the business of micromanaging the economy. I don’t really care how you sell it; it’s just a good idea. And since all but about 535 of the members of Congress read my blog...
Yes, I’m hoping that Congress will pick up ideas like this from people like Scott Sumner and me, but I’m not expecting it. I’m still long the bond market in my personal accounts. For the sake of the country, though, I’m begging Congress and the Fed. Take my capital gains. Please.
Disclosure: Through my investment and management role in a Treasury directional pooled investment vehicle and through my role as Chief Economist at Atlantic Asset Management, which generally manages fixed income portfolios for its clients, I have direct or indirect interests in various fixed income instruments, which may be impacted by the issues discussed herein. The views expressed herein are entirely my own opinions and may not represent the views of Atlantic Asset Management. This article should not be construed as investment advice, and is not an offer to participate in any investment strategy or product.