The Federal Reserve can’t seem to get any love these days. Within hours of the bank’s announcement that it would lower its growth and employment forecasts and continue its “Operation Twist” bond-buying program through the end of the year, the financial blogosphere was thick with criticism of Ben Bernanke and the central bank he heads.
From the left, the refrain has been that the Fed is not doing enough. The central bank has a duel mandate to keep prices stable and unemployment low, and inflation has been consistently low while unemployment remains stubbornly high. Writes Matthew Ylglesias in Slate:
“The central bank clarified that it is fanatically committed to holding inflation close-to-but-below two percent, and while it’s happy to speak many words about output and employment it basically doesn’t care.”
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From the right we hear that though unemployment is a problem, the Fed doesn’t have the tools necessary to fix it, and by trying, it will cause runaway inflation and free-market distortion. In the Financial Times, Mohamed El-Erain writes,
“Whether you are worried about insufficient demand or the economy’s sluggish supply response, it is hard to argue that what ails the US is in the domain of Fed tools. The most it can do is buy time while trying to inform and — at the margin — influence steps that can only be taken elsewhere . . . What this continued Fed activism will do is to continue altering the functioning of markets, contaminate price discovery and distort capital allocation.”
Even worse, some fear that the Fed’s stay-the-course comportment belies the fact that after two rounds of so-called quantitative easing and two rounds of Operation Twist, the central bank doesn’t have any ammo left to help a still-sputtering economy. Ezra Klein worries as much, writing yesterday:
“A scary interpretation of Bernanke’s position is that he doesn’t believe the Fed could do much more to help the economy, but he doesn’t want the market to know that, and so he keeps not doing more but telling the markets he could do more if he wanted to.”
Klein may have hit on Bernanke’s true thinking, but the “out of bullets” theory isn’t shared in all quarters. In fact, there is one tool, called “nominal GDP targeting,” that has been getting a lot of support lately from economists and journalist – from both sides of the political isle.
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Basically nominal GDP targeting is a strategy whereby the Federal Reserve, instead of trying to keep inflation stable and unemployment low, would announce its intention of taking any action necessary to maintain a long run nominal GDP growth rate target. This would mean that instead of buying up a certain amount of bonds like the Fed has done with QEs 1 and 2, it would set a target for the effect of those bond purchases and then, in theory, buy up as many securities as necessary to make it happen.
This strategy has received the support of liberal economists and journalists like Christina Romer and Ryan Avent. This makes sense, considering NGDP targeting would involve a much more activist Fed.
But, recently, the idea has been touted by a handful of conservatives as well. The most recent high profile endorsement came in an article written by National Review senior editor Ramesh Ponnuru and former Bush Administration economist David Beckworth. They defend the policy on conservative grounds arguing that though the policy would promote more dovish Federal Reserve currently, it would actually be a better defense against inflation in the long run because it would prevent the Federal Reserve from being too loose with monetary policy during times of extreme productivity growth. Write Ponnuru and Beckworth:
“Imagine that a new technology significantly increased the speed of computers. This one-time productivity-enhancing supply shock might temporarily result in 5 percent real economic growth and 0 percent inflation under our rule. A 2 percent inflation target would again have a perverse consequence; this time it would require a potentially destabilizing surge in nominal spending to raise inflation. Better to ignore the supply shock and allow the temporary disinflation than to have a boom in spending.”
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Indeed, Ponnuru and Beckworth aren’t the only conservative proponents of this policy. The most vocal supporter of NGDP targeting, Scot Sumner, is also a conservative, and Mitt Romney economic advisor Greg Mankiw wrote a paper in the 1990s extolling the virtues of targeting nominal GDP.
Not everybody in on the right would be keen on this kind of regime, however. In the past couple of years some factions within the Republican Party, led by Ron Paul, have veered increasingly towards the Austrian school of economics, which is highly skeptical of central bank meddling in the economy and of governmental stimulus of any kind. This cycle’s Republican presidential primary was rife with tough words for Ben Bernanke’s unconventional policies, and Mitt Romney himself has opposed further quantitative easing from the Fed.
Of course, if Ben Bernanke and the rest of the Fed aren’t on board, it doesn’t matter what politicians think. And up to this point, Bernanke has resisted expanding the Fed’s balance sheet further – which would be the whole point, in the short run, to switching to NGDP targeting.
That said, if the situation in Europe bestows upon us another Lehman Moment, the Fed will probably scramble for more bullets. Conventional wisdom is that if the economy tanks again, Bernanke will resort to QE3, but perhaps a serious enough downturn will convince Bernanke that a “monetary regime change” is in order.
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