Fed Plans Changes to Communication Strategy by Gavyn Davies

The case for introducing a target path for nominal GDP was well argued by Christina Romer in the New York Times yesterday. She compares the current crisis of high unemployment with the crisis of high inflation which faced the Fed in 1980. Then Paul Volcker broke the mould by introducing targets for the money supply, which made it easier for him to win a consensus on the FOMC for a continuous tightening in monetary policy over several years.

Now, Professor Romer says it is Ben Bernanke’s moment to change the rules of the game by adopting a target for the level of nominal GDP, with the intention of restoring it to the path which it would have followed from 2007 onwards in the absence of a recession. Because this target would focus on the level of money GDP, and not its annual rate of change, it would mean that any shortfall relative to target would have to be restored in future years. That would entail raising the current level of national income by around 10 per cent, a herculean task which would completely change the terms of the debate on the FOMC. It would also radically change the outlook for financial assets.

Although the idea has merit, and may well be discussed by the FOMC in future, it is not likely to emerge from this week’s meetings.  Ben Bernanke has discussed many radical actions for monetary policy in the past, notably relating to Japan a decade ago, but I do not recall him ever giving much attention to a nominal GDP target.  He has consistently focused on the advantages of adopting a clear and consistent target for the rate of inflation (note, not the level of prices, but their rate of change, so past shortfalls would not need to be restored), and in a recent speech on 18 October he said the following:

As a practical matter, the Federal Reserve’s  policy framework has many of the elements of flexible inflation targeting…The FOMC is committed to stabilising inflation over the medium term while retaining the flexibility to help offset cyclical fluctuations in economic activity and employment.

He went on to argue that inflation targeting had proven its worth in stabilising inflation expectations in both directions in recent years, and he concluded as follows:

My guess is that the current framework for monetary policy – with innovations, no doubt, to further improve the ability of central banks to communicate with the public – will remain the standard approach, as its benefits in terms of macroeconomic stabilisation have been demonstrated.

That does not sound like a Fed Chairman who is contemplating a major shift in the whole apparatus of monetary policy right now. Furthermore, recent speeches by Janet Yellen and Bill Dudley, the Chairman’s key lieutenants, have been gradualist in their approach.

How can you achieve catch up growth without a higher inflation rate? Fiscal stimulus? Will it cause inflation?

Fed Panel Is Divided on Direction by Binyamin Applebaum

A growing number of economists outside the Fed have advocated the more aggressive approach of permanently changing the central bank’s focus, from the level of inflation to a broader measure of growth — the present value of economic output — that would similarly make clear that the Fed was willing to tolerate a higher level of inflation in the short term. That approach, however, has gained little traction within the central bank.

...
“If this drift in inflation risk tolerance were to persist, or were expected to persist, it could give rise to a damaging increase in inflationary expectations,” one of the dissidents, Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, said earlier this month.

This position is embraced by many Republican members of Congress, and the candidates for the Republican presidential nomination, but the dissident Fed officials have not returned that embrace. Mr. Kocherlakota, in the same speech, described the Fed’s work as “a largely technocratic exercise that is fundamentally apolitical.”

???

High unemployment going into the 2012 election could easily cost Obama the election. Has there been a "drift in inflation risk tolerance"? Seems to me, that without higher inflation we can not achieve "catch-up" growth.

Charles L. Evans, president of the Federal Reserve Bank of Chicago, has proposed that the Fed should announce temporary boundaries for inflation and unemployment, pledging to keep short-term interest rates near zero until the unemployment rate drops below 7 percent from its current level above 9 percent, or the medium-term outlook for the rate of inflation rises above 3 percent. It is now somewhat below 2 percent, the maximum rate the Fed views as healthy.

“Given how badly we are doing on our employment mandate, we need to be willing to take a risk on inflation going modestly higher in the short run if that is a consequence of policies aimed at lowering unemployment,” Mr. Evans said in a recent speech.

“The Fed has done a good deal of thinking out of the box over the past four years,” he said. “I think it is time to do some more.”

Helpful policies could be QE / purchases of MBS coordinated with Obama adminstration efforts to help the mortgage market and bringing down the exchange rate by purchasing foreign currency. A "currency war" would help export sectors and add demand.

(links via Thoma)