we're experiencing truly historic times for monetary policy - business insider

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David Beckworth

We're Experiencing Truly Historic Times For Monetary Policy

David Beckworth, Macro and Other Market Musings | Dec. 13, 2012, 9:15 PM | 735 | 5

This past summer Ramesh Ponnuru and I wrotethat it is time

for monetary regime change:

Twice in the last century, economic turmoil revealed the

failure of a monetary regime and forced the West to

abandon it for another. During the Great Depression of

the 1930s one country after another abandoned the gold

standarda decision vindicated when they recovered inthe same order. The inflation of the late 1960s and

1970s, meanwhile, persuaded most of the developed

worlds central bankers to quit trying to fine-tune the

real growth rate of the economy and instead concentrate

on achieving price stability.

It is once again time for regime change. The crisis in

Europe and our stagnation at home both have primarily

monetary causes, and a solution will require a new

approach to monetary policy that learns from both the

successes and the failures of the past.

We argued that NGDP level targeting is the new monetary regime needed. Since we wrote this piece,

there have been some major changes in Fed policy that have increased the likelihood of this approach

becoming reality. First, the Fed decidedat its September FOMC meeting to start a new large-scale

asset purchase program, QE3, conditional on the state of the economy, rather than tie it to a specific

dollar amount up front. This conditionality approach was a vast improvement over previous QE programs

in that it better tied expectations of future monetary policy to economic outcomes, similar to NGDP level

target. QE3, however, was linked to the vague objectives of "labor market improvements...in the context

of price stability." More clarity was needed to for this program to fully utilize the power of expectations

management.

Yesterday, the FOMC unexpectedly did just that. It tied QE3--or more accurately QE Flexsince it now

includes both MBS and treasury purchases--to the specific targets of 6.5% unemployment rate and 2.5%

inflation. This is huge. It makes very clear to the public that the Fed will not stop until these targets are

hit. Markets, in turn, should respond in anticipation of these goals being hit. That is, the elevated demand

for liquid assets should start declining as households and firms start moving their funds into higher

yielding assets. This rebalancing should raise asset prices, help repair balance sheets, and ultimatelyspur nominal spending. In other words, by better managing expectations, the Fed should cause the

public to do the heavy lifting--and they already have started. If all goes according to plan, the Fed may

not have to actually purchase that many additional assets. Ironically, this means that had the Fed been

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doing this all along its balance sheet would be much smaller now.

So this announcement is big news and fundamentally changes how U.S. monetary policy gets

conducted. Matt Yglesias sumsit nicely up as only he can:

With today's policy announcement, the Federal Reserve's Open Market Committee has stopped

screwing around and started doing real expectations-based monetary easing.

Indeed. But the transformation is not complete. The Fed needs to take the final step and adopt an

explicit NGDP level target. The new unemployment rate and inflation targets get us closer to this ideal,

but as Michael Woodfordnotesthey are not the same. The Fed can only target nominal variables in the

long-run and that is where it emphasis should ultimately be. A NGDP level target would do just that.

Interestingly, the Fed's actions today were not the only winds of change bearing down on monetary

policy this week. Current Bank of Canadagovernor and future Bank of Englandgovernor Mark Carney

came out and endorsedNGDP level targeting in a speech. Wow! It was not so long ago he was against

it. These ongoing developments all point to a sea change in how monetary policy gets conducted. These

truly are historic changes.

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on Dec 13, 9:32 PM said:

Nominal Gross domestic product (NGDP)

"It makes very clear to the public that the Fed will not stop until these targets are hit."

depression
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i'm not quite sure what's different now with the announced numbers vs the way it was before when the FED kept us guessing ...

i mean before the FED put out the hard targets , did anyone think interest rates were going to be rising ? Did any of the major players think the

ground was becoming more firm for an economic recovery ? i for one can say that i expected the FED to keep pumping , just as i expect them to

keep at it today ...

i don't think these new changes in FED policy are going to amount to much .... if you want to discuss what has impact right now , then i'll agree that

the FED buying up 45 BILLION dollars of Bonds each month is more likely to move the dial compared to this new program of explicit goals by the

FED ..

I agree with the Intro of the article , that radical changes will have to be made , much like after the great depression ..... and i think i can get a feel for

what those new changes in the economy might be someday .... but one thing is for certain .... we are FAR FAR away from that day ....

In the meantime the FED will keep trying new things ..

ReplyReply

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(URL)on Dec 13, 10:18 PM said:

@depression: Here is the problem, Depression. Now we have a global economy and we have diminishing

wages in the USA. We have nominal GDP trying to push oil (WTI) to 120 bucks. We have inflationary

commodities with Nominal GDP in a deflationary environment. That is a recipe for disaster.

Nominal GDP is a recipe for disaster. Scott Sumner is not afraid of massively increasing oil prices. I am. I am sane. He is crazy.

ReplyReply

Gary Anderson

11 00

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@Tornado Jones: I don't agree with Joe about Nominal GDP. I believe in judicious and sparing QE. It only should

buy time, not become a way of life.

ReplyReply

Gary Anderson

11 00

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@depression: Add up all the Fed buying and it comes to about a $1 TRILLION PER YEAR added to its balance sheet....

this is historic. During the Great Recession, the Fed increased its balance sheet by $1.5 trillion, now they want to add a

trillion per year into the foreseeable future? Are alarm bells going off anywhere?

The Fed has boxed itself into a corner. They can never stop because if they do interest rates will go up and we will hit some serious problems

in trying to service the debt.... this is a historic moment.

ReplyReply

ooohlalalarry

00 00

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@ooohlalalarry: Interest rates don't go up in Japan. We need to lower the cost of living.

ReplyReply

Gary Anderson

00 00

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Yes, it is a historic time for the Fed. Historic because for the first time, the Fed has become irrelevant.

Isn't the purpose of the QEs is to boost markets, raise investor confidence and hopefully boost the economy? QE2 had a few months effect on the

markets, QE3 gave the markets a boost for about a week, and QE4 gave the markets a boost for about an hour.... truly historic.

ReplyReply

ooohlalalarry
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