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A Reply to Angus on the Fed’s Cheap Talk

September 6, 2012

“In our current institutional framework, the Fed cannot credibly commit to future actions that will conflict with their period by period utility function.
That is to say (more or less accurately), the Fed cannot credibly promise to tolerate higher inflation than it prefers after the economy recovers because, when the economy recovers the Fed will still not like inflation and there is nothing to prevent them from not tolerating it. Knowing this, people will not believe the initial announcement.”


The task of market monetarists is to alter the preference itself, both with the Fed and with Congress. If you believe higher nominal growth would lower unemployment and expand real growth, there is no time consistency problem at all. The Fed raises NGDP now, people love it, and tomorrow they simply maintain the higher path. If you think higher nominal grow will be horrible politically, then yes, it will probably be reversed. The argument then doesn’t come down to time consistency at all, but what level of NGDP growth should be preferred.

Whether the Fed could cause higher NGDP is not a concern for market monetarists. If you want to argue that the Fed could buy up all outstanding Treasury debt and abolish interest on excess reserves, and NGDP wouldn’t budge one inch, then explicitly make that argument. And honestly, if that were reality, it wouldn’t be so bad. Market monetarists don’t focus on the interest rate channel. If you argue that nominal interest rates won’t drop, that won’t convince them that NGDP won’t change.


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