The Fed and Commitment
I am a loyal reader of Kids Prefer Cheese, a blog by Mike Munger of Duke, and Kevin “Angus” Grier of Oklahoma. Professor Grier wrote a post a few days ago, which sparked a Twitter discussion between Grier, myself, and Dr. Phil of Economics. While I enjoyed the discussion, Twitter can be a poor format for academic discussion because 140 characters is often too little for more than quick points and no context.
Angus mentioned NGDP targeting as an example of a central bank target which required commitment. His wording was that NGDP targeting would require “Keeping inflation above their stated preferences”. If the Fed’s true goal is inflation, then yes, I concede an NGDP goal is unsustainable. But it’s unsustainable because you can’t have two nominal targets simultaneously.
Let’s say a whole bunch of economists are advocating that the Fed targets the nominal price of apples. They say, “the best way to help the economy is for apples to cost $1, now and forever”. Let’s assume they convince politicians, voters, economists, etc. of this position. Does it make sense to say that an apple price target is not time consistent? Is it reasonable to say “No, because when orange prices deviate from the Fed’s secret orange price target, they will change to targeting the price of oranges?” Does it make sense to criticize inflation targeting because when the price of gold goes too far from the Fed’s ideal gold price, they will revert to stabilizing the price of gold?
The whole advocating an NGDP target is that you believe it’s better than an inflation target. If you think inflation targeting is better, then yes, NGDP targeting won’t work because there will be times that the economy will suffer because you’re following an NGDP target. But that’s not a time consistency issue. It’s begging the question of what the better target is.
Right now, the Fed doesn’t even have an inflation target. If they did, inflation would be a lot higher, and it would have been a lot higher in 2008. They don’t have an unemployment target either, or once again, they would be doing more expansionary policy. Maybe you think they can’t raise employment with expansionary money, fine. I disagree, but I understand the position. We’ll never know what Fed officials are thinking in their heart of hearts, but that’s the reason why discretion is a terrible idea! When no one can figure out the motives of the world’s most powerful economic actor, that’s not a good sign for the institutional quality of your country. Personally, I’d take a legally enforced inflation target over a discretionary NGDP target any day.