In The Interest Rate Monoculture Scott Sumner asks, Why does almost everyone assume that interest rate targeting is best?
I would ask, who _does_ think interest rate targeting is best? The targets on the table are inflation targeting, specifically Flexible Average Inflation Targeting, the Fed’s actual target, and NGDP targeting favored by Sumner and others. Sumner does not cite a single economist who advocates for interest rate targeting, which the Fed actually had from 1945-51. And for good reason. Targeting the short-term interest rate (at what level?) would in effect turn macroeconomic management of inflation and NGDP over to fiscal policy. This policy change, although favored it appears by ex-President Trump, has little support elsewhere. Nor is “interest rate” targeting favored as the only alternative to “money supply” targeting, which is almost universally rejected. “Monetary supply” management is yet another possible _instrument_ for achieving some target.
Sumner seems to be referring to the use of short-term interest rates, like the Effective Federal Fund Rate as the main _instrument_ for the achievement of its inflation _target._ I would agree with Sumner that over-emphasis on that one instrument compared to IOR and purchases/sales of longer-term instruments is a communications error[i] and led during the Great Recession to concerns that the Fed was “out of ammunition” or that its ability to manage inflation was constrained by the “Zero Lower Bound” of short-term interest rates. But none of this bears on what outcome the Fed should target.
Much of Sumner’s post is puzzling as he recognizes that both interest rate targeting and money supply targeting lead to unstable outcomes of variables of fundamental concern like inflation and output, yet claims than many people favor it. In this he shares the view of John Cochrane, whom he cites, in rejecting “interest rate targeting,” although Sumner has many long quibbles with Cochrane’s analysis.
Most puzzling of all is that in rejecting “interest rate” targeting, assuming that nowadays it is even a “thing,” Sumner does not in fact advocate for anything different, for NGDP targeting, for example, which he has advocated in the past. [See: https://thomaslhutcheson.substack.com/p/why-target-ngdp]
[Standard bleg: Although my style is know-it-all-ism, I do sometime entertain the thought that, here and there, I might be mistaken on some minor detail. I would welcome comments on these views.]
Image Prompt: Archer apparently undecided between aiming at a target labeled “Interest Rate” and another target labeled “?”
[i] In addition to flawed operational protocols outlined in:
https://thomaslhutcheson.substack.com/p/jackson-hole-questions
https://thomaslhutcheson.substack.com/p/improving-fed-decisions
I argued 25 years ago for real interest rate targeting, with fiscal policy taking on the job of macro stabilisation. It wasn't super-relevant in the following decade of low and stable inflation, and I haven't reconsidered the issue properly