In “Moving Toward NGDP Targeting” Scott Sumner cites a recent Discourse column by Patrick Horan where Horan “made the case for a more flexible interest rate targeting regime:”
I don’t understand Sumner’s thesis. Supposedly the Fed does NOT target interest rates; it targets inflation, specifically, Flexible Average Inflation Targeting, FIAT. Horan seems to be talking about _instrument setting_, not _targeting? _” The idea of smaller more frequent instrument setting with no expectation that movement of an instrument in one direction in period _t_ implies further moment in the same direction in period _t+1_, is hardly new, whatever the target!
https://thomaslhutcheson.substack.com/p/improving-fed-decisions
Not paying interest on reserves (IOR) is sensible if the principal policy instrument is movement in the EFFR. The two have similar effects and can easily interfere with each other if not very finely tuned jointly. Who needs that hassle? But what does use or non-use of IOR have to do with whether NGDP or inflation is targeted?
“The use of IOR gives the impression that interest rates are equivalent to monetary policy. People begin to believe that higher market interest rates represent tighter monetary policy, which is not necessarily true.”
“Give the impression?” A movement in a policy instrument is a movement in a policy instrument. People presumably have the same understanding of how movements in an instrument affects the target variable as the Fed does. Who is impressed?
“I suppose you could adjust IOR up and down each day as a tool to control NGDP”
Yes. The Fed could use small, frequent setting of the EFFR or IOR to control either inflation or NGDP. (Or open market operations.) But significance of the choice of instrument on the choice of target is not explained?
“During late 2008, the Fed was distracted from stabilizing NGDP by a misguided belief that they needed to proceed methodically in cutting interest rates.”
The Fed was “distracted” (or something) from keeping _inflation_ up to target. The Fed has never explained why it allowed inflation and inflation expectations to go negative in 2009 and then flailed even to return and keep inflation up to target 2009-2020. True it was slow to drop the EFFR to near zero in 2008, but that was not the totality of its error.
“In late 2021 and in 2022, the Fed raised rates much too slowly, again based on the mistaken view that they needed to move methodically. You don’t need to stabilize interest rates; you need to stabilize NGDP expectations. Ironically, interest rates are probably more stable over the medium term if the central bank allows high frequency short run volatility as part of a regime that targets NGDP. That’s because stable NGDP growth tends to also stabilize the natural rate of interest.”
This criticism of the management of the EFFR is valid but it is not more relevant to targeting NGDP than to targeting inflation. TIPS _inflation expectations_ in September 2021 flashed substantially over-target inflation but the Fed did not act until March 2022.
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Sumner’s entire post could be re-written by copy and pasting “NGDP” with “inflation” and it would remain equally coherent. The advantage cited for NGDP targeting over interest rate “targeting” (the current protocols for managing the EFFR with infrequent changes by substantial amounts ) sems to apply equally to inflation rate targeting.
I would pose the following questions.
1. Why change from FAIT to an NGDP target?
2. What is the operational difference? Which instruments would be moved differently on the basis of what different information?
3. What would the difference be under the two regimes in response to:
a. A positive sectoral supply shock?
b. A positive sectoral demand shock?
c. A negative sectoral supply shock?
d. A negative sectoral demand shock?
Image Prompt: An archer undecided between aiming at two different targets, one labeled "NGDP" and the other labeled "Inflation."
[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.]
Style note: I'm suddenly noticing posts with failed markup (leading and trailing underscores or asterisks that don't work) all over Substack. Very distracting.
Question: Does the word "monetary" have any content any more, other than describe "what the Fed does" as opposed to "fiscal" (what the government does)? The answer seems pretty closely tied to the interest on reserves issue, and it would be useful, sometime, to have that spelled out, in your terms rather than Sumner's, more completely.
Question: Did FIAT die a quick natural death as soon as the problem was too much inflation rather than too little?
Observation: Apart from its merits (if there are any), is NGDP targeting even possible in the real world. By possible I mean "politically possible." I don't see how the Fed's mandate could possibly survive its having an opinion on whether the economy was too big or too small. For the Fed's customers (Congress, the media, the voters -- not, in this case, the banks), there is no too big.
Comment: NG
Thomas, this explains it better;
https://onlinelibrary.wiley.com/doi/epdf/10.1002/soej.12729