NGDP Is a 'Simple Rule'
The Federal Open Market Committee (FOMC) released the minutes of their meeting at the beginning of August, and most of the financial media seized on a particular passage which revealed the Fed's readiness to act. "Many members judged that additional monetary accommodation would likely be warranted fairly soon," the minutes stated, "unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery." Those words suggested a third round of quantitative easing was not far off, given the low likelihood that conditions show the sort of strengthening which has been elusive so far for this recovery.
And yet, I do not find those words the most important part of the FOMC minutes; rather, I remark upon a telling but almost entirely overlooked presentation which appears to have occurred on July 31, the first day of the meeting.
The title? "Simple Rules for Monetary Policy."
After less than a year of Fed inflation targeting at 2 percent annual growth of the Personal Consumption Expenditures chained price index, the FOMC minutes demonstrate an interest in "alternative" rules. The presentation discussed rules from a number of angles, such as their consistency with the dual mandate and their capacity to serve as "clear and transparent benchmarks." The FOMC also considered a number of problems inherent to rule-based policymaking: under what circumstances discretionary deviation from rules would be appropriate and how it would be achieved, the consequences of data mis-measurement on rule-based policy, the implications of the nominal zero lower bound on rules, the impact of "model uncertainty" on optimal monetary policy rules, and whether the policy variable(s) -- such as the short-term interest rate -- should be "inertial" or allowed to fluctuate sharply to fix the target variable at the desired level.
It is tempting to wonder whether NGDP targeting came up during the FOMC discussion, given Eric Rosengren and Charles Evans, two alternate members present at the meeting who are respectively the Federal Reserve Bank presidents of Boston and Chicago, have both endorsed it. Given explicit debate over the practice in the FOMC's November 2011 minutes, whether it entered the discussion is uncertain.
It should be obvious, though, that an NGDP level target would meet the Fed criteria voiced in the minutes. Above all, an NGDP target is a "simple rule" which fulfills the dual mandate, serves as the most clear of benchmarks, dodges the zero lower bound problem, and has been shown to outperform other rules under model uncertainty. "Hybrid" NGDP targeting, which assigns weight to both the level and rate of growth of NGDP, would most closely fit the Fed's interest in "inertial" policy rules.
The minutes do prove the consideration of Taylor-type rules, in which a nominal variable and a real variable determine the short-term interest rate. I can gather that from the Fed's concern that it may mis-measure "potential output," given that the output gap is often the real variable input in a Taylor-type rule. Another strong piece of evidence comes from the fact that "Simple Rules for Monetary Policy" is also the exact title of an academic paper written in 1999 by John Williams, who is now the Federal Reserve Bank president of San Francisco and currently sits on the FOMC.
Williams' paper focuses on minimizing the variance in three variables -- a multi-period rate of inflation, the current output gap, and the lagged federal funds rate -- in the FRB/US macroeconomic model. It also examines many of the side questions mentioned in the FOMC minutes. Williams also co-authored a second paper in 2010 under a similar name with John B. Taylor.
Neither paper considers NGDP targeting, though both discuss positively the idea of including the price level in place of inflation in the multivariable target. In practice, a rule which assigns equal weights to deviations in price level and in the level of real output is, as far as I can tell, effectively identical to an NGDP target.
Although I fully expect that the Fed's next easing move to be discretionary rather than rule-based as I would prefer it, this presentation is strong evidence that the Fed is moving -- if only in spirit and not explicitly quite yet -- towards an NGDP level target.