What does it mean to ask “Is money too loose?”31st August 2018
Is money too loose? That might seem like a simple question, calling for a yes or no answer. But it isn’t, because people wrongly think of monetary policy is a series of gestures, not a regime.
Our current regime has multiple goals, including an average inflation rate of 2%, and cyclical stability. Often the two goals do not conflict, as in 2009. But sometimes they do, like right now.
For example, monetary policy in Japan became more expansionary under Prime Minister Abe, producing slightly higher inflation and substantially higher NGDP growth. I’ve argued that it’s still too contractionary because Japan remains well below its 2% inflation target. Others say the labor market is now very strong (which is true) and that no further monetary stimulus is needed. That’s also true, if you are focusing on the “stabilization” part of monetary policy. But I believe Japan would still benefit from raising trend inflation high enough to escape the zero rate bound.
Recent Fed policy has given the US economy exactly the same sort of sugar rush as the Japanese felt after 2013. Both NGDP growth and inflation are accelerating modestly. From a “stabilization” perspective, policy may be too expansionary. On the other hand, core PCE inflation is right at 2%, after a long period of underperformance. From this perspective, policy is finally getting right on track.
Here’s another way of thinking about the dilemma. The Fed’s dual mandate calls for above 2% inflation when unemployment is high, and below 2% inflation when unemployment is low. The average rate should be 2%. Unemployment is currently low, and hence the Fed should shoot for below 2% inflation. But the Fed ran a tight monetary policy during the Great Recession and slow recovery, so if they run below 2% inflation right now they may lose credibility. If you run below 2% inflation during both recessions and booms, then the average rate will obviously fall below 2%.
Right now, the Fed can either try to make its 2% long run inflation target credible at the expense of cyclical instability, or it can try to smooth out the business cycle at the expense of its long run 2% inflation target. It cannot do both.
Or the Fed can adopt NGDPLT and do its best to run a countercyclical inflation rate. Under NGDPLT, there are no “dilemmas”, just a clear target to shoot for, each and every day.
PS. Demand-side fiscal policy is quite expansionary, but that doesn’t change anything I said here. RGDP growth has been raised by supply-side reforms like the corporate tax cut, and that does interact with monetary policy by boosting NGDP growth (assuming the Fed targets inflation at 2%.) In retrospect, Obama’s biggest policy mistake was not cutting the corporate income tax sharply in early 2009, instead of enacting the actual stimulus bill. Of course if he’d had that ideology then he never would have gotten the Democratic Party nomination.
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