Struggling back to neutral, (monetary) policy edition | FT Alphaville

Struggling back to neutral, (monetary) policy edition

Ezra Klein has offered a name for the current situation that’s not nearly as sexy as the ones we came up with, but which is reasonable enough:

If it were up to me, we would call what we’re in a “household-debt crisis,” or something more elegant that gets the same idea across, as that would at least help us think more clearly about what we need to do to get out. …

That means that in this crisis, indebted households can’t spend, which means businesses can’t spend, which means that unless government steps into the breach in a massive way or until households work through their debt burden, we can’t recover.

Sounds familiar.

Ryan Avent responds that this is an income story as well…

The big problem for households is that incomes have fallen below levels that were expected at the time debt was taken on. And incomes are expected to stay below that level for some time; indeed, nominal incomes are falling ever farther behind the pre-crisis trend.

… and he’s right:

Avent adds that nominal income is well within the Fed’s control, and that it should do what it can to generate faster NGDP growth.

As it happens, targeting nominal growth is number six on our list of Fantasy Fed options and has been getting a steadily louder drumbeat of late. But, we think, it’s not an idea that’s likely to gain traction among policymakers. Not at Jackson Hole or anytime soon(ish) thereafter.

A quick review of why

We haven’t managed to find a recent instance of Bernanke actually commenting on nominal GDP targeting, but on page 20 of this 1997 paper he writes that NGDP targeting is less preferable to inflation targeting (which he has said he’d be willing to consider). His primary objections are the greater flexibility provided by inflation targeting and difficulty communicating the concept of NGDP to the public.

It’s possible that he’s since changed his mind; we don’t know! But we also remember being left repeatedly frustrated last year by his unwillingness to comment on price-level targeting. Among the few statements we know that he’s made about the similar idea of temporarily higher-than-normal inflation is that he thinks it might risk decades worth of central bank credibility (cough) if inflation expectations were to become unhinged.

We’re just speculating, of course, but we’re pretty sure that similar lines of reasoning now apply to Bernanke’s thinking on NGDP targeting, i.e. that it wouldn’t contain inflation as well as it’s meant to in theory.

We suppose that the Fed could hypothetically one day start implicitly targeting NGDP the way it now implicitly targets 2 per cent inflation. But (and this would clearly depend on where you set the target), as we just noted it would mean tolerating an extended period of higher inflation than it has previously signaled it would.

Whatever the case, it’s unlikely. There are, of course, numerous other options. But the point is that Bernanke doesn’t seem ready to go much beyond the commitment to keeping rates low through 2013 that he announced at the last FOMC meeting. The furthest we think he’d go is to lengthen the duration of US Treasuries either through reinvesting paydowns from MBS and agencies into longer-duration government bonds or swapping out of shorter duration Treasuries.

Of course, if either significant disinflation or outright deflation start to threaten again, everything is back on the table. We don’t rule this out, and in fact it seems more likely that inflation and inflation expectations will trend down rather than up in the near future.

But at the moment, the fact remains that both are higher than they were at this point last year and, probably, too high for the Fed to consider anything big and new.

Which means that if policy is needed to offset household deleveraging and the corresponding reluctance of businesses to spend, help would have to come from the fiscal side.

That’s the subject of our next post