Important points to focusing the monetary policy oversight conversation on NGDP

If you’ve had complaints about Trump’s and his GOP’s spending binge, you probably haven’t heard about the projected price tag of Ocasio-Cortez’s economic plan that includes Medicare for all, and a right to housing and higher education, among other public doles that is said to cost $40T over the next decade. When I heard about it, of course I had an objection to the plan on ideological grounds, but also on practicality grounds because while there are plenty of reports about the price tag of the plan, in my mind, there is at least the logical complication of what this would do for the split between P and Y in MV=PY after hearing the endless drumbeat over the last decade about how important people think inflation really is.

So important the inflation metric is, at one time over the last decade, that the political system and the monetary bureaucrats were willing to collapse the economy and the banking system over somewhat elevated forecasts.

Really, though, the purpose of this post isn’t to pull out the figurative steely knives toward Ocasio-Cortez’s plan. I am simply pointing out that when it comes to spending, regulation and all manners of big government, public conversations about economic policy seem to happen in the cushy comfort of an ideological vacuum divorced from the reality that there needs to be something positive from it all coming out the other side. Otherwise, these plans likely aren’t economic policy plans so much as they are utopian wish lists that require a leap of logic to find the utopia in them, in and of themselves. After all, there are such places where great efforts have been made to feed, house and educate a society, but next to nothing is done about governance problems of the place, and what they end up with is people with master’s degrees in civil engineering living in shacks and plowing fields behind an ox as a matter of survival.

I wonder, though, how discussions about economic policy might change if the monetary policy oversight conversations between Congress and the Fed were to shift toward focusing on NGDP and the various things that go into MV=PY instead of continuing on with the confusing, opaque and insular interest rate and inflation kind of policy conversation discussion platform currently in place.

For example, back in 2006, an NGDP of conversation with the Fed may have helped to better identify and remedy the cause of the elevated inflation forecasts of the period, saving an enormous amount of heartache and loss.

Monetary policy can solve inflation problems. But monetary solutions to supply side inflation problems, like oil price spikes, come with all sorts of undesirable baggage, and I am not aware that anyone in Congress at the time was questioning whether monetary policy SHOULD be used to solve the late oughties inflation problem, as if there was a lack of awareness that there were at least two different ways to view the problem needing to be solved and which view the monetary solution would address.

The first view of the 2006-08 inflation problem is as problem of too much demand for energy. In simple terms, when the government goes to solve an inflation problem with monetary policy, it is trying to solve an excess aggregate demand problem because monetary policy manages how much overall demand there is in the economy. In this specific case, monetary policy reduced inflation caused by elevated gas prices by reducing aggregate demand (trading persistently elevated cyclical unemployment for reduced gas prices).

The second seemingly hidden view of the same inflation problem is too little energy for the demand. This problem has many of the same symptoms as an excess aggregate demand problem but is an  entirely different problem with a solution that doesn’t involve inflicting elevated cyclical unemployment on a prolonged basis. Instead, the solution involves the department responsible for the energy supply to be held accountable for starters, and some real homework to be done on the part of policymakers in developing a multi-pronged approach to solving energy availability problems.

In an environment where there’s lots of highly charged politics revolving around generalizations of inflation that lack the discipline of never reasoning from a price change, it is quite easy for politicians to be unaware that there are different possible causes of an inflation problem that may or may not be best solved as central bankers might solve them.

Suppose that, in 2006, Congress had been in the practice of grading the FOMC on NGDP growth performance and having regular conversations about the meaning of MV=PY, not only with the Fed, but among themselves. Not only would expected results of the monetary policy intentions of day been more visible, Congress likely would have been more aware of the supply side component of P and perhaps may have been more skeptical as the “Whip Inflation NOW” buttons were being passed around by hawkish Fed officials because NGDP growth was not rising above trend.

This is not to say that Congress may have been able to definitively identify the source of the inflation problem. It’s easy to look at the problem in hindsight and point to where the problem solving went awry and the wrong solution deployed. But Congress could have directed the Fed to, instead of using an aggregate demand solution to solve a specific supply side problem, it should use its army of economists to find the problem and report back, dispelling the Fed’s inclination to bake reasoning from a price change into everything it does and engaging it in problem solving.

It’s true that unintended and unexpected elevations of inflation need some sort of policy response and the possibly of them even feared. At least in my view, however, failure of the government to recognize the various causes of inflation, such as bad supply side policy, and deployment of inappropriate prevention measures and solutions for inflation problems is of much greater fear because these cures most often do more damage than the disease, which itself goes unaddressed. And I think that having rational conversations about inflation, economic health and funding may be spurred by discussions about NGDP growth and could go a long way toward stopping inflation problems before they start and provide better grounding in the reality of tradeoffs when it comes to discussions about economic policy in general.

As a side note, better discussions about monetary policy could also shed some light as to whether Ocasio-Cortez’s “economic plan” is consistent with current law. It isn’t just a matter of how much it costs when considered in a vacuum and where the money to pay for it might come from. It would raise estimates of the natural rate, impacting employment availability in aggregate, and so, it would necessarily involve repealing the Full Employment and Balanced Growth Act. There’s nothing worse than Congress violating its own law.

But why worry about having job and the various things government can do to damage the prospects of obtaining gainful employment when one can get everything one needs: housing, food, and higher education from everyone else. What could possibly go wrong there?

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