I noticed a Scott Sumner post about the composition of tactics and strategies for monetary policy, which I think is more or less about why the Fed’s performance is in his view (these are my words not his – and I may have misunderstood) is about right, except the tools used for the tactics are wrong.
This is a bit different philosophic ambiance that what I’ve perceived from Sumner’s writing before, and I am puzzled. In the early days of blogging, Sumner suggested 5% NGDP growth per year as optimal. He had characterized the average of 4% NGDP growth from 2009-2014 as a happy accident, given that it was not the result of predictable policy. And then as NGDP growth was allowed to drift downward to 3% or less starting in 2015, he suggested that it was a tragedy.
But in this post Sumner states:
The Fed has a big NGDP problem. It’s becoming increasingly clear that when the labor market recovers, RGDP growth will be very slow, maybe 1.2%. Add in about 1.8% on the GDP deflator, and 3% NGDP growth looks like the new normal, assuming the Fed intends to stick with 2% PCE inflation targeting.
I believe that this will eventually become the conventional wisdom. Today on BloombergTV, Michael Darda made a similar claim. He suggested that 3% NGDP growth is the new normal for the Fed, as productivity growth has fallen to 0.6% and working age population growth has also slowed to about 0.6%.
Many people are confused on this point—they speak of “slack” in the economy, and an ability to grow faster to soak up that slack. Even if they are correct (which is unclear), that has no bearing on the trend rate of growth. The trend rate averages growth during both recessions and expansions. Yes, NGDP growth has averaged closer to 4% since 2009, but that’s a period when the unemployment rate fell from 10% to 5%. It’s not going to fall to 0% over the next 7 years. In the long run, unemployment (and labor force participation) is stable, then neither rise nor fall. That’s why America’s trend rate of growth is actually well below the actual growth over the past 7 years.
So that explains 1.2% RGDP growth…
This looks like talking in short cuts, mixing real and nominal factors into a jumble and then heading for the exit before any of it is entirely clear. But I don’t need to look at any labor force growth data zingers to explain the happy 4% growth accident to follow the golden thread of logic, if I simply start with the prediction, which makes it perfectly clear that all the aforementioned factors are contingent upon the Fed continuing with targeting 2% PCE inflation.
With this alone, yes I agree that the Fed has a big NGDP problem. I agree with it because the Fed has a big inflation targeting problem which, at least in my point of view, also implies both strategic and tactical problems.
Having an inappropriate target that even if in their best efforts to meet it produces NGDP growth that keeps us suspended just on the edge of the netherworld between growth and a recession is a bad strategy. Never mind that the Fed has no plan on how to deal with a recession should one actually happen. And it is indefensible when taken together with the entirety of the statutory mandates, to manage monetary and credit aggregates commensurate with the economy’s long run ability to increase production.
It just does not matter if labor force growth has slowed. When the LFPR is finally starting to grow again after years hovering at historical lows since shortly after the Great Recession began, and the Fed is reducing the base in order to produce a rise in interest rates with only rather unreliable inflation forecasts to go on, and a whole pile of other indicators suggest sluggishness, there’s a whole lot of a big problem there that cannot be allowed to become as bygone as the undershooting.
The opportunity cost of doing monetary policy as fecklessly as this impacts real people in a way that is much the same as stealing nuts from squirrels or pulling the wings off flies – intentionally done or not, it makes little difference to the people on the other end of it.
I totally disagree that the new normal is understandable and acceptable Fed performance. It’s not even close.