Thomas Raffinot’s paper and the need for monetary policy reform

Scott Sumner recently posted excerpts of Thomas Raffinot’s new paper entitled Interest-Rates-Free Monetary Policy Rule and published by the Mercatus Center for Monetary policy, that includes the synopsis and a couple of graphs.

The paper is a giant step toward getting monetary policy discussion going that is exclusive of interest rates in the multiple ways it demonstrates that looking at the current level of interest rates can be a misleading indicator of the stance of monetary policy. It also explain to some extent the degree of uncertainty in measuring both inflation and the output gaps.

In the paper, Raffinot uses the Koenig (2012) version of the Taylor rule in order to create a portable indicator to judge the stance of monetary policy. It also includes two charts for the United States, one based on real-time data that the central bank had available at the time, and one that uses actual data as a backward-looking one.

This paper is one we really needed, given the obsession with interest rates in public discussions about monetary policy. It is a more than thorough approach to explain how this obsession has caused some pretty serious harm that is aimed straight at the economics community. So hopefully it can gain some traction and perhaps lead to priors questioning and positive change within that community.

For my part, I am mostly on the outside looking in; from across sectors so to speak, with all of the decisions that are made hitting close to home. And so, because I understand to some degree many areas relevant to the conversation, I have an opinion of both the paper and what it means to real people – so here goes:

  • The discussion regarding differences in inflation indicators appears insightful. However, the chosen inflation data that is plugged into the indicator formula is CPI @ 2.5% in order to control the Fed’s target between the two major headline indexes (CPI and PCE). It might be fair to criticize it on the basis that headline inflation is not necessarily monetary in nature, and there are more reliable market-based measures of inflation, such as TIPS spreads. The paper also contains a discussion of the GDP deflator as a more stable measure, yet it is not used.
  • Graphs of the NGDP gap from trend for similar time periods, the 2000’s, by Marcus Nunes differ a great deal from the graphic results presented in Raffinot’s paper as formula output. Because this method uses a controlled CPI measure, with negative oil price shocks occurring during these time periods resulting in monetary policy appearance as loose, the graphs are probably more relevant in judging the Federal Reserve by its own yardstick than to pointing out that improvements need to be made in terms of matching the Fed to general welfare reality. Only at the Hoover institution, and now perhaps implicitly in this paper, have I seen it argued that tight money is what is needed during negative supply shocks.
  • It isn’t in this paper, but seeing the results of the method for calculating the Fed’s performance in graphic form brings to mind a question that is raised by those who take the saying literally that inflation is always and everywhere a monetary phenomenon even though supply side inflation happens in barter economies as well. If the need to tighten monetary policy during a negative supply shock is quite clear and straight forward, what is the prescription during a positive supply shock? That must surely be the time to fire up the printing presses, no? Because of the seemingly perverse and contradictory outcomes in practice, negative supply shocks are the time to tighten policy, and positive ones are also the time tighten policy, isn’t it a rather serious problem for the Fed to be targeting headline inflation? It says in Ecclesiastes that there is a time and place for everything under the sun, but it seems like in many circles, suggesting that there needs to be a balanced approach to monetary policy is heretical. Anything that strengthens what I believe to be a misguided argument that MP was loose goosey prior to the onset of the financial crisis because of headline CPI readings misses the point of what is wrong with the “regime” and is no closer to fixing the problem it poses for working people wage earners. Honestly, the last thing we need is negative nominal shocks on top of negative supply shocks, and to then be robbed of the relief that comes with positive ones.

PS: If you’d like to see the graphs that I refer to in this post, please click on the link at the top. I do not have permission to post them, thus they are not included here.

PPS: Rumor has it that Marvin Goodfriend is on Trump’s shorter than short list of nominees for the BoG. If you’re like me and believe that MP reform and accountability are among the most important issues of our time, then the thought of Mr. Goodfriend, the guy who has argued incessantly for Fed independence and in the same fashion against QE after he wrote the book on it, as a member of the BoG appears to be a major knife in the back courtesy of our supposedly populist president.