I can't remember when I first became convinced that the Federal Reserve should stop targeting
Maybe a year ago?
I bring it up today because the idea has abruptly broken through to the mainstream, and because the state of the economy will determine whether our kids have decent jobs after college (or any job at all), not to mention whether parents will have the money to pay for college in the first place. So now's the time.
I think about NGDP-targeting this way:
The Federal Reserve has a dual mandate: price stability and full employment. It is required to pursue both.
Since the crash, we have had unusually low core inflation, lower than average inflation during the Great Moderation, which was 2%. Update 1/10/2012: PCE inflation has averaged 1.37% over the four years 2007-2012.
We have also had a catastrophic collapse in employment, which is not becoming any less catastrophic as the years go by:
This chart shows the percent of the civilian population that is employed. Before the crash more than 63% of the civilian population was employed; since the crash we have bounced between 58 and 59%.
The chart above is, literally, an image of a depression. In it we see employment drop off a cliff, hit bottom (let's hope), and stay there. The chart makes it impossible for me to call the situation we are in a "recovery," a "weak recovery," a "faltering recovery," an "anemic recovery," a "limping recovery," a "recovery experiencing strong headwinds," or any other formulation that includes the word recovery. This is not a recovery. In my book, this is a depression: a minor depression, but a depression nonetheless. It's not getting better, and I don't believe that more 20-year olds acquiring STEM degrees will fix things.
More STEM degrees may or may not be a good idea; better K-16 education (I've expanded my horizons) unquestionably is a good idea.
Neither one is going to fix the chart.
Why is that?
Since I'm not an economist, I have to choose which expert(s) to believe. And, after spending probably a year of my life reading the various explanations of the crash, I'm persuaded by Scott Sumner and the market monetarists, (pdf file) which is not to say anyone else has to be persuaded, obviously. I'm writing an amateur economics post on an education blog just to let you know about market monetarism if you don't already.
I'm convinced the market monetarists are right, and I want our
Wages are sticky -- sticky meaning wages can go up, but not down. (Wages are sticky in one direction.)
I live in a state, New York, where public sector wages are beyond sticky; here in New York, public sector raises are sticky. I'm tuned in to public sector compensation because I've been dealing with my district's budget crisis for a few years now, but wages are sticky across the board in every sector, public and private.
Sticky wages kill jobs. Period. Sticky wages kill jobs because when profits decline, some employees have to be laid off so other employees can maintain their current salaries. In theory, when profits (or tax revenues) fall, wages could fall, too, and everyone would still have a job. Companies would bring in less money in sales, so they would pay less money in compensation, problem solved.
In reality, when profits (or tax revenues) decline, wages stay put. So people have to be laid off.
I have had a front-row seat watching this process unfold here in my town. Where sticky wages are concerned, I don't need experts to explain the world to me. Sticky wages are real, I've seen them, they take away jobs.
Update 1/10/2012: human employees replaced by wolves....
Which brings me to the Fed.
The Bernanke Fed strongly opposes deflation and will do whatever it takes to prevent it.
The Bernanke Fed also strongly opposes inflation (the cure for deflation), and appears to think that if low inflation is good, lower inflation is better. It's fine to go to 1.5% "core" inflation (CPI minus food and energy). It's fine to go to 1%. Two percent is a ceiling, not a target. Update 1/102012: The new 'ceiling' appears to be 2.5%.
At some point (where?) inflation is bad because it might turn into deflation.
Also, if you go into recession for 18 months, and "lose" all the inflation you would have had during that period, the Bernanke Fed thinks that's fine.
There is no such thing as an inflation shortfall in the Bernanke Fed, it seems.
Housing prices, overall, are at 1990 levels.
The Bernanke Fed is a deflation fighter, and yet the Bernanke Fed has presided over a 25% deflation in house prices in just 3 years time.
Given what we've been through, I conclude that neither real estate nor jobs are coming back as long as the Fed continues to target inflation. If the Fed is targeting 2% (or 1%) inflation, and we need 33% inflation (roughly) just to get back to where we were, then we're looking at the new normal. Since I personally see no way jobs can be decoupled from prices, that means jobs don't come back, either. Not for years and years and years.
Update 1/10/2012: Hamilton Jobs Gap Calculator
So I'd like the Fed to stop targeting inflation and start targeting nominal GDP, which includes inflation but is not limited to inflation. The beauty of NGDP is that it combines inflation and employment in one number. Double mandate, single target.
I'll post links to the market monetarist blogs and the various endorsements and counter-endorsements later on. In the meantime, Scott Sumner began his blog, The Money Illusion, in 2009. Within the past month Goldman Sachs published a report endorsing the idea, and Cristina Romer wrote a column agreeing. Brad DeLong and and Paul Krugman have both endorsed; at National Review, Ramesh Ponnoru was an early adopter and advocate.
Update 1/10/2012: Worthwhile Canadian Initiative has the easiest-to-understand explanation of why inflation targeting has failed -- and why "level" NGDP-targeting would succeed -- that I've seen so far.
* I've just this moment Googled a line from Brad DeLong saying 1% is the new 2%.