End the Fed as we know it

Canada.2020 (Creative Commons 3.0)

Canada 2020 and TD Bank host Larry Summers in Ottawa, November 8 2012

Article Highlights

  • The next US central bank boss must end the Fed as we know it.

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  • To better meet its dual mandate, the Fed should clearly target a 5% or so growth path for nominal gross domestic product.

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  • Larry Summers seems a bit dubious of Fed quantitative easing programs and the potency of monetary policy when rates are superlow.

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The next U.S. central bank boss must end the Fed as we know it. For more than five years, the bank has fumbled its dual mandate to stabilize prices and maximize employment. In 2008, the Fed’s passive tightening of monetary policy turned a moderate recession -- one caused by a burst housing bubble and oil price spike -- into a historic collapse. Despite a deteriorating economy, the Fed under Ben Bernanke was slow to cut short rates. And hawkish statements of Fed policymakers actually boosted the federal funds futures rate. As Richmond Fed economist Robert Hetzel has put it, “Restrictive monetary policy rather than the deleveraging in financial markets … offers a more direct explanation of the intensification of the recession” in 2008.

The Bernanke Fed followed that historic blunder by timidly executing a series of stop-and-go bond buying programs. While the economy is certainly healthier for the bank’s quantitative easing, the results are hardly optimal. Inflation remains below the bank’s target, the jobless rate highly elevated.

Of possible Fed candidates, only former Obama White House economist Christina Romer has explicitly endorsed N.G.D.P. targeting, though it’s believed Janet Yellen is also a fan.

To better meet its dual mandate, the Fed should clearly target a 5 percent or so growth path for nominal gross domestic product (N.G.D.P.). If this figure grew by 4 percent one year, the Fed would cut rates or buy bonds until its models – or better yet a N.G.D.P. futures market -- showed growth returning to trend. The idea is supported by some top monetary economists including Scott Sumner of Bentley University and Michael Woodford at Columbia.

Of possible Fed candidates, only former Obama White House economist Christina Romer has explicitly endorsed N.G.D.P. targeting, though it’s believed Janet Yellen is also a fan. Larry Summers, on the other hand, seems a bit dubious of Fed quantitative easing programs and the potency of monetary policy when rates are superlow. But the Fed has a critical role in ensuring macroeconomic stability. And the bank needs a leader who fully understands and embraces that reality.

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