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US Monetary Policy at a Crossroads: Ben Bernanke Has a Decision to Make


Or is Bernanke trying to send the market a message that he is indeed targeting nominal GDP without admitting it?


A price-level target is a de facto nominal GDP target and Bernanke's reference to Svensson with regard to policy is notable considering the backdrop of when this policy change was enacted. You will recall that at the 2012 Jackson Hole summit, it wasn't Bernanke's speech that drew the most attention; it was Columbia's Michael Woodford who advocated the Fed adopt conditional policy based on forward guidance of a nominal GDP target (emphasis mine):

An example of a target criterion that has received considerable attention within the Federal Reserve System is the "7/3 threshold rule" proposed by President Charles Evans of the Chicago Fed (Evans, 2011) and analyzed in Campbell et al. (2012).

Adoption of such a commitment by the FOMC would be an important improvement upon current communication policy, in my view. It would emphasize the conditions for exit from the current extremely accommodative policy stance, rather than a date.

An alternative that I believe should be equally easy to explain to the general public, but that would preserve more of the advantages of the adjusted price-level target path, would be a criterion based on a nominal GDP target path, as proposed by Hatsius and Stehn (2011), Romer (2011), and Sumner (2011) among others. Under this proposal, the FOMC would pledge to maintain the funds rate target at its lower bound as long as nominal GDP remains below a deterministic target path, representing the path that the FOMC would have kept it on (or near) if the interest-rate lower bound had not constrained policy since late 2008. Once nominal GDP again reaches the level of this path, it will be appropriate to raise nominal interest rates, to the level necessary to maintain a steady growth rate of nominal GDP thereafter.

Nominal GDP Regression

Woodford included a nominal GDP chart with a log-linear trend line from 1990 to 2008 that shows a substantial output gap that remains in place today. In fact, at the current pace of nominal GDP growth, the US economy isn't even in the ballpark of where it needs to be to close that gap.

As I wrote back in December in Bernanke Capitulates, Launches De Facto Nominal GDP Target:

The current run rate of nominal GDP growth is 4.0%, and Bernanke's implied growth rate, with a targeted 2.0-2.5% inflation rate, would equate to an NGDP growth rate of 4.5% to 5.0%. To put those numbers in historical context, the average annual NGDP growth rate since 2002 is 4.0%, and since 1992 it averaged 4.7%.

If you run a regression line to extrapolate output gaps in the future, you will find that in 2015, which was the Fed's previous target for ending accommodative policy trend NGDP should be at $19.6 trillion. In order to close that gap, NGDP would have to grow at a compound annual growth rate (CAGR) of 7.0%, which is virtually impossible given a 2.5% rate of inflation. To put that number in context, in 2006, during the height of the credit bubble, NGDP was growing at 6.5%. By 2020 trend NGDP is 24.7 trillion, a level that would be reached if the economy were to grow at a 5.6% CAGR, almost 100bps above the 20-year average. If the economy avoids any significant disruptions and continues to grow at 4.0%, the output gap might be closed sometime between 2020 and 2025.

When the Fed launched QE3 in September, right after the Jackson Hole conference, they clearly made a policy change by switching from date-based guidance to open-ended economic conditional guidance. This was perceived as a more dovish policy initiative. It was, as Svensson advised, an attempt to affect the private sector's inflation expectations in an attempt to lower real interest rates. At the December meeting, with Operation Twist due to expire, the Fed defined the threshold guidance by targeting 6.5% unemployment and raising their inflation bogey from 2.0% to 2.5%.

I find it very curious that Bernanke would cite Svensson when his policy prescription is so similar to Woodford's. When you read between the lines, the policy change is just too coincidental not to be leaning towards a nominal GDP target, but his insistence on an unemployment threshold is muddying the market's interpretation. Is Bernanke trying to send the market a message that he is indeed targeting nominal GDP without admitting it? If so, why is there so much attention on tapering QE with a significant output gap still in place?

If you want to know why the bond market is blowing up, this is it. The market is very confused. Rightly or wrongly they got long an inflation target commitment and then the Fed got cold feet when they conducted the ex post cost/benefit analysis. Which is it? Is it tapering with inflation/consumption decelerating or a nominal GDP target? Tapering is tightening and a nominal GDP target is easing on steroids.
No positions in stocks mentioned.

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