Let´s avoid bad choices

Greg Ip discusses asset bubbles and how they could make Jerome Powell´s life at the Fed difficult:

Any central banker watching the stock market today should get a queasy sense of déjà vu.

A housing boom preceded the last recession. A tech stock bubble ushered in its forerunner.

Today, stock and property prices are once again setting records, in absolute terms and relative to household incomes.

That may leave the Federal Reserve and Jerome Powell, nominated to succeed Janet Yellen as Fed chair next month, confronting some agonizing trade-offs in the next year or two: What if low inflation calls for low interest rates but those low interest rates make an eventual, destructive asset bust more likely?

Should he lean against an incipient bubble by raising rates faster now, or plan to mop up the mess if assets collapse later?

We look at it in another way. What preceded the last recession and its forerunner, as well as previous ones, was a tightening of monetary policy, the stance of which is not gauged by interest rates but by what was happening to nominal spending (NGDP) growth. The charts illustrate.

Note, for example, that with “forward guidance” (FG) in mid-2003, NGDP growth (and the stock market) picked-up. Also, note that from mid-2014 to mid-2016, when NGDP growth recoiled, the stock market balked, but picked up when NGDP growth turned.

The level of nominal spending is less than “ideal”, and its growth rate is on the low side, but that has been enough to keep the stock market chugging along and, by allowing the wage/NGDP ratio to fall, has kept unemployment trending down.

In our view, the choice facing Powell is not “should he lean against an incipient bubble by raising rates faster now, or plan to mop up the mess if assets collapse later?”

What the Fed or Powell cannot allow is another collapse in NGDP like the one we saw in 2008-09. The cost in terms of banking and financial markets distress, worsening public finances, mass unemployment and international discord is simply too big to contemplate.

Recently, the Fed has intensified the discussion on alternative monetary policy frameworks. Bernanke, for example, said in a recent conference:

Speaking at an event at the Brookings Institution, where he is a scholar, Bernanke suggested that Trump Fed chairman nominee Jerome Powell is likely to formally begin re-examining the Fed’s target this year and that there “there will be some pretty serious discussions” on changing it in 2019.

Bernanke’s comments are the latest sign that the Fed is moving toward a historic reassessment of its monetary policy.

We hope that they go about it soon and that they end up choosing an NGDP level target instead of the present “front runner” price level targeting.


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