The Weakening Case for Loosening Money
My column this week criticized the Federal Reserve's monetary policy for being too unpredictable and, even worse, too tight. That argument is in keeping with a long-running theme of the column, that the Fed has been too tight for the entirety of the period since the financial crisis. It's been too tight based on its own interpretation of its statutory goals -- unemployment and inflation both remain below its target. And it's been too tight when measured against the better standard of nominal-spending growth.
The economy, measured in nominal terms, grew at a fairly steady 5 percent clip during the "Great Moderation" that preceded the crisis. It fell at the height of the crisis, and has been growing at a roughly 4 percent rate since, which means that the gap between its previous trend line and its current level has been widening.
I think the Fed should have committed to stabilizing nominal spending -- and to making up for a failure to keep growth high enough in a given year by loosening policy the next year -- because that would have made the recession less severe and accelerated the recovery. And I still think the Fed should pursue a looser policy. But it's worth mentioning that this critique is losing force as time goes by.
The reason is that the expectations of future nominal spending that the Fed should be trying to stabilize have been changing. The further the pre-2007 trend recedes into the past, the less relevant it is and the more markets adjust to the new trend line. In 2005, mortgages were offered with the implicit expectation that incomes would keep rising in nominal terms at their accustomed rate. They're not being offered that way anymore.
Another thing that happens as time goes by: Cyclical problems become structural ones. Early in the crisis, most of the unemployed might have been able to get jobs if nominal spending had picked up. Now, many of the long-term unemployed have dropped out of the labor force, and higher nominal spending won't bring them back.
My column urged the Fed to embrace a nominal-spending rule. But the act of moving to a new rule isn't a mechanical one. The Fed would have to pick a target growth rate and a starting point for its trend line.
In making that decision, the Fed (along with those of us in the "market monetarist" camp) has to face the fact that what's done is done. Our economy suffered enormous harm because the Fed failed to maintain the old trend. We should go partway back to it, but the amount of good it would do falls a little bit every month.
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