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On CNBC’s Kudlow Report last night, Larry Kudlow was skeptical of my claims that Janet Yellen favored a rule-based rather than discretionary monetary policy. A rule-based Fed is a big goal for many center-right economists, some of whom want that rule to be a gold standard.
Now Larry is correct that Yellen has not explicitly endorsed my rule of choice, a nominal GDP level target. But consider: A Fed that followed an NGDPLT rule might allow for a period of catch-up growth after a downturn to return to a, say, 5% NGDP level trajectory. That, even if the composition of NGDP growth for a period saw inflation above the Fed’s usual 2% tolerance. Inflation might be a “suboptima” 4% as part of 6% NGDP growth.
Keep that in mind as you read how the Goldman Sachs econ team interprets Yellen’s views on monetary policy:
Fed officials appear to be contemplating an even bigger shift. This is evident from a series of speeches given by Vice Chair Janet Yellen in 2012 that presented simulations with the Board staff’s large-scale econometric model, FRB/US, using an “optimal control” approach to monetary policy. Under such an approach, the central bank chooses a path for the federal funds rate which best meets its objectives over the next several years as a whole, even if this means committing to a policy that may appear suboptimal at certain points along the way. For example, the chosen path may imply that in 2013, the Fed expects inflation in 2015 to be above its target but nevertheless commits to refraining from an aggressive monetary tightening at that point. …
So far, no sitting Fed official has publicly called for an NGDP target. But Yellen’s optimal control approach is equivalent to a specific form of such a target. To our knowledge, nobody has pointed this out yet, although it is at least implicit in the academic literature on this issue. In a highly stylized model, Woodford has shown that the optimal policy at the zero bound is an NGDP target. In a simulation that also uses FRB/US—as does Yellen’s optimal control work—San Francisco Fed President John Williams and Fed economist David Reifschneider have shown that the optimal policy at the zero bound responds not only to current inflation and unemployment gaps but also their cumulated history. In other words, the optimal policy at the zero bound in FRB/US does not look like a Taylor rule but resembles an NGDP target.
Granted there’s a whiff of Kremlinology about all this. Still, I’ll take that approach and what we think we know about Yellen over fiscalist Larry Summers’ apparent belief that the effects of unconventional monetary policy are limited in a zero bond environment and that fiscal policy is the superior instrument.
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