Monday, April 2, 2012

The Hetzel Book

Robert Hetzel's new book is out, The Great Recession: Market Failure or Policy Failure. You can find it here. Hetzel is one of the market monetarists' favorite Fed economists, since he recognizes that the Great Recession was primarily due to a drop in spending on output and that the Fed could and should prevent and reverse such shifts in spending.

John Taylor recently gave Hetzel a favorable review. In that review, he finds support for his view that the Fed kept the policy interest rate too low, too long in 2002 and 2003. According to Taylor, this was the key cause of the Great Recession.

Market Monetarist David Beckworth has been making a similar argument about excessively low interest rates in 2002 to 2003 for some time, though he has also insisted that the Federal Reserve could and should have kept nominal GDP growing at trend in 2007 and 2008 and has been arguing since for an expansionary Fed policy aimed at returning nominal GDP back towards trend. Taylor, on the other hand, continues to argue that current monetary policy is too expansionary.

Market Monetarist Marcus Nunes has been critical of Beckworth (and Taylor,) pointing out that nominal GDP was well below trend in 2002 and 2003, and so an expansionary monetary policy was appropriate at that time. Nunes challenges Taylor, arguing that Hetzel agrees that an expansionary monetary policy was appropriate at the time. (Hetzel doesn't follow the simple rule of comparing nominal GDP to trend, but rather has a blow by blow account of current events during the period.)

Scott Sumner weighs in on the discussion, pointing out that free market economists find it easier to come to agreement on the broad outlines of a policy than on particular Fed actions. In an earlier post, Sumner had dug up some Taylor analysis from 2008, that suggested that when the Fed lowered its policy rate, this lowered the value of the dollar, and increased oil prices, and caused a recession. Of course, with hindsight, it is hard to believe that anyone would argue that the Fed's monetary policy was too expansionary in 2008, with spending on output dropping at the fastest rate since the Great Depression. Sumner was heartened that that Taylor at least agreed that he asked some good questions.

As an advocate of a target for a growth path of nominal GDP, I tend to agree with Nunes at first pass. Nominal GDP was below trend in 2002 and 2003. Long ago, Beckworth complained that it was growing faster than trend, but how else could nominal GDP get back to trend? The difference is between a growth rate target and a growth path target. The experience of the last few years has settled any debate on that issue--there is a near consensus among Market Monetarists in favor of a "level" target.

However, what struck me most about the quotations from Hetzel was the following:

“In 2003-2004, the Greenspan FOMC did make a decision that would later have enormous implications. At this time, the FOMC backed off its long-run objective of returning to price stability and instead adopted an ill-defined objective of positive inflation, perhaps best characterized as 2 percent plus…"

I advocate a 3 percent growth path for nominal GDP, which generates a stable price level on average (assuming potential output remains on its long run trend of 3% real growth.) Is Hetzel really saying that the apparent 5% trend for nominal GDP was an illusion and that during the nineties, the goal remained zero inflation? In the end, there was a plan for additional disinflation that was only rejected 10 years ago? And worse, is Hetzel claiming that it was that shift that led to problems?

I am more and more convinced that there is no substitute for a clearly articulated policy rule. In particular, a specified growth path for nominal GDP. Even if nominal GDP happens to come close to an appropriate path, creating appropriate expectations is key.


  1. Interesting post.

    Okay, monetary policy was a little loose what? Inflation budged up a bit. We know we can prosper with moderate inflation, and have for long stretches. Printing more money when oil prices spike seems like a good policy to me.

    The Big Fed Mistake was tightening when they should have been printing more money. The effects of a sustained deep recession are deeply hurtful for large numbers of people.

    Sustained deep recessions and deflations should be avoided at all costs, not moderate inflation.

    I still don't understand the emphasis on zero inflation or even two percent inflation (especially as measured by subjective nominal indexes).

    So what if there is 3 percent inflation?

    Better to overshoot in favor of prosperity and take 3 percent inflation, than enter into a long and deep deflationary recession, as we have.

    Of course, there are arguments about sticky wages and the nature of real estate investing (loans made in nominal dollars to leveraged borrowers by leveraged banks), that also argue for moderate inflation.

    The first goal of macroeconomic policy is prosperity, not price stability.

    To paraphrase Ben Franklin (I think), "He who gives up prosperity for the security of price stability, will soon have neither."

    See Japan.

  2. BTW, Krugman posts today on Fed paper showing wage stickiness n the USA.

    Thus, I think we do need a moderate rate of inflation.

  3. Bill are you buying that "postivie inflation" really was that "fateful" a decision?

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