Sunday, January 24, 2010

Sumner's Debating Points

Scott Sumner believes that we should not be debating whether Bernanke should be reappointed, but instead:

1. Whether to cut the fed funds target from 0.25% to 0%

We should not target the federal funds rate at all. I suppose the proper range is between positive and negative infinity. While Fed actions will impact interest rates of various sorts, none should be subject to specific targets but should rather float with changes in supply and demand.

However, it is especially important that the Fed specifically reject its past policy of targeting the fed funds rate. The Fed's emphasis on a target for that rate has created the myth that monetary policy is no longer effective because it is so low.

The answer isn't to lower it a bit more, but rather to clearly explain that the fed funds rate is no longer of any interest to the Fed.

2. Whether to put an interest penalty on excess reserves.

The Fed should pay an interest rate on excess reserves equal to 1/4 percent below the 4 week T-bill yield. Currently, that would be negative. So, the Fed should be charging banks for holding excess reserves.

This should not be described as a penalty. The Fed is not punishing banks for hoarding reserves. The Fed is charging banks for the privilege of holding funds in a perfectly safe and liquid form when real investment opportunities involve risk and take time.

While the current rate should be negative, it should rise above zero when the 4 week T-bill yield is greater than .25 percent.

3. Whether to do additional QE.

Yes. The Fed should sell off its holdings of mortgage backed securities, but more than offset those sales with purchases of T-bills, bonds, and notes. The interest rates should be driven to zero on up the yield curve. While the yields on 4 week T-bills are nearly zero, the Fed can buy one year T-bills, notes maturing in 2 years, 3 years, and so on.

4. Whether to set an inflation or NGDP target.

NGDP is better than inflation, though I prefer a target for Total Final Sales of Domestic Product. It does not include inventory investment. While including planned inventory investment would be fine, the reason to use that measure of nominal expenditure rather than nominal GDP is to avoid including unplanned inventory investment. That the national income accounting identity counts goods produced and not sold as having been sold to the producer, and that "profits" on those unsold good count as income, hardly makes it consistent with macroeconomic equilibrium.

5. Whether to target growth rates or levels.

The level, or rather, growth path, of nominal expenditure should be targeted. However, this only makes sense if it is the growth path of nominal expenditure that is being targeted. Creating monetary disequilibrium to force sticky equilibrium prices back to some arbitrary level is counterproductive. Reversing shortfalls or excess expenditures to avoid the need to make changes in sticky disequilibrium prices or wages is desirable.

6. And of course the key overarching question: Would the economy benefit from an increase in AD, or nominal spending?

Yes, the economy would benefit by an increase in nominal expenditure. Nominal expenditure is currently 9 percent below its long run trend.

The notion that current real GDP is equal to potential output and the current unemployment rate is equal to the natural unemployment rate is highly implausible. (I do think it likely that the current level of potential output is below the long run trend of real GDP. I accept that keeping nominal expenditure growing at trend will cause changes in the prices of goods and services.)

P.S. Bernanke should be fired because he listened to Geithner and focused on bailing out broker-dealers on Wall Street rather than maintaining nominal expenditure. He participated in the effort to scare Congress into approving this bailout. Those scare tactics were destructive and plausibly were a key cause of the drop in nominal expenditure. He continues to be committed to going back to the failed policy of targeting the federal funds rate at levels that are expected to be consistent with the core CPI rising at a 2% annual rate from wherever it is.

P.P.S. I will never support a Fed chairman because Obama and Congress are unlikely to provide anyone better.

P.P.P.S Sumner's points are in reverse order. First commit to raising nominal expenditure, commit to a growth path. For nominal expenditure. Do quantitative easing aimed at raising the monetary base. Stop paying interest on reserves. Drop Fed funds targeting.


  1. Do other economists even think about the issues raised by Sumner? A survey of various economists on these issues would be very interesting.

  2. I guess I should modify the above comment by saying that I am sure every economists thinks about point one, whether to raise or lower the FF rate. But I guess that is the problem. Economists think of tightening or easing monetary policy in terms of the FF rate so when the FF rate approaches zero there is little left for the Federal Reserve to do.