Tyler Cowen linked to a Binyamin Appelbaum interview of Boston Fed President Eric Rosengren:
Q. A number of the academics at this conference said they don’t think you should be trying to raise rates. What do you make of their hesitations?
A. We haven’t hit 2 percent inflation for a while. Some of them have argued that we should in effect be price-level targeting, which is to say that the misses that we’ve had in the past ought to be made up in the future. So they have a different model than we actually are using for monetary policy. We have an inflation target right now. If we wanted to move to price-level targeting, as was advocated by a number of the academics at the conference, we should have that discussion. We should announce it publicly. I don’t think we should do it without telling the public.
I think also the inability of so many central banks to hit their 2 percent inflation target has caused some people to say, “I want to actually see evidence that you can hit 2 percent, and since we’ve just seen the consequences of hitting the zero lower bound, I want to take out some insurance against hitting the zero lower bound more quickly.” I think both concerns are credible. My concern with those arguments would be that the very scenario that causes the next recession might be that we overshoot.
Rosengren currently favors an increase in the Fed’s target rate, whereas I’m a bit more skeptical. But I do applaud the way he analyzes these issues. Level targeting makes a lot of sense, but only if you’ve announced that you are going to do level targeting. Otherwise it may end up destabilizing the economy. Monetary policy would react in ways that the markets did not anticipate.
The next recession is likely to have the same cause as the previous one—Fed tightening triggered by inflationary concerns. If you run 3% inflation for a while because you are doing level targeting of prices, that’s fine. But if you run 3% inflation, and then tighten because inflation is over your 2% target, then the high inflation could trigger another recession.
That’s why I keep insisting that the Fed needs a completely new strategy (NGDPLT), and that we focus far too much on minor tactical issues, such as the question of whether the Fed will raise rates in December.
In contrast, when the economics profession should have been screaming tight money from the rooftops (say in 2008) they were almost completely silent (except a few MMs, and people like Bob Hetzel.)
PS. Here’s another quote I like:
So you don’t see instances where we go from 4.2 percent to 4.7 or 5 percent and level off. What you actually see is when we start tightening we end up with a recession.
I’ve done a number of posts pointing to the fact that the US does not have any mini-recessions, whereas our macro models predict that mini-recessions should be more plentiful than actual recessions. That is, when unemployment start rising, you don’t see it rise 1.0% or 1.5%, and then stop. It either rises by only a tiny bit, or by a lot. The Fed needs to prevent those cases where it rises by a lot. (Oddly, other countries do have mini-recessions.) If we switched to any sort of level targeting (P or NGDP), then I predict the US would start having mini-recessions instead of normal recessions.