Arguing for the advantages of having the central bank target the growth rate of nominal GDP
I had specifically suggested that announcing a target path for nominal GDP would be a desirable way to make an advance statement about the criteria that you would be looking at later. Now, I wasn’t saying that to suggest that that’s the only formula that would be valuable, but I thought it was useful to give a concrete example showing how the thing that I was talking about could be undertaken in practice. ... A nominal GDP target path would have the advantage of being a single criterion, yet one that conveyed concern both about the real economy and about the price level and nominal variables at the same time. It would have given an explanation for which substantial stimulus would have continued to be appropriate for some time to come. But it was also a criterion that was intended to reassure people that what looked like very aggressive monetary policy wasnot going to allow inflation to get out of hand. If inflation picked up very much, the FOMC would quickly have reached the nominal GDP target and then would have to restrain nominal demand growth in order not to shoot past the target path. The public wouldn’t have to be worried that we were pushing so hard on stimulating the economy that maybe we were going to let demand get totally out of control, and we were just not thinking about that because it wasn’t the fire that had to be put out this year.
How the Fed is likely to use interest rates on excess reserves as its main policy tool when it comes time to raise short-term interest rates
I am not worried that the Fed is not going to have effective tools for implementing its interest rate policies. We have yet to reach the point where they do want to raise interest rates, but assuming that things evolve as everyone is currently anticipating, we are likely to reach it within the coming year. At that point, I think, there will be tools that allow them to do it. It will be an interesting experiment in monetary economics because the Fed will be attempting to control short-term interest rates in a situation where almost certainly its balance sheet is going to be unusually large. That means that there are going to be extraordinary quantities of excess reserves in existence, and this means that Fed control of short-term interest rates will not be achievable in the way that it always was in the past: through rationing the supply of reserves. ...
I think the fact that interest rates can be and are currently being paid on excess reserves is very important. Of course, the Fed asked for that authority from Congress back in 2008 before embarking on the large expansion in the size of its balance sheet. The reason, I think, is that it was preparing for this question that we are going to face within the next year or so: When you have this big balance sheet, have you given up control over short-term interest rates? The FOMC wanted to be sure the answer to that question was “no,” and it could do that by having the ability to pay whatever interest rate it deemed appropriate on those reserves. So that’s a very important tool, and probably the most important tool that they are going to have when the moment arises.
Should the Federal Reserve have a mandate to pursue financial stability, along with full employment and a stable price level?
The question whether there should also be a financial stability mandate is a more reasonable one to take up. Though I have to say that I find it a little surprising that people would think that there isn’t one. It’s true that the Federal Reserve Act mentions price stability, it mentions maximum employment and it doesn’t, in a similarly direct way, talk about the responsibility for financial stability. But, historically, if we ask why the Federal Reserve Act was passed at all, we know that Congress established the Fed in response to a financial crisis. From the legislative history, it’s clear that the whole point of the Federal Reserve Act was to have an institution that would act to ensure financial stability.
It’s true that when the current language of the Federal Reserve Act was drafted in the 1970s, financial stability had become a less central concern, and instead inflation and unemployment were both big problems. Still, the idea that anyone would have thought that it was somehow not the Fed’s concern is strange. I find it hard to imagine that if the Fed thinks it should do something out of a concern for financial stability, anyone would actually be able to object that this was overstepping the bounds of what Congress ever wanted it to be concerned with. ... I don’t see anything wrong with making it more explicit. It’s just that it seems to me that an amendment of the act to do this would be fixing something that isn’t really a problem.
