In the context of economic analysis at the elite level, this is the rough equivalent of Jan Hatzius and Goldman Sachs going full Occupy Wall Street. In a weekly research letter, Hatzius and his team of economic analysts endorse the practice of the Federal Reserve setting a nominal GDP level target to reduce unemployment and increase economic growth. This would be considered a radical stance by the usual suspects, however warranted by the actual economic situation in the country. We have the analysts for a major investment bank prioritizing the full employment portion of the Fed’s mandate over the price stability portion, which is almost unheard of at this level. Here’s an excerpt from the letter. You can find it in full in PDF form here.

With short-term interest rates near zero and the economy still weak, we believe that the best way for Fed officials to ease policy significantly further would be to target a nominal GDP path such as the one shown in the chart on the right, indicating that they will use additional asset purchases to help bring actual nominal GDP back to trend over time. The case would strengthen further if deflation risks reappeared clearly on the radar screen.

While a shift to a nominal GDP level target would be a big decision, it would be consistent with the Fed’s dual employment and price mandate. It differs from the standard Taylor rule interpretation of the dual mandate in two ways. First, it depends on the price level, not the inflation rate. Second, it puts more weight on the output/employment part of the mandate.

This can get pretty heavy pretty quick, but essentially Hatzius and Goldman wants the Fed to communicate that they will continue buying assets until GDP reaches the trend level of before the financial crisis. You can see the chart in question in the paper (I cannot find it reproduced at the moment, but this tells the story. The economy is well below where it should be in 2011 if there were no financial crisis and recession. Normally after recessions you have a jump in growth, so that GDP catches back up to trend. We never caught up. And that gap accounts for the high unemployment that we now have. The Fed can impact this by targeting the price level in the way the Goldman Sachs analysts now support. The President of the Chicago Federal Reserve, Charles Evans, made a similar statement earlier this month:

I think there are special circumstances when price-level targeting would be a helpful complement to our current and prospective strategies in the U.S. … There are quite a number of academic studies of liquidity trap crises that find either price-level targeting or temporary above-average inflation to be nearly optimal policies; and yet, central bankers and the public generally loathe the idea that even a temporarily higher inflation rate could be beneficial or be consistent with price stability over the longer term.

A third and complementary policy tool would be to announce that, given the current liquidity trap conditions, monetary policy would seek to target a path for the price level. Simply stated, a price-level target is a path for the price level that the central bank should strive to hit within a reasonable period of time. For example, if the slope of the price path, which I will refer to as P*, is 2 percent and inflation has been underrunning the path for some time, monetary policy would strive to catch up to the path: Inflation would be higher than 2 percent for a time until the path was reattained. I refer to this as a state-contingent policy because the price-level targeting regime is only intended for the duration of the liquidity trap episode.

Specifically, what Evans said is that the Fed should not raise interest rates until the unemployment rate hits 7-7.5% unless core inflation goes above 3%. The Goldman analysts said this wasn’t an aggressive ENOUGH approach.

Here’s the main point, putting aside all the technical matters here: at the elite level, there’s a dam breaking. When Goldman Sachs essentially endorses the full employment side of the Fed mandate over the price stability side, something has happened. The banking lobby has been hawkish on inflation for so long, preferring to let the public suffer, that it’s jarring to see analysis like this. But I guess they even realized that they need some manner of healthy economy to succeed over the long term. And a less restless population.

Again, you can read it here.

David Dayen

David Dayen

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