Garett Jones  

Practical Monetary Policy and My Foolproof Plan to Win an Olympic Gold Medal

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Want to know how to win a gold medal in Rio in 2016? Here's a guaranteed plan to reach the top spot on the podium:

1. Qualify for an Olympic event.

2. Do better than every other competitor.

That's it! There's your path to victory. If you find an error in my guaranteed foolproof advice, do let me know.

One of the big problems with monetary policy is that a lot of the advice economists give to governments is just as true and just as useless as my foolproof two step plan. Milton Friedman, wise on many topics, ran into this problem when he recommended growing the broad money supply--checking accounts, savings accounts, currency--at a fixed percentage rate every year.

How, exactly, is the Federal Reserve supposed to do that? They could do it the way that Dr. Evil might try to win a gold medal---trickery, violence and threats of violence--but that's not the kind of success we're talking about. We're asking how does a central banker use the small set of tools she understands---buying and selling government bonds, setting a short-term interest rate--to achieve the very distant goal of growing the entire stock of readily spendable wealth by 3% per year? Isn't every link in this chain of causation a loose joint, a squishy steering wheel, an uncertain outcome?

It's nice to have a goal, and it's better to have good goals than bad goals, but good policy requires more than goals: Good policy requires an action plan.

This is known as the "instruments versus targets" distinction in macroeconomics, and it pays to make the distinction clear. One reason John Taylor's rule for setting short-term interest rates swept the field of macroeconomics is because it told central bankers exactly what to do with the instruments that central bankers actually use and understand. Taylor didn't say "do good things, don't do bad things," he said, "If inflation falls 1% cut the short term rate by 1.5%". Practical advice, not a noble goal.

The new Evans Rule for monetary policy is similarly practical, it goes something like this: "As long as inflation is less than 2.5% and the unemployment rate is above 6.5%, keep the short term interest rates at near-zero. Actually, keep it there a little longer than that." The Fed's hope is presumably that this rule achieves good policy goals, just like "Wake up at 6 M-F, bike 10 miles in under 40 minutes" might be good advice for someone trying to stay in shape.

One can be extremely confident when giving goal-based advice because it's always right. When you switch to giving instrument-based advice--when you switch from cheerleading to playing the game--you have to warn your audience that Your Mileage May Vary, that there's many a slip 'twixt cup and lip.

Me, I'll just stick to my foolproof plans.

Next up: My foolproof one-step plan to quit smoking!

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COMMENTS (10 to date)

Good post.

Where do you think NGDP Targeting falls along the "instruments versus targets" distinction? My own view is that it falls into the same trap you describe befalling Milton Friedman many years before.

Garett Jones writes:


In this case, it's right there in the name: NGDP targeting provides a target, and it's a target I'm sympathetic to, but it's not an instrument. It doesn't tell us how to accomplish a goal.

The combination of "Evans Rule + rule-based QE" we have now is closer to telling the Fed how to use instruments to implement NGDP targeting. Maybe that combo works, maybe it doesn't, time and VARs will tell, but at least one can evaluate whether it reaches a target....

jsalvatier writes:

You seem like a pretty sharp guy, so this seems like a surprisingly poorly thought out opinion of yours. Could you elaborate?

I thought it was fairly well established amongst vaguely contrarian econobloggers (which I assumed you were part of) that conducting monetary policy isn't all *that* challenging:

You target the forecast so that you expect to hit your target, using the quantity of open market operations as your "instrument" (interest rates just lead your astray). The central bank has approximately infinite power over nominal variables so hitting your target (in expectation) is eminently doable. Oh, and you should target a level, not a rate, and the demand for money is the key variable.

Are you disagreeing with that consensus? Are you unaware of it? It seems remiss not to address it at least.

egd writes:
1. Qualify for an Olympic event.

2. Do better than every other competitor.

That's it! There's your path to victory. If you find an error in my guaranteed foolproof advice, do let me know.

You should note that this strategy works best with non-team sports. It may actually be detrimental in team sports.

MG writes:

@egd - Well, if monetary policy is a bit of a team sport in a world with many currencies, then Garrett's injunction is even scarier: Advise on monetary policy is either useless...or harmful.

Andre Mouton writes:

Good post.

The problem with a rule-based approach is, of course, that one can inagine two worlds - each with 7% unemployment and 2% inflation - where circumstances dictate two different approaches. Non-monetary factors often decide the success of monetary policy. The great question with Japan's new strategy isn't "can they do it?" but, "what effect will this have on large stock of Japanese debt?"

For us, the dollar standard has had real implications for interest rates and inflation, and has tended to disguise or alter - or simply export - the effects of monetary policy. It's not clear the Fed understands this, or much cares. Monetary rules - even non-specific ones like inflation- or NGDP-targeting - are comforting because they imply an uncomplicated world... a pleasant dream. I can't blame them.

D. F. Linton writes:

I you sit me down in the cockpit of a helicopter there is no real doubt that I have control of it. I have read that if I twist the throttle the engine will rev and if I move the collective control the rotor will generate more or less thrust which I could point in various directions by moving the cyclical control. None of that means I could actually fly the helicopter to some destination or anywhere at all without crashing it.

I suspect that our Central Monetary Planners are in quite a similar situation.

Eliezer Yudkowsky writes:

I take it you don't believe in the NGDP futures targeting scheme that Scott Sumner advocates? I don't quite understand myself how that's supposed to work exactly, but it did sound fully instrumental.

Take writes:

" The Fed's hope is presumably that this rule achieves good policy goals, just like "Wake up at 6 M-F, bike 10 miles in under 40 minutes" might be good advice for someone trying to stay in shape.

This is only chance the way to keep something stay in shape. And also this is only work for bureaucracies or prof. or maybe high-talented CEOs. But they won't be able to qualify your consequentialism for olympic ( How to win gold medal) because olympic is needed for competitiveness and sportsmanship (viz. fairness, ethics, respect,fellowship) with other competitors who have been training at their environment form whole over the world (internationally).

As in international economics, there is an economic trilemma (impossible trinity). It's saying of impossibility to have all three of the following at the same time;

1. A fixed exchange rate
2. Free capital movement (absence of capital control)
3. An independent monetary policy

China ~ Impossible=2
United states & Japan ~ Impossible=1
EU ~ Impossible=3

We know what is happening in Europe right now. The most notable thing in europe this time is too much responsibilities toward ECB and a few economically healthy nations because of impossibility for microeconomic monetary policy by nations bases like FED is doing constantly such as QE. EU-Healthy-nation's tax-payers are going to support unhealthy other nation's debts and not-related people(third party) will get benefits from that. Therefore, I am worrying about not olympic gold medals but Olympic 's future per se. I am seriously thinking about last winter olympic sochi 2014.

TAKE Global City Plan R&D writes:

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