Scott Sumner  

Policy needs to be symmetrical

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Thomas Hutcheson left an interesting comment after my previous post:

There is an alternative: use unemployment (some vector or indicators not just U3) to target the "unemployment" portion of the Fed's mandate and the Price level to target the "price stability" portion.

Under this approach the Fed would goose inflation (with interest rate changes, QE in LT government backed securities, private securities, exchange rate intervention, whatever instrument it chooses) as long as their forecast for the price level remains below target.

The Fed would try to rein in inflation (again, with whatever instruments) when the price level was above target unless the unemployment vector was also above target. What ought to go into the unemployment vector, how to make the price level forecast, and which instruments to use, what level of unemployment to target and what rate of change of the price level to set as the target would remain matters of "Fischerian" discretion.

I think that's a pretty good description of what I would call "dovish bias" in policy. Lots of people think that way. If you look closely, however, the policy is not symmetrical. He calls for "reining in" high price levels as long as unemployment is not high, but then calls for boosting low price levels without any reference to the unemployment rate. His proposal will be asymmetrical, and hence destabilizing. To make it symmetrical, the Fed would need to refrain from boosting a low price level if unemployment is also low.

Under his proposal, the Fed would probably find itself refraining from slowing down excessively fast NGDP growth as long as inflation was not high. This would lead to labor market overheating, and an eventual relapse into recession.

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COMMENTS (3 to date)
maynardGkeynes writes:

The Professor writes: Under his proposal, the Fed would probably find itself refraining from slowing down excessively fast NGDP growth as long as inflation was not high.

Can someone explain to me (other than the Professor, whom I would prefer to have answer less basic/better informed questions): How does this differ from what Greenspan was doing during the alleged "maestro" era? Looks pretty similar to me -- keeping interest rates low, however much the economy seemed on the verge overheating.

Scott Sumner writes:

Maynard, Yes, you could argue that rates were too low around 1999-2000, as NGDP growth was fast, despite inflation close to 2%.

The same may have been true around 2005-06.

Thomas Hutcheson writes:


I agree with you that any approach needs to be symmetrical, but consider the possibility of unemployment becoming "too low" (because inflation has reduced real wage levels below what workers will accept in the long run?) extremely unlikely to occur if the Fed were in fact following a dual mandate with explicit, announced PL targeting. Can we imagine the Fed tolerating years of above-target price levels as it has below trend since the 2008? Any apparent asymmetric character would arise from the asymmetric tendency of out of equilibrium prices to adjust more rapidly upward than downward.

Where I disagree is that the "dovish" POV is shared by very many others. If it is, they are nowhere near the Federal Reserve system, the Presidency, Congress or the MSM. :)


Thanks for the promotion. The highest academic rank I have ever held, many years ago, is adjunct.:)

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