August 24, 2016
Sebastian Mallaby had a column in the WaPo on the Fed’s 2.0 percent inflation target. Mallaby argues that the 2.0 percent target is arbitrary and makes the case that moving to a higher inflation target, as recently suggested by San Francisco bank president John Williams, would be desirable.
While Mallaby makes some good points, he also gets some items wrong. First, he notes the Fed’s decision to ignore the growth of the housing bubble in the last decade. He said that they viewed the issue of financial stability as one appropriately left to regulators, not a concern for monetary policy. This is largely right, but it ignores the point that the Fed also has enormous regulatory power, including the responsibility for oversight on the issuance of mortgages.
Alan Greenspan essentially ignored these responsibilities, seeing them as inconsequential.This is largely because he didn’t see bubbles as any big deal, or at least this is what he publicly said in a speech he gave at the American Economics Association convention in January of 2004. In this speech he patted himself on the back for having the good sense to let the stock bubble run its course and then pick up the pieces after it burst. (The next day, Ben Bernanke, who was then a Fed governor, explained why it was necessary to still have a 1.0 percent federal funds rate, more than two years after the recession had officially ended. This suggested it was not easy to pick up the pieces.)
The other area where Mallaby is not exactly on target is in discussing the Fed’s tools. While he is correct in arguing that the Fed has more room to lower the federal funds rate in the context of a higher inflation rate, it is not right that this is its only tool. The Fed could target a long-term interest rate. For example, it could set a target of 1.0 percent for the 10-year Treasury rate for the next year.
This sort of targeting of a longer term rate would provide a more direct boost to growth than lowering the federal funds rate. While it might be desirable to rely on a more known tool for monetary policy, it is wrong to imply that there is nothing more the Fed can do to boost growth.
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