We nearly got what Market Monetarists have been asking for – the Federal Reserve now have a relatively clear defined target and it will implement it through changes to the money base (by buying Mortgage backed securities). It is not a NGDP level target, but probably more a light version of the Mankiw rule or the so-called Evans rule.
Chicago Fed governor Charles Evans has suggested that the Fed should ease monetary policy – expand the money base – until unemployment drops below 7% or PCE core inflation increases above 3%.
The FOMC did not give any numbers yesterday, but I think it is pretty safe to assume that the Bernanke rule is in fact a Evans rule and it seems like most market participants also see it in this way.
This illustrate the clear advantage of a rule based approach to monetary policy rather than a discretionary monetary policy. The participants can pretty easy figure out when the Fed will step up monetary easing and when it will start tightening monetary policy.
This also means that the markets will help the fed do a lot of the lifting. Hence, if investors know that the fed will ease as long as the Bernanke-Evans rule says so investors will buy stocks, sell the dollar, expect long-yields to increase. This is of course also the market reaction we got after the FOMC’s announcement.
Similarly the Fed now have a pretty clear “exit strategy”. A big problem until now has been that the markets have been uncertain about when the fed would change direction in monetary policy. Now it seems safe to assume that the fed will continue ease until unemployment drops below 7% or PCE core inflation increases above 3%.
Update: My friend Daniel Pfaendler has a comment on his blog on the fed’s policy action. Krugman has two posts on Bernanke – here and here.
PS Paradox: The GOP wants to sack Bernanke for proposing what essentially is a Mankiw rule. I wonder what Romney’s economic advisors think about that
The Market Monetarist 
Saturos
/ September 14, 2012Paul Krugman sees it just the other way: http://krugman.blogs.nytimes.com/2012/09/13/a-quick-note-on-the-fed/
Lars Christensen
/ September 15, 2012Saturos…I think Krugman changed his mind in his follow-up post.
Daniel Pfaendler
/ September 14, 2012Hi Lars,
I agree with your views and I have added a link to your blog in my latest post (http://researchahead.blogspot.de/2012/09/lower-tail-risks-more-liquidity.html).
Best, Daniel
Lars Christensen
/ September 14, 2012Thanks Daniel…I am happy you dropped by – and even more happy that you agree!
Diego Espinosa
/ September 14, 2012Lars,
In general I agree with your analysis. However, will the Fed really tighten if UE is 8% and PCE>3%? What would happen to markets if the Fed ceased QE and pulled back on their forward guidance at a time when UE was so high? Would economists compare such an action to that of 1937?
Lars Christensen
/ September 15, 2012Diego, there is naturally that risk. However, I basically think we could be heading for a style of Mankiw rule, where the difference between UE and PCE core determines changes in the money base. That would be very good news and be very close to a McCallum style NGDP targeting rule. So I do think we should think of this as a linear policy rule rather than digital policy rule.
Diego Espinosa
/ September 15, 2012In either case, their UE target invites intense scrutiny by the broader public. They have set the expectation that Fed policy can materially influence UE. As such, its likely they will be seen by voters/Congress as “owning it”, no matter what the inflation rate. This is dangerous territory for a central bank.
Benjamin Cole
/ September 15, 2012Speaking of the GOP—Romney has put out a five-page plan, co-authored by John Taylor, on how to get the economy going. Monetary policy is not mentioned!
I think there is a ray of hope in this. I have long suspected that Taylor will advocate MM or something close as soon as there is a GOP president.
Otherwise, the five-page Romney plan would have had to usual genuflection to tight money and gold etc.
Taylor, of course, has authored a paper, on his website yet, absolutely gushing about Japan’s use of QE in the mid-2000s.
Lars Christensen
/ September 15, 2012Benjamin…lets hope that is the case.
Lars Christensen
/ September 16, 2012Diego, I completely agree. Central banks should not target non-nominal variables. There is certainly a danger (down the road) that this policy of explicitly targeting the unemployment level will lead the fed into a very dangerous territory.
I there will continue to endorse NGDP targeting as a much better alternative to what the fed is doing now.
However, the fed deserves some credit for implementing a (sort of) rule witch also should make the exit strategy more clear. This should do a lot to avoid the dangerous of the policy. But again – central banks should not target non-nominal variables. I fully agree on that point.
George Selgin makes a similar point as you do: http://www.freebanking.org/2012/09/15/2003-redux-or-why-market-monetarists-had-better-start-talking-the-dangers-of-qe3/