The Forgotten Greenspan Rule: Hikes coming everywhere
At the FOMC meeting on 17 November 1992, Fed chair Alan Greenspan said:
“I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that.”
Greenspan never wrote the rule down. But from the 1990s onwards the Fed de facto followed an implicit target for nominal demand. Whenever it strayed from that target for long, things went wrong.
Today I present The Forgotten Greenspan Rule. The idea is Greenspan’s, the formulation is mine, and this is the first time it is presented publicly.
The implicit target is the inflation target plus trend growth in real GDP. In the US that is 2% + 2.6% = 4.6%. The rule then asks three questions, in this order:
- Is nominal demand growing at least 1 percentage point faster or slower than the implicit target – without the gap narrowing?
- Is the 10-year yield moving away from the implicit target – a sign the market does not believe the central bank?
- Is the policy rate far from neutral?
The first yes decides whether to hike or cut. Otherwise, hold. Unlike the Taylor rule, it says nothing about the level of rates – only direction and timing.
Since 2015, across 19 central banks, the rule has called the direction of rates 12 months ahead in 61% of quarters. A naive rule manages 43%. For the Fed alone the hit rate is 68%, and the rule was ahead of the Fed at 9 of 13 turning points.
In May 2008 the rule said cut, but the Fed held at 2% until October. Once rates hit zero, quantitative easing was the right policy – but by then the Fed had hesitated for too long. In May 2021 the rule said hike, and the Fed waited until March 2022.
Right now US nominal demand is growing at 5.9% against an implicit target of 4.6%, according to the BEA. 10-year yields are above the target and have moved higher this year. The rule has said hike three quarters in a row.
Many blame today’s inflation on the war around Hormuz and higher energy prices. But a war is a negative supply shock. It pushes prices up and real growth down – it does not push nominal demand up. If supply were the problem, nominal demand would be running at or below target.
It is running well above. So the inflation problem is not primarily on the supply side. It is on the demand side – monetary (and fiscal) policy has remained too easy since the Covid lockdowns. And nominal demand is the one thing the Fed actually controls – not the labour market and not oil prices.
The picture is the same globally. 12 of 19 central banks should hike, and we are going to see many more rate hikes.
Last week eight central banks made rate decisions, and five followed the rule. The ECB has already followed it, hiking to 2.50% in June and September. The Swedish Riksbank has started – it hiked to 2% on 4 November, but that is still below the neutral level.
Of the banks where the rule said hike, only Norges Bank did not listen. It left rates unchanged with nominal demand at 4.7% against a target of 3.4%. It will have to hike if it wants inflation down.
Looking ahead, the rule says seven of the next eight central banks should hike – including the Fed on 9 December and the ECB on 17 December.
Watch the film and tell me what you think.
