Photo: World Economic Forum
The big news in central banking this week came from the Fed, which announced the adoption of an “Evans Rule,” a concept named after Chicago Fed President Charlie Evans, who proposed back in 2011 that the Fed link easy money with explicit economic targets.In other words, rather than giving some arbitrary date for when the Fed expected to tighten again, the Fed is now saying it won’t tighten until unemployment hits 6.5 per cent, or inflation projections get above 2.5 per cent.
But however evolutionary this move was, it was also to an extent largely expected. Just not quite yet. Goldman’s Jan Hatzius told us in an interview last week that he expected it to happen at a meeting in early 2013. So the surprise is more of timing.
In the meantime, the monetary policy cognoscenti are intrigued by the noises coming out of the U.K., which of course recently poached Canada’s top central banker Mark Carney, who will start at the BoE in the Spring.
Carney gave a speech this week, wherein he talked about the sexiest idea in monetary policy, and the holy grail of the new school of policy nerds: NGDP targeting.
He said (via FT Alphaville):
From our perspective, thresholds exhaust the guidance options available to a central bank operating under flexible inflation targeting.
If yet further stimulus were required, the policy framework itself would likely have to be changed. For example, adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP.
Bank of Canada research shows that, under normal circumstances, the gains from better exploiting the expectations channel through a history-dependent framework are likely to be modest, and may be further diluted if key conditions are not met. Most notably, people must generally understand what the central bank is doing – an admittedly high bar.
However, when policy rates are stuck at the zero lower bound, there could be a more favourable case for NGDP targeting. The exceptional nature of the situation, and the magnitude of the gaps involved, could make such a policy more credible and easier to understand.
Of course, the benefits of such a regime change would have to be weighed carefully against the effectiveness of other unconventional monetary policy measures under the proven, flexible inflation-targeting framework.
Scott Summer, the blogger known for pushing NGDP targeting, used words like “bombshell” and “really big deal” to describe Carney’s comments.
Meanwhile, at FT Alphaville, Joseph Cotterril points out that all it would take is a directive from the U.K. Treasury for the Bank of England to change its mandate to give Mark Carney the flexibility he needed to try anything he wanted. And yesterday, U.K.’s finance Chief George Osborne was quoted as saying he was open to exploring such new mandates for the bank.
The pieces are coming together for a potential sea change.
You have an incoming monetary policy rock star (Mark Carney) exploring the bold idea of the central bank pursuing a policy where it targets a level of total output, and you have a Treasury that may be supportive of him, and can change the mandate of the Bank of England very easily.
2012 is really ending in historic fashion for the world of monetary policy.