If things are going well

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There are an increasing number of pundits suggesting that we may be on track for a soft landing. I don’t have strong views either way, but let’s assume that is the case; the US is increasingly likely to achieve a soft landing. What then? What should the Fed do next?

One answer is, “Keep doing what it’s doing, as that seems to be working”.  But it’s not clear what it means to maintain a steady monetary policy, as the economics profession has never provided a satisfactory definition of “monetary policy”. Indeed I wrote an entire book on this subject, which (I hope) will come out soon.

Karl Smith likes what he sees, and suggests that the economy is doing so well (in terms of achieving a soft landing) that the Fed should hold off on further rate increases.  This view makes sense if we assume that stable interest rates represent a stable monetary policy.  (Note: Smith also looks at indicators such as money supply growth, so his views are more nuanced than I’ve indicated here.  Read his Bloomberg piece.)

Someone else might look at the same evidence, and agree that policy should stay the course. But for them, staying the course might be implementing the interest rate increases that the Fed has been predicting in recent meetings. After all, those predicted rate increases influence long-term interest rates, and the economy seems to be doing well at the current level of long-term rates. So should we stay the course by carrying out the Fed’s predicted rate increases?

A third pundit might argue that the Fed “dot plot” is not fully credible. The market expects a slightly lower path for interest rates than the path predicted by the Fed. And it’s the market expectation of the future path of rates that the economy is reacting to. So perhaps the Fed should not keep rates where they are, nor should they raise them at the pace they have predicted. Instead, if the economy is doing well then perhaps the Fed should raise rates at the pace that the market is predicting.

I don’t much like any of these views, as they all rely on interest rate targeting. And I don’t believe the Fed should be targeting interest rates—let the financial markets set rates. But if the Fed insists on setting rates, and if the economy is indeed on track for a soft landing, then the least bad policy would be to have rates follow a path equivalent to the current market prediction.

Once again, I am not advocating that policy; I’m saying that policy would be appropriate if we are now on track for a soft landing.  My own view is that the risks are still slightly to the upside, toward overheating.

PS.   In a new article I wrote for the National Review, I point out that low and stable NGDP growth is a necessary and sufficient condition for the Fed to achieve its policy goals:

The Fed does not currently target nominal spending. But as a practical matter, the Fed cannot achieve its goal of low inflation and high employment without stable nominal-spending growth. Whenever spending growth is far below 4 percent, unemployment will rise sharply. Whenever it is far above 4 percent, inflation will rise. Because spending growth is the sum of inflation and real GDP growth, it is the best single indicator of the Fed’s performance.

A policy target of 4 percent spending growth is much more credible and transparent than a vague policy aimed at 2 percent inflation and high employment. How should high employment be defined? The Fed doesn’t tell us. How does it balance the goals of avoiding high inflation and encouraging high employment? The Fed doesn’t tell us. What does it do if it misses a policy goal? Again, the Fed doesn’t tell us.

Read the whole thing.