Two Plus Two is Four: Connect the Dots

Jay Powell has a bland speaking style, but if you listen carefully to the content, his press conferences can be quite interesting. I don’t have a written transcript, so the following is not precisely word for word, but pretty close:

“Inflation expectations are quite central in how we think about inflation. We need them to be anchored at a level consistent with our two percent inflation goal…we need to conduct policy in a way that supports that outcome.

So he wants to set policy at a position where the public expects two percent inflation. What about level targeting?

“We are also as a part of our review...looking at potential innovations, changes to the framework that would be more supportive of achieving inflation on a symmetric two percent basis over time...that’s at the very heart of what we are doing in the review.”

Translation: the Fed is edging closer to level targeting, or average inflation targeting. Later, he indicated that the policy review would last until the middle of next year. I doubt they’d change policy right before the election, so look for a late 2020 announcement.

What about real growth?

“Our outlook overall is for moderate growth of around two percent, which is pretty close to trend…and we feel like our current stance of policy is appropriate as long as that remains the outlook.”

Translation: policy is currently set at a level expected to produce roughly two percent RGDP growth. If expected RGDP growth changed then policy would need to be adjusted.

Let’s summarize these “dots.” Policy is set at a level where the Fed expects two percent RGDP growth. Policy is set at a level where the public expects two percent inflation. Hmmm, what sort of expected NGDP growth does that imply?

Powell also indicates that the policy framework needs to change in a direction where the misses are “symmetric,” which is what happens with level targeting. That change will likely be announced later next year.

More than ten years ago, I began blogging on the need for stable growth in NGDP, with level targeting. I argued that policy should be set at a position where the markets expected five percent NGDP growth, later changed to four percent when the Great Stagnation kicked in and the Fed said it wanted to stick with a two percent inflation target.

We do not yet have a policy regime where the Fed sets policy at a position that the market expects will result in four percent NGDP growth, with level targeting. But we are a heck of a lot closer to that regime than we were in February 2009.

Can I say we are 50 percent of the way there? And what about the other 50 percent? We need to shift from a focus on the public’s inflation expectations to a focus on the financial market’s inflation expectations. And we need to shift from a focus on the Fed’s RGDP growth outlook to the market’s RGDP outlook. And we need to add the two.

Two plus two is four. That’s not so complicated, is it?

Three more years of steady NGDP growth and America will have its first ever soft landing. In that case, I’ll declare victory and go home.

Photo by Chip Somodevilla