March 30, 2020

Monetary Policy: The Way Forward

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Institute NGDP Level Targeting to Stabilize the Economy

By setting an NGDP (nominal Gross Domestic Product) level target in place of an inflation target, the Fed will stabilize the growth of total spending in the economy, which in turn will stabilize household and business incomes. This is especially important during crisis periods because it will keep incomes in line with people’s previous expectations of income growth. Although NGDP level targeting does not prevent the economy from falling into recession, it prevents the recession from worsening because it helps people and businesses continue to make regular payments such as mortgages and payrolls.

Allow the Fed to Buy Other Assets When Interest Rates are at Zero 

To make monetary policy effective and minimize the damage from economic crises, the Fed needs to convince markets that it has enough monetary policy tools to achieve its targets of full employment and two percent inflation. Although in theory, a central bank can always inject more money into the economy by buying assets, the Fed is legally restricted to only purchasing US Treasury bonds and mortgage-backed securities and cannot easily buy riskier assets such as corporate bonds and stocks. 

Congress should give the Fed explicit permission to buy these other assets as part of its normal operations, but only when interest rates are zero and the Fed cannot engage in traditional monetary policy operations. Giving the Fed this expanded but clearly-defined power would prevent markets from panicking over the Fed’s ability to respond to recessions, which would actually make it less likely that the Fed would need to intervene in the first place.