But all is “forgiven” (including her incursion into the usefulness of fiscal stimulus at the ZLB) because the “meat” of the Lecture comes later:
Given that expectations management is so important, particularly at the zero lower bound, but apparently so hard to use—what is a monetary policymaker to do? For an answer, I think the best place to look is back in history. The most successful attempt to stimulate an economy at the zero lower bound with monetary policy occurred in the United States in the 1930s.
People tend to think that Franklin Roosevelt’s most dramatic actions involved fiscal policy and the New Deal. But, his monetary actions were even more dramatic and more important.13 Roosevelt staged a regime shift—by which I mean he had a very dramatic change in policy.14 A month after his inauguration, he took the United States off the gold standard, which had been the basis for our monetary operations since the late 1800s. Then the Treasury, not the Fed, used the revalued gold stock and the gold that flowed in as means to increase the U.S. money supply by about 10 percent per year.
This regime shift had a powerful effect on expectations. Figure 5 shows stock prices, which can tell us about expectations of future growth, and a measure of expected inflation. In each panel, I have drawn in a line at March 1933, just before the dramatic change in policy. Stock prices surged instantly, suggesting that expectations of future growth improved dramatically. And price expectations also switched radically. These estimates were derived by James Hamilton, an economist at the University of California, San Diego, who backed out estimates of inflation expectations from commodity futures prices in the early 1930s.15 Hamilton finds that people went from expecting deflation of close to 10 percent a year early in 1933 to expecting inflation of 3 percent just a few months later.
This rise in expected inflation implies a dramatic fall in real interest rates, since nominal rates remained at zero the whole time.
And the change in expectations and real interest rates had a profound impact on behavior soon after. Firms started to invest and hire again. Consumers started to spend. Figure 7 shows truck sales in the early 1930s. One of the first things that took off following Roosevelt’s regime shift was car and truck sales—as farmers and consumers decided that the future was bright enough that they should take the leap.
The bottom line from this episode is that for policymakers to really move the dial on expectations and push them firmly in the direction they want them to go—it takes a regime shift. Smaller, more nuanced moves are easily missed or misinterpreted by people in the economy.
Suppose the Federal Reserve wanted to make a bold change in policy today that would really change expectations and strengthen the recovery. What could it do?
Back in 2011, a number of economists, including me, argued that the Federal Reserve ought to adopt a new operating procedure for monetary policy: a target for the path of nominal GDP. A nominal GDP target is just a different and more concrete way of specifying the Fed’s dual mandate. The Fed is supposed to care about both inflation and real growth. Nominal GDP, which is the current value of everything we produce, is just the product of both those things—price changes and real growth.
Switching to this new target would have some important benefits. In the near term, it would be a regime shift. It would unquestionably shake up expectations. Since we are currently very far below a nominal GDP path based on normal growth and inflation from before the crisis, it would likely raise expectations of growth, and so help spur faster recovery. But one of the best things about a nominal GDP target is that it is also a good policy for the long run. It says that once nominal GDP is back to the pre-crisis path, inflation should be at the Fed’s target of 2 percent and real growth should be at its normal, sustainable level.
Now, a nominal GDP target is just one way a central bank could try to improve its expectations management. But my reading of history is that such a bold change is more likely to move expectations in the desired direction than the largely incremental changes the Fed has been trying to use so far.
From the conclusion:
In my talk today, I have tried to point out what I think we have learned about monetary policy from the crisis, and to suggest some ways that policy might evolve in light of those lessons. Let me close with a final, more general lesson for monetary policy from history. That lesson is: Don’t fight the last war. Just as generals sometimes go very wrong by focusing too strongly on not repeating past mistakes, so do monetary policymakers.
So, how do we avoid the natural tendency to fight the last war? One way to do better is to learn from all of history, not just the most recent past. Taking the long view is the surest way to prevent short-term mistakes.
We also need to embrace evidence-based monetary policymaking. Fed officials and the economists who advise them should always question their views and prescriptions. Central banks, think tanks, and universities should continue to invest in policy-relevant research. And when the evidence clearly points in a new direction, policymakers need to have the nerve to follow it.
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