I am currently in DC attending a star-studded macroeconomic policy conference at the Peterson Institute. Today’s participants included Bernanke, Summers, Blanchard, Draghi, Fischer, and many other eminent economists. Bernanke’s paper was by far the most interesting, especially his proposal for addressing the zero bound problem:
So, to be concrete, at some moment when the economy is away from the ZLB, suppose the Fed were to make an announcement like the following:
(1) The FOMC has determined that it will retain its inflation-targeting framework, with a symmetric inflation target of 2 percent. The FOMC will continue to pursue its balanced approach to price stability and maximum employment, meaning in particular, that the speed at which the FOMC aims to return inflation to target will depend on the state of the labor market and the outlook for the economy.
(2) However, the FOMC recognizes that, at times, the zero lower bound on the federal funds rate may prevent it from reaching its inflation and employment goals, even with the use of unconventional monetary tools. The Committee agrees that, in future situations in which the funds rate is at or near zero, a necessary condition for raising the funds rate will be that average inflation since the date at which the funds rate first hit zero be at least 2 percent. Beyond this necessary condition, in deciding whether to raise the funds rate from zero, the Committee will consider the outlook for the labor market and whether the return of inflation to target appears sustainable.
Of course I’d prefer NGDP level targeting, partly for reasons outlined in this post. But Bernanke’s proposal would still be a dramatic improvement over current policy. More importantly, this is something that is much more politically feasible than any other proposal that I’ve seen. It actually makes the long run future price level more predictable than under current policy, which conservatives should love. It makes policy more expansionary at the zero bound, which liberals should love. It also eliminates the need to offset under and overshoots of inflation when not at the zero bound, which should assuage the fears of those who oppose traditional forms of level targeting. Indeed I think Bernanke’s proposal is now the odds on favorite to be official Fed policy the next time the US hits the zero bound. Most people at the Fed understand that something like this is needed at the zero bound, and Bernanke’s proposal could be sold to Congress as being fully consistent with the Fed’s 2% inflation target.
You might assume that under Bernanke’s proposal we’d still be at the zero bound, because we are still far below the 2% trend line from 2008. Not necessarily:
Note though, that if this policy rule had been in place prior to 2008, and if it had been understood and anticipated by markets, then longer-term yields would likely have been lower and the effective degree of policy accommodation during the past decade might have been significantly greater. In that counterfactual world, inflation might have been higher and the average-inflation criterion might have already been met. This is because the Fed would have already communicated their intention to be more accommodative going into the ZLB episode.