Cristina Romer details exactly what’s wrong with… maybe everything in Washington today. But that’s not what she thinks she’s detailing. Here’s her advice to Fed Chairman Ben Bernanke, thoughtfully published by the New York Times:
HOW would this help to heal the economy? Like the Volcker money target, it would be a powerful communication tool. By pledging to do whatever it takes to return nominal G.D.P. to its pre-crisis trajectory, the Fed could improve confidence and expectations of future growth.
Such expectations could increase spending and growth today: Consumers who are more certain that they’ll have a job next year would be less hesitant to spend, and companies that believe sales will be rising would be more likely to invest.
Another possible effect is a temporary climb in inflation expectations. Ordinarily, this would be undesirable. But in the current situation, where nominal interest rates are constrained because they can’t go below zero, a small increase in expected inflation could be helpful. It would lower real borrowing costs, and encourage spending on big-ticket items like cars, homes and business equipment.
Even if we went through a time of slightly elevated inflation, the Fed shouldn’t lose credibility as a guardian of price stability. That’s because once the economy returned to the target path, Fed policy — a commitment to ensuring nominal G.D.P. growth of 4 1/2 percent — would restrain inflation. Assuming normal real growth, the implied inflation target would be 2 percent — just what it is today.
Though announcing the new framework would help, it probably wouldn’t be enough to close the nominal G.D.P. gap anytime soon. The Fed would need to take additional steps. These might include further quantitative easing, more forceful promises about short-term interest rates, and perhaps moves to lower the exchange rate. Such actions wouldn’t just affect expectations; they would also be directly helpful. For example, a weaker dollar would stimulate exports.
You might look at Romer’s plan and think, “Brilliant!” Or maybe you swing the other way and shout, “Idiot!” I read it and I say: Hubris.
Romer assumes — and Bernanke is no better — that the Fed can wave its magic policy wand and get just the right amount of growth with just the right amount of inflation and then it will be able to switch off the inflation just before it gets too big.
Is there anything in the Fed’s 80 year history that should give Romer/Bernanke/et al. that kind of confidence? This is hubris, and it’s not just at the Fed. We have a powerful and overgrown capital city filled with men and women who are just sure they know better than you how to live your life, spend your money and run your business.
And Romer’s piece is evidence that the last three years haven’t humbled them one whit. They’ll have to be humbled at the ballot box.
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