Against the backdrop of solid economic performance and balanced but salient risks, Federal Reserve Chairman Jerome Powell used his comments at this year's Jackson Hole symposium to outline the case for continuing, gradual interest rate increases (Powell 2018). A monetarist cross-check of Powell's macroeconomic analysis, organized around the recent behavior of nominal gross domestic product (NGDP), supports his optimistic outlook and confirms the need for additional but gradual policy tightening. A reconsideration of the risks presently facing the central bank, however, highlights the further advantages that would accrue if the Federal Open Market Committee (FOMC) used a specific monetary policy rule to guide its future actions, even as it continues to confront uncertainty regarding the structural relationships through which those actions transmit their effects through the economy.
Current Monetary Conditions
Chairman Powell delivered his upbeat message at Jackson Hole with specific reference to the recent behavior of unemployment and inflation, while acknowledging the difficulty that macroeconomic theory has in reconciling the low levels of both variables with the Phillips curve, which depicts an inverse relationship between the two. NGDP growth provides another useful index of the effects that monetary policy is having on tire economy. Examination of its recent trends provides another view--a cross-check that can be used to reinforce or dispel doubts raised by Powell's more traditional, Keynesian approach.
As the sum of real GDP growth and nominal price inflation, NGDP growth conveniently captures, in a single number, the Fed's performance in satisfying both sides of its dual mandate for maximum sustainable growth with stable prices. At the same time, however, NGDP, precisely because it is a nominal variable, measured in units of dollars, is under the central bank's control in the long run. No one should expect the Fed to be able to hit a numerical target for NGDP growth on a quarterly or even an annual basis. But, if FOMC members are dissatisfied with the average rate of NGDP growth prevailing over a period of several years, they can always adjust their monetary policy strategies to successfully bring about whatever sustained acceleration or deceleration in nominal income growth they desire.
Moreover, die Fed's ability to regulate the growth rate of NGDP does not depend on die stability of the Phillips curve relationship that clearly concerned Powell and is the focus on the Federal Reserve Board staff study (Erceg et al. 2018) that he referred to in his comments at Jackson Hole. Going all the way back to David Hume ( 1985), economists have puzzled over the lack of stable patterns tiirough which monetary policy actions appear to affect real variables, like output and unemployment, first, before changing nominal variables later--what Milton Friedman (1948: 254) famously called the "long and variable lags." But, empirical studies such as Lucas (1980) and Sargent (1982) leave no doubt that, consistent with economic theory, the average growth rate of nominal variables like NGDP are satisfactorily pinned down by the central bank's monetary policy strategy. Moreover, in die current environment, where various nonmonetary forces may well be causing the very low rate of measured unemployment to overstate die true degree of resource utilization in the U.S. economy, focusing instead on the real component of NGDP growth guards against one of the risks alluded to in Powell's remarks: a policy stance that becomes inappropriately restrictive out of concern for inflationary pressures working through a misperceived Phillips curve.
Finally, as noted by Tobin (1983) and McCallum (1985), die equation of exchange MV = PY identifies nominal income (PY) as a measure of the money supply (M) that gets adjusted automatically for shifts in velocity (V). Thus, analyses based on the behavior of NGDP growth provide a monetarist cross-check against mainstream Keynesian approaches, like Powell's, organized around die Phillips curve instead. According to this monetarist view, interactions between trends in M, reflecting monetary policy actions that affect the money supply, and V, interpreted following Friedman (1956) with reference to the determinants of money demand, replace those between the actual and natural rates of unemployment as the key mechanisms determining inflation.
For all these reasons, it is very reassuring that a systematic look at die recent behavior of NGDP growth reinforces Chairman Powell's positive assessment of current monetary conditions and thereby strengthens his case for additional monetary tightening. The graphs in Figure 1 update those presented in a previous SOMC...