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Further exploring the comparative institutions angle: even given the obvious epistemic and political constraints, it seems plausible that a world where the Fed at least tries to target nominal income is a better world than one in which the Fed tries to target inflation, the price level, some measure of unemployment, or some (linear?) combination of these. Free banking is the first-best institutional arrangement, but it isn't obvious to me that any of the real-world frictions are more of a concern for a monetary authority with a static or dynamic nominal income target. In fact, I think it's plausible that, if anything, these frictions are relatively less troublesome than in trying to hit a more narrowly-defined target variable.

I can't speak for other market monetarists, but I agree with the Hayek quotation. Policy should not be discretionary, instead we need clear rules that take discretion away from the monetary authority (which I define as the institution that controls the medium of account.)

I'd prefer a regime where the market determines the money supply and the level of interest rates, and the government defines the medium of account as a futures contract linked to NGDP.


Point taken, but consider the Friedman quote about the consequence of error given the centrality of money, and the Hayek quote about the direction of error and his other about the shape of the order that results being not temporary, and now revisit your response. That is my point.

Even a likelihood of small error IF the consequences are dire, might not be worth it. Is the Fed an institutions that possesses anti-fragility?

Peter, here is an answer for you:

Prof. Boettke,

I'm not sure how robust the Fed is to fragility. My intuition is "Not very," as is the case with most (all?) top-down institutions/organizations. But given the existence of the Fed, I think it would do the least harm, in the sense of approaching monetary neutrality, with an NGDP target. Again, I prefer free banking, and I'll continue to support it as first-best.

Allan Meltzer, who wrote a 3-volume history of the Fed, concluded that, in its almost 100-year history, it has just produced a few years of stability and low inflation. He cites 1923-28, when it was on the gold standard; and 1985-2003 when it appeared to follow the Taylor Rule.


I totally agree. The Fed for most of it's near 100 year history the Federal Reserve mostly fail to do what it easy be able to do and that is to ensure nominal stability.

It is by the way not given the Fed followed a Taylor Rule during the Great Moderation. Rather new research by Josh Hendrickson indicates that the Fed followed a NGDP growth targeting rule rather than a Taylor function:

Or as Greenspan put it back in 1992:

“Let me put it to you this way. If you ask whether we are confirming our view to contain the success that we’ve had to date on inflation, the answer is “yes.” I think that policy is implicit among the members of this Committee, and the specific instruments that we may be using or not using are really a quite secondary question. As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions. I would say in that context that on the basis of the studies, we have seen that to drive nominal GDP, let’s assume at 4-1/2 percent, in our old philosophy we would have said that [requires] a 4-1/2 percent growth in M2. In today’s analysis, we would say it’s significantly less than that. I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that. And I don’t see any change in our view…and we will know they are convinced (about “price stability”) when we see the 30-year Treasury at 5-1/2 percent.“

on the Fed ensuring nominal stability, what role of the Fed in the great moderation from 1983 to 2007?

see also John Taylor, The Rules-Discretion Cycle in Monetary and Fiscal Policy, Finnish Economics Papers, 2011 at

His lecture reviews the historical trends in the balance between rules and discretion:
• toward more discretionary policies in the 1960s and 1970s;
• toward more rules-based policies in the 1980s and 1990s; and
• back again to discretion in recent years.

In each of these swings, monetary policy and fiscal policy moved in the same direction.

These swings are correlated with economic performance—unemployment, inflation, economic and financial stability, the frequency and depths of recessions, the length and strength of recoveries.

The lecture also provides evidence that the correlation is causal with the moves toward more rules-based policies improving economic performance.

Jim, thanks...I think it is pretty clear that Fed policy became significantly more rules based from the mid-1980s and basically until 1997-98. Here I would completely agree with Bob Hetzel's view of things.

Josh Hendrickson's new paper is extremely interesting as it seems quite clearly to indicate that the Fed was targeting nominal GDP growth rather having a Taylor rule during the Great Moderation.

I think it is tremendously important that the Fed returns to a clear rules based policy - preferably a target for the nominal GDP level.

I am all for rules, but the Taylor rule is not a good one.

A mechanical rule for a short and safe interest rate based upon inflation and the output gap has not been very effective.

If this really does represent what the Fed did during the Great Moderation, they were lucky in kept flow of nominal expenditure on a steady growth path.

That doesn't mean there aren't worse rules. For example, keeping a nominal interest rate constant, no matter what. Or, a rule for closing the output gap regardless of inflation (or better yet, nominal expenditure.)

Scott has made the point from the Market Monetarist side of the aisle; so let me add that as someone convinced that we cannot expect discretionary central bankers to deliver sound monetary policy I also do not see any reason why we cannot toss the central banking bathwater and yet cling fast to the Market Monetarist baby.

Recently on I linked to my paper on "Quasi-Commodity Money" alluding to the possibility of an "automatic" NGDP targeting regime. As it happens the paper was written for an upcoming LF conference commemorating the 1962 volume of essays to which Pete's post refers.

I think a related problem to the implementation of mechanical rules is the measurement of the involved economic aggregates. How are they to be measured?

Take the Taylor Rule for instance, which supposedly is a good description of Fed policy during the 'Great Moderation'. The Taylor Rule incorporates an output gap and inflation - but how are these quantities to be measured?

The way inflation has been measured has varied considerably over time, especially since the 80s - for instance, hedonic adjustments, the incorporation of housing rental (as opposed to housing prices), and also the Fed switching from the CPI to the Personal Consumption Index.

Someone on once investigated the relationship between M3 money supply with CPI - and found a high correlation between these two quantities in the past, with CPI usually lagging M3 by 18-36 months. That relationship no longer holds true since the 80s - and in fact positive M3 growth is now correlated with negative CPI!

I'm not familiar with measurements of the output gap, but the natural level of output is something which is unobservable too.

Had these economic aggregates been computed the same way as they used to be in the 70s, perhaps it might be discovered that the Taylor Rule had been a poor description of Fed policy.

If it is decided for the government to pursue mechanical rules for accountability reasons, then this accountability is only complete with strict, proper guidelines on how these economic aggregates are to be measured, not to be fiddled with.

I just want to add to my previous comments that if the Taylor Rule had failed to deliver the stability expected of it, a large part of its failure could be due to the dubious ways the relevant economic aggregates were measured - and thus not so much the failure of the Taylor Rule per se.


I agree there don't have to be a conflict here. I have again and again argued that NGDP level targeting could be part of a privatisation strategy. Your recents papers seems to perfectly in line with that thinking. The only different is that MM'ers like Scott and me accept that central banks do exist and given that fact we have view have a view on how they should conduct monetary policy (market based NGDP level targeting). That is in my view much closer to the Free Banking ideal than any ad hoc rules like the Taylor Rule. Both Scott and I are in favour of futarchy in monetary policy. We want the central bank to set the target, but want the market to decide on implementation.

More on this see my comment to Pete:

Lars, I perfectly understand what you and Scott (and David Beckworth) are about, and do not disagree with it. I, too, do not imagine that "tossing the central banking bathwater out" is something we can or will do any time soon. It is but a long-run ideal.

George, I know you know;-) Now I just hope that Pete also realizes that we are 99% in agreement and that Market Monetarists are arguing for institutional arrangements that Hayek and Friedman would agree with.

Finally lets hope that we are not all dead in the long run - because I would like to see that long run ideal to become reality one day!

Pete hasn't provided us with the entire passage from Capitalism and Freedom, and we're not focused on the gravamen of Friedman's argument. He was arguing against an independent central bank. It is a system in which responsibiity for monetary policy is dispersed, while power is concentrated in a few hands.

If Friedman's criticism, a Public Choice one, isn't addressed, it will not matter what rule is chosen. Who enforces the rule? What sanction is there for not following the rule?

As to the Hayek quote, the history of the Fed is one of focus on the short-term. In the main, members of the FOMC react to movements in the unemployment rate. The 1920s were an exception because the Fed was on the gold standard. From 1979 on, Volcker had the support of two administrations to crush inflation. But these periods were exceptional.

i have been in search of this since a while now

A possibly naive question from a non-economist - but why can't we just freeze the amount of base money and let the economy grow? In other words, why does a central bank have to be targeting anything? Isn't it the case that (absent sudden changes like Friedman's great contraction) any amount of money will suffice for any given level of economic activity as long as prices adjust?

The Fed was on a gold standard from 1929-1932 as well.

In my view, the Great Recession reprepresents the Fed's third great failure, the Great Depression, the Great Inflation, and the Great Recession.

One occured under a gold standard, two without.

Because of devaluation and revaluation of gold, gold provides no absolute limit on government manipulation of money. The money could be completely private, and by change the dollar price of gold, just about anyhing could be generated.

Further, government manipulation of gold demand, by changing its own holdings of gold doesn't require central banking or that the government issue its own money. It can finance gold reserves with ordinary debt or use budget surpluses or deficits.

Unlike Meltzer, I count the most recent disaster as being the fault of the Taylor rule.

Assuming a constant natural interest rate and an inflation rather than price level target are part of the problem. But an interest rate target (which is much more of a problem with the Fed than focusing too much on unemployment,) and interest rate smoothing are the central problem.

What bothers me most about Meltzer's endorsement of the Taylor rule is this endorsement of the central bank manipulating short term interest rates.

O’Driscoll is right. You can’t expect political appointees to chain themselves to any kind of rule. Politicians are strictly short-term thinkers and they pressure their appointees to the Fed to respond in like fashion. All Fed members are sensitive to what the press says about their policies.

And we shouldn’t give the Fed too much credit for the great moderation. Fast productivity growth covereth a multitude of monetary sins.

McKinney, I would tend to agree and Free Banking could be method to get around this problem. Another possibility could be "futarchy" in monetary policy:

Well, I don't think we are going to replace democracy with futarchy. In any case, the crucial problem of central banking is not a technical one, but one of incentives.

The price level has risen 23x since the Fed was founded. Is there anyone who seriously believes the Fed has been searching for the right model on how to control inflation?

Allan Meltzer concluded from his history of the Fed that the institution has not for most of its history had any interest in controlling inflation. Read his article on the Fed and politics in the 2010 JME for the short version.

The Fed is a governmental agency responding to political incentives. Mostly that means financing government deficits and engaging in short-term policies to offset fluctuations in employment. You don't need a model to do that: just a printing press.

Jerry, I am certainly not claiming that the Fed has done a good job - far from it. The Fed only managed to ensure nominal stability for a very short period of it nearly 100 years in existence.

However, I am critical about the point the that Fed is going to produce run away inflation. The Fed erred on the "downside" during the Great Depression and is doing the same thing right now. During the Great Inflation it obviously erred on the upside. The point is not the "direction" of the nominal instability - just that the Fed (and other central banks) rarely ensure nominal stability. But what is the answer? Free Banking? Yes maybe, A gold standard? Certainly not...NGDP level target based on a futarchy monetary policy, yes great idea...

I'm not a monetary economist too. A weakness of the analytical conditions of monetary equilibrium as usually presented is that they do not extend to the requirements of a dynamic equilibrium.

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