Herman Cain for Federal Reserve Board?
The 5–5–5 plan for Monetary Policy
It looks like Trump is doubling down on his appointment of Stephen Moore to the Fed by also tapping Herman Cain — a pizzapreneur with no formal economics training.
This seems like classic trolling, but it might have an upside.
For those who don’t remember, Cain ran for President in 2012 on a platform of simplifying the tax code. His 9–9–9 plan, modeled off of Domino’s popular 5–5–5 deal, would have given us a 9% personal income tax, 9% federal sales tax, and a 9% corporate tax. We’ll never know whether the increase in sales tax would have made up for the cuts in the other taxes, but it gave me an idea for how Cain could position himself to outsmart his academic colleagues on the Fed board if he made it through confirmation hearings:
The Federal Reserve has operated under an interest rate targeting regime for decades.
Rates were dropped to the lowest level — 0% — back in 2008, and the Fed only began to raise them recently, when it became clear that the economy was improving rapidly.
Trump wants the Fed to keep interest rates at 0%, but if they credibly promised to do this indefinitely, it would actually go against Trump’s aims.
Here’s why:
Ostensibly, the Fed can control the price of credit and overall tightness or looseness of monetary policy by controlling the shortest-term interest rate — the overnight rate at which banks lend to each other to meet federal reserve requirements.
In reality, they are increasing and decreasing the monetary base and subtly communicating the future path of short-term interest rates, which in turn forms the economy’s expectations of inflation, growth, real rates of return, and thus the long-term interest rate.
Michael Woodford is the leading monetary theorist. His textbook is a standard reference for academic economists and central bankers, and emphasizes that expectations of future policy are equally if not more important than the current interest rate or money supply. Woodford has accustomed central bankers to thinking in terms of forward guidance of interest rates, in which the statements accompanying Fed meetings hint at where policy is headed.
In 2012, Woodford argued that the Federal Reserve was shooting itself in the foot by stating that economic conditions were “likely to warrant exceptionally low levels of the federal funds rate at least through late 2014.” This wording, Woodford argued, was self-defeating in two respects.
1. It signaled that the Fed would not take further actions to ease monetary policy.
2. It suggested that they would begin to raise rates to prevent inflation as soon as the economy picked up.
With these expectations in mind, the economy remained mired in the paradox of zero lower bound.
Today the Fed is raising rates despite historically modest inflation. This seems like the right move, since the economy is expected to grow at around 5% this year in nominal terms (~3.1% real growth + ~1.9% inflation). Even better, though, would be an explicit target for nominal GDP growth of 5%.
That’s where the new 5–5–5 plan for monetary policy comes into play. The Fed could set a 5% nominal GDP growth target averaged over the next 5 years, with the intention of eventually raising short-term interest rates to 5% to reflect a strong economy and increasing returns to investment.
Alright, wonks — tell me where I’m wrong on this one.
