WASHINGTON (MarketWatch) — The Federal Reserve should target the level of gross domestic product, Goldman Sachs economists said ahead of a wave of speeches from central bank officials.
In a note published Friday night, Goldman Sachs said the best way for the central bank to loosen policy significantly further would be to target a GDP path, and commit to using more asset purchases to achieve that path.
“While a shift to a nominal GDP level target would be a big decision, it would be consistent with the Fed’s dual employment and price mandate,” the economists wrote.
The note comes as several Federal Reserve speakers take to the podium this week, including Chairman Ben Bernanke on Tuesday and Vice Chairman Janet Yellen on Friday.
At the moment, the Fed has no formal inflation or unemployment target, though it informally targets inflation at around 2% a year, and pushes for unemployment to be at “natural” levels, which most economists fix at somewhere on the order of 5% to 6%.
Chicago Fed President Charles Evans has suggested the Fed could pledge not to hike interest rates until unemployment declines to a level of around 7% to 7.5% provided core inflation does not exceed 3%. New York Fed President William Dudley — the former chief economist at Goldman — has suggested that if inflation were to undershoot the central bank’s target by half a percentage point next year, the Fed could offset the miss with an additional half-point increase later on.
The idea of targeting nominal GDP isn’t new, and the Goldman economists cite a 1994 study by Robert Hall and Gregory Mankiw — the latter an adviser to Republican presidential candidate Mitt Romney — that such targeting could be a “reasonably good rule for the conduct of monetary policy.” They also advised targeting the level of nominal income and not the rate of change.
Since nominal GDP is the price level multiplied by real GDP — and because real GDP is closely related to employment — having a nominal GDP target incorporates both goals of current Fed policy, the Goldman economists say.
The advantages of adopting the policy is that the central bank commits to making up for past inflation under- and overshoots, so that households and businesses would expect higher inflation following a period of economic weakness. There’s also a greater need to bolster the economy now, because the long-term unemployed often lose skills needed to be employable.
“This justifies putting more weight on the output and employment part of the dual mandate than under normal circumstances,” the Goldman economists say.
The Fed has so far taken extraordinary steps to goose the economy. The federal funds rate is targeted between a record low 0% to 0.25%, the central bank’s balance sheet has swelled to roughly $2.9 trillion, and the Fed has committed to shifting $400 billion of assets to longer maturities. The Fed also has committed to keeping rates at low levels through the middle of 2013.