The S&P 500 was up 1.2% last week, as the US economy continues its relentless recovery. The ramp up of the Covid-19 vaccination rate should help ensure the return of economic health.
As has been the case for weeks now, the greatest threat to short-term recovery seems to be the evolution of new virus strains, which could at least slow vaccination efforts, but so far mostly hasn’t threatened the broad national and global efforts at returning life to normal for most. Boosting the willingness of those skeptical of taking vaccines could help accelerate recovery, as some evidence indicates too many Americans are resistant to vaccination.
That said, another significant risk to short-term recovery, and the greatest risk to long-term recovery, is the possibibility of monetary policy mistakes. The Fed’s new average inflation targeting framework seems to be an improvement over mere inflation targeting, offering opportunities for some catch-up in economic growth if inflation falls below the average target, but is still a far cry from optimal. Much closer to optimal would be an NGDP level target.
Here’s why. Let’s suppose the US suffers another commodity price shock, like an oil shock, which has often been the precipitant of US recessions. Under average inflation targeting, if the Fed does what it should and allows inflation to increase to keep NGDP (aggregate demand) on a stable path, it will have to lower the inflation rate at some point in the future to meet its average inflation target. Thus, we unnecessarily lose economic growth under that scenario, and associated employment gains, just because the targeting regime is suboptimal. This hurts the least productive workers the most, as they are typically the first to be laid off and the last hired in economic cycles.
Under NGDP level targeting, the NGDP growth path remains constant, minimizing unemployment during commodity price shocks and keeping real GDP growth close to capacity.
This may seem counter-intuitive to many, but if we consider the real average wage, for example, as the nominal average wage/NGDP, then it’s understood that any fall in NGDP increases the average real wage, and hence, unemployment. Temporary higher inflation is preferable to higher unemployment, keeping real GDP growth from falling as much as it would under any inflation targeting regime.
NGDP level targeting would also be better for stock investors, at least of the buy and hold variety, as most market volatility would be eliminated, with the growth in value of the S&P 500, for example, rising at the rate of economic growth, holding interest rates constant. And interest rates would be steadier under such a regime.
For further perspective, here’s economist Marcus Nunes on the problems he has with inflation targeting, in the recent historical context.