The Need for a Monetary Strategy

Today the Federal Open Market Committee described its upcoming plans for the federal funds rate through 2023.  It is good, as I wrote last month on this blog that “Rules Are Back In The Fed’s Monetary Policy Report,” after a short absence, but it would more helpful if the Fed incorporated some of these rules or strategy ideas into its actual decisions.

Apparently this did not happen, as the chart below shows. The chart gives the FOMC’s projection of the federal funds rate and three different rules-based paths for the federal funds rate through 2023. This FOMC projection is the “value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the specified calendar year,” as stated in Table 1 of the Fed’s Summary of Economic Projections.

The three other rate paths show the federal funds rates from three policy rules using the same parameters as those in the Taylor rule–discussed in the Monetary Policy Report–with the so-called equilibrium interest rate reduced from 2 percent to 1 percent, as has been suggested at the Fed. The three policy rules use the four-quarter inflation rates of the GDP price index, the PCE price index, or the core PCE price index, based on the most recent Congressional Budget Office (CBO) projections. They use the same percentage deviation of real GDP and from potential GDP as in the CBO report. Most other forecasters do not have inflation and real GDP much different from CBO.

Even with this smaller equilibrium interest rate, the Fed’s path for the federal funds rate is well below any of these policy rules. There is a difference now (in the first quarter of 2021), and the difference grows over time.

There is no mention of why the discrepancy exists between the Fed’s actual decisions and the rules. Does this mean that the Fed will actually keep the rate this low under these circumstances regarding real GDP and inflation?  Will it then raise the rate sharply in 2024? Taken literally, this is the implication because there is no indication that the Fed will do otherwise. I see no reason why the Fed could not be indicating now that its strategy is to raise policy interest rate as economic growth increases and inflation rises. Such an interest rate strategy would clarify the Fed’s monetary policy and facilitate the market adjustment when it takes place. So would a strategy for asset purchases and other aggregates.  

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Rules Are Back In The Fed’s Monetary Policy Report

The Federal Reserve’s latest Monetary Policy Report just released on February 19, 2021 has a whole section on monetary policy rules.  That policy rules are back in the Report is a very welcome development. It re-initiates a helpful reporting approach that began in the July 2017 Monetary Policy Report, as I discussed here, when Janet Yellen was Fed chair. The approach continued under Chair Jay Powell in 2018, 2019 and early 2020, but it was dropped in July of last year. The good news is that it is back.

Five rules are discussed in the February 2021 Monetary Policy Report, especially on pages 45 through 48. To quote the Report, these include “the well-known Taylor (1993) rule, the ‘balanced approach’ rule, the ‘adjusted Taylor (1993)’ rule, and the ‘first difference; rule.  In addition to these rules” and this is very important, there is a new “‘balanced approach (shortfalls) rule,’ which represents one simple way to illustrate the Committee’s focus on shortfalls from maximum employment.” Here is a table of rules from the Report:

There were also five rules on the earlier Reports, but one is out and a new one–the Balanced-approach (shortfalls) rule–is in. As stated in the document this modified simple rule “would not call for increasing the policy rate as employment moves higher and unemployment drops below its estimated longer-run level. This modified rule aims to illustrate, in a simple way, the Committee’s focus on shortfalls of employment from assessments of its maximum level.”

How much different would this shortfalls rule be compared with the regular balanced-approach rule? There is a helpful graph in the Report which answers this question. I have magnified a portion of that graph below so it is easier to see. Notice that the balanced-approach (shortfalls) rule is below the balanced-approach rule in 2017 through the start of the pandemic in 2020. This is the period when the actual unemployment rate in the United States is lower than the estimate of the long-run unemployment rate. Thus the shortfalls rule does not increase the interest rate as does the balanced approach rule without the shortfall. The rule in between these two in the graphs is the Taylor rule. The shortfalls and the non-shortfalls rule then move together during the start of the pandemic as the unemployment rate rises well above the long run rate. The adjusted Taylor rule stays above zero, but then will stay low for longer than the Taylor rule.

The important contribution of this new discussion is that one now has an explicit way to think about the Fed’s new “shortfalls from maximum employment” approach. One can see if the new rule performs better that the balanced approach or the modified Taylor rule, for example, by simulating models. A huge amount of research can take place both outside as well as inside the Fed. There is much work to do. So let’s get going!

While this is an excellent start, more could be done. It is a bit disappointing, for example, that, as the Report says, the aims “of having inflation average 2 percent over time to ensure that longer term inflation expectations remain well anchored, are not incorporated in the simple rules analyzed in this discussion.” This is a very important issue and may be the subject of future Fed Reports.

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Watch, Listen, and Enjoy a Film About Thomas Sowell

The new one-hour program “Thomas Sowell: Common Sense in a Senseless World,” is a must watch. Beautifully narrated by Jason Riley of the Wall Street Journal, it tells the amazing life story of Thomas Sowell, born in 1930 in North Carolina, raised by a great aunt after both his parents died, moved to Harlem at 8 years old, joined the Marines, went to Harvard for college and Chicago for a Ph.D., taught at Cornell and UCLA, finally settled at the Hoover Institution at Stanford University, and in the process became “one of the greatest minds,” as Riley puts it, “of the past half century.”  

Free to Choose Network just announced that they are releasing this fascinating documentary “for airing on public television stations across the country – and for streaming on Amazon Prime, YouTube, and at” The public TV airings begin this month, but already the response on YouTube is huge with over 2 million views in just one week.

There is so much to like about this film. Visuals stream across the screen with a perfect selection of background music, as we see photo after photo, including a 1940 vintage rotary telephone which young Tommy wished he had. And Jason Riley takes us on location to 720 St Nicholas Ave in Harlem where Sowell lived, and to the front of the Harlem Branch of the New York Public Library, where a slightly older friend, Eddie Mapp, told him about library cards and books, and changed his life forever.

We watch teachers in the classroom helping little kids learn, illustrating Sowell’s long-term interest in the value of education. We hear friend Walter Williams reminisce about the days when he and Sowell were the only two Black conservatives, so people would say that they should not travel on a plane together. Larry Elder speaks on how Sowell causes “people to rethink their assumptions,” Stephen Pinker on how Sowell will never compromise just to appear agreeable, Victor Davis Hanson on how “Tom is an empiricist,” and Peter Robinson on the many books Sowell published after turning 80. They all talk about what Thomas Sowell means to them and what he is like.

Tom’s special gift for explaining things and sharing with others is illustrated with Rapper Eric July and his Backwordz style of music. We hear Dave Rubin ask Sowell in a TV interview about why he changed course away from Marxism early in life: “So what was your wake up to what was wrong with that line of thinking?” asks Rubin, and Sowell simply answers “Facts,” with maybe the best one-word answer in history. And that sets the stage for much of Tom Sowell’s unique empirical, eye-opening approach to research and writing, whether about economics, race, history, discrimination, education or culture. Throughout the program Jason Riley shows time after time that Sowell is one of those very rare people: “an honest intellectual.”

Throughout the show we see quotes on the screen from Sowell: “My great fear is that a black child growing up in Harlem today will not have as good a chance to rise as people in my generation did, simply because they will not receive as solid an education.”  He talks of a turning point in the 1960s after which there was no longer a stigma from being on welfare, and urban schools went downhill. His latest book, Charter Schools and their Enemies, recounts the story of the Success Academy in New York City and holds out hope for the future.

Tom’s long held view is that there are no “solutions” to the difficult real world problems we face as a society; there are only “tradeoffs” where you try to get as close as possible to the optimal answer. Here the film develops a clever analogy with Tom Sowell’s avid hobby—photography—where one is always changing and adjusting the aperture or the focus to improve the image, but never reaching an all-encompassing solution.

The film squeezes in meaningful interludes, such as his common sense book about Late-Talking Children based on a very personal story, or the saga of Steinway pianos where freedom to set up a new firm in America and try out new ideas was essential.

The film includes his time at the Hoover Institution where instead of teaching thousands in classrooms he reaches millions with his books and his welcome emphasis on free markets and personal responsibility.  He was drawn there in part by his teacher when at Chicago, Milton Freidman.

Lucky for us, Jason Riley is about to publish a new book about Thomas Sowell. It is a biography called Maverick. I have had a chance to take a peak, and it is wonderful, a perfect book to read after the movie. Indeed, it is a must read.

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Ideas and Actions for a Free Society: Still Relevant After a Year

Exactly one year ago, on January 15-17, 2020, a special meeting of the Mont Pelerin Society was held at the Hoover Institution at Stanford University. The Mont Pelerin Society was founded in 1947 for the “preservation and improvement of the free society,” and the 2020 meeting was the 40th anniversary of the meeting held at Stanford in 1980.

It is difficult to even think about all that has happened in the year since that meeting. The Coronavirus—not even mentioned at that meeting a year ago—has wreaked havoc around the world, and changed government policy in major ways. Nevertheless, the presentations at the meeting are still quite relevant, perhaps more relent than ever before, as a host of speakers presented new ideas and actions for a free society, looking at the past as prologue to the future. Fortunately, all have been documented in this volume

In describing the theme of that meeting, the introduction to the volume notes that “the challenges to the free society are again mounting and threatening economic growth and rising prosperity. We hear calls for a return to socialism, for restrictions on trade, for regulations on firms and individuals that go well beyond cost-benefit calculations.” These challenges and calls have clearly accelerated, but the appropriate responses and the case for preserving and improving freedom are still the much same.

The meeting, and the volume, begins with my interview of George Shultz on Choosing Economic Freedom and ends with Peter Robinson’s interview of Peter Theil on China, Globalization, Capitalism, Silicon Valley, Political Correctness, and Exceptionalism. Throughout the meeting and the volume there are extraordinary presentations about freedom by Robert Chitester, Robert Chatfield, Eamonn Butler, Jennifer Burns, Bruce Caldwell, Alberto Mingardi, Peter Boettke, David Henderson, Condoleezza Rice, Victor Davis Hanson, Amity Shlaes, Robert Skidelsky, Niall Ferguson, Jesús Fernández-Villaverde, Douglas Ginsburg, Jeff Bennett, John Cochrane, Lars Peder Nordbakken, Paulo Guedes, Anthony Kim, Fred McMahon, Valeria Perotti, John Cogan, Susan Dudley, Lars Feld, Ayaan Hirsi Ali, Samuel Gregg, Bridgett Wagner, Axel Kaiser, Ernesto Silva, Arnold Harberger, Terry Anderson, Lee Ohanian, Russell Roberts, Jamie Borwick, Thomas Gilligan, Edwin Feulner, Gabriel Calzada, Henry Butler,  Benjamin Powell, Nicolás Cachanosky, Inchul Kim, Annelise Anderson, Jeff Sandefer, Tyler Goodspeed, Ruth Richardson, Dominique Lazanski, Joe Lonsdale, and Sally Pipes. There were many more who enthusiastically participated in the discussions.

Take a look, and you will find much that is relevant today.

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Electronic-Commerce, Non-Store Sales and the Pandemic

Last week at the American Economic Association meetings, held online, many papers focused on Covid-19. A good example was the session organized by Dominick Salvatore which included Jan Eberly, Raghu Rajan, Carmen Reinhart, Joe Stiglitz, Larry Summers, and me. Most papers focused on the economic policy impact of the Coronavirus. I focused the “supply side” policies rather than on the “demand side” policies. Using a simple model, key facts naturally emerge if one simply divides retail sales into store-sales versus non-store-sales or electronic sales. To see this, take a look at these three figures. 

The first figure shows that the onslaught of the pandemic in the second quarter of 2020 immediately caused a sharp decline in retail sales less non-store sales in the United States. This was followed by rebound in the second third quarter of 2020.  Note that the rebound, while very sharp, left total retail sales in stores no greater than they were before the pandemic.

The second figure shows that non-store sales increased from the time the pandemic began, just as in-stores sales were collapsing.  Without non-store sales, total retail sales would have declined.


And the third figure shows an alternative measure: electronic-commerce. It is only available on a quarterly basis but tells the same story as the in-store versus non-store story—a large increase starting at the time of the pandemic.

In sum, the pandemic had a big economic impact on in-person store sales, measured by total sales less non-store sales. But there is a countervailing positive effect through non-store sales or e-commerce.

As of this writing, the increase in non-store or e-commence sales is not abating, but rather continues to rise, even after in-store sales have rebounded. Regulatory policy, tax policy, monetary policy and even international policy must encourage this supply-side growth, not thwart it, if the economy is to continue to grow and create jobs.


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Stampede Out, Stampede In

Today I published an article in Project Syndicate called “The Stampede from Silicon Valley.” The fact-based message of the article is clear: Tax, regulatory, and other economic burdens that firms face in California are creating a stampede to other parts of the country—especially Texas. There are many examples–Hewlett Packard Enterprise, Oracle, Tesla, and even venture-capital firms like 8VC, who announced the exodus with an WSJ op-ed.  State and local policymakers, who want to prevent an even larger outbound stampede, need get to work.  There are some positive signs to build on, such as the California voters’ approval of Proposition 22, which frees up gig workers, and the voters’ rejection of Proposition 15, which would raise taxes on business. As one of the recent departures from Silicon Valley recently told me, “I still love California and hope to help fix it.” Well, now is the time. 

In fact, also published today was a front page story in the Wall Street Journal telling the same stampede story from the perspective of Austin, one of the go-to cities in Texas. Headlined, ‘Startup City’: Breakneck Growth Strains Austin,” the article tells the story of the arrival of the same firms: Hewlett Packard Enterprise, Oracle, Tesla, and other firms such as venture capital firms like Atomic.  The concern from the Texas side is to keep economics competitive while preventing some of the crowding effects of higher growth and land use regulations with added problems like homelessness and forest fires.

Let us hope that good competition leads to better economic performance both in and out of Silicon Valley and Austin. Indeed, some of the reaction I am getting to my Project Syndicate article warns of the failure to reduce economic burdens in the United States as a whole versus other countries, which may make the United States less attractive for business and income growth going forward. And to be sure, there are even a bigger problem globally if less emphasis is paid to economic freedom. There is work to be done in all parts of the world.

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The Best Part of the Coronavirus Relief Bill

As the Wall Street Journal reported and I tweeted yesterday, Senators Chuck Schumer and Patrick Toomey made important news when they agreed that with the new Coronavirus relief legislation, “the $429 billion would be revoked and the Fed wouldn’t be able to replicate identical emergency lending programs next year without congressional approval”

This is a welcome development because it is a start on the best monetary road back to a stronger economy. With the vaccines on the way and with markets functioning again, this is the time for the Fed to get back to a more rules-based monetary policy that it was moving toward before the pandemic struck.  

This favorable development owes much to the outspoken insistence and careful reasoning of Senator Toomey. He argued that the Fed’s new direct lending programs enacted earlier this year were not needed going forward, and that their very existence blurred in dangerous ways the operation of fiscal and monetary policy. As Toomey explained on Squawk Box this morning in an interview with Becky Quick, “These facilities were always intended to be temporary…. Their purpose was to restore normal functioning in the private capital and lending markets.”

He then explained that questionable interpretations of the legislation had been recently put forward raising doubts about this temporary status. So he took action, and he drafted legislative language to clarify the situation in the coronavirus relief bill. The concern was that monetary policy would become an instrument of fiscal policy to the severe detriment to good economic policy and thereby threaten a return to a strong, low-unemployment, low-inflation economy. With new legislative language, he said, “The good news is these programs will be the temporary facilities they were intended to be.”

 As an editorial in the Wall Street Journal said today: “The best provision in the bill is the limit on potential abuse by the Biden Treasury and Federal Reserve. Credit here to Pennsylvania Sen. Pat Toomey, who held firm on limiting the Fed’s maneuvering room without a new act of Congress.”

I hope this action is an important down payment on a return to a more strategic monetary policy going forward. As far as we can tell, the impetus for this change did not come from the Fed. But it is good news for the Fed that members of congress are supporting a more rules-based monetary policy, and they may even have some help next year from the Administration over at the Treasury.

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Happy 100th Birthday to George Shultz

Today is George Shultz’s 100th birthday. There were so many wonderful celebrations and tributes, and many more to come. My family—Allyn, John, Jennifer, Josh, Olivia, Andrew, Jack, and I—walked over to his house and sang Happy Birthday as loud as we could.  Many of the beautiful special tributes are summarized here  

At a Hoover Fellows Roundtable on economics and national security, I started by quoting something George Shultz said almost 50 years ago when he served as Secretary of the Treasury.

“Economists have a particular responsibility to relate policy decisions to the maintenance of freedom, so that when the combination of special interest groups, bureaucratic pressures, and congressional appetites, calls for still one more increment of government intervention, we can calculate the cost in these terms.”

George Shultz’s lessons resonate today, including in a recent book we wrote together called Choose Economic Freedom, stressing that research should focus on the theme that “Good economic policy works and excessive intervention in the economy causes problems.”

We need to do this more actively as government interventions are popping up all over the world, as we hear it loud and clear. In a way, COVID has given more attention to government solutions.

So how do we better relate decisions to the maintenance of economic freedom? I say follow the methods of George Shultz. Begin with data. Look more carefully at empirical measures of economic freedom whether at Heritage or Fraser or the Word Bank Doing Business. It is convincing that economic freedom leads to improved living standards.

Next communicate more about economic freedom—on Zoom or anywhere.  Deal with the digital divide by providing Broadband for All program. Free up the K-12 system and allow charter schools and school choice as in Tom Sowell’s new book Charter Schools and Their Enemies.

Telemedicine is also in the rise and helping people.  Facebook and Google are often criticized, but they are promising many new forms of communication, and we could all do more work in this area, as far as the eye can see.  As former Google CEO Eric Schmidt pointed out recently the past few months have “brought forth ten years of forward change. … all of a sudden, the Internet is no longer optional.” From my own experience teaching economics online, I heartily agree.  And there is the amazingly quick discovery of vaccines to deal with COVID-19. George Shultz would go on and on with many more examples

Most of all remain optimistic. We cannot be discouraged that some of this will take time, and we should remind ourselves of George Shultz’s warning that “An economist’s lag is a politician’s nightmare”

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Economic Policy and Foreign Policy Go Together

I gave the Peter G. Peterson Distinguished Lecture on “National Security and Fiscal Policy” at the Foreign Policy Association (FPA) in New York last week. Henry Fernandez gave a kind introduction and Tom Michaud moderated with great points. And thanks to FPA for the book edited by Michael Auslin and Noel Lateef, American in the World 2020.

Four years ago, Paul O’Neill gave the Inaugural Peter G. Peterson Lecture. Pete Peterson was in the audience. Paul and I served together in the George W. Bush Treasury, and we became good friends. Paul focused on the deficit in the 2016 lecture; he learned from Pete and I learned from both.   Last year, another good friend, John Lipsky gave the Peter G. Peterson Lecture, and he wondered creatively how long the economic expansion would last. It turned out not long, but for reasons that neither John nor anyone else could forecast. What a different time we are in now!

I really like the idea of combining national security and fiscal policy as in the theme of the lecture series. A few years ago, George Shultz (who gave Ethel LeFrak Distinguished Lecture a decade ago at the FPA) edited a book Blueprint for America which has a chapter by Admiral James Ellis, Secretary James Mattis and Director of Foreign and Defense Policy at AEI, Kori Schake. They showed that foreign policy had become unmoored. They called for a “strategy of security and solvency,” showing that economic policy is integral to foreign policy.  In sum, we need good economic policy to bolster our diplomatic and defense policies. That means action by the Departments of State, Defense and, don’t forget, Treasury.

Accordingly, I started the lecture with fiscal policy, and I looked at the response to COVID-19 as federal government outlays as a share of GDP rose from 20% to over 30% in 2020.  Projections suggest that outlays will decline temporarily in the next few years, but then rise toward 30% in coming decades with the current fiscal policy.

I argued that an alternative fiscal consolation plan is needed, and this could be put in place whenever the next stimulus package is agreed to. A good plan holds federal expenditures as a share of GDP at about the 20 percent ratio that prevailed before the pandemic. That spending restraint avoids a potentially large increase in federal taxes and prevents the outstanding debt relative to GDP from rising from its current level. The spending restraint would come exclusively from permanent changes in entitlement programs, which are the principal source of the federal government’s long-term fiscal imbalance.  Building on my work with John Cogan and Danny Heil, I argued that such a fiscal consolidation plan could become fully effective in fiscal year 2022, after the COVID pandemic has passed, and that the impact would be a substantial increase in real GDP in the short run and the long run. The reason that real GDP rises is that households expect higher after-tax incomes in the future.

Now when you think about fiscal policy you think about tax policy. The proposed consolidation plan does not call for an increase in tax rates so the corporate rate would remain at 21% following the decline from 35% in the 2017 Act. Reduced tax rates on small businesses and individuals would remain.  Indeed, there is evidence that these increased productivity growth, which drives up wages. Productivity growth nearly doubled, from 0.8% a year between 2013 and 2016 to 1.5% a year from 2016-19.

When you think about fiscal policy you also think about monetary policy. Here the Fed should return to a basic strategy. It dealt with the onslaught of the pandemic with understandable emergency actions. But the changes put in place in the past 2 months have been too vague. The Fed should return to the rules-based path of 2017-19.

Then there’s regulatory policy.  I’ve been struck by how the private sector has already been responding to the new economic restrictions.  I am giving a course to 350 students at Stanford. All online. All virtual. Students are all over the world. Thanks Zoom. Facebook will have half of its employees working remotely. On-line retail is booming. We need regulatory policy at the federal and local level which allows more of this.

Then there is trade policy, also key to foreign policy. The problem is how to negotiate down tariffs and other restrictions. The aim should be lower trade barriers. There have also been concerns about supply chains. That is an old problem: People said we needed to produce our own textiles for military uniforms. Well, we can stockpile some things!

In sum, what I tried to show in the Peterson Lecture is why sound fiscal policy and its corollaries in other parts of economic policy—tax, monetary, regulatory, trade policies–are are all essential to our foreign policy.  As Ellis, Mattis and Schake said “no country has ever long retained its military power when its economic foundation faltered.” There are also other areas where we can improve.  COVID-19 and the economic response have revealed large income disparities in the US. These have foreign policy implications too, and we need to deal with them. Again, the point is that economic policy and foreign policy go together.

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The Importance of Economic Policy in the 2020 Election

The following article by John Cogan and me responds to commentary on our Wall Street Journal article and emphasizes the importance of economic policy.

The Importance of Economic Policy in the 2020 Election

John F. Cogan and John B. Taylor

October 11, 2020

We published an article in the Wall Street Journal last Wednesday entitled Trump’s “Economic Dream Come True.” It generated a huge amount of commentary, both via the Wall Street Journal’s on-line platform and on social media more generally, including many entries on Twitter.

Our main purpose in writing the article was to make the point that the strong and broad-based growth in the U.S. economy since early 2017 up to the onset of the Covid pandemic is a result of the sound economic policies of lower tax rates and less regulation.  Toward the end of the article we concluded with a few words about the importance of other policies by writing: “As good as the economy was, it could be even better. To reach full potential, Americans should elect a president and Congress that will restrain federal spending to keep debt at bay, reverse restrictive trade policies, and a return to a more-predictable, rules-based monetary policy.”  

Judging from the commentary, our sentence has been misinterpreted to mean that we are recommending the platform of a particular candidate on these other policies. This was not our intent. Our intent was merely to say that in order for the economy to reach its full potential, federal spending restraint, free trade, and a more-predictable, rules-based monetary policies must be added to lower tax rates and regulatory relief. We have written much about the economic benefits of these policies elsewhere and regard the aforementioned policy mix as the right policies to maximize economic growth

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