John Cochrane: Just how bad is the economy? How do we fix it?

John Cochrane has made a valuable attempt to explain to non-economists just how bad the US economy is. John uses simplified chart presentations of GDP, employment and productivity – using straightforward trends. For example, here is John’s chart of the 1980’s recovery from the severe 1981-82 recession. This is what a normal recovery is supposed to look like.

Instead what the US has now looks like the following, showing that GDP has downshifted onto a much lower track, and worse – anemic growth rate from this lower base.

So, what to do? John writes:

This is an economists’ horror movie. Yes, productivity did rebound. But it seems to be growing slowly as well.

The trends are an economists’ horror movie. Real GDP seems not to be recovering at all — no period of swift growth to go back to a trend. We seem stuck at 2.4% growth forever. The CBO is giving up on us too. Employment will not recover as a fraction of population until the economy recovers. We seem stuck at low employment forever. And now we seem headed to a 1970s productivity slowdown as well.

I don’t view this as contentious, outside of Presidential politics. Paul Krugman thinks the economy is pretty awful too.

What to do? If only it were so simple as to have the Fed print up another two trillion dollars, or have the Treasury borrow another $5 trillion and blow it on stimulus boondoggles. We’re stuck in sclerotic growth, and to everyone but a few die-hard extremists, that means growth-oriented policies are the only way out.

Here is my puzzle. Dr. Cochrane is one of the most capable economists I know of. Yet he completely dismisses the monetary cause and the monetary solution to the problem. I read the comments carefully for an explanation. Several commenters raised my question. For example:

But what about a Price-Level target, or even better, a NGDP target? You never discuss these as possibilities.

What if the Fed were to declare an NGDP target toward the pre-cash trendline with a simulatenous open ended commitment for QE?

Dr. Cochrane replies

(…) I don’t think the Fed controls NGDP. If it did, it certainly would not have stood for what just happened. I think the Fed’s basically at its limit.(…)

I think that is wrong. The Fed can create any level of nominal GDP that it targets. Yes by buying assets, but even more powerful than open market operations are expectations. The Fed needs to establish a credible rule-based target that puts nominal GPD (NGDP) back on the trend line at 2007 full employment and commits to maintaining that NGDP trend at a slope around 5 to 5.5%. And yes, you can tell I have been persuaded by the market monetarists such as Scott Sumner. So have a growing number of economists:

E.g., Christina Romer, former Chair of the Council of Economic Advisers in the Obama administration: Dear Ben: It’s Time for Your Volcker Moment.

E.g., see Harvard’s Jeff Frankel: Nominal GDP Targeting Could Take the Place of Inflation Targeting

E.g., see Mark Thoma “Inflation Targeting is Dead”.

E.g., see Kansas City Fed Michael Woodford’s paper just released at the Jackson Hole conference “Methods of Policy Accommodation at the Interest-Rate Lower Bound“. 

I’ll come back to the NGDP level targeting solution soon. Off to a meeting…

UPDATE: Looking for clarification I added the following comment: 

John, outstanding post, thank you. I am puzzled that you do not seem to believe there are any effective monetary policies to support with your objective of boosting the economy back-on-trend. In particular you appeared to rule out NGDP-Level-Targeting:

(…)I don’t think the Fed controls NGDP. If it did, it certainly would not have stood for what just happened. I think the Fed’s basically at its limit.

In your note: A Big Stick for the Fed you outlined an argument for CPI futures targeting:

The Fed needs something new. Here’s what I think works best. In every theory, governments easily cut off inflation or deflation by switching to a commodity standard.


Instead, the Fed can target the thing it cares about – expected CPI inflation – rather than the price of gold. To do it, the Fed can target the spread between TIPS (Treasury Inflation Protected Securities) and regular Treasurys, or target CPI futures prices. Here’s a simple example. Investors buy a CPI-linked security from the Fed for $10. If inflation comes out to the Fed’s target, they get their money back with interest, $10.10 at 1% interest. If inflation is 2 percent below target, the Fed pays $2 extra — $12.10. This pumps new money into the economy, with no offsetting decline in government debt, just like the helicopter drop. If inflation is 2 percent above target, investors only get back $8.10 – the Fed sucks $2 out of the economy at the end of the year. If investors think inflation will be below the Fed’s target, they buy a lot of these securities, and the Fed will print up a lot of money, and vice versa.

(…) This note draws on a more detailed paper, “Understanding Policy in the Great Recession: Some Unpleasant Fiscal Arithmetic.”

Could you please comment:

1. do you still support your proposal to target a CPI-linked security?

2. would you support a Fed target based upon a NGDP-linked security?

I am encouraged that the latter policy (2) was recently proposed by Christina Romerin Dear Ben: It’s Time for Your Volcker Moment.