Last week the White House announced that Richard Clarida will be nominated to become Vice Chair of the Federal Reserve Board. More than a month ago, Clarida became the front-runner for the role. He is widely seen as a centrist and a pragmatist holding mostly conventional views on monetary policy. Mostly.
As Vice Chair, Clarida will be the third pillar of the Fed’s new leadership, joining Chair Jerome Powell and recently announced incoming NY Fed President John Williams. Having been an economics professor at Columbia University since 1988 and a Global Strategic Advisor at Pacific Investment Management Company (PIMCO) since 2006, Clarida provides a complement to both Powell’s largely business background and Williams’ career inside the Fed.
With a couple of mutual research interests, Clarida and Williams will likely work well together. They’ve both explored the natural rate of interest (r*) — Williams is the coauthor of the widely cited r* estimates and Clarida has examined natural rates from an international perspective. Another area of mutual interest is price level targeting. As I have noted previously, Williams is an advocate of the Fed adopting such a target while Clarida has also explored its merits for monetary policy.
At first blush this may be concerning, given the shortcomings of price level targeting. However, the evolution of Clarida’s post-crisis thinking on monetary policy, including towards price level targeting, shows that he may be persuaded by the superior merits of nominal GDP level targeting.
In 2010, Clarida presented a paper at the Boston Fed conference, Revisiting Monetary Policy in a Low Inflation Environment. The paper discussed what economists had learned throughout the 2000s, with a particular focus on what they ought to learn after years of low inflation (a subject with renewed saliency in recent years).
He also discussed the large-scale asset purchases of the Fed’s quantitative easing program, casting doubt on much of the literature of the day — which tended to find positive, but limited effects of such purchases on reducing bond yields. Clarida, on the other hand, thought large-scale asset purchases could be very robust. He had two main points, one flawed and one overlooked.
The first was that a determined central bank, prepared to buy the requisite amount of securities up to the outstanding stock, could always put a ceiling on the yield (or, put another way, a floor underneath the price) of the securities it targeted. Now, this proposal puts the central bank squarely into the credit allocation business, which is a role it ought to avoid.
However, the second, subtle point in his framework that should not be ignored is that Clarida recommends the central bank fully commit to an outcome rather than announce various mechanical steps. This goal-oriented strategy suggests that Clarida may indeed become receptive to the benefits of nominal GDP level targeting — a point to which I will return.
But why did Clarida suggest focusing on securities’ yields at the time, rather than consider changing the central bank’s nominal target?
He explained that adopting a price level target, a possible alternative to the Fed’s then “stable prices” mandate and now 2% inflation growth rate target, was not a time consistent policy. That is to say, a central bank would initially commit to level targeting when its policy was below the trend line but then fail to run an expansionary policy to reacquire that trend line. Clarida believed that, while attractive in theory, a central bank could not credibly commit itself to future actions. Modern Fed parlance would call this forward guidance and, to Clarida, that was not a sufficiently robust strategy because it lacked the “proper commitment technology” to satisfy markets and the public that the central bank would indeed execute its promises in the future.
But by 2016, as the recovery from the Great Recession proved to be weaker than expected, Clarida’s thinking about forward guidance and the viability of a level target had changed.
At a Brookings conference early that year, which focused on whether the US was ready for the next recession, Clarida said that despite the fact that textbooks and economic theory suggest forward guidance should not work in practice, it, in fact, does. He also suggested, or perhaps wondered, if this meant a price level targeting strategy could work (his slides are here).
He rightly pointed out that a price level target would have the advantage of making up for past monetary policy failures that inflation growth rate targeting lacks. Level targeting corrects for the bygones problem in growth rate targeting, making up for past mistakes rather than embedding those errors in current policy.
Incidentally, this was not the first time he had suggested a price level target for the Fed.
In a Global Perspectives note at PIMCO published in 2014, Clarida endorsed a price level target. He believed such a target would be an improvement for the new Yellen Fed over the Evans Rule, which had been in effect for more than two years. Promising to leave rates at the zero lower bound until either inflation was above 2.5% or the unemployment rate was below 6.5% was not enough to guide policy going forward. These thresholds were not goals and therefore were insufficient anchors for monetary policy (indeed the Fed abandoned the Evans Rule the following month).
Clarida saw the weakness in the Fed’s communication strategy of putting thresholds on inflation and unemployment and proposed a price level target as an alternative.
As mentioned, a price level target is not the proper alternative for the Fed’s target because it can make a central bank procyclical and thus amplify, rather than dampen, the business cycle. A price level targeting central bank runs the danger of tightening policy because of an adverse supply shock and over-easing because of a productivity boom. Nevertheless, Clarida was right to criticize the kind of open-ended policy that characterized the Evans Rule and this kind of thinking will be a welcome addition to the Board.
Clarida now seems predisposed to three views about monetary policy that could significantly influence the Fed's actions going forward:
- That a central bank fully committed to reaching a nominal target is superior to one focused on mechanical operations.
- That employing forward guidance is indeed an effective tool for conducting monetary policy.
- That level targeting can make up for past errors in monetary policy in a way that growth rate targeting cannot.
Combined, I think these views point to Clarida being more amenable to a nominal GDP target than even he may presently admit. After all, nominal GDP level targeting requires two things of a central bank to work in practice: first a central bank must credibly pledge to keep nominal GDP growing along a stable trend line and then it must be prepared to do whatever is necessary to achieve that level of nominal growth.
Clarida has already expressed the importance of both of these elements. In addition, he has repeatedly shown a willingness to let his thinking evolve when presented with new information. Therefore, he may yet be persuaded on the shortcomings of price level targeting in favor of a superior option.
Clarida may have said little about nominal GDP targeting to date — but with his nomination, the Fed may be getting a nominal GDP target advocate for the future.