Sumner On If the Fed Had Maintained 5% NGDP in 2008

     Not exactly a novel meme for him. Here's having a difference with M.C.K. over at Free Exchange Post over whether the Fed could have dampened the housing bubble before it popped. He thinks that monetary policy is too blunt an instrument for that. Here's what he would recommend:

    "My first best solution (admittedly not realistic today) is to get rid of all government intervention in credit markets. No Fannie and Freddie, no FHA, no deducting interest on mortgage loans, no FDIC, etc. Laissez-faire."

    "My second best solution is to try to regulate to make our system look more like Canada’s. Unlike 99.99% of bloggers I think small banks are the problem and big banks (like Canada) are the solution. I also favor bans on making sub-prime loans with taxpayer-insured funds. Require a minimum of 20% down, unless the lender is not insured by FDIC. Also change laws on non-recourse loans, etc. Change tax laws so that debt is not subsidized (as compared to equity.)"

     http://www.themoneyillusion.com/?p=12617

      As for the counterfactual, what would have happened had the Fed simply followed the Sumner Rule?'

      "My bigger problem with this entire line of analysis is that it’s all (implicitly) based on a giant misconception, that the severe recession was caused by financial turmoil, not tight money. If the Fed had kept NGDP plugging along at a 5% rate we would have had some very mediocre years—call it stagflation if you wish. Maybe 1% RGDP and 4% inflation until the excesses were worked off. But the high unemployment and greatly intensified debt crisis need not have happened."

       Maybe it's not the main point, but I can't but notice that Sumner is again erroneously defining stagflation. He's done this before-he thinks that had the Fed acted we would have had "stagflation" instead of the Great Recession.

       He defines stagflation though as low GDP and high or higher inflation, apparently from the way he always uses it. In fact stagflation is when you have the worst of all worlds: high inflation and high unemployment. I doubt anyone would have considered things better if we had just as high unemployment in 2009 with much higher inflation as well.

       Actually I think Woj was just saying that NGDP doesn't have a very strong correlation with unemployment. Indeed, NGDP doesn't look at unemployment directly. So you can imagine a scenario where we could have seen higher NGDP in 2009 and yet things would have not been any better, arguably they would have been worse.