"The idea is to fix expectations of the future so people know they'll have some certainty in the environment," Swonk says. "The Fed is showing they'll be there to help recoup the losses in GDP and they won't take the punchbowl away too soon."
Moving the target from inflation to NGDP is one thing, but executing it is another. The Fed would still have the same tools at its disposal, so what can it do differently? A solution would be another round of quantitative easing, in which the Fed expands its balance sheet to buy long-dated U.S. Treasuries, pushing interest rates even lower.
"The Fed's forecast has medium-term inflation too low, which implies that the Fed has to keep easing," Swonk says. "That could mean quantitative easing, but my guess is they'll first try to play more with expectations. The mid-2013 goal with interest rates was the first step in that."
Further quantitative easing, which would be branded as QE3, is already a political hot topic. While the FOMC was in a two-day meeting before Operation Twist was announced in September, high-ranking GOP officials sent a letter to Bernanke urging no further monetary stimulus. New Fed targets would set off a firestorm.
"There's going to be an economic debate, whether this works or not, and that's legitimate," Swonk says. "But the political debate, saying the Fed can't stimulate the economy because it might help Obama, well, that's not the Fed's job. Frankly, they're the only ones in Washington thinking about the long-term economy. They'll do whatever they need to do. The Fed takes pride in its chairmen not being loved by politicians. They have to continue to act as independent and credible as they can."
Some investors oppose nominal GDP targeting. Michael Pento, president of Pento Portfolio Strategies, argues that increasing the rate of inflation raises the rate of unemployment.
"Every time the Fed has increased the money supply and sent prices rising, the rate of unemployment has risen, not decreased," Pento writes in an email. "The simple reason for this is that inflation diminishes the purchasing power of most consumers. Falling real wages means less discretionary purchases can be made. Falling demand leads to increased layoffs and the unemployment rate rises as economic growth falters."
With the next FOMC meeting on interest rates scheduled for Nov. 1 and 2, there will be speculation over what Bernanke and Co. will say and, perhaps more importantly, how they will say it. For that reason, Moody's Analytics' Sweet says Bernanke was right to speak on Tuesday in Boston about how the Fed will communicate their decisions more effectively.
"They're going to need to improve upon that if they're going to go for a NGDP target," Sweet says. "That said, a NGDP target would be easier than a higher inflation rate. That would be a much harder sell for the Fed. With NGDP, they can say they're targeting higher employment, income and production, rather than saying they want higher inflation."
-- Written by Robert Holmes in Boston
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