Interview: Prof. Nick Rowe, Carleton University, Canada

Nick Rowe is an Associate Professor of Economics at Carleton University in Ottawa, Canada.

The economy is still facing a heated debate over “stimulus versus fiscal austerity”, while the unemployment remains very high. What needs to be done to tackle the unemployment situation, before more time goes by?

Monetary policy needs to be the main way to increase AD and reduce US unemployment. (And see my answer to question 2 on this, because "monetary policy" does not mean "setting a short-term nominal rate of interest"; or rather, it can mean much more than that, if the Fed communicates its target properly).

I'm in two minds about fiscal policy for the US. Normally, I would say keep fiscal policy loose. First, because I may be wrong about monetary policy being sufficient, so if you want to make really sure your pants don't fall down it is better to wear both belt and braces, even if you think a belt alone is sufficient. Second, because US real interest rates are very low at present, so on purely microeconomic public finance grounds, this is a very good time for public investment. But, the US does have a serious "structural" deficit/debt problem. And I mean "structural" more in the political sense than in any standard economic sense. For some reason, probably having to do with the US system of government, they seem to have difficulty agreeing on and sticking to any long-term policy. So a fiscal policy of "loose today and tighten tomorrow" may not be politically feasible. So, I am undecided between  recommending loosening or tightening fiscal policy.

What is the best way for the Fed to revive the weak demand? To adopt a inflation targeting or a nominal GDP level target? What is your take on these proposals?

For analytical purposes, let's introduce a third option: price level path targeting.

In the case of the US (unlike countries like Canada which have a previously existing credible policy of inflation targeting), I think price level path targeting (with say a 2% inflation rate) would be better than inflation targeting (with the same 2% inflation rate). The Fed should clearly announce that it wants the current price level to be (say) 5% higher than it is now, and then grow at 2% per year, thereafter. And it will keep on doing anything and everything that it needs to do to get onto that target path for the price level. That would include buying the S&P500 index of stocks, for example. Paper claims on *real* assets, not just government bonds. (This is actually getting very close to fiscal policy where the government buys new public investment; but the difference is that the Fed knows it has an income-earning and easily sellable asset.) As is now understood, price-level path targeting is better than inflation targeting in that the change in expected inflation after a shock acts as an automatic stabiliser. Which is very important for the US right now.

Now compare price level path targeting with Nominal GDP level path targeting. I can't decide between these two. In the face of shocks to the supply-side, or the Phillips Curve, NGDP targeting is better than price level targeting. (Plus, politically, NGDP targeting is easier to justify as an interpretation of the Fed's existing mandate.) But it is much easier for the Fed to communicate a price level target than an NGDP target, because people will find it easier to understand a price level than NGDP. And credible communication is really important for the Fed right now. So, I'm undecided between the two.

Why there are such differences in terms of monetary policy during a severe global recession between the U.S. and the Eurozone?

Oh God. Where to begin?

Start with the US, abolish the Federal Government (leaving only the Federal reserve), give each US state a separate language, history, and culture, so they think of themselves as Californians rather than Americans, and you get the Eurozone. The US Fed and Treasury can decide together what to do for the good of the US. The ECB can't. Every day, the ECB has to ask Henry Kissinger's question: "If I want to speak to Europe, who do I call?". Europe is an elite fiction. The only reality is Germany, Greece, Ireland, etc.

The Eurozone does not come as close as the US to being an Optimal Currency Area. But that is not the most important point. Every currency area has to compromise to some degree with the "one size fits all" problem. The important point is that the Eurozone does not have a functional lender of last resort. Because the Eurozone is not a nation, does not think of itself as a nation, and does not have a central fiscal authority. If the ECB buys (as opposed to repoing) Greek government bonds, it's "Germans bailing out Greeks".

Thank you very much.

Nick Rowe is a Professor of Economics at Carleton University in Ottawa, Canada. His research fields are macroeconomics and monetary economics. His expertise involves exchange-rate regimes and central-bank inflation targeting. Prof. Rowe is also a member of the CD Howe Institute’s Monetary Policy Council and the Centre for Monetary and Financial Economics.