Open e-mail to Joe Gagnon

Joe Gagnon has a nice blog which allows comments only by e-mail.  He has a proposal in two parts

Next week the Fed should promise to hold the prime mortgage rate below 3 percent for at least 12 months. It can do this by unlimited purchases of agency mortgage-backed securities. By giving people a fixed time period to take advantage of the lowest mortgage rates in history, the Fed could meaningfully boost the housing market just when buyers are beginning to believe that prices are starting to head up. The Administration could capitalize on this opportunity by forcing the housing agencies and jawboning the banks to stop applying excessively high credit standards for prime mortgages.
To maximize the potential benefits of sound monetary policy, the Fed should seriously consider the proposals of Christina Romer and Michael Woodford to target a fixed path of nominal GDP, the broadest measure of economic activity in dollar terms. The path should be based on a year of normal conditions, such as 2007, and should increase at a rate of 4.5 percent, which would allow for average growth of 2.5 percent and average inflation of 2 percent. Because we are far below such a path right now, it would take a few years of growth above 2.5 percent and/or inflation above 2 percent to return to normal. This policy would allay market fears of premature Fed tightening while being consistent with the Fed’s stated long-run inflation goal of 2 percent.  

Dear Joe Gagnon

Absolutely.  I’d note that Bernanke’s cost 3) higher expected inflation is an important benefit, since it implies lower real interest rates if nominal interest rates are at the lower bound.
I think that “trading among private agents could dry up, degrading liquidity and price discovery ” really means that profits of financial intermediaries might be reduced.  I’m sure Bernanke doesn’t care about them, but the argument that a high volume of trade is socially useful as asset prices are closer to fundamental values if trading volume is high doesn’t pass the laugh test.  This is casually assumed, because almost all experts say it is so.  Almost all experts are financiers.  They know that a high volume of trading is key to their profits (not just fees, the traders who think they are sophisticated know they need noise traders in order to profit from their sophistication).  
With admirable modesty and a firm devotion to avoiding pointless quarrels among people who mostly agree, you merely note that you think that the Romer/Woodford nominal GDP targeting proposal would be a useful addition to your proposal.  You don’t argue that it would be necessary for unlimited purchases of agency MBS aiming to hit a prime mortgage rate target to have a huge effect on the economy.  You don’t concede that their proposal would have any major impact on the economy all by itself.  But you won’t quite say that you think that nominal GDP targeting is barking up the wrong tree (with my intercontinental ESP I am sure you think that — in any case I do).
I guess this is the right approach.  If the debate is current policy vs the Romer/Woodford/Gagnon proposal then each of the two very different parts of the proposal have a better chance. Emphasizing disagreements among people who basically agree is a good way to organize a circular firing squad.   
I have edited my third paragraph to remove a false assertion on a point of fact.  Woodford definitely supports purchases of agency MBS.  He has written this repeatedly.  I’m sure Romer agrees too.  Bernanke definitely suggested (as definitely as a Fed chairman can) that he thinks that MBS purchases should be part of any further QE which he might decide is a good idea maybe.  So I’d say you (you four including Bernanke I’d bet) don’t mostly agree but agree completely except for a bit of different emphasis.
Still I fear the dread worst of both worlds compromise.  It seems to me very likely that the FOMC will reach a near as possible consensus for QE III of the sort closest to normal monetary policy — that is based on much larger than usual purchases of much longer maturity than usual Treasuries, but still on money for treasuries open market operations.  It seems to me that this must be what happened when they decided to design QE II to be about as ineffective as possible (I am thinking of the choice of 7 year notes rather than MBS and not about the $600 B ceiling or the assurance that they weren’t aiming for higher inflation).
Quite frankly, I think you are too modest for the country’s own good.  Please blow your own horn more
Sincerely yours Robert Waldmann
This is an open e-mail which I will post on the web.  If you should under estimate the importance of your time and reply, I will consider the reply private unless told otherwise.