Scott Sumner on the Government's Response to COVID-19 and the Future of Level Targeting

Episode Summary

Executive Summary: Scott Sumner argues the Fed has focused too much on credit facilities and too little on traditional monetary policy. He says the priority should be a credible level target for prices or nominal GDP, backed by aggressive asset purchases if needed. In his view, this would better support aggregate demand, financial markets, and the recovery than ad hoc credit allocation or helicopter drops.

Main Topics: COVID-19’s economic shock and policy response (Priority: 5/5): The conversation opens with the collapse in output, employment, retail sales, and inflation during the pandemic, and evaluates the combined fiscal, monetary, and credit-policy response from government. Fed should prioritize monetary policy over credit allocation (Priority: 5/5): Sumner argues the Fed is being pulled into credit-support roles better handled by Congress, and that this distracts from the Fed’s core job: stabilizing nominal spending. Level targeting as the key regime change (Priority: 5/5): He makes the case for price-level or nominal-GDP level targeting as a more powerful tool than QE or rate cuts because it anchors expectations and raises future spending expectations. Asset purchases, credibility, and “whatever it takes” (Priority: 4/5): The discussion covers how the Fed can make level targeting credible through large-scale Treasury purchases first, and risky-asset purchases only as a last resort if necessary. Why helicopter drops are a last resort (Priority: 4/5): Sumner criticizes helicopter money as inefficient and potentially distortionary, arguing asset purchases are superior because they can later be reversed without tax distortions. Neutrality, corporate bonds, and legal/political risks (Priority: 4/5): The hosts discuss whether buying corporate bonds makes the Fed a credit allocator, and Sumner responds that such purchases are acceptable only if they are temporary and subordinate to the target. Current crisis as a demand shock layered on supply shock (Priority: 5/5): Sumner says the crisis began as a supply shock but has become a major demand shock, making nominal-spending stabilization essential to avoid a deeper slump.

Key Arguments: The Fed should focus first on expanding nominal demand, not on targeted credit programs, because broad monetary stimulus supports the whole economy more effectively than lending to selected firms. A credible level target for prices or nominal GDP would be more powerful than QE or rate cuts because it changes expectations and reduces the demand for base money. If the Fed needs to support markets beyond Treasuries, risky assets should be a last resort and only temporary, to avoid permanent credit allocation and political backlash. Helicopter drops are inefficient because they cannot be unwound by selling assets later; reversing them may require distortionary taxation. Negative interest on reserves is expansionary because it discourages reserve holding, but low market interest rates usually reflect prior tight money and weak nominal GDP, not easy money. The pandemic shock is not only a supply shock; falling inflation shows a substantial demand shock has emerged, so the Fed should prevent nominal-income collapse. A temporary or crisis-only price-level target could be a practical compromise, but average inflation targeting would be too weak and insufficiently committed to restoring the lost price path.

Data Points: U.S. Q1 2020 GDP: -4.8% - David Beckworth cites first-quarter GDP as evidence of the pandemic-induced collapse. Unemployment rate: close to 15% - Used to describe labor-market deterioration during the pandemic. Jobless claims: 35 million - Referenced as the number of people who had claimed unemployment insurance benefits. CPI change: negative territory - Beckworth notes CPI fell below zero for the first time since 2008. Potential price-level target path: 2% per year from December last year - Sumner describes a possible level target with 2% annual price growth starting from late 2019. Price-level goal by end of 2021: 4% higher than end of last year - Illustration of how a level target would work over roughly two years. Negative reserve-rate thought experiment: less than $5 million total - Sumner says a hypothetical -25 bps rate on bank reserves in 2006 would have had almost no effect because excess reserves were tiny. Corporate-bond loss under temporary purchase scenario: 10% - He contrasts modest losses on risky assets with the total loss implied by helicopter drops. Helicopter drop loss: 100% immediately - Used to argue helicopter money is less efficient than asset purchases. Zero lower bound reference year: 2006 - Sumner uses 2006 as a pre-IOR baseline in his negative-rate thought experiment. Historical policy review period: last 2 years or so - Beckworth references the Fed’s ongoing review of its framework and toolkit.

Pivotal Quotes: "I would have preferred they focus on specific needs and not have focused as much on just sort of a general stimulus approach." — Scott Sumner: On fiscal policy design during the pandemic. "I think level targeting is probably the single most important thing that the Fed should be doing that is not doing so far." — Scott Sumner: On the Fed’s most important missing policy tool. "If we haven't even done that and we haven't done... why would we even be talking at this point about doing fiscal stimulus?" — Scott Sumner: On the order of operations: monetary policy first, credit/fiscal measures second.

Implications: The episode argues for a major framework shift: stabilize nominal spending with level targeting before resorting to credit allocation or helicopter money. If adopted, the Fed could support recovery more broadly and reduce political/legal risks.