The housing bubble pushed expectations for economic growth so far out of wack that one Federal Reserve bank chief warns against the use of nominal gross domestic product as a target when setting Fed policy.
While speaking at the University of Notre Dame, Federal Reserve Bank of St. Louis CEO James Bullard said targeting price levels or inflation is what the Fed does best. At the same time, he suggested having multiple mandates for the Fed -- price stability and employment -- could set the U.S. down the wrong path in today's economy.
"As the dust has settled since 2008, it has become more and more apparent that U.S. real GDP is growing along a different path than the bubble-induced pre-crisis path," Bullard said in prepared comments. He noted that post-crisis economies grow more slowly and America's GDP pre-2008 was set to unrealistic expectations, making it a bad idea to gauge U.S. growth by nominal GDP.
Bullard mentions that nominal GDP – which considers both pricing levels and real gross domestic product – is majorly impacted by a post-crisis economy that no longer includes an overly inflated housing bubble.
"Nominal GDP targeting, without proper adjustment, could be a policy disaster," Bullard said.
He added, "When the economy is hit by a shock, the optimal policy returns the price level back to its previous path."
With real GDP experiencing slow growth caused by the loss of unprecedented housing activity, Bullard is afraid the use of nominal GDP as a growth target could create issues in overall monetary policy.
His argument tends to argue against Fed Chair Ben Bernanke's long-time assertion that the Fed should be focused on its dual mandate of increasing employment and targeting inflation.
"Simple versions of a leading macroeconomic theory suggest that the price level path can provide a signature for optimal monetary policy," he said this week.