"But what concrete steps will the Fed actually take to raise Nominal GDP? Can anyone tell me that?"
I must have heard that question a hundred times over the last couple of years. And a dozen more times in the last day, ever since Paul Krugman endorsed the proposal to target NGDP. I always imagine it being asked in a gruff Yorkshire accent, by some middle-aged no-nonsense practical man of business with a background in mechanical engineering.
So this is written for the people of the concrete steppes.
First off, you aren't thinking about this right.
Sure, I've used mechanical metaphors for monetary policy in the past. But those metaphors only take you so far. Machines don't have expectations; people do. The actions that people take now depend very much on their expectations of what other people will do, and on their expectations of what the central bank will do.
You want me to tell you a story in which the central bank pulls a lever, and that lever causes another lever to move next, followed by another lever, then another, spelling out a causal chain from beginning to end, where the end is a higher level of NGDP.
But economics isn't like that. Because people aren't like that.
Sometimes the future causes the present, because people's expectations of the future affect what they do in the present.
Sometimes it's not even what will happen in the future that causes the present. It's people's expectations of what would happen in future if they behaved differently today that causes them to behave the way they do today. I switch to snow tires in the Fall because I expect I would have an accident in the Winter if I didn't. It's the threat of an accident that makes me put on snow tires. I don't actually expect to have an accident.
Next week, millions of Canadians will get up and go to work about one hour later than they did this week, if we measure time by the sun. "What concrete steps will the government take to get Canadians to do this? Can anybody tell me that?"
No, I can't tell you that. I don't have a clue what concrete steps, if any, the government will take. But I fully expect it will work. All the government does is announce that it wants us all to do this, and to put all our clocks back one hour. Maybe the government has the power to force government clocks back one hour, and force some government workers to start and leave work one hour later by the sun. But the rest of us just follow along, simply because we expect everyone else to follow along.
There will be two groups of people who will continue to get up at the same time by the sun. People who didn't get the memo (and most of them will follow along with a short lag). And people who live very isolated lives, whose timing doesn't depend on what everyone else is doing.
Driving on the right side of the road is an equilibrium. If you expect everyone else to drive right, you too will drive right. Driving on the left side of the road is also an equilibrium. If you announce that beginning Sunday everybody will switch to driving on the left, and if people believe you, or simply believe that other people believe you…everybody will switch to driving on the left. You don't actually have to pull any levers. All you need is credibility. Or people to believe you have credibility. Or believe that others believe you have credibility.
The US economy is currently in equilibrium. It's not a market-clearing equilibrium. It's not a very good equilibrium. But it is an equilibrium. If it wasn't an equilibrium, it would be somewhere else. But it isn't somewhere else, so it must be. Given what people expect other people to do, both now and in the future, each person is choosing to do what he is currently doing.
But this isn't the only possible equilibrium. I can imagine a better equilibrium, in which Nominal GDP is higher and growing faster, and expected to remain higher and growing faster. NGPG is higher and growing faster both because real GDP is higher and growing faster and because prices are higher and growing faster. It's a better equilibrium. And those of us who advocate E(NGDP) level-path targeting want the US economy to move to that better equilibrium.
What would the Fed be doing differently, in that other, better equilibrium? The Fed will be smaller than it is today, and the Fed's interest rate will be higher than it is today. Real interest rates will need to be higher, because consumption and investment demand will be higher, because consumers and investors will have higher expectations of future real income and real expenditure. Nominal interest rates will be higher because prices are expected to be growing faster. The Fed will be smaller, because people won't want to hold as much money, and banks won't want to hold as many reserves at the Fed, now the economy is growing and interest rates are higher.
So, all the Fed needs to do to get the economy to that new, better equilibrium is to pull the lever in the right direction, right? Raise interest rates, and reduce the money supply, right?
Of course not. If the Fed did that, without changing expectations, the result would be a a move even further away from the better equilibrium, as demand fell even further.
The Fed needs to change expectations. Get people to expect that NGDP will follow the higher path. That's what the "E" in "E(NGDP)" stands for.
"Right!" the people from the concrete steppes exclaim gruffly "and how exactly will the Fed do that?!"
1. The Fed clearly announces its target path for NGDP. That's by far the most important bit. Everything else is secondary. And if the Fed had credibility, that would be enough.
"Why should anyone believe the Fed can hit that path?"
2. The Fed makes a threat. On the first day the Fed will print $1 billion and use it to buy assets. On the second day the Fed will print $2 billion and use it to buy assets. On the third day the Fed will print $4 billion and use it to buy assets. And the Fed will keep on doubling the amount it prints and buys daily, forever and ever, until E(NGDP) rises to the target path. (And will go into reverse and sells assets if E(NGDP) rises above the target path).
"What assets will the Fed buy?"
3. The Fed puts on its best James Dean (oops, Marlon Brando, thanks Andy) voice and replies: "What have you got?"
There are two rooms at a party. The first room is nearly empty. The second room is nearly full. Because everyone wants to be where everyone else is. Then Chuck Norris enters the second room. He threatens to beat up 1 person at random in the first minute, 2 people in the second minute, 4 people in the third minute, and so on, until the room is empty. This is no longer an equilibrium.
A few people were nearly indifferent to being in the second room. So they leave even if the chance of them getting beaten up is tiny. That means there are fewer people left in the second room. This makes the second room slightly less attractive for those who want to be where everyone else is. And it slightly raises the probability of being beaten up by Chuck Norris. So more leave. Which repeats the process, so still more leave. And if you and I can see what's coming, so can the people in the room, who don't want to be the last to leave. There's a rush for the exits, and Chuck doesn't even have to lift a finger. OK, if someone didn't hear the threat, or doesn't recognise Chuck Norris, he might actually have to carry out his threat for a few minutes. But simply seeing all the others leave the room will be enough to induce most to leave the room very quickly.
Chuck Norris doesn't have to beat up everyone in the room. He just has to threaten to beat up as many as it takes to clear the room. The number of people he will actually beat up is a lot less than the number he threatens to beat up. If his threat is credible, and everyone hears it, he doesn't need to beat up anyone.
Eventually, if the Fed bought up every single asset in the economy, and swapped it for cash, NGDP would rise to the Fed's target path. Prices would rise without limit as the Fed bought up the last remaining assets because the sellers could name their price. And people would hire the unemployed to build factories which they could float on the stock and bond markets and sell to the Fed at any price they liked. Or sell to the people who had already sold all their assets to the Fed.
But there is no way it would ever get that far. That's like saying that Chuck Norris will eventually beat up everyone in the room. That's not an equilibrium.
Some people are just barely willing to hold cash in the current equilibrium. If they expect even the slightest rise in NGDP in even the distant future, they will get out of cash, and into real assets, or claims on real assets like commercial stocks and bonds. And this will increase the demand for goods today, either directly, or because firms find it easier to issue new stocks and bonds to finance investment. Which raises NGDP, and expected future NGDP, even if just a little. Which encourages additional people to exit cash too, and buy real assets and claims to real assets. Which raises NGDP and expected future NGDP still further. And so on. As soon as people figure out what's going on, and what's going to happen, expected NGDP rises to the target path. The Fed only has to carry out its threat until people catch on to what's happening. Then it has to reverse course and sell all the assets it bought, and then some more, to prevent the economy overshooting the new equilibrium.
Want me to make it more concrete still? OK. Here's the New Keynesian version:
Eventually, if it carries out its threat for long enough, NGDP will eventually rise. Some people figure this out. Maybe only a few. They expect either a rise in the future price level or a rise in future real income, or a bit of both. If they expect a rise in the future price level, that means lower real interest rates for given nominal interest rates. That encourages current consumption and investment demand. If they expect a rise in future real income, that also encourages current consumption demand and current investment demand. (People consume more today if they expect to have higher real income in future; firms invest more today if they think there will be bigger demand for the extra goods that will help them produce in future.) So current consumption and investment demand rises, which increases current NGDP.
The more slow-witted people and firms see that rise in current NGDP, and spend more on consumption and investment, and also revise upwards their expectations of future NGDP, which causes an additional rise in consumption and investment and NGDP.
More people begin to figure out that maybe the Fed's target is credible after all.
And so on.
Oh, and if you believe in the debt-deleveraging hypothesis, there's an additional channel. Higher expected future NGDP makes it easier to handle a given debt load, by reducing future expected debt/income ratios.
Update: I really want people to read a triad of very good posts by Bill Woolsey: his response to thoughts on NGDP targeting by Paul Krugman; Brad DeLong; and Steve Williamson. Bill lays out clearly some of the issues about how NGDP level path targeting works.
Worthwhile Canadian Initiative 
“if me measure time by the sun”
Ooops! Fixed. (BTW, it is this weekend, isn’t it? I didn’t get the memo.)
How about Chuck Norris says “I’m serving cake in the other room, if you would please come with me?”
Instead of your favourite fiscal-industrial policy (buying assets), the Fed could offer everybody some money (a helicopter drop). So long as it’s a powerful enough inducement, they should never really have to use it much, whichever tool they are threatening. The threat of it ought to be enough. But just in case Chuck does have to use his special skills, the party goers would prefer cake. They’ve already had enough beatings (TARP, TALF, PPIP, etc).
What you’ve described is a massive QE program.
You’ve explained why you think such a QE program would be effective at generating economic activity.
What you haven’t explained is why the effectiveness of such a program would depend on announcing an NGDP target associated with it.
Why not announce the same QE program with an unemployment/employment target?
I see the NGDP target as an excuse for massive QE, but certainly not the only excuse.
Question: What’s so special about NGDP targeting in relation to massive QE?
Answer: there is nothing unique about the relationship between QE effectiveness and NGDP targeting.
And that’s the reason why NGDP targeting won’t prevail as policy, in addition to the difficulty of convincing people not to be concerned about the risks of massive QE, whatever the associated goal or target.
The thing I don’t get about NGDP targeting is what happens if real GDP doesn’t respond (or continues to fall) doesn’t this NGDP targetting policy just become massively inflationary? If this causes real GDP to fall the NGDP supporters will call for more inflation to reach their NGDP targets. I’m not a hyperinflationist but this whole NGDP targetting seems like it might have some serious negative consequences and none of its supporters have properly addressed the possible downsides of this policy. Economists are all jumping on this policy in what seems like a desperate attempt to “just do something” even of that something ends up being bad policy.
K: Hmmm. You mean the threat of a (steadily increasing) helicopter drop. Hmmm. That would work fine, if credible. But if it weren’t 100% credible, and you had to carry it out, you would have to reverse it as soon as you hit the target. Which is hard.
JKH: “What you’ve described is a massive QE program.”
No. What I have described is the threat of a massive QE program.
“What you haven’t explained is why the effectiveness of such a program would depend on announcing an NGDP target associated with it.”
Because the threat is conditional on hitting/not hitting the target. The Fed is saying “I will steadily escalate QE as long as NGDP is below target, and steadily escalate reverse QE as long as NGDP is above target.” So people figure out what level of NGDP to expect, and that expectation affects their current behaviour.
And it’s that threat/promise to reverse QE that removes the risk of overshooting. Because there will be overshooting if the Fed doesn’t reverse. Because the Fed is too big right now, relative to its size if people expected higher NGDP.
Ian. If RGDP fails to respond, then raising NGDP will cause 5% inflation, which is not a disaster. And if RGDP fails to respond, that means we were totally wrong about aggregate demand being the problem. The supply-siders, who say it’s all structural, so fiscal and monetary policy demand-side policies can’t work, would be right after all.
I think it should be a Brando voice (from The Wild Ones) rather than James Dean.
But the answer to “What have you got?” in this case could be difficult. My guess is that the Fed could pull this off just by threatening to buy assets that it has unambiguous legal authority to buy, and that as a result it wouldn’t actually have to buy those assets, but I’m far less than 100% confident in this guess. It’s not too hard for me to imagine that there are some serious tough guys in the second room who will say to Chuck Norris, “Yeah, I’d like to see you try!” And it is hard for me to imagine the Fed being as tough as Chuck Norris, so there’s a serious risk that you end up with a lot of people getting their heads smashed and then the Fed eventually backing down, particularly since the people getting beat up may have friends in Congress. It’ll definitely work if we can get the antimatter counterpart of Paul Volcker to play the part of Chuck Norris, but one doesn’t get the sense that Ben Bernanke is up to the role.
Ian: I believe it would take a fundamental breakdown of everything that makes modern society work for an NGDP level target of 5% to fail to produce ANY change in RGDP over anything but the very short term. However, it is theoretically possible under an NGDP level targeting regime to have something like 6% on inflation and -1% on real growth (a point Milton Friedman brought up once), and we would rightfully term that a “recession”. The virtue of constant nominal spending is that it smooths out the fluctuations inherent in recessions.
Modern recessions associated with a large and long-running decline in real material welfare are also associated with a plunge in NGDP, not offset by the monetary authority to return to trend…leaving adjustment to the vagaries of prices.
Explain how this would have worked in Japan in 1990. The stock and real estate bubbles have begun to pop, and and CB responds by buying everything. How does the CB not lose money?
It seems to me that you can’t take the position that QE-on-crack can always work by driving asset prices to silly levels and that the CB won’t lose money. The CB can definitely lose money unless it only buys assets at realistic prices – but with that constraint, it isn’t guaranteed to be able to hit an NGDP target.
Max, If the Fed loses money (or is expected to lose money), so much the better for its credibility! If the Fed loses money, it could be forced into inflationary policies, which would be all the more reason for people to take its threats to raise NGDP seriously. A Fed that doesn’t mind losing money is like a psychotic Chuck Norris that might keep beating up people in the second room just because he enjoys it, even after everyone is clearly headed for the exit.
I have a question.
If there were no expectations and people waited until things really happened before acting would NGDP targeting stop working ? Suppose we have a very secretive CB that sees that NGDP has moved below the target it has set (but has not shared with anyone). It decides it needs to increase the money supply. Without telling anyone it just starts buying up assets for newly printed money. People can either hold onto that money or spend it. As you point out they must eventually start spending it or the CB will end up owning every asset in the world. Once they start spending then NGDP increases and eventually the CB may have to start reselling the assets it has bought in order to stop NGDP rising too much (once people see spending really is increasing they start to spend more too). The CB keeps NGDP on a steady path without anyone knowing what it is doing.
It might have to do more buying and selling of assets than in the expectatio-based model, and it would certainly make it harder for businesses to plan ahead (though they would eventually get used to NGDP rising at a steady rate and plan accordingly) – but I can’t see why this model would not work.
So my question is: Is the expectations piece just a cool thing that makes everything work faster and better or does the whole model break without it ?
Andy: Oops! Brando it is. Fixed. I don’t spend enough time watching old movies. (How do you do a strikeout in Typepad anyway?)
JP Koning is my goto man on what central banks can legally do. See his comments on the Chuck Norris post.
My view is that the Fed is large, relative to any individual player. Plus the Fed has very deep pockets (it can print). Plus, who would really gain from standing up to the Fed, and trying to fight? Only someone who held large stocks of Tbills. And if they are that rich, they must be smart, and would realise they could get richer still by beating the crowd to the exits.
Niklas: Yep. There is that (mistaken) view though that fiscal policy affects RGDP and monetary policy affects NGDP but not RGDP. (Scott addressed it in one of his posts). So there is this view out there that the recession is caused by a shortage of AD, but that monetary policy can only affect P. Might be what’s behind this.
Max: wouldn’t (at least some) asset prices be higher if expected NGDP were higher?
Rob: “So my question is: Is the expectations piece just a cool thing that makes everything work faster and better or does the whole model break without it ?”
Hmm. That’s a hard thought-experiment for me. Because I find it hard to explain the current recession without saying that people’s fear of future low real and nominal income plays such a large part in explaining why we are in a recession in the first place.
But yes, if everybody really was just very very slow in adjusting their expectations, for whatever reason, that would mean that the Fed would have to do much more of the heavy lifting, and it would take longer for its policy to have any effect.
JKH: Three things, in combination, make NGDP targeting special: (1) it’s simple, (2) it involves both the price level and real output, and (3) it’s cumulative (at least it would be under proposals being advanced by the market monetarists). There are other ways to combine price level and real output/employment (such as what Gov Evans suggests), but why not use the simplest combination? You couldn’t, though, use just employment, because that would leave the price level indeterminate, and inflation-phobes would have a legitimate objection with which the vast majority of economists would agree. NGDP targeting tells just how much inflation you’re willing to tolerate in each circumstance and thus provides a guarantee against hyperinflation. The cumulative aspect is important, too, because it allows (and requires) the Fed to make bigger and bigger threats the more the threats aren’t heeded. If NGDP misses the first time, the Fed gets more aggressive.
“wouldn’t (at least some) asset prices be higher if expected NGDP were higher?”
Not necessarily, since expected NGDP doesn’t fully determine asset prices.
If the CB doesn’t want to lose money, it has to make a judgement about what prices are reasonable given the NGDP target.
JKH:
“Why not announce the same QE program with an unemployment/employment target?”
Quite agree with your comments. At least your proposed target has the advantage of “targeting” what bothers mots people in this economy.
Not sure why the futility of QEn shell game, no matter what is targeted, is not blindingly obvious.
vjk: we used to target the unemployment rate in the 1960’s and early 1970’s. It failed miserably. We figured out why. Friedman and (independently) Phelps explained why in 1969 (Hayek explained why earlier, but nobody understood what he was on about). Nobody believed Friedman at first. Eventually everybody did. That’s why the Keynesians became New Keynesians.
Nick:
The feds can (a) control overnight interest rate in normal times; (b) engage in swapping government paper of various tenors in not so normal times. (a) is practically at zero, (b) has not had/is not having/won’t have any real effect on economy other than temporary distortionary influence on commodity prices and causing stock market wild fluctuations due to mainly transient psychological reasons. Thus (b) is meaningless. Also, see research on Japanese QE experience which is arguably inconclusive, but still does not provide much ground for optimism in the context of the US QE madness. Just the opposite when considering leakages due to the US foreign trade imbalance, something Japan did not have to deal with.
It is also highly unlikely that the CB will repeat its Maiden Lane act with buying non-government paper. As I mentioned in the parallel thread, the Maiden Lane act was most likely illegal since 13(3) was misapplied, or as my legal colleagues would put it: “the feds overstepped its boundaries”. Besides, thanks to the Frank-Dodd amendments, 13(3) is now severely limited exactly in order to prevent the ML from happening again.
So, we have a pretty weak Chuck dispensing empty threats. He might as well “target” a flight to Venus ! And more and more players are becoming aware of the feds impotence trying to play fiscal on an unknown and dangerous terrain.
A couple of more questions:
a) How is the threat of massive QE fundamentally different than the status quo, given that the market already believes the Fed will do more QE under sufficiently bad economic circumstances? I know that the target in this proposal is specific, but the fact is that the market perceives that the threat of action already exists, implicitly. The threat is not that much different, although the specificity of the target is.
b) If the target is specific in that it is NGDP, how does the threat have any follow through substance and credibility unless it is quantified by a formula for the contingent strength of QE under various scenarios where NGDP has not yet met target? What would be an example of such a formula quantifying the threat?
c) In Scott Sumner’s original NGDP futures proposal, it was important that the Fed intervene in the futures market directly. How is the importance of such an intervention requirement consistent with the idea here that a mere threat will do the job?
How is the amount of medium of exchange going to increase?
Should positive productivity gains and other things be distributed evenly between the major economic entities?
This is not as off-topic as it sounds. If people produce more, how are they going to afford to purchase more, assuming they want to purchase more stuff, which they may not want to do?
For example, let’s say the amount of vehicles that can be produced doubles over the next five(5) years. I’m not going to buy a vehicle more often or buy more of them.
It seems to me you are assuming real aggregate supply (AS) basically equals real GDP, which IMO does not have to be true, but can be true.
“Oh, and if you believe in the debt-deleveraging hypothesis, there’s an additional channel. Higher expected future NGDP makes it easier to handle a given debt load, by reducing future expected debt/income ratios.”
If price inflation rises (especially monthly expenses), but wages don’t, I see that making it harder for workers to pay back currency denominated debt. Budgeting.
I’m a Conservative Investor. At these prices and in this climate, Stocks are iffy. Yields on Long Bonds are a joke. So, I’m fiddling around. If the Fed announces Inflation going forward, I will act ( Leave The Room ). I consider betting against the Fed Risky. I will buy Stocks and Long Bonds and Corporate Bonds when I see Yields ( & Quality ) that I can live with. If I’m right, at some point, other Investors will rush into the market late ( Leave The Room ). They always do. There is no doubt that some number of other people are thinking as I do. The question will be how many.
Now, I could be wrong, but I’m puzzled that people would find this hard to follow.
Thanks for the answers Nick, so if we want to increase the current NGDP of America what size would the QE styled operation have to be under current conditions?
JKH:
a. I think there are two differences: First, the implicit NGDP target under the status quo is just too damned low to get the economy to recover; all it can do is stop it getting worse. Second, it is because the implicit NGDP target is so damn low that the Fed has to do so much QE just to keep it there. The demand for money is so big, and interest rates are so low, simply because the implicit NGDP target is so low. With a credible higher NGDP target, the Fed could actually do negative QE, raise interest rates and shrink its balance sheet. It would have to, to stop overshooting.
b. I don’t think the formula has to be very specific. (It would only have to be very specific if you wanted to hit the target exactly). The instructions: “keep pressing the gas pedal down harder and harder if you are below the speed limit, and keep easing off on the gas pedal if you are below the speed limit” will work pretty well for a young driver. Not perfectly, but good enough. Despite all the Bank of Canada’s fancy model, that’s really what it comes down to in practice. The model has lots of fudge factors built in, and they don’t always do what it says.
c. I see Scott’s proposal to use the futures market as a way to try to get a better answer to b above, that allows the wisdom of crowds to try to help out.
With the US economy right now, It’s pretty obvious it needs looser monetary policy and more AD. Scott’s specific proposals about NGDP futures markets are only relevant once you get NGDP up into the right ballpark, and are not sure whether you want to tighten or loosen monetary policy to fine tune it more exactly. That stuff comes later.
Ian: “Thanks for the answers Nick, so if we want to increase the current NGDP of America what size would the QE styled operation have to be under current conditions?”
We threaten unlimited positive QE until NGDP hits the target. If/when it hits the target, the Fed will need to do negative QE. I’m not sure how much.
It would be a lot easier to implement if there were an NGDP futures market, as Scott Sumner proposes, because then we could just watch that futures market like a car driver watches the speedo, and it would tell us if we had too much or too little.
The only assets that the Fed can purchase are assets that are held by the upper 1-2% of the population. I dont see how even if they sold every last one of their assets for twice the current price of them how this will increase any business sales levels .Money needs to get in the hands of working people NOT the investing people. If the fed could start paying every American twice their current house value (and rent it back to them), buy anyones car who wanted to sell it for twice its book value or any other number of things owned by average joes it might work. Until the average joes go back to buying things we wont get anywhere. This isnt a top end of town problem, its a lower end of town problem created by the excesses in the top end of town. QE I, II and III have failed and QE (infinity) will fail too unless the little guy gets to sell HIS stuff to the fed.
And what the hell is “Negative QE”??? The Fed FORCING you to buy assets back from them………….. and you guys call the Kenesians “Statists”!!??
Nick : Thanks for laying out the ‘mechanism’ in such detail – I’m now less confident than before! Everything really depends on the presumption of omnipotence of the central bank. Why couldn’t the BoE convince George Soros, for example, that the value of the pound will remain where it wants it to remain? Perhaps there is some asymmetry there – printing currency to buy other assets is much simpler than selling assets to buy your own currency – but this just tells us that the central bank is not Chuck Norris, after all!
The Chuck Norris parable works perfectly when applied to one highly centralized market – the overnight inter bank market. But to extend it to the gross sum of all economic activity in a large country just doesn’t scale so well. What about the change in expectations when the central bank’s balance sheet itself starts becoming ‘unsustainable’?
Of course, this does not mean that announcing a policy of ‘we will level target the NGDP’ is not good policy. It is. It is better policy than what most central banks have around the world. It will change expectations, for sure. That will make the task easier. It’s just that sometimes, the central bank may be Sisyphus, not Chuck Norris.
Gizzard: “And what the hell is “Negative QE”??? The Fed FORCING you to buy assets back from them………….. and you guys call the Kenesians “Statists”!!??”
?
Negative QE = the Fed selling assets. Obvious really. Think ECON1000. Remember Open Market Operations? In open market operations, the central bank can either buy assets, or sell assets. “QE” is just a silly new name for “OMO”.
Ritwik: interesting point. Defending the pound was an example of tightening monetary policy. Tightening monetary policy can be nasty, and difficult.
@Nick, what metric of NGDP would you use? In 2008 and 2009 NGDP varied wildly, I think, posting QOQ changes that could cause difficulties in predicting future quarters. From what I see, NGDP is often revised post hoc, making the numbers used for future targeting less certain. If there were a runaway situation the measures could be lagging more than price levels, which are better known (maybe that’s not a good assumption?).
My concern with GDP targeting is that GDP is itself not necessarily a good measure of medium-term economic performance. That is, if there is an investment boom, GDP is booked early through capex but would subsequently fall if the investments are poor. In cases where investment is lacking and asset valuations are depressed maybe there isn’t much danger in that, but what about the case where asset valuations are elevated relative to earnings? NGDP targeting might exacerbate the situation.
Anyways I’d be curious to hear your thoughts on this.
jesse: I worry about that too. The nice thing about CPI inflation or price level path targeting is that the numbers aren’t revised.
Is the Fed not barred by the Federal Reserve Act from buying assets not backed by the full faith and credit of the U.S. Treasury? Which would make dabbling in a futures market illegal under current law? Equity purchases would also be illegal?
Gizzard said: “This isnt a top end of town problem, its a lower end of town problem created by the excesses in the top end of town. QE I, II and III have failed and QE (infinity) will fail too unless the little guy gets to sell HIS stuff to the fed.”
I agree. See here:
The origins of the economic crisis
“The question then arises: if the output per unit of labour input (labour productivity) is rising so strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself? This is especially significant in the context of the increasing fiscal drag coming from the public surpluses which squeezed purchasing power in the private sector since around 1997.”
“The trick was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments. This seemed to be a much better strategy than paying higher real wages. The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers. The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold. And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.”
I call that a too much debt problem (both private and gov’t). That means there is a medium of exchange problem. It also looks like this.
savings of the rich (including corporations) = dissavings of the gov’t (preferably with debt) + dissavings of the lower and middle class (preferably with debt)
Gizzard, what if the “little guy” has no assets to sell?
KH: read the comments by JP Koning on my “Chuck Norris” post. He knows a lot more than me about that.
TMF: stop please.
Nick, your comment on the uselessness of employment targeting is the heart of the problem with NGDP targeting. It might be good academics but it is terrible politics. Again I repeat that wages are the primary means in which we distribute wealth and consumption in the modern world. A policy that does not address wages and employment or is not clear about how these will be affected is useless.
Second, on Central Banks being crazy Chuck Norris who doesn’t care about losses. ISTM that economists want Central Banks to act without a profit motive and therefore without costs, unlike every other market actor except government (sort of). As Soros episode shows, that isn’t true. The Central Bank is not omnipotent and does have limits. We are testing those limits in many countries. ISTM macroeconomists are afraid of abandoning the only tool they are really comfortable with.
Determinant: UK politicians in the 1970’s learned that trying to use monetary policy to target unemployment was both terrible economics and terrible politics. Dennis Healey said something memorable on the subject (though I, of course, have forgotten it). Using monetary policy to target real wages or real consumption would also be a miserable failure for exactly the same reason. Have we learned nothing from history? It took 20 years at least to repair the damage from that miserable failure, and it was very costly to repair. Look at one of Stephen’s graphs of the 82 recession.
If I wanted the Bank of Canada to maximise profits I would recommend, hmmm, somewhere around 100% for the inflation target. Certainly not 2%. And impose 100% reserve requirements on commercial banks, so people couldn’t get around it by using chequeing accounts.
If the resource producing nations of the world and the speculators on natural resources get a hint of this, they might raise the prices so high that existing production might get hampered.
I guess that would translate into the 6% inflation and -1% growth that one commenter mentioned.
Also, a lot of the GDP growth in China right now seems like major malinvestment. I’m not sure that without proper institutional reform, it is just ok to pump away the cash.
Nick:
There is a marked difference between Chuck Norris and Ben Bernanke: Chuck is wielding a bazooka.
As a rational (or irrational) actor I can be fully certain that Chuck is able to carry out his threat: I can see the weapon with my eyes and I have witnessed him using it on others.
Thus Chuck only has to suggest his intention and I’ll be a first mover.
Where is Ben’s bazooka and where is his track record of using it? I can only see that he bought three trillion dollars worth of bonds – which only had a transitory effect. Had I been a first mover in 2009, expecting higher rates from Ben’s actions, I’d have lost a lot of money.
So can you outline exactly how Ben would be able to increase NGDP, for my eyes to see? And no, SPVs were highly controversial, if you think the Fed has the legal mandate to print money and distribute it to non-bank economic actors you’d be wrong: the Fed picking economic winners and losers in a fiscal manner goes against everything that CBs historically stand for.
So if Ben only buys financial bonds then the market will not accept the proven water pistol as a bazooka threat.
So Ben would have to demonstrate the capability and willingness to go fiscal, for him to be able to target NGDP, do you agree?
Both asset purchases or heli drops must have a chance of failure or we wouldn’t ever have to use them ( we’d just have to threaten). If asset purchases fail, the CB can lose money which will result in them having to tax it back. So the same potential inefficiencies occur there too. And it’s regressive.
There’s a huge free lunch to be had and we are deciding who should eat it. You think that the risk of everyone eating a bit too much outweighs the benefit of everybody sharing it equally. So you’d rather just give it all to Mr Creosote cause you know it’s partially reversible if he overeats.
The first line is ironic because I am indeed a Mechanical Engineer with a business background, and my last comment on Sumner’s blog was basically “well, how does this expectation thing actually work? What levers are pulled?” You got everything except for the Yorkshire accent, although I’ve dealt with people with a Yorkshire accent. You can’t understand a bloody thing they say.
I will echo that an unemployment target is a terrible idea and it has actually already failed if you include the 1970’s. The underlying issue is the structural rate of unemployment. Due to high unionization in both the US and UK economies, high rates of NGDP growth did not increase the real demand for workers by pushing down real wages. Real wages stayed level due to COLA’s for union and government workers. NGDP can’t do anything about structural factors and no economist should pretend that either monetary or fiscal policy can do anything about structural issues. If the number of workers is fixed through structural factors, then either monetary or fiscal policy will only go through to inflation, not RGDP.
All that said, I still have a hard time wrapping my head around how the Fed could have acted differently during, say, September of 2008. I guess theoretically the government could have purchased all Treasuries in the short-term market and put in a penalty interest rate on excess reserves. In such circumstances, people really, really, really want to be in the first room and Chuck Norris would have to beat up A LOT of people.
So I’m not exactly sold completely on market monetarism. Probably NGDP-level targeting is an ideal, but the country could also use reregulation of finance to prevent another credit bubble followed by a banking panic. Even if the Fed is perfect at responding to banking panics, such credit bubbles IMO do reduce RGDP growth and put more of the NGDP growth to inflation. Furthermore, I’m not sold that Chuck Norris could really beat up enough people to keep NGDP growth steady in such circumstances. At the end of the day, the market would not believe that the Fed could buy trillions of dollars of assets and push interest on reserves low enough to keep NGDP growth strong, and the market would be right.
Hi Nick:
I don’t have the time to do a comment or your post justice, working >12hrs. But based on the weekends posts, etc, and past 4 years, my mind is firming up around a couple of ideas. I left a shorter version on delong’s two days ago.
I do not want central banks engaging in asset buying. Random or not I think this is a political decision involving who to give the hot potato to. That was why I asked about the price level jumping economy wide on the bike post, or if it works itself out through multiple markets.
Central banks should be confined to conversion of the different time preferences between individuals and governments, and passing the liquidity premia = seigniorage back on to the gov.
Based on last convo where you said framing the optimal size of central bank between gov and central bank doing the asset buying no material difference. I think you and FTPL, are equivalent. I want you to revisit this,
Mccallum 06 argues nothing gained from adopting the ftpl over quantity theory, and kocherlakota shows that it is untestable. But the adopting it gives a different perspective on recession wrt to moa, from stocks or gov, a perspective more in line with your views, of moe walras law violation: maybe?
anyway in that comment you raise some objections, I can only work on one of them, you do not agree that a gov maximizes surpluses like a company maximizes profits. What about utility?
Anecdotal/unsound/scattershot/for shits’n giggles.
I worked in a gov briefly these things are huge with frickin laser beams on their heads, using the free market as only one of many ways of getting the outcomes they want. LOUD NOISES and hand waving. And you are telling me that they don’t maximize…. i sure hope utility is equivalent to surpluses, otherwise I’m screwed.
And another thing governments are real just like humans are real. individual cells same dna build up into a humans, who combine into governments, with abilities that the individuals don’t have, like um war boats.
anyway if i’m right, you and adamp agree on more than china.
summary: I don’t like the stick you are giving chuck norris. ergo I will oppose giving chuck norris this stick, thereby affecting his ability to effect expectations.
but i need to read woolsey on delong
It is not the job of central banks to get involved in commercial risks, like buying assets which they might make a loss on when those assets are sold back to the private sector. In other words Krugman is right to say that it would be better to combine targeting with expansionary fiscal policy. Put another way, if new money is going to be distributed, it should be distributed to everyone, not just the asset rich.
Of course given the current intransigence by Congress, it is difficult to implement the above fiscal policy. But that just proves the idiocy of putting technical economic decisions into the hands of members of Congress, 90% of whom have not opened a basic introductory economics text book. It doesn’t detract from the basic merit of Krugman’s point.
I pointed out the merits of putting some fiscal into the targeting brew on David Beckworth’s blog two or three months ago.
Matt Waters,
“well, how does this expectation thing actually work? What levers are pulled?”
If someone told you that they were going to kick you in the leg, would you wait until they kicked you before you responded? Or would you move beforehand?
You don’t have to pull levers if you’re dealing with sentient beings, if you can communicate with them.
“Perhaps there is some asymmetry there – printing currency to buy other assets is much simpler than selling assets to buy your own currency – but this just tells us that the central bank is not Chuck Norris, after all! ”
Surely there are symmetrical limits, but it pushes the Chuck Norris analogy too far?
The Fed could not credibly commit to raising US NGDP to $900bn by 2013, because the markets would know that would require too much inflation, and the Fed would get whacked by Congress.
HM Treasury could not credibly defend Sterling in the ERM, because the markets realised that would require interest rates to go higher than was technically feasible. It would have been technically feasible to defend Sterling, I think.
The legal mandate of an independent central bank sets the limits of its credibility, perhaps?
Sorry, I meant to write “politically feasible” in the “HM Treasury…” sentence.
My concern with NGDP targeting is that you are trading volatility in output for volatility in other dimensions. I imagine it would be manifested in interest rates, for one.
Prakash: “If the resource producing nations of the world and the speculators on natural resources get a hint of this, they might raise the prices so high that existing production might get hampered.”
That isn’t an equilibrium. You’ve got real GDP falling, and the real price of oil rising. Excess supply of oil, so price of oil comes back down.
WR: it can be unlimited in magnitude, and/or unlimited in duration. Having it both makes it easier for me to tell the story, but the unlimited in duration (or rather the threat of it being so) is what really matters. If you have a permanent 10% rise in Ms, the only equilibrium is an eventual 10% rise in P, and hence NGDP. The US economy won’t be in a liquidity trap forever.
K: “Both asset purchases or heli drops must have a chance of failure or we wouldn’t ever have to use them ( we’d just have to threaten).”
Start in equilibrium. If something caused the demand for money to rise, you would need to do an actual (not just a threatened) increase in the supply of money, in order to stay in that equilibrium.
Matt: so you are precisely my intended audience!
Agree with your second paragraph. You can’t use monetary policy to cure a structural problem. The attempt to do so simply results in ever-accelerating inflation.
Third para: Yes. Starting in equilibrium, if something causes the demand for money to increase, you have to actually increase the supply (possibly by a very large amount) if you want to stay in that equilibrium, as well as threaten to do even more if needed, to stabilise expectations.
4th para: agreed too, probably. Finance has a supply-side effect, as well as demand side. Monetary policy can’t fix the supply-side effect of a bad finance sector.
edeast” Wow, I had forgotten my old comment. Here’s what I get when I revisit it: in the limit, as the rate of inflation falls, and the rates of return on all government liabilities approach equality, the QT approaches the FTPL. But that’s probably when the central bank owns everything. FTPL is a special case of the QT.
Ralph: “Put another way, if new money is going to be distributed, it should be distributed to everyone, not just the asset rich.”
It’s not being “distributed” in the sense of being handed out for free. It’s being sold in exchange for assets. Or, rather, that’s what’s being threatened.
When the economy will recovers, asset prices will rise (except on safe nominal assets like long government bonds).
Britmouse “The Fed could not credibly commit to raising US NGDP to $900bn by 2013, because the markets would know that would require too much inflation, and the Fed would get whacked by Congress.”
Isn’t US NGDP bigger than that already? (I think you have a couple of zeros missing in your example). Never mind, I get your point. But the Fed would not be committing to create massive inflation. It would be committing to do whatever is necessary to get NGDP up a few percentage points, and keep growing.
The legal mandate of the Fed might curtail its credibility.
Andrew: “My concern with NGDP targeting is that you are trading volatility in output for volatility in other dimensions. I imagine it would be manifested in interest rates, for one.”
You are probably right. But it would probably mean greater volatility in P, rather than r, compared to inflation targeting, in the face of supply shocks. But that’s more a long run question, of the best target. That’s the Bank of Canada’s current problem, not so much the Fed’s current problem.
The closer interest rates are to zero, the less distinguishable is money from other financial assets. That means the less provable is the proposition that people want money per se, as opposed to saving (or wealth) per se. And if it turns out they want the saving characteristic rather than the money characteristic, swapping money for financial assets does little for aggregate demand, because it has no effect on saving.
Nick: “Start in equilibrium. If something caused the demand for money to rise, you would need to do an actual (not just a threatened) increase in the supply of money, in order to stay in that equilibrium.”
Money is almost 100% endogenous in our economy – you don’t have to add money. To balance an excess demand for savings you just have to raise inflation expectations, thereby dropping the real rate… you know the story.
NDGP targeting seem like poorly concealed fiscal helicopter drops to the rich (“let me pay you so that I can hold some of your risk for a while, while inflating the value of your other assets in the process” somehow doesn’t look like a threat).
Also, why mess with the prices of financial assets, why not simply give the rich a lot of money instead?
Furthermore, wouldn’t you get bigger RGDP effects by dropping it on the poor instead?