"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 
JKH: basically yes. Which is why the threat must be bigger, than in normal times.
K: I know the story, and I know it’s wrong. Money is not “endogenous” in the sense of M=Md, as I showed in Wicksell and the hot potato. And an excess demand for saving in the form of antique furniture cannot cause a recession, as I showed in lots of old posts.
Nemi: two sorts of people got hurt bad in the US recession: those who held large stocks of risky real and financial assets; those who lost their jobs, or couldn’t get one, like the young. Restoring the old NGDP path equilibrium would help both those groups, yes.
Your comment reminds me of that old joke about the Russian peasant, who was offered anything he liked, except his neighbour would get twice what he asked for.
If you want to transfer wealth from one group to another, then argue it honestly. But don’t let envy stand in the way of fixing the recession.
Nick: “I know the story, and I know it’s wrong.”
Nick: Sigh… I’ll try to find some time this weekend to write the Why Liquidity Preference is Irrelevant to Macroeconomic Control Guide For Market Monetarists 🙂 That should settle this once and for all! For the most part I think Matt Rognlie did the heavy lifting in his last post.
The investors who lost money in ’08 got what they deserve. You want the gains, you’re supposed to take the losses. That’s how our system works.
Nemi: It’s not the targeting of NGDP that’s wrong. It’s the purchase of capital assets. Once we are beyond setting expectations of the path of the short rate we are in a world of fiscal policy that will have significant wealth impacts. There is a very large free lunch on the table and anything we do to get ourselves out of a liquidity trap will involve making decisions about who gets to eat it. That includes both helicopter drops and Nick’s industrial policy.
“I think you have a couple of zeros missing in your example”
Magnitudes bigger than £1 are hard for me to comprehend. I meant $900tn. 🙂
There are 2 aspects being fudged in the discussion here, imo. One is: is it sufficient for Chuck to stare at people for them to leave the room. And if so, why? The second is: even if the people do leave the room, for whatever reason, does it help anyone standing outside the building?
Personally, I find this explanation from above for question 1 to be quite convincing
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!
For the simple reason that, for a central bank, its own fiat is inifinitely forthcoming whereas all other assets aren’t. ‘We will print all it takes to smack you over the head’ is believable because it’s physically possible, whereas ‘we can sell you all the insert favourite asset in our vault at market prices ’til you cry’ isn’t.
Chuck Norris only manages to clear the room in films -because that’s what script says. I doubt he’s quite as successful behind the screen. When markets are significantly challenged, they will put up a fight. Whereas if the challenge isn’t significant enough to evoke a reaction, who cares?
The second question is harder to answer. I suspect there is a continuum between pure monetary (i.e. system internal asset swaps such as in QEII) and pure fiscal (i.e. buying physical stuff in exchange for money) with varying effectiveness, depending on the ailment and on who profits in what way.
Oliver: “…whereas ‘we can sell you all the insert favourite asset in our vault at market prices ’til you cry’ isn’t.”
If a central bank has assets equal to its monetary liabilities, it can in principle sell all its assets and drive its outstanding money stock to zero. The danger is that selling its assets might drive the value of those assets, in money, down to zero. But in that case, in any case, driving asset prices to zero is about as far as is possible to go anyway.
“I suspect there is a continuum between pure monetary (i.e. system internal asset swaps such as in QEII) and pure fiscal (i.e. buying physical stuff in exchange for money) with varying effectiveness, depending on the ailment and on who profits in what way.”
I tend to agree with this. But remember though, the central bank will be threatening to buy, not actually buying. It will actually be selling. But I don’t see how this is related to your second question, which I take to be: “who gains and loses if the economy recovers back to its original path?”
Nick,
The Fed is only effective if there is demand for bank reserves. If not, buying equities merely changes the ownership of corporate profits from private individuals to the Treasury (through Fed profit remittances). If the Treasury decided to nationalize all publicly traded companies but leave their Boards intact, would this increase the value of equities? No. But magically, the Treasury taking ownership of those same assets via the Fed does?
Also, a little discussion of the risks would be useful. If the Fed buys massive amounts of equities at higher prices (assuming it raises those prices) and RGDP does not improve, the Fed will pass on a large loss to the Treasury. This will be a transfer of wealth from taxpayers to shareowners: a fiscal action. Failure would be disastrous for the Fed’s independence.
“If you want to transfer wealth from one group to another, then argue it honestly. But don’t let envy stand in the way of fixing the recession.”
I think in today’s world where the average person is either an anti-Fed Ron Paul type or a lefty occupy type its going to be very difficult politically for economists to push through their NGDP theories. Which means that if we see any inflation at all it will be a half hearted effort and not the required amount that economists want. This whole NGDP stuff seems like it will have too many difficulties and unforseen consequences that its almost not worth it. I say almost because I do find the ideas interesting even though they may not be practical.
David: are people indifferent between holding any proportions of cash and equities, forever? I don’t think so. Equities rate of return dominate cash, and cash medium of exchange dominates equities.
Ian: Yep, it depresses me. Any attempt to cure the recession must either be a lefty plot to steal our savings or a righty plot to make the wealthy richer. I would like all the stupid conspiracy theorists of both sides to go off and form their own disfunctional country, where they could all riot away happily ever after, while people like Sumner and Krugman cobble together some sort of workable compromise despite their political differences (and happily argue fine points of theory for hours afterwards at the bar).
Thanks for the reply!
To one, I had never thought of it in those terms. I’ll chew on your answer and see what happens. I guess I’m not at ease, intuitively, with comparing an endless source with a finite one.
To two, I meant that, no matter how precise a central bank is in hitting its target, its effectiveness should be measured not by that precision but by how it impacts the majority of people. And I then jumped to the thought that different kinds of interventions will have different impact (duh) and I simultaneously came up with that continuum thingy to describe what I meant. Maybe my mind is even more fidgety than my fingers :-).
Nick,
People have a desired risk in their claims on future cash flows. If you do not change that risk, you do not change the required return. Transferring ownership of equities from private actors to tax payers leaves intact the aggregate risk of the private sector’s portfolio of claims. They are “indifferent”, in aggregate, to that action.
To believe otherwise, you have to argue that actors are constrained in their access to financial vehicles, or face high information costs to analysing their future tax liabilities. Basically, the same arguments for why fiscal policy works, which makes sense, since anything that does not create demand for bank reserves IS fiscal policy.
David: Money is more liquid. By definition (almost), since it’s the medium of exchange. So MMT won’t apply in this case.
(MMT=Modigliani-Miller Theorem. But, funnily enough, the two meanings of MMT do perhaps have a lot in common.)
Nick,
I’m not sure if I’m addressing your answer directly, but here goes: the Fed can change the aggregate liquidity risk of the private sector by virtue of the unique nature of its balance sheet (which extinguishes liquidity risk rather than passing it to Treasury). The reduction in aggregate risk caused by taking away the liquidity risk of risk assets, in normal times, is quite low. When liquidity risk spikes, QE is quite effective for this reason. Given the market measures of liquidity risk today are reasonably normal, I would argue QE would have little impact that cannot be produced by fiscal policy.
BTW, I’m not advocating fiscal policy, just pointing out that there are things the Fed does that are unique (supplying demanded reserves, extinguishing liquidity risk of assets), and things that the Treasury could do just as well, and is doing, given that the balance sheet of the Fed belongs to Treasury.
“Ralph: “Put another way, if new money is going to be distributed, it should be distributed to everyone, not just the asset rich.”
Nick “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).”
Its being sold for an extravagent price likely. Sold at twice its “market” value. And if thats threatened only its completely ineffective. What you are saying is that the fed needs to sit there and say ” Now boys, you arent trading enough of this stuff at a high enough price…… either you buy things from each other or I’M going to come in and buy everything from all of you for twice the asking price…… GOT IT!!” And of course a number of people are going to say “FIne, buy it from me for twice what its worth….I’m in!!”
And this will do NOTHING for general commerce. Youll have a bunch of rich guys selling stuff to the govt (and insisting its the free market at work!) And saying “Look at the Dow take off, look at commodities take off, WHEEEE were all rich” And then everyone will look around and go “Why arent there any customers in my store, how come no one wants to buy my nice valuable stuff?”
This supply side fetish with asset prices is the worst tangent economics has ever gone off on. Rising asset prices should be a result of healthy economic activity. They are not a cure for low sales.
If nominal GDP targeting works, next time we can skip all this rigamarole and have some Fed Chair simply declare “On next Tuesday, I decree the Dow to be 20,000…. hear that 20,000 and I will release a list to each state what each counties house prices must be by the following Monday. Gold prices shall be 2,000$/oz and orange juice…..”
It would be so easy if all we needed were higher asset prices
“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.”
Nick Rowe: 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.”
The currency effects of this policy seem theoretically uncertain but the market response to the past 2 QE programs should encourage an evaluation of them. In theory, if market participants anticipate a recovery via NGDP expectations, the currency effect could be positive. However, the policy is unproven so longer-term expectations will not initially be there and a massive unbounded QE program could be (initially) very negative for the USD, positive for risk assets and spike hard assets. Would likely cause additional inflation in China due to their peg and could blow up their investment-driven economy. An excess supply of oil would only result from a global recession due to relatively inelastic EM demand growth. The EU may not make it through another recession. Would the initial market-driven implications of the Fed committing to an unbounded QE campaign cause enough short-term dislocations that would cause a reversal of policy – meaning the equilibrium state you cite is never realized due to the process of getting there (not to mention the thought that I’m not sure I want to see those implications if I’m anywhere near accurate)? Sorry that last bit is a mouthful.
I would very much appreciate you evaluating the potential for currency effects – not just in a theoretical future equilibrium but through the process of getting there.
Thanks – Darren
Nick: “I would like all the stupid conspiracy theorists of both sides to go off and form their own disfunctional country, where they could all riot away happily ever after, while people like Sumner and Krugman cobble together some sort of workable compromise despite their political differences”
Who’s rioting? I don’t even think I have been that impolite. I did compare rich people to Mr. Creosote, which may have been a bit over the top, but there certainly was some excess pigging out before and at the peak of the crisis. But “stupid conspiracy theorists?” That seems unfair.
The Fed can’t just go out and buy stocks. They are not allowed. If buying bonds doesn’t work, somebody is going to have to use the democratic, legislative process to write some new rules. There is no “default” or obviously neutral policy that they can follow, and there will be wealth transfers involved. How is it that the nature of those new rules doesn’t represent a legitimate democratic concern of all citizens?
Too Much Fed you said
“Gizzard, what if the “little guy” has no assets to sell?”
How bout this;
Fed guy: How bout that shirt on your back, how many holes does it have in it?
OWS guy: Uhh two
Fed guy: Are they in the armpits?
OWS guy: Yeah
Fed guy: Well we can fix that pretty easy, I could sew that myself……… I’ll give ya 500$/month for the next 18 months for it.
OWS guy: Cool. How bout these jeans
Fed guy: Ooooooooh those jeans look nice…. 32 waist?
Very helpful post.
Still mulling it over, but I have two questions.
Will nominal GDP targeting work if it entirely affects prices and not quantities? Do you need some degree of money illusion in order to affect quantities?
“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. ”
Since a bond promises to pay nominal amounts of cash, if the introduction of NGDP targeting is expected to lead to significant increases in prices, why would anyone want to get out of cash into bonds? It seems to me that everyone would want to simultaneously get out of bonds into a better inflation hedge.
The consistent mistake made in this discussion is that:
1. the LOWER the future NGDP level target – towards 3%, not 4.5% like GS wants.
2. the LOWER the trend line – so not from a hot money peak like 2008, but some lowered assumed trend, or just abasic giveback. Like since Q1 2011.
The more CREDIBLE the threat is.
And the more politically ACCEPTABLE it is.
I’ve yet to see its champions consider that we may get level target NDGP with 8.5% unemployment, which proves according to the hawks the problem is structural.
QE1/2 was essentially Chuck Norris entering the room and threatening to beat up everybody in the room, except those holding a no-beating voucher that he’d distribute to everybody first.
STOP PAYING INTEREST ON EXCESS RESERVES.
“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.”
K: you weren’t rioting. You were fine. (Except I could have done without being reminded of that particular MP sketch though!)
Morgan: If you pick a lower NGDP growth path target, and by implication a lower long run inflation target, do you really want the Fed to get bigger? http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/10/the-optimum-size-of-the-central-bank.html
Thomas: Yep, that would help.
JP: “Will nominal GDP targeting work if it entirely affects prices and not quantities? Do you need some degree of money illusion in order to affect quantities?”
If the recession was caused by a fall in AD, then presumably it can be fixed by an increase in AD. You need sticky prices, both for the recession, and for the cure to work.
“It seems to me that everyone would want to simultaneously get out of bonds into a better inflation hedge.”
Agreed. They would want to get out of both money and safe nominal bonds. (Some risky or illiquid nominal bond prices might rise, if the reduction in risk offsets the higher safe nominal interest rate.)
Don: close, but there’s another, similar one, with “trouble down pit”, as the catchphrase IIRC?
Gizzard: “If nominal GDP targeting works, next time we can skip all this rigamarole and have some Fed Chair simply declare “On next Tuesday, I decree the Dow to be 20,000…. hear that 20,000 and I will release a list to each state what each counties house prices must be by the following Monday. Gold prices shall be 2,000$/oz and orange juice…..””
You are almost getting it there, but you are still hopelessly confused about what monetary policy can and cannot do. Monetary policy can pick one nominal target. It cannot pick two nominal targets.
I realize quite well that Monetary policy by law can only affect bond prices, which is why it cant have the affect that you are hoping for. Interest rates could go to zero permanently (actually there are those who advocate that) and it would still have very little affect on AD. Yes bondholders would move to stocks or any other number of commodities to chase return but the transmission channel to more salaries for the working stiff to pay his debts and buy a little extra just aint there.
If they changed the laws and allowed the fed to actually buy a larger number of things it might work, but then it would just be a fiscal mechanism by another name.
You may not realize it but you are advocating what Mosler has said all along about the fed controlling long term rates, focus on quantity of bonds not price. Stand willing to buy unlimited quantities and youll get the highest price (lowest interest rate) possible.
Nick,
I think its instructive to compare Fed asset purchases with Treasury asset purchases. Start with the premise that expectations have not changed (i.e. that the banking system demands no additional reserves).
If the Fed buys assets, it replaces them with a s.t. liquid asset — ER’s.
If the Treasury buys assets, it replaces them with a s.t. liquid asset — T-bills.
What’s the difference? ER’s can be converted to reserves or currency, of course. But the assumption in the first paragraph (no demand for bank reserves) stipulates that they won’t be. Under that conditions, there is no difference between an ER and a T-bill. In fact, banks should be indifferent between holding one or the other, such that their price would be equivalent (only market imperfections — shadow bank non-access to the IOR — prevent them from being exactly equal).
Of course, if you assume the Fed changes expectations at will, then what difference does QE make? If banks demand reserves (due to a Fed commitment) at the zero bound, they have only to put upward pressure on the FFR in competing for those reserves. The Fed would then supply all the reserves the system demanded to keep the FFR at target. QE would be irrelevant. The Fed need not promise threaten a fiscal action if it controls expectations; if it doesn’t, a fiscal action will be just that.
Who actually thinks about NGDP when deciding how much to spend in the first place. Maybe 1% of the population even heard of (or remembers) the concept, and probably even less for those who make the big private sector decisions. They care about the demand for their specific products, not goods-in-general. It is a grave mistake to confuse expectation of a sum with sum of expectations.
Nor would we even want people to have these expectations. When people hoard money, there’s a reason for it. Forcing them to spend doesn’t satiate the desire that led them to save that money — the “real” factors behind it.
The basic disagreement is that ER’s are not “money”. I think of them as a “phase state”. They are “ice” (a s.t. asset), which could be converted into “water” (medium of exchange), but only with the application of “heat” (higher NGDP expectations). In the phase state of “ice”, reserves are no different from T-bills, and QE is fiscal policy.
You don’t change the phase state of “ice” by threatening to create more “ice”. Sure, if Treasury threatened to buy up all those assets — and lock them away in a sovereign wealth fund — this might raise their price and bring forth a Tobin’s Q effect. Or the Fed could do it. No difference.
Gizzard: “I realize quite well that Monetary policy by law can only affect bond prices,….”
Oh dear. That’s not what I meant at all. We aren’t even speaking the same language. And no, I am not saying anything like the same thing as Warren Mosler. Warren would understand that. Warren thinks in terms of a very different model to me.
Silas: “It is a grave mistake to confuse expectation of a sum with sum of expectations.”
Yes, which is precisely why the variance of monetary policy matters so much.
“When people hoard money, there’s a reason for it. Forcing them to spend doesn’t satiate the desire that led them to save that money — the “real” factors behind it.”
That reason might well be the fear of deflation and recession that comes from an overly tight monetary policy.
David: “Sure, if Treasury threatened to buy up all those assets — and lock them away in a sovereign wealth fund — this might raise their price and bring forth a Tobin’s Q effect. Or the Fed could do it. No difference.”
But I think that’s what I’m talking about.
If comments here are any indication, the assertion that targeting NGDP all depends on expectations has already proven itself a failure.
don: Maybe. But comments are not a representative sample. Those who disagree are more likely to post. Plus, they’re an ornery lot that hang around here. Google to see other bloggers’ responses.
Nick, what mechanism prevents people who receive this newly-printed currency in exchange for their savings – from deserting to a foreign currency rather than spending it locally? A higher inflation expectation can cut two ways: it can cause people to spend their money now before it loses value, or it can cause people to put their savings in foreign currency, which is expected to keep its value.
rogue: Nothing. Some may indeed try to do just that, which would cause the exchange rate to fall, and increase net export demand, and raise the prices of traded or tradeable goods. In a small open economy, that would be one of the main channels. I left out that channel, mainly because I wanted to argue that it’s not just a “demand-diversion”, so that, in principle, all countries could do the same.
Nick,
1. You must be Canadian. If you argue end game, the final trump card played is always the Tea Party grab their 200M guns and the fed (bankers) eats donkey dick.
Repeat after me: the A power (the Tea Party) has votes and money. The B power (the oligarchs) have only money. The C power (the Dems ) have only votes.
If you don’t properly weight power, you can’t really do economics.
2. Since you end game Fed own everything argument is off the table, you got anything else?
3. So far my point stands: lower target, more recent date of start (Q1 2011) is BOTH more politically viable and more Fed credible (less future cloudiness).
C’mon Nick, be strong enough to consider what this means… what if level target 4% NGDP from Q1 2011 means we raise rates when unemployment is 8.5%
Why the rush to see Sumner’s win as a liberal win? an adoption of bigger focus on employment by the Fed?
It can easily be just a good excuse to lock in 1% inflation going forward.
My narrative make far more sense.
“If the Fed buys massive amounts of equities at higher prices (assuming it raises those prices) and RGDP does not improve, the Fed will pass on a large loss to the Treasury. This will be a transfer of wealth from taxpayers to shareowners: a fiscal action.”
Right, and this means that asset price support is not a generally applicable method of increasing demand. It can only be implemented to the extent that asset prices are unreasonably depressed. Otherwise, instead of changing expectations, the CB will just create a massive rush to liquidate assets (since the CB’s offer to buy everything at temporarily inflated prices is not credible and will inevitably be withdrawn).
Nick, You claim (October 21, 2011 at 08:42 AM) that having government buy assets gives stimulus, but that when the process is reversed (i.e. assets are sold) the stimulus effect is NOT reversed, and hence that government does not make a loss on the operation. I think that is a bold assumption.
If changing variable A changes variable B in a particular way, the best assumption that can be made, absent some good evidence to the contrary, is that reversing the change in A will reverse the change in B. Put another way, I think you are assuming a pump priming effect. You could be right, but I want to see some very good evidence for the effect before being convinced. I suspect plenty of others do as well.
Ralph: “Nick, You claim (October 21, 2011 at 08:42 AM) that having government buy assets gives stimulus, but that when the process is reversed (i.e. assets are sold) the stimulus effect is NOT reversed, and hence that government does not make a loss on the operation. I think that is a bold assumption.”
That’s a neat way of putting it. It’s bizarre, isn’t it? If you think of monetary policy in terms of pulling levers, it makes no sense at all. The Fed pulls a lever, and the economy moves forward; then the Fed pushes the lever back to where it was and the economy moves back to where it was. There would have to be some sort of ratchet in the mechanism to get any different results.
Chuck Norris starts beating people up. Then they all get the memo, and leave the room. Then he stops beating up. Maybe he even hands out pain-numbing drinks. But they don’t go back into the room. Expectations have changed. They are in a new equilibrium.
Nick
Are you not suggesting that the Fed threaten to spend whatever it takes to turn ALL savings (in bonds) into cash. This is what monetary policy does as I understand it, it affects the amount of savings in bonds vs non bonds by adjusting interest rates. Your threatened end point is no bonds, “We’ll buy em all for whatever price we have to pay” This will mean bond rates of zero of course ( This is referred to in some circles as monetizing the debt I believe) and the hoped affect is people borrowing all this free money to increase the level of economic activity. This ignores the fact that borrowing is suppressed not because interest rates are too high but because private debt levels are already too high relative to incomes. Any plan to restore bank lending activity must address incomes first or it will fail miserably.
I realize your not saying the same thing as Mosler, you dont understand Central Bank/banking operations as clearly as he does. But this NGDP targeting is QE to the nth power and can only “work” by increasing the wealth affect of the 1% and lowering the cost of loans to the 99%. Which is why it will fail
And regarding new equilibriums, what makes you think the “new” equilibrium has lower unemployment and higher productive economic activity? Your blithely assuming/asserting that it will but how? Just because one equilibrium has more cash and less bonds doesnt mean more people will be working. ZImbabwe had no bonds, what was their unemployment rate 50-75%?
You seem to be operating under the notion that higher inflation leads to higher employment. Higher employment can eventually lead to higher inflation but the reverse is not true at all.
Its the confidence fairies you’re looking for isnt it?
Nick: “If you want to transfer wealth from one group to another, then argue it honestly. But don’t let envy stand in the way of fixing the recession”
I could say the same thing since the best bang per printed dollar certainly is not acchived by the purchase of capital assets. Also, I could not think of another stimilus policy that would be more beneficial for the 1 %, including temporary tax cuts, so why else would you prefere this approach?
Yes,yes – i know – the “serious” policy option is always to throw money at the rich and hope that it somehow, magically, will trickle down to the poor and into the real economy- and this time it will surely work!
PS: Yes – I would like to transfer wealth – but that is beside the point. I think a helicopter drop to the poor would benefit everyone, but I have lost fate in trickle down policy a long time ago.
Gizzard: “Are you not suggesting that the Fed threaten to spend whatever it takes to turn ALL savings (in bonds) into cash.”
Why stop at bonds? Sure, we could have a lovely semantic debate on where monetary policy ends and fiscal policy begins, but over the last few months and years I’ve been coming to the conclusion that that debate is sterile. There’s a continuum. If the money supply changes, it’s monetary. Depending on what is bought with that money, it can be also more or less fiscal, along a continuum. If you buy new bridges it’s fiscal. If you buy shares in new bridges, or bridges that are 1 year old, is it fiscal? Buying 1 year-old bridges is not part of G, strictly speaking. But how different is it, economically (sod what the accountants say)?
“But this NGDP targeting is QE to the nth power and can only “work” by increasing the wealth affect of the 1% and lowering the cost of loans to the 99%.”
Nope. That’s not even correct if you take a mechanistic view of the monetary policy transmission mechanism, and totally ignore feedback and expectations. It leaves out Tobin’s Q, for example.
“Its the confidence fairies you’re looking for isnt it?”
You calling Chuck Norris a confidence fairy? Sure, when Chuck Norris enters the room, everyone suddenly becomes much more confident that everyone else will exit the room. So Chuck Norris must be the confidence fairy. But you’d better not mess with the confidence fairy. Because you will be facing him alone, if you stick to your beliefs. Even if they are not confident everyone else will exit the room, some people will leave anyway, because they were close to the margin of leaving in any case. And then others follow. And then some more.
nemi: What you say is correct. A helicopter drop to everyone would have a bigger effect than the same amount of money used to purchase assets. (As well as have different distributional consequences).
But you have forgotten something. When the policy works, the Fed must go into reverse. It actually has to reverse back further than it went forward. Because the stock of money it has issued is bigger than the equilibrium demand when NGDP hits the target. So when you say “helicopter”, you are really talking “vacuum cleaner” (reverse helicopter) in the final equilibrium. If you want to use helicopters only, this is what it looks like: the Fed threatens to helicopter money to everyone. But as soon as the threat has changed expectations, the Fed taxes back all the money it handed out to make that threat credible, and then taxes back some more.
You don’t want the Fed to do that. Nor do I.
Nick you said earlier
“You are almost getting it there, but you are still hopelessly confused about what monetary policy can and cannot do. Monetary policy can pick one nominal target. It cannot pick two nominal targets.”
This was in response to me saying instead of doing this QE to nth why not just have the Fed decree what the prices of different assets are. Thats what their ultimate goal is(not to decree the price increase but to HAVE the price increase) so why not go full out authoritarian and just tell everyone what the price of gold, the Dow, OJ etc will be today.
Then when I talked about the “true fact” (thanks W!) that the fed can only change interest rates and affect (directly) bond prices by current LAW, you come back with;
“Why stop at bonds?”
So which is it? Can the fed target only bond prices by doing unlimited “monetization” of exisiting bonds or CAN it also target stock prices or gold prices or pantyhose prices by unlimited monetization of those items. Make up your mind. Can it pick more than one nominal target or not. Actually let me rephrase that, because I KNOW that currently the fed can only work with interest rates and ratio of cash to bonds; Are you suggesting that Congress ALLOW the fed to target multiple prices of multiple assets by purchasing whatever the f–k they want.? The FULL Chuck Norris….. “no g-dd–m COngress tells ME what to do………. IM CHUCK NORRIS!!!”
“Agreed. They would want to get out of both money and safe nominal bonds. (Some risky or illiquid nominal bond prices might rise, if the reduction in risk offsets the higher safe nominal interest rate.)”
and
“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.”
One more question. Following the introduction of NGDP targetting, firms may find it easier to issue new stock to finance investment, but not new bonds. After all, bonds are unattractive when prices are expected to rise. You say that, given the expectation of higher NGDP, firms will be able to finance more investment, which increases NGDP. But what if the net effect is a wash? What if firms can finance more new investment with stock but less with bonds?
Gizzard: monetary policy can determine any level of any single magnitude measured in $ units. But it cannot determine any level of any two (or more) magnitudes measured in $ units. It has to choose between them. It can set the dollar price of bread, or the dollar price of beer, but it cannot set the dollar price of both bread and beer independently at the same time. Because that would mean setting the relative price of bread and beer, which has the units litres per kilogram, not $.
And let’s not get into setting nominal bond prices (nominal interest rates), because those have the units today’s dollars per tomorrows dollars per unit of time. So while it can be done, it is done in the exact opposite direction you think it is done. You raise nominal interest rates, in the long run, by loosening future monetary policy relative to current monetary policy.
Nick,
You said, “But I think that’s what I’m talking about,” in response to my comment that Fed and Treasury asset purchases are equivalent when there is no demand for bank reserves. So QE is a fiscal action at the zero bound?
As for Chuck Norris, there is another effect he could have. He threatens to come into the room and beat people up with high inflation; those in the room leave through the door marked, “unproductive inflation hedging” instead of “Tobin’s Q-inducing investment”. You get higher commodity prices, bloated inventories, chronically low savings, higher term premiums, higher equity risk premiums (single-digit P/E’s), and a constantly-devaluing currency that puts at risk its “reserve” status.
“No,” you respond, “Chuck Norris will threaten to beat up anyone that goes out that door”. So you have, on the one hand, Chuck threatening to beat up anyone that leaves the room, and on the other, beating up anyone that does through the wrong door. Sounds like a recipe for start-stop policy and higher volatility.
À propos of Brad DeLong’s remark:
“The problem, I think, is that every time Nick Rowe writes ‘Chuck Norris won’t have to lift a finger’ he is changing the situation from one in which Chuck Norris enters the room into one where a six-foot cutout of Chuck Norris is carried into the room, and an economist says: ‘this cardboard cutout will beat you up unless you move.’ And people laugh.”
I think the real difference here is that Canadian macroeconomists are thinking of how the Bank of Canada has handled monetary policy over the past 20 years, and especially how it handled its inflation target mandate in the first few years of inflation targeting. In the early 1990s, the BoC was Chuck Norris beating up however many people it took to make it clear that it meant business. Ever since then, no-one has dared to test the BoC’s mettle.
One might have thought that the Fed would have earned that reputation after the Volcker deflation, but somehow it didn’t. Perhaps the lack of a clear mandate was to blame?
Thanks for doing this Nick. I wrote a similar post yesterday in response to a question by Kevin Drum, but can’t post it on this lousy hotel computer. Maybe when I get home.
Ian: Yep, it depresses me. Any attempt to cure the recession must either be a lefty plot to steal our savings or a righty plot to make the wealthy richer. I would like all the stupid conspiracy theorists of both sides to go off and form their own disfunctional country, where they could all riot away happily ever after, while people like Sumner and Krugman cobble together some sort of workable compromise despite their political differences (and happily argue fine points of theory for hours afterwards at the bar).
Yay! An economy without people!
Your comment reminds me of that old joke about the Russian peasant, who was offered anything he liked, except his neighbour would get twice what he asked for.
If you want to transfer wealth from one group to another, then argue it honestly. But don’t let envy stand in the way of fixing the recession.
Ah, yes. The “envy” card. Wealth is relative—socially sustainable polities need to reduce the gap, not maintain the enormous disparities.
JP: “One more question. Following the introduction of NGDP targetting, firms may find it easier to issue new stock to finance investment, but not new bonds. After all, bonds are unattractive when prices are expected to rise. You say that, given the expectation of higher NGDP, firms will be able to finance more investment, which increases NGDP. But what if the net effect is a wash? What if firms can finance more new investment with stock but less with bonds?”
If NGDP targeting works, and returns the economy to normal, I would expect investment demand to rise (because firms will be able to sell the extra output that extra capital goods can produce). That increased investment demand will cause the equilibrium real return on both corporate bonds and stocks to rise. That will make it harder for firms to finance new investment. But that’s what’s needed, to prevent excess demand for loanable funds and excess demand for output.
You forget that you have to convince the entire globe because “money” can go anywhere it wants in today’s world. Also you have to compete with countries who aren’t targeting NGDP also, aka market economies. There are a few left. So what you need for NGDP targeting to work is a vacuum where the “victims” of this manipulation can’t get any information from other competing systems or move their “money” there.
Nick: If the money supply changes, it’s monetary.
Hm, no it is not. Yours is a misguided definition of monetary vs fiscal. If the Fed turns a zero result to the Treasury as the outcome of its operation then it is monetary. Anything but zero is fiscal. The probability of the Fed delivering exact zero is close to zero meaning that the Fed is constantly engaging in fiscal operations of different signs. In particular since we can never be sure today what the final outcome of any of its operations will be tomorrow. On the other hand in case of government bonds held to maturity it is clear. The outcome is exactly zero. And it is exactly the reason why central banks are allowed to deal only with government bonds. The fiscal effects are minimized to the minimum leaving only monetary effects.
Sergei: if you want to use a dictionary in which “monetary policy” is defined in such a way that the probability of monetary policy happening is zero…..OK. But I’m not going to use that same dictionary myself.