I have a proposal that would improve aggregate demand management. I call my proposal "money-financed government expenditure on sacrificing goats".
I propose that every time the government sacrifices one goat, the Bank of Canada is required by law to increase the base money supply permanently by $1 billion, relative to what it would otherwise have been. To say the same thing another way, the Bank of Canada should be required to pay the government for all goat sacrifices, at a price of $1 billion each.
If animal rights people object to my proposal, I am quite willing to modify it so that the "goat sacrifice" is purely symbolic. No (real) goats are involved at all. The government just announces that one "goat" has been "sacrificed". But the price is still $1 billion per "goat sacrificed". The government can spend that extra $1 billion seigniorage whenever it likes, on whatever it likes.
This is how an increase in G (money-financed goat sacrifices) would increase aggregate demand:
The money base is mostly currency, and the demand for currency depends on Nominal GDP. If people hold (say) 5% of annual nominal income in currency, a permanent increase in the stock of currency of $1 billion would require a permanent increase of NGDP by $20 billion. Even if Canada were temporarily at the Zero Lower Bound on nominal interest rates, the commitment by the Bank of Canada to increase future NGDP by $20 billion would increase expected future NGDP, which would increase current aggregate demand, which would increase current NGDP.
If my proposal were implemented, the Zero Lower Bound would cease to be a problem. The government could sacrifice enough goats to lift the economy off the ZLB.
But there is one big problem with my proposal: how could my proposed law be enforced? The lawyers would have a lovely time arguing about that counterfactual conditional clause in the law. We know, roughly, what the monetary base is now. But how could we ever know what the monetary base would have been if the government had not sacrificed one goat in the past? If we can't answer that counterfactual conditional question, we can't figure out if the Bank of Canada did in fact pay $1 billion to finance the goat sacrifice. How can we ensure that goat sacrifices are in fact money-financed?
We would need an agreed-on economic model. We could require the Bank of Canada to use that model to issue a forecast for all future levels of the money base, conditional on number of goats sacrificed. And we would then check to see that those forecasts were reasonable, and were all $1 billion apart for every additional goat sacrificed, at all future times. Then we could check to see if the actual money base matched the Bank of Canada's previous forecasts, given the actual number of goats sacrificed in the past. But if the model was wrong, or if something else unexpected happened, so the Bank of Canada's forecasts turned out to be wrong, we could never tell whether the Bank had made a bad forecast, or was violating the new law. Hmmm.
Maybe it would be much simpler just to require the Bank of Canada to raise its NGDP target path by $20 billion every time the government sacrificed a goat. And then check to see if actual NGDP followed the new target path. The effect on the monetary base would be much the same, and the law would be much easier to enforce. And laws that are easier to enforce are much more credible.
I see that Jordi Gali has a proposal (HT Mark Thoma) that is very similar to mine. He too wants goat sacrifices to be money-financed. The only difference is that Gali wants the government to sacrifice real goats, and to pay the going market price for goats.
This sounds a bit wasteful to me. Why sacrifice real goats, when sacrificing symbolic goats does the job just as well? And even if sacrificing $1 billion worth of real goats has (say) twice the effect on aggregate demand of sacrificing $1 billion worth of symbolic goats, we could easily sacrifice $2 billion worth of symbolic goats instead.
But the biggest problem with Gali's proposal is that it has exactly the same problem as mine. How would we enforce his proposed law that goat sacrifices be money-financed?
How would we ever know whether an increase in government spending was or was not money-financed? Only if the central bank announces a permanently higher target path for NGDP, or a permanently higher target path for the price level (or a temporarily higher inflation target), and if it hits that new target path, would we know that the increase in G was in fact money-financed. But if the central bank made that announcement, and if it were a credible announcement, we wouldn't need the increase in G.
Money-financed sacrifices of real goats will not really be money-financed if we cannot enforce the law making them money-financed. And if we can enforce the law making them money-financed, we don't need a real goat.
Worthwhile Canadian Initiative 
I know, I was the one who brought up the fallacy of division. Thanks for repeating.
You’re the one who thinks he can make a horse drink. I’m saying the Horse will drink when it’s thirsty.
Would Ben Bernanke have been able to refinance his house if Janet Yellen anounced a 5% ngdp target? Because that’s what I hear you saying.
The Q1 2008 survey of professional forecasters was estimating ngdp would grow by 4.8% in Q4 2008 and 5.6% in Q1 2009 (5% in 2009). Q4 2007 estimate for Q4 2008 ngdp was 5.1%. The 2008 Q2 survey estimate for Q4 2008 ngdp was for 4.5%.
(annualized %)
How many quarters lag does it take for monetary policy to gain traction? The base began expanding in the summer of 2008. The same time as ngdp forecasts for Q4 2008 were revised lower to 3.1%. Actual 2008 ngdp was -0.9%. What actions would you have expected the fed to have taken to prevent ngdp from falling in Q4 2008? They took action once they realized growth was going to come in lower than had been previously forecast.
Yes I know they weren’t targeting ngdp. I doubt that means they aren’t/weren’t concerned with its growth path. You’re probably going to write that if they had been targeting ngdp then this all would be a non issue since they would have hit their target then because forecasts would be more accurate/credible. crystal ball
http://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters/
How Do Forecasts respond to Changes in Monetary Policy? By Laurence Ball and Dean Croushore
Click to access brq401dc.pdf
Forecast Disagrement in the Survey of Professional Forecasters by Keith Sill
65% of the time the Bank of Canada undershoots their 2% inflation target since 1993. Except 2009 the Bank of Canada would have been within the range of respectability, analogous to the inflation target range of 1-3%. Had the target been ngdp they would have undershot the target only 45% of the time 1999-2011. Why are you so confident ngdp targeting would have so wildly transformed monetary policy to the point of guaranteeing 5% ngdp growth?
analogous to the inflation target range of 1-3%, had they been targeting ngdp.
Miami: On average, the Bank of Canada has hit its 2% inflation target almost exactly. See my old posts here and here for the data, and for why I switched to supporting NGDP level path targeting.
You need to understand the distinction between growth rate and level-path targeting. Under level-path targeting, the central bank makes up for past mistakes. So if it targets 5%, but misses and actually hits 4%, it targets 6% the following year (or 5.5% for 2 years). This ensures that drops in NGDP will be temporary, not permanent.
Nick when you come up with a stable money demand function we will buy all this stuff. This is the very old monetarism. With its pros and its vast fallacies. Try harder
tim: you are missing the point. If the central bank announces a permanently higher NGDP level-path target when the government sacrifices a goat, does it really matter whether or not MB rises in exact proportion?
Can you please tell me why on earth all central banks are targeting inflation by controlling interest rates and NOT targeting NGDP by controlling money supply? This is a “positive” question not a normative one. Tell me your opinion. In and out the ZLB
tim: OK. But I’m going to break your question into two/three parts:
1. Why IT vs NGDPLPT?
In the late 1980’s the Bank of Canada was all set up to target NGDP (I can’t remember if it was NGDP growth rate or NGDP level path). They had the model all ready. The new Governor came in and said that people would understand inflation but not NGDP. And the (forgotten the name, but small business owners group) said they wanted to know what inflation rate the Bank was aiming for, to help them negotiate wages with the unions. So the Bank adopted Inflation Targeting.
Historical accident, in other words. And the rest of the world followed. (Sorry Kiwis, for leaving the RBNZ out of this story, but your story was a little different, and you weren’t really doing IT right originally anyway 😉 .)
2. Why use i as an instrument rather than MB?
I don’t know. I’m not sure it really matters much. My guess is that it’s because central bankers were historically bankers, and commercial banks set i (plus terms for loans). So they always thought in terms of i. Plus the influence of Wicksell maybe?
3. At the ZLB they couldn’t cut i, so they had to increase MB.
Frances Coppola said: “TMF, price inflation by itself makes no difference to hours worked.”
Exactly. And in my example for both cases, hours worked fall. So targeting NGDP may not help and could even harm the labor market if prices rise and RGDP falls.
http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/09/fractional-reserves-and-the-optimum-quantity-of-money.html
Frances, I don’t see a capital requirement there. I believe that would make a difference.
Sorry about the delay.