Many centuries ago wealth mostly flowed from land, especially good agricultural land.  For Malthusian reasons the Earth’s population increased to roughly the maximum level that could be fed with existing technology and existing political institutions.  Most people lived in Eurasia, especially China, India and Europe. Sandy countries were not very important.

Because of improvements in technology, places like Arabia and Australia now have important resources that people didn’t care about back in 1500, such as oil, iron, and nice beaches.  But the world’s population distribution still pretty much reflects the distribution of 1500, except that the Americas gained a substantial inflow from Europe and to a lesser extent Africa and Asia.

The sandy countries naturally buy manufactured goods from places with a lot of people (China for low tech goods, and Europe from more sophisticated goods.)  In return they export oil, iron, coal and real estate.  The half dozen richest countries of the Arabian peninsula, and Australia, both have similar models, although there are important differences, such as the fact that the Aussie economy is more advanced and diversified.  But the similarities are what interest me; both export natural resources that once had little value, for manufactured goods produced in densely populated places. Both benefit from their small populations.  In the Middle East, oil output per capita is the best way of guessing living standards. It explains why Kuwait is much richer than Iran, despite similar aggregate oil output levels.

Maybe this is all obvious, but let me point out that many people treat these two areas very differently.  Australia has run current account deficits for many decades, often quite large ones. Many view these deficits as an example of a country “living beyond its means.”  In contrast, most of the Arabian countries run large CA surpluses, and many have accumulated large stocks of foreign assets.

However this is a very superficial difference, due to a quirk in the accounting techniques used by economists.  When Arabian countries sell oil to Europe it is treated as an export of goods.  When Australia sells real estate that is close to sandy beaches to the Chinese it’s not treated as an export of goods.  Rather it’s treated as if Australia was borrowing money from the Chinese.  It makes it seem like Australia is living beyond its means, when in fact it is simply benefiting from the increasing popularity of sandy places.  Arabia will run out of oil long before Australia will run out of desirable real estate to sell to Asian investors.

BTW, although I mentioned only two examples, there are many more.  In the 1800s, the eastern seaboard of the US was mostly settled, except south Florida, which was considered a wasteland. Sandy and thinly populated Inner Mongolia has recently gone from being poor to being one of China’s wealthiest provinces.  It’s not the sand that makes the Mongolians rich, it’s the fact that the sand kept their population low.

Why is Australia doing better than Saudi Arabia? Perhaps because Saudis were well adapted to life in the desert, and Australians are not.  The Aussies are European transplants who come from green agricultural societies.  The few people in Australia who are well adapted to life in the desert (aborigines), are quite poor. (See Walkabout.) Perhaps agricultural societies adapt better to the boring drudgery of modern industrial life.  Of course not all agricultural societies succeed, so there must be much more to it.

In any case, Australia is often called the lucky country.  Might it have something to do with the fact that it’s one of the few thinly populated sandy countries occupied by people who moved from developed and densely populated agricultural economies?  If Europe had understood this model in 1900 they would have occupied Libya and Arabia, and pushed aside the native population. Fortunately they did not.

PS.  Over at Econlog I have a critique of the White House defense of ARRA.

In my previous post I suggested that a nominal hourly wage target has a great deal of appeal from a theoretical perspective.  Indeed I advocated that the Fed adopt a wage target in a paper I published back in 1995.  Economists such as Earl Thompson and David Glasner discussed the idea even earlier.  Now the very influential Jan Hatzius has suggested that wage growth can help guide Fed policy (in a paper written with Sven Jari Stehn.)

Goldman Sachs economists Sven Jari Stehn and Jan Hatzius propose a simpler approach: the Fed should focus on wage growth as a primary input into the “reaction function” that dictates its response to changing economic conditions.

Why focus more on wage growth instead of inflation, or even the unemployment rate itself?

Ultimately, wages will respond to tightening labor market conditions, whereas consumer price inflation may not.

“Low inflation should be indicative of the size of the employment gap,” write Stehn and Hatzius in a report.

“This approach, however, relies on a tight link between slack and price inflation. And the experience of the last couple of years suggests that price inflation is not very responsive to the employment gap at low levels of inflation and seems to fluctuate quite randomly when we are in the neighborhood of price stability. The behavior of core PCE inflation between 2011 and 2013 is a good example: core inflation rose by a full percentage point during 2011 and then dropped by the same amount in 2013, without any compelling macroeconomic explanation.”

Brad DeLong also linked to this story.

HT TravisV

About 20 years ago I published a paper arguing that the Fed should use futures markets to target a nominal hourly wage index.  The intuition was as follows:

1.  Recessions are basically sub-optimal employment fluctuations.  They occur due to sticky wages.

2.  When the aggregate wage rate falls, the wage rate rises above its equilibrium value.  That’s because some wages are sticky.  So when wage growth declines (as in 2009) equilibrium wage growth is falling even more sharply, but some wages are sticky.  Hence (paradoxically) the average wage level is actually “too high.” The opposite is true when wage growth accelerates.

3.  In a large diverse free market economy, the law of large numbers assures that a monetary policy that keeps average hourly wage growth steady is likely to keep aggregate nominal wages close to the equilibrium level (think of “equilibrium” here as being analogous to the Wicksellian equilibrium interest rate.  The one that provide macro stability)

4.  More recently Greg Mankiw and Ricardo Reis reached a similar conclusion, for similar reasons, but much more rigorous modeling.

I’ve never seen an hourly wage target as being politically feasible, so I gravitated toward NGDP targeting, which had already been proposed by people like Bennett McCallum, and seemed most likely to replicate the good effects of a wage target. Here is how they are similar:

1.  Suppose you target nominal wage growth at 4%.  Now assume that the public’s preferred growth rate of hours worked is pretty steady, say about 1%/year.  Then a policy targeting 5% growth in aggregate nominal labor compensation should get you similar results.  Even better, it is much easier to measure, because many jobs do not have hourly wage rates.  So it might be better.

2.  And a NGDP target is likely to be similar to a total labor compensation target, as labor compensation is much more than 50% of GDP, and other key components like depreciation and indirect business taxes are non-volatile.

Those who find a wage target unrealistic, or who reject sticky wage models because of a misreading of the wage cyclicality data, are likely to move in a different direction, toward inflation targeting. And yet the logic of stabilizing the stickiest prices is so powerful that they may not move all that far away.  Here is Miles Kimball:

Since oil prices are flexible, the quickest way to get to the relative prices that will prevail in the medium-run is to have those flexible oil prices adjust, while the short-run price index emphasizing sticky prices stays unchanged. (This is why I am in favor of the Fed’s emphasis on “core inflation,” though I think the Fed does too little to focus on the especially important prices associated with especially interest-rate-sensitive goods.)

At first glance a core inflation target seems quite different from a NGDP target. But I see both as imperfect compromises–substitutes for wage targeting.  Indeed core inflation is heavily influenced by wage inflation, as it excludes the prices that most strongly deviate from wage inflation–food and energy.

Why do I trust NGDP more than core inflation?  I don’t think the inflation rate measured by the government is a particularly good proxy for the inflation rate that produces macroeconomic stability (when stabilized.)  Indeed Kimball alludes to that problem with his comment on interest rate sensitive goods.  Between 2006 and 2012 the core inflation rate showed housing prices rising about 10%, and housing is 39% of the core index.  Over the same period Case-Shiller showed housing prices falling 35%.  The official index looks at rental equivalent, not the price of newly constructed homes. Which one better explains what was happened to housing output?  Or employment in housing construction?

In an imperfect world I trust NGDP much more than core inflation, partly for reasons identified by Kimball:

Actually, contrary to conventional wisdom, I am not persuaded that there are many events commonly called “recessions” that have supply-side causes, except when supply shocks led to inappropriate monetary policy responses.

I agree.  NGDP includes RGDP growth, which is (by definition) highly cyclical.  The NGDP signal would have definitely told the Fed that money was too tight in 2008-09.  The core inflation signal?  Yes, but to a lesser extent.  And when you get to level targeting there is the possibility of mischief.  Core inflation had previously overshot the target, and thus a passive central bank could excuse inaction with a core inflation rate that had fallen 1% below trend in 2009 much more easily that a central bank with a NGDP target.  NGDP had fallen 9% below trend between 2008:2 and 2009:2. Note that the Fed’s preferred PCE inflation rate has averaged almost exactly 2% since June 2003. But only 1.2% since July 2008.  And if you don’t do level targeting of core inflation, there is the possibility of a Japanese situation, where year after year they claim they tried but failed to achieve price stability.

The case for NGDP is very much a pragmatic case.  You won’t find any DSGE models spitting out “NGDPLT” as the answer.  It’s a good compromise target that is robust to a wide range of flaws in our models, and our monetary policy apparatus.

BTW,  Miles Kimball’s post was a reply to a very good Bill Woolsey post.  Here’s an excerpt from the Woolsey post:

While I wouldn’t describe this as a reason why the price level should be kept stable, I might see this as a reason why stabilizing the growth path of wage income is better than stabilizing total nominal income.   Glasner and Sumner both have argued for stabilizing the growth path of a wage index for much the same reason.  These are the sorts of reasons why most of us understand that nominal GDP level targeting is not perfect, just better than inflation or price level targeting.

Exactly.

Jeffrey Frankel also sees NGDP as a robust target:

This is yet another instance of a long-standing point: if central banks are to focus attention on a single variable, the choice of NominalGDP is more robust than the leading alternatives. A target or threshold is a far more useful way of communicating plans if one is unlikely to have to violate it or explain it away when things change later.

PS.  I have a new post over at Econlog that is loosely related to this one.

PPS.  Here is a presentation that I did at an IEA conference in London.

. . . without actually being correct.

For years I’ve pointed out that whereas the huge house price run-up in the US was reversed after 2006, house prices in Britain, Canada, Australia, and New Zealand remained at lofty levels, after a similar rise in prices.  Indeed Australian house prices moved still higher.

Commenters kept insisting “you just wait, the Australian housing bubble will burst one of these days.”  Australian economist Steve Keen was so sure the bubble would burst that he bet his reputation on it:

Mr Keen is a long time bear on Australian house prices, who famously lost a bet with an economist at Macquarie Bank in 2008 over his claim that prices would soon reverse sharply. Two years later he walked 225km from parliament house to Mount Kosciuszko wearing a T-shirt saying “I was hopelessly wrong on house prices – ask me how” to honour the wager.

That’s why I like Aussies, they have an honesty that is increasingly rare in our world.  Now Australian housing prices are soaring higher again.  Is it a bubble on top of a bubble?

And in Australia too, foreign buyers, together with cheap money and supply constraints, have helped push up house prices, prompting some commentators to warn of an emerging housing bubble in some of the country’s bigger cities.

(Read more: Are fears of an Australian housing bubble overblown?)

Prices in Sydney jumped 15.1 percent last year, pushing the median house price to A$763,169. In Melbourne and Perth, property prices increased 8 percent, according to Australian Property Monitors, an information provider to the banking and property industries.

“I think we are seeing the creation of a spectacular bubble on top of a spectacular property bubble,” says Steve Keen, a professor of economics and author of a blog called Debtwatch.

Keep in mind that although Australia has 23 million people (same as Shanghai) squeezed into an area the size of the continental US, almost all of them live in “the country’s bigger cities,” which feature California-style restrictive zoning.  So prices may or may not stay high.

Since I’ve been proved right on the fact that the earlier run-up in prices was not a bubble, I’ll take my chips from the table and go home.  No further predictions; I’ve proved my point that “bubbles” are not a useful concept for Australia.  OK, just one more prediction.  I predict that if Steve Keen continues to predict bubbles in Australia there will come a time when it will look like he is correct, and he’ll be feted as the greatest seer since Nouriel Roubini.

Of course he won’t have been correct about there being a bubble, as bubbles don’t exist.  Asset markets move up and down unpredictably.  That’s the whole point of the EMH.  Ex ante there was no way of knowing in 2006 that Australian prices would keep going up while US prices would reverse and fall.  It could have been the other way around.

BTW.  Australia’s been running big current account deficits for decades, and they can continue doing so for many centuries to come.  (When I lived there in 1991 one pundit told me that Australia had a bleak future because of its CA deficits.) Australia gets some cars and TVs built with Chinese labor, and China gets some retirement condos on the Gold Coast built with Australian labor. Believe it or not economists call that sort of mutually beneficial business deal a “deficit.”  I’m not kidding. Don’t be fooled by words, focus on reality.

Here is Daniel Thornton of the St. Louis Fed:

The analysis presented here suggests that QE had little or no effect in reducing long-term yields relative to what they would have otherwise been.² If QE did not significantly reduce long-term yields relative to what they would have otherwise been, it cannot have increased output or employment either.

I’m old enough to recall when the St Louis Fed had monetarist leanings.  A monetarist would immediately reply that interest rates are a lousy indicator of the stance of monetary policy.  But this statement isn’t even consistent with New Keynesian models.  After all, QE could easily raise the Wicksellian equilibrium interest rate in a NK model, and hence boost AD even if actual interest rates did not change.  Thus the term ‘cannot’ is way too strong.  What if the Fed had done Zimbabwe-style QE.  Would you expect interest rates to fall?  Would NGDP growth rise?

I’m also puzzled as to why he looks at time series data and not market reactions to policy announcements.

Elsewhere Thornton acknowledges that there are other possible mechanisms:

Another possibility is that other countries experienced a greater output decline relative to that of the United States, which caused their yields to decline compared with the United States. The second chart shows the gross domestic product (GDP) growth rates of Canada, France, Germany, the United States, and the United Kingdom since 2005. The GDP growth patterns of four of the five countries have been similar since the fourth quarter of 2008; the sole exception is France, whose growth declined more. Hence, it appears unlikely that divergent growth rates could account for the lack of support for QE.

Lots of puzzles here.  Surely US growth has exceeded British growth by a wide margin.  In any case, Britain also did lots of QE, so why make this comparison? Germany and France don’t even have their own monetary policies; they are part of the eurozone. And growth in the eurozone has been far below US levels, presumably due to the ECB’s unwillingness to be as expansionary as the Fed. Indeed they raised interest rates twice in 2011.

PS.  Off topic, but notice all the chatter about how unemployment is not a useful policy guide for the Fed.  Who argued the Evan’s rule should have been based on levels of NGDP.  I hate love to say I told you so . . . .

HT:  Jeff Livingston