Archive for January 2013


The Keynesian critique of British fiscal policy

Back in 2011 I did a post entitled “The job-filled non-recovery.” Now in 2013 The Economist has an article entitled:

The Job-Rich Depression

BRITAIN’S economy has had an odd five years. In output terms, things have been terrible. The slump that started in 2008 is far worse than the 1930s depression; only the years after the first world war were harsher. Consumption has been dragged down by weak real wage growth, investment has been held back by tight credit and exporters have struggled with weak demand in the euro zone. The initial estimate of GDP growth in the fourth quarter of 2012, due shortly after The Economist went to press, was expected to contain more bad news.

.   .   .

Yet the job market is humming. Data released on January 23rd show that employment has topped previous peaks (see first chart). The combination of economic slowdown and plentiful jobs means output per worker has fallen 12% further than at the same stage in previous recessions. That is equivalent to the loss of the entire manufacturing sector. Britain is now startlingly unproductive compared with other rich countries. What is going on?

.   .   .

Some point to Britain’s growing army of part-timers, who account for a third of the 1.3m net new private-sector jobs created since 2010. Interns and other unpaid workers are classified as employed but may produce little output while learning their trades.

Still, neither answer solves the puzzle. Average hours worked have increased even as part-time jobs have become more common. And the 275,000 or so unpaid workers are a tiny fraction of Britain’s 30m- strong workforce. Britons really are producing less per hour worked. It is not the data that are odd. It is the British economy.

What can we make of this?  Keynesians feel the problem is too little aggregate demand, and point to the very low RGDP growth rates.  But RGDP is not the right way to measure AD, so this creates some problems for the Keynesian model.  Old Keynesians tended to focus on the unemployment rate, but the British labor market is no worse than most other developed countries (US employment is far from the peak.) So where is the evidence that austerity is a problem?

New Keynesians use inflation as their AD indicator, but that’s run way over target for the past 5 years.  So by that measure there is no AD problem at all.

I think the Keynesians are partly right, the UK does have an AD problem.  I say ‘partly right’ because I suspect they also have big AS problems, which the Keynesians tend to underestimate.  But I’d like to focus on where I agree—they have an AD problem.

Now I’d like to suggest an AD indicator that is far superior to either jobs or RGDP—you guessed it, NGDP.  The growth rate of British NGDP has recently been quite low, and that’s keeping the unemployment rate above the natural rate.

So I’d encourage Keynesians to focus on NGDP as a policy indicator. It’s the variable that will best describe the AD problems they worry about. If you focus on RGDP, that raises the question of why so many extra workers haven’t created any extra output. New Classical skeptics will say there must be a productivity problem, and the Keynesians won’t have a good answer. After all, in the Keynesian model more AD leads to more NGDP—how that gets partitioned between RGDP and P depends on the slope of the SRAS curve, which demand-side policymakers cannot control.

In contrast, the NGDP “musical chairs” approach says that a sharp slowdown in NGDP growth will almost always cause excess unemployment, regardless of the supply-side of the economy.

PS.  I won’t have time to answer comments over the next few days.

Goodhart on NGDP targeting

Here’s Charles Goodhart in the Financial Times:

But observations of policy-making over the years raise doubts that an ad hoc  entry into a new policy regime will be followed by a nimble exit when the  appropriate time comes. The fear is that, once the sell-by date of these  initiatives passes, central bankers will be acting contrary to everything  learnt, painfully, in the 1970s. They will be relating monetary management to  real variables on a longer-term basis. In the end, any short-term benefit will  be dwarfed by the long-run pain as they push inflation higher in the vain  pursuit of a real economic objective.

NGDP does not target real variables; it targets a 100% nominal variable.  And it is not an expedient—the goal is to permanently replace the discredited inflation targeting regime, which forces central banks to lie about what they are really trying to do.

While there may now be a case for some further temporary monetary expansion,  this can be done within the context of the present flexible inflation target.

Central bankers would be better employed by improving unconventional  instruments of monetary policy. The UK’s funding-for-lending scheme is a good  start, as it offers a route to stimulating aggregate demand that bypasses the  clogged arteries of conventional stimulus. The BoJ already has a significant  portfolio of loans on its books, and the Fed would be wise to follow if the pace  of the US expansion remains tepid.

It’s a big mistake for central banks to get in the business of influencing the amount of credit in the economy.  Much better to focus on producing a stable growth path for nominal income and let the markets decided how much of that income gets allocated into borrowing and lending.  Instead of ad hoc “unconventional instruments” that are unlikely to work in an emergency, why not use a policy target that reflects the central bank’s actual goals.  Then you won’t ever need to use unconventional instruments to make up for the failure of inflation targeting.

Adopting a nominal income (NGDP) target is viewed as innovative only by those  unfamiliar with the debate on the design of monetary policy of the past few  decades. No one has yet designed a way to make it workable given the lags in the  transmission of monetary policy and the publication of national income and  product.

I had thought that “targeting the forecast” was one of the cutting edge ideas in monetary economics.  If so, then data lags are not a problem.  It’s a shame that people like Michael Woodford have not kept up with research in monetary economics over the “past few decades.”

Rather, a NGDP target would be perceived as a thinly disguised way of  aiming for higher inflation. As such, it would unloose the anchor to inflation  expectations, which could raise, not lower, interest rates by elevating  uncertainty about the central bank’s reaction function.

NGDP targeting is not intended to raise the rate of inflation.  For any long run inflation target, there is a NGDP target path that produces the same expected rate of inflation.  Ex post inflation might be higher, but it’s equally likely that it would be lower.  And the inflation uncertainty would not raise interest rates, as the debt markets care much more about NGDP than inflation.  In the long run nominal interest rates are more closely correlated with the long run trend rate of NGDP growth than inflation.

We do not know, and cannot predict, what will be the sustainable rate of real  growth in our economies. Let’s hope it is well above the relative stagnation  observed in recent years in the UK, US, and Japan. But it would be  over-optimistic to believe our economies can permanently revert to prior faster  growth. In the short run, excess monetary expansion might temporarily lead to a  burst of growth. But the likely implications of a dash for growth and the  abandonment of an inflation target would at some point unhinge the government  debt market.

Again, Goodhart is assuming debt markets care about inflation.  They don’t.  They care about NGDP growth.  As long as NGDP growth is around 4%, long term nominal rates will remain relatively low.  That’s the case regardless of whether the 4% NGDP growth is associated with o% RGDP growth and 4% inflation, 2% RGDP growth and 2% inflation, or 4% RGDP growth and 0% inflation.

Furthermore, Goodhart seem to believe that we need to estimate the long term RGDP growth rate in order to choose a NGDP target path.  But one of the strongest arguments for NGDP targeting is that it avoids the need to estimate trend real GDP growth, or output gaps, or the natural rate of unemployment.

HT:  Nicolas Goetzmann

NGDP (probably) up around 4% in 2012 Q4

The government measures GDP in two different ways; GDP and GDI.  The Gross Domestic Income measure is generally regarded as the most accurate, but unfortunately the complete data comes out one month after the flash estimate of GDP.  Hence the press tends to report the GDP numbers.

Fortunately, the BEA does report most of the GDI data at the same time as GDP.  Today’s report shows the reported part of NGDI rising from $13,430.2 bill in Q3 to $13,569.5 billion in Q4.  About 4.1% at an annual rate.  The same 4% track we’ve been stuck in since mid-2009.  When the missing data is reported (interest and corporate earnings) the number will be revised, but is still likely to be much higher than the 0.5% reported growth in NGDP during Q4.  That number made no sense in light of the steady job growth in Q3 and Q4.

Niklas Blanchard is now blogging

Niklas Blanchard was an early supporter of market monetarist ideas, but then stepped away from blogging.  I’m happy to report that he’s back with an excellent post.  Niklas criticizes Taylor’s claim that interest rate targeting is like a price control.  Of course it isn’t.  I have to believe it was just a slip by Taylor, as he surely must know how the Fed targets interest rates via adjustments in the supply of reserves.

Here’s Niklas:

This makes very little sense given the fact that the Fed is shifting demand for assets. By buying assets now, and promising to buy them in the future, the Fed is directly influencing the demand for the assets that it buys. Taylor is claiming that the Fed is providing a cap on returns on holding assets. Taylor’s analogy says that this policy is like the government mandating that everyone get a flu shot (would would cause shortages of flu shots), when the proper analogy would be that the government is providing inoculations in order to keep the price low.

Perversely, it is the lack of forward guidance that Taylor seems to be seeking that necessitated the moves in the Fed’s balance sheet that Taylor is now worried about. Had the Fed been providing forward guidance the whole time (for instance, a target for the level of NGDP), it is more likely that NGDP would have remained stable throughout this entire period, and that the Fed’s balance sheet would be a fraction of the size it is today, and presumably we would not be having this conversation.


Does John Taylor want easier money or tighter money?

Here’s John Taylor in today’s Wall Street Journal:

As they meet this week, Federal Reserve Chairman Ben Bernanke and his colleagues will be looking at an economic recovery that has been far weaker than expected. Early in 2010 they predicted that growth in 2012 would be a robust 4%. It turned out to be a disappointing 2%. And as the recovery fell short of their expectations, they continued and then doubled down on the emergency interventions used in the panic in 2008.

The Fed ratcheted up purchases of mortgage-backed and U.S. Treasury securities, and now they say more large-scale purchases are coming. They kept extending the near-zero federal funds rate and now say that rate will remain in place for at least several more years. And yet—unlike its actions taken during the panic—the Fed’s policies have been accompanied by disappointing outcomes. While the Fed points to external causes, it ignores the possibility that its own policy has been a factor.

At the very least, the policy creates a great deal of uncertainty. People recognize that the Fed will eventually have to reverse course. When the economy begins to heat up, the Fed will have to sell the assets it has been purchasing to prevent inflation.

If its asset sales are too slow, the bank reserves used to finance the original asset purchases pour out of the banks and into the economy. But if the asset sales are too fast or abrupt, they will drive bond prices down and interest rates up too much, causing a recession. Those who say that there is no problem with the Fed’s interest rate and asset purchases because inflation has not increased so far ignore such downsides.

The Fed’s current zero interest-rate policy also creates incentives for otherwise risk-averse investors—retirees, pension funds—to take on questionable investments as they search for higher yields in an attempt to bolster their minuscule interest income.

Clearly John Taylor doesn’t like ultra-low interest rates right now.  But low interest rates are not a monetary policy.  Near-zero interest rates can occur during deflationary monetary policies (Japan), or during monetary stimulus.  Everyone from Milton Friedman to Frederic Mishkin to Ben Bernanke tell us that interest rates are not reliable indicators of the stance of monetary policy.  So that doesn’t tell us whether Taylor wants easier or tighter money.

Taylor seems to think that growth has been too slow, complaining about only 2% RGDP growth in 2012.  That suggests that easier money is needed. But he also complains about QE, claiming it didn’t help the recovery. However the stock market responded very positively to rumors of QE, not once but three times.  That suggests QE boosts growth.

Here’s Taylor again, suggesting money is currently easy:

There is yet another downside. Foreign central banks—whether they like it or not—tend to follow other central banks’ easy-money policies to prevent their currency from appreciating sharply, which would put their exporters at a disadvantage. The recent effort of the new Japanese government to force quantitative easing on the Bank of Japan and thus resist dollar depreciation against the yen vividly makes this point. This global increase in money risks commodity booms and busts as we saw in 2011 and 2012.

Obviously Japan desperately needs easier money, its NGDP is lower than 20 years ago.  I presume Taylor would agree that deflation isn’t a very wise policy.  So it’s a good thing if Fed actions force the BOJ to ease. And of course the world desperately needs an economic recovery, which would obviously boost commodity prices.  So I’m not sure why that’s a concern.

Like John Taylor, I’d like to see higher interest rates.  Unlike Taylor, I explicitly favor a more expansionary monetary policy.  I favor a higher NGDP target, which would raise long term Treasury bond yields.  He seems to favor higher interest rates via a tighter monetary policy boosting short rates (the liquidity effect.)  In my view that policy would depress long term bond yields to Japanese levels, as markets (correctly) expected a replay of the US in 1937, or Japan in 2000, or Japan in 2006, or the eurozone in 2011—4 attempts to raise short rates above zero—all premature, all 4 attempts failed.  They all drove aggregate demand and risk free long term interest rates even lower.

John Taylor says he wants higher interest rates for savers.  But only market monetarist policies can deliver higher interest rates to savers. There’s no short cut to recovery—we need faster NGDP growth.

NGDP has averaged just over 4% in recent years.  Suppose we had a tighter monetary policy and reduced NGDP growth to 2%.  What sort of RGDP growth would you expect?  I’d expect about 1%.

HT:  Michael Darda.