Reply to Kevin Drum

I don’t have much time now, but a quick reply to Kevin Drum:

The thing is, it’s not clear to me how much real difference there is between targeting NGDP, targeting inflation, targeting real interest rates, dropping money from helicopters, or engaging in quantitative easing. This is what I’d like NGDP advocates to make clear. Instead of telling us what they’re targeting, or what their preferred policy is called, tell me three things:

■What do you want the Fed to say publicly?
■What open market operations do you want the Fed to engage in?
■Beyond that, is there anything else the Fed should be doing?

To see the advantages of NGDP targeting over inflation targeting, just look at the UK, where CPI inflation is running about 4.5% and NGDP growth is somewhat lower.  Under inflation targeting the BOE would have to tighten right now; with NGDP targeting they should ease. I’m pretty sure Kevin Drum would agree that at least in that case, NGDP targeting gives the “right” answer.

As far as the question of what should the Fed actually say; I’ll give two answers. In general, the Fed should promise to maintain NGDP growth along a 5% growth trajectory, and commit to make up for any near term overshoots or shortfalls. That’s called level targeting.

The tougher question is what to do right now, when they’ve clearly undershoot the implicit Fed target for demand growth. At first I wanted them to return to the pre-2008 trend line, but I think that’s now clearly (politically) impossible, and perhaps unwise.  Recently I’ve been throwing out numbers like 6% or 7% NGDP growth for 2 years, and 5% thereafter.

But what matters isn’t what I think, but what the Fed thinks. They need to decide on a NGDP target that they are willing to commit to, and make a very public commitment based on a majority vote. It must be public, to make them very reluctant to renege on their promise. Fortunately, the Fed doesn’t currently have strict inflation target, they have a dual mandate, so my proposal would not require them to abandon a previous target.

It’s clear that the Fed would like at least somewhat faster NGDP growth, as the newspapers are full of stories that they are strongly considering another initiative, and they’ve recently done two experiments (Operation Twist and the 2 year promise of low rates.) The Fed needs to decide how much NGDP growth they’d like to see over a period of several years, and promise to keep buying (or selling) assets until they expect to hit that target.

As to the question of how do they “actually” implement the policy, the promise does most of the heavy lifting (see this Nick Rowe post for an explanation.) I’ve often argued that with a robust NGDP growth target (say 7% for 2 years) the Fed might well have to reduce the monetary base, not increase it. The base is already almost three times its normal level. There are two explanations for that unusually high base demand; interest on reserves and very low expected NGDP growth. If you eliminate IOR, and dramatically raise expected NGDP growth, I don’t see where people and banks would want to hold all that much base money. But of course it’s a free country, and if idiots want to lend $10 trillion to the Federal Government at an interest rate of 0%, I see no reason not to accommodate their demand. I don’t know the precise laws governing Fed purchases, but given all the wild and crazy things the Fed has done since 2008, I doubt there would be any law preventing them from buying up close to $15 trillion in US, Japanese, Canadian, and German government debt.  Of course this is reductio ad absurdum, in practice NGDP growth expectations would quickly soar much higher if they actually started down this road, and I’d guess that before long the monetary base would drop from its current bloated level back to about $1 trillion, its normal level.

BTW, I don’t even think the elimination of IOR is at all essential; if they are worried about the MMMF industry then a level targeting commitment plus a vow to buy trillions if necessary would be enough.  It would cause such an upward explosion in asset prices that no purchases would be necessary.

However if the Fed actually does NGDP targeting, they are more likely to let-bygones-be-bygones, and go for 5% NGDP growth. In that case OMPs might be necessary. The less they aim for, the more heavy lifting with market distorting OMPs will be required.  And that policy might well result in 4% NGDP growth over the next 12 months, and be perceived as a failure.

PS.  All this talk of “helicopter drops” is a waste of time.  A central bank radical enough to contemplate such a policy would never be at the zero bound in the first place.  There are far less costly and radical ways to reflate.

PPS.  I just returned from 4 days in Washington.  My visit to the Senate fell through, but I did have a presentation at the Treasury that seemed to go well.  I was brought back to Earth by my presentation at the Atlantic Economic Society meetings this morning.  No one showed up, even 3 of the 5 presenters failed to appear.  I guess I’m not as popular as I was beginning to assume.

I’d love to post more on NGDP targeting but won’t have time for a while, as I’m far behind in my school work.  Ditto for answering comments.  It’s frustrating, as I’d like to “strike while the iron is hot,” but numerous factors beyond my control will prevent that from happening.  If you send me emails, don’t expect a quick response.


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21 Responses to “Reply to Kevin Drum”

  1. Gravatar of Andy Harless Andy Harless
    23. October 2011 at 20:09

    The less they aim for, the more heavy lifting with market distorting OMPs will be required.

    I think just the opposite. If you threaten someone with a gun, you’re less likely to have to use it than if you threaten them with a club. An ambitious target will certainly be an equilibrium; a less ambitious target, on the other hand, may imply a floor on the real interest rate that is still too high to generate the required level of demand, in which case the expectation effect won’t quite work, and a lot more brute force will be required.

  2. Gravatar of ssumner ssumner
    23. October 2011 at 20:13

    Andy, Aren’t we agreeing then? I’m saying a low NGDP target is harder to achieve.

  3. Gravatar of Morgan Warstler Morgan Warstler
    23. October 2011 at 20:42

    It all dovetails SO NICELY.

    Scott, you want the Senate to enjoy your company???

    Get the right behind you. Forget everyone else. Like Friedman.

    So funny, that I just keep having this conversation here! I explained (again) how 5% level target from 2008 under discussion, would become 4% or lower from say 2011.

    But there is real upside to such a Fed move, something that gets the hawks on board.

    The Fed makes a rock hard commitment to level target NGDP and they are basically assured things can’t get any worse (or there is printing) AND as soon as it gets an ounce better – we RAISE RATES.

    What more do you want???

    Can’t get worse.
    Raise rates soon.
    Put aggressive fiscal pressure on the government to cut public employees.

    Remember, banks are concerned about housing prices for themselves in the short term, but they KNOW the economy won’t recover if the folks working at the DMV earn more than the folks working at CVS (Matty is a friggin idiot).

    Get over the idea that level targeting CAN be HARD MONEY, and suddenly you’ll win Scott’s dreams.

  4. Gravatar of Bill Woolsey Bill Woolsey
    24. October 2011 at 03:38

    I think the Fed should publish a list of numbers for GDP. An initial one in a year, and then each subsequent quarterly one being .05/4 greater than the previous one.

    It is a growth path for nominal GDP. They should draw a graph. We plan to keep the economy on that line.

    This business about 5% growth and then faster or slow growth–that is the wrong way to look at it.

    Sure, it is true. But the goal isn’t some kind of complicated scheme about growth rates that vary depending on the past rates. It is just a series of numbers. It is very, very determined.

  5. Gravatar of 名目GDP目標の始め方 by Scott Sumner – 道草 名目GDP目標の始め方 by Scott Sumner – 道草
    24. October 2011 at 03:40

    [...] 名目GDP目標の始め方 by Scott Sumner // 「鉄は熱いうちに打て」との心意気だそうなので、サムナーのブログから”Reply to Kevin Drum“(23. October 2011)です。タイトルの訳が違う?  [...]

  6. Gravatar of Bob Murphy Bob Murphy
    24. October 2011 at 03:59

    Scott this is gorgeous (really):

    Under inflation targeting the BOE would have to tighten right now; with NGDP targeting they should ease. I’m pretty sure Kevin Drum would agree that at least in that case, NGDP targeting gives the “right” answer.

    When you get a chance, please elaborate on that statement. If I can figure out what made you write the above, I think I will understand your views a lot better.

    To give you the context: For a long time, I had thought your position was that if the central bank implemented your policy, we would see real GDP dominate the increase in NGDP, and that inflation would just swell up to the normal amount that the inflation-targeters like. I had thought (and Bill Woolsey I believe confirmed) that if your policy led to inflation that was way above what the inflation-targeters wanted, that you would agree there was a problem with your approach.

    But lately you have been denying this, and the quote above is in line with this particular twist on your approach. (Maybe it’s not new, and I just misunderstood all along.)

    So please elaborate on the above. Are you saying it’s possible right now that, say, the right thing in Britain is to get 6% unemployment and 12% inflation next year? How did that happen?

  7. Gravatar of Josh Josh
    24. October 2011 at 04:17

    - Unless I’m missing something, it is only a very small percentage of the population that would have any reaction at all to (let alone understand in any way) the Fed’s putative announcement that they’d be targeting NGDP. If they wanted it to explain their policy to everyone, especially in order to change behavior, they would avoid using the term ‘NGDP’. What would they say?

    - As part of the larger percent of the population which would be unsure exactly what the implications of NGDP targeting are (even after following this blog for 2 years), I see in this post two consequences I’ve always worried Scott might mean: ‘asset prices shoot up’ and policies which encourage people to spend their saved capital sooner.

    Asset prices may shoot up, but surely this is of limited import unless the prices of good also shoot up, and presumably this is undesirable, unless somehow we are all getting palpably and liquidly richer faster than goods and services are getting pricier.

    So let me voice the fear: does all the talk of NGDP targeting really just disguise a prescription for raising prices and depleting savings?

    I know Scott is busy right now, but I think in the near future he should try to more clearly address these fears without using the term NGDP, if possible. Those of us who are leery of inflation have all kinds of pretty clear movies in our heads about how inflation dissipates wealth and how it disincentivizes saving. If somehow NGDP targeting doesn’t do that, we need a much less blurry movie about how it’s all supposed to go down…

  8. Gravatar of John John
    24. October 2011 at 05:13

    Since buying up all these treasuries and adding to bank reserves is still contractionary, I have another plan for how the Fed could boost recovery. Replace Bernanke with a new chairman that they have to wheel out in a straightjacket. The new chairman should only giggle and mumble “Inflation, inflation, I want more inflation!” Have his handlers say that we have to keep him in this jacket because anytime his hands are free he tries to print money. Have a flag of Zimbabwe in the background during this presentation. Or you could appoint Sumner to do the same thing.

  9. Gravatar of Scott Sumner Scott Sumner
    24. October 2011 at 05:21

    Morgan, See Bill’s comment. That’s my view.

    Bob, You said;

    “When you get a chance, please elaborate on that statement. If I can figure out what made you write the above, I think I will understand your views a lot better.”

    That’s easy:

    1. Kevin says he doesn’t understand the advantage of NGDP over P. I presume Kevin thinks the UK needs easier money. NGDP calls for easier money right now and P doesn’t. That’s it.

    You said;

    “To give you the context: For a long time, I had thought your position was that if the central bank implemented your policy, we would see real GDP dominate the increase in NGDP, and that inflation would just swell up to the normal amount that the inflation-targeters like. I had thought (and Bill Woolsey I believe confirmed) that if your policy led to inflation that was way above what the inflation-targeters wanted, that you would agree there was a problem with your approach.”

    You are confusing two completely separate issues. Inflation doesn’t matter at all, for any reason. Only output and NGDP matters. Any problem believed due to inflation, it actually due to something else. Thus high inflation would not make me change my monetary policy target. Instead, I said high inflation would make me change my mind about the hypothesis that the current high level of unemployment is due to a demand shortfall.

    You said:

    “So please elaborate on the above. Are you saying it’s possible right now that, say, the right thing in Britain is to get 6% unemployment and 12% inflation next year? How did that happen?”

    I don’t know what this means, as I don’t favor them targeting inflation or unemployment. If you are asking whether an optimal monetary policy could produce 12% inflation, the answer is obviously yes. Suppose a severe supply shock reduced RGDP by 7%. Then with a 5% NGDP target you’d have 12% inflation. Living standards would fall because wages would rise only about 5%, but of course there is nothing a central bank can do to prevent living standards from falling when there is a severe adverse supply shock–unless they can print oil. BTW, I’ve heard Austrians argue for a stable money supply. You can get far more than 12% inflation with a stable money supply, just assume V rises 20%.

    Josh, NGDP targeting is a 100 times easier to explain than current Fed policy. Compare the two:

    Now: “The Fed tends will try to implement the Taylor Rule formula.”

    With NGDP: “The Fed will try to keep total national income rising by 5% a year.”

    Try explaining to Taylor Rule (current policy) to a average Joe.

    You said;

    “As part of the larger percent of the population which would be unsure exactly what the implications of NGDP targeting are (even after following this blog for 2 years), I see in this post two consequences I’ve always worried Scott might mean: ‘asset prices shoot up’ and policies which encourage people to spend their saved capital sooner.”

    I have never, in my entire life, advocated policies that would encourage people to consume rather than save–just the reverse. I favor policies that would dramatically raise America’s saving rate.

    You said;

    “So let me voice the fear: does all the talk of NGDP targeting really just disguise a prescription for raising prices and depleting savings?”

    Absolutely not. Moving to NGDP targeting has no effect on the average inflation rate. None. It makes inflation more countercyclical. But that should be exactly what people like Bob Murphy want, as it would reduce bubbles. That’s why Hayek favored NGDP targeting.

  10. Gravatar of acarraro acarraro
    24. October 2011 at 05:21

    One aspect of NGDP targeting I have never seen debated is the effect on the fixed income market. I think in the long term it could transform the market completly.

    I agree that inflation measures are imperfect and that it’s not clear a “correct” formula exists. But one of the reason why inflation targeting is attractive is that it tries to mantain the value of money constant. It justifies the fixed part of “fixed income”.

    If we abandon that peg, all fixed income investments become much more equity like in nature. It’s true that you’d only be exposed to systematic, economy-wide risk, but it changes the equation substantially. Correlations between bond indices and equity indices should increase substantially.

    In a way it’s a automatic bail-out for all debitors in case of economy-wide recession. Even in good times bonds look more equity-like, as any productivity jump would in part be passed to bondholders as a reduction in expected inflation (even as far as deflation if the real jump is big enough).

    What if there is a massive earthquake in california? It wipes out a large part of the california economy… Do we catch up immediately? It’s not as far fetched as it sounds given what happened in Japan… If we do catch up even in that case, you could be talking about a significant loss for all bondholders… Memory might create as many problems as it solves…

    Don’t get me worng, I still think it might be the best thing to do, it’s still a massive change…

    Maybe the distinction between bondholders and equityholders is never as good as you sometimes believe so weakening is not a problem…

  11. Gravatar of Ken Ken
    24. October 2011 at 05:34

    I noticed the same passage that Bob Murphy did. I’m guessing Scott has discussed this before, but I’d love to get more info if possible. Thanks as always.

  12. Gravatar of Ken Ken
    24. October 2011 at 05:36

    Whoops. I see you responded already!

  13. Gravatar of Morgan Warstler Morgan Warstler
    24. October 2011 at 05:40

    Woolsey just switched!!!

    Why Bill? Is it because you decided 3% is hard money?

    Guys, why can’t I get discussion around this??? I mean I certainly deserve it.

    Goldman is at .045/4

    I think the hawks on the Fed get us .04/4.

    But I do think you’ve taken another step by maing it quarterly.

    The next issue is the measure:

    1. How do we make sure it doesn’t slide?
    2. How do you get rid of re-calculations later?

    Scott, go re-read Cochrane’s bit on doing a futures market, he brought even that back to forcing the government to dance on fiscal.

    You shouldn’t do a post without making sure you have driven this point home. Seriously.

  14. Gravatar of flow5 flow5
    24. October 2011 at 07:28

    “The Fed needs to decide how much NGDP growth they’d like to see over a period of several years, and promise to keep buying (or selling) assets until they expect to hit that target”

    That’s it in a nutshell.

    “I don’t even think the elimination of IOR is at all essential; if they are worried about the MMMF industry then a level targeting commitment plus a vow to buy trillions if necessary would be enough”

    The MMMF might not be hurt, but IOeRs will slow the growth of real-output.

  15. Gravatar of StatsGuy StatsGuy
    24. October 2011 at 08:15

    Scott, there is another slightly more mechanical reason that the monetary base will remain higher – increases in capital asset ratios demanded by BIS and reinstated regulation. Essentially, to reduce the moral hazard / TBTF problem, banks are being required to hold more of their own money to offset risk to their balance sheets. When loans are 50x capital base, small increases in default risk (like Greece or home equity or CMBS) can force the government to backstop risk to limit a meltdown.

    Much of Bernanke’s speech in Oct was on the interplay between the finance sector and AD.

    http://www.federalreserve.gov/newsevents/speech/bernanke20111018a.htm

    Just a note that, while important, the 0.25% IRR shouldn’t be overplayed as an explanation for the increase in base.

    Make sure to read Bernanke’s speech – interplay between AD and macroprudential policies suggests a THIRD objective the Fed has, perhaps more important in the short term than the others (financial system stability).

  16. Gravatar of Andy Harless Andy Harless
    24. October 2011 at 10:18

    Oh, wait, sorry, I guess I misread it. So we do agree. In the immortal words of Emily Litella, “Never mind.”

  17. Gravatar of JP Koning JP Koning
    24. October 2011 at 12:45

    “I don’t know the precise laws governing Fed purchases, but given all the wild and crazy things the Fed has done since 2008, I doubt there would be any law preventing them from buying up close to $15 trillion in US, Japanese, Canadian, and German government debt.”

    Why foreign government debt? Aren’t purchases of US gov debt sufficient? I thought NGDP targeting required purchases of risky assets like stocks and MBS.

  18. Gravatar of Josh Josh
    24. October 2011 at 14:18

    Thanks Scott – and I know you are busy.

    I think most people’s movie of what the Fed does is not ‘implementing the Taylor Rule’ but rather ‘keeping inflation in check, except, to some degree, when doing so conflicts with a politically acceptable level of employment’. However accurate or inaccurate (or incomplete) this movie may be, and however effective or ineffective the Fed is at it. Since I think many people think of inflation as ‘stuff costing more’ rather than ‘me earning more’, most people want the Fed to do this job.

    Contrasted with this, ‘keep national income growing at 5%’ actually seems confusing. ‘Is the government going to give me a 5% bonus on my paycheck?’ ‘Is the government going to give someone ELSE a bonus on their paycheck?’ Either of these interpretations of that explanation SEEM to threaten both a) to spike inflation (even if only temporarily) and b) the possibility that the government will create winners and losers by distributing income.

    It doesn’t matter if someone like me accepts that Scott Sumner is very smart, not to mention likable and holds sympathetic political views. Is it possible to explain in non-technical, logical terms, by what mechanism targeting works without devaluing savings and undermining the financial achievements of those who acted responsibly and carefully while others were borrowing and spending unreservedly.

  19. Gravatar of flow5 flow5
    24. October 2011 at 16:37

    “Just a note that, while important, the 0.25% IRR shouldn’t be overplayed as an explanation for the increase in base”

    No, the IOeR shouldn’t be underplayed as an explanation for the increase in excess reserves. There is not now, nor has there ever been, such thing as your “base”. And in fact, the payment of interest on reserves is the sole explanation for the change in the banks behavior with regard to holding larger idle IBDDs since 1942.

  20. Gravatar of Potpourri Potpourri
    25. October 2011 at 06:22

    [...] preparation for our debate, I tried to get Scott Sumner to elaborate on his position. In response he said, “You are confusing two completely separate issues. Inflation doesn’t matter at all, for [...]

  21. Gravatar of ssumner ssumner
    27. October 2011 at 16:21

    acarraro, I don’t think fixed income holders care all that much about inflation. NGDP growth seems more important, and probably better correlates with interest rates.

    flow5, But does IOeR slow output through some mechanism other than NGDP?

    Statsguy, I thought capital requirements could be filled with stuff like T-bills.

    JP Koning, No, there’s no need to buy stocks.

    Josh, You said;

    “I think most people’s movie of what the Fed does is not ‘implementing the Taylor Rule’ but rather ‘keeping inflation in check, except, to some degree, when doing so conflicts with a politically acceptable level of employment’.”

    That’s sounds reasonable. And since now is obviously one of those times (9.1%) I guess most people agree with me that the Fed should not strictly target inflation right now. That opens the door to NGDP.

    You said;

    “Either of these interpretations of that explanation SEEM to threaten both a) to spike inflation (even if only temporarily)”

    But you just told me that people wanted the Fed to let inflation spike when unemployment was unacceptably high.

    My bottom line is that the general public is totally clueless about macro. Asking what they think about inflation is silly, as very few Americans even understand what inflation is. Most confuse it with the cost of living (according to polls, which showed that in the 1980s Americans thought inflation was higher than during the 1970s.) They also confuse demand and supply-side inflation, which are such different concepts that they really should not both be called inflation. One is a drop in real output, the other is a rise in NGDP–which raises real incomes of Americans. No relationship at all between these two phenomena.

    Ask Americans what would happen if the Chinese raised the yuan so that they exported less to the US. Would it help? Then ask them whether it helps by boosting inflation? See if they even understand the concept of demand-generated inflation.

    Or ask what would happen if we switched from dollars to pennies as a medium of account. Everything costs 100 times more, and everyone makes 100 times more. To economists that would be hyperinflation. To the average person it would be nothing at all. They don’t understand any of these concepts. Which is why NGDP makes much more sense, as inflation just confuses them.

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