Monetary regimes in your review mirror may be closer than they appear.

Here’s a new idea discussed in the Financial Times:

Nominal consumption, not nominal GDP?

Nathan Sheets, head of the Fed’s international division until August, clearly plans to enjoy his freedom as head of international economics at Citi. In a new note he proposes a fairly dramatic communications option for the Fed – setting a target for the level of nominal consumption – which is definitely not the kind of thing you’re allowed to say in public when you work at the Federal Reserve Board.

As Mr Sheets notes, the Fed has ruled out any dramatic changes to its framework for the time being, but “our view is that in the event of a sizable financial shock from Europe—or evidence that the economy was slipping into recession—the Fed would be looking for a ‘bazooka,’ and such a regime would again be considered”.

Lots of commenters were skeptical last week when I said this:

It’s now quite possible that the Fed may have to move toward NGDP targeting before they would have liked.  The Fed cannot allow another collapse of NGDP like we saw in 2009.  The cost in terms of banking distress, worsening public finances, international discord and mass unemployment is simply too great to contemplate.  I have no doubt that Ben Bernanke of all people understands this.

Perhaps the Europeans will come together and do something dramatic in the next few days.  But if not, the Fed must be prepared to hold an emergency meeting and do whatever it takes. 

Commenters argued that the Fed had just decided against doing NGDP targeting.  I had no basis for claiming that it might be on the agenda.  Now a Fed insider is saying the same thing—a euro  crisis could force immediate action. 

Yes, nominal consumption is slightly different from NGDP.  But once it gets to the point were we are debating which type of NDP targeting, then the game is almost over.

HT:  Christopher Mahoney, David Levey.


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36 Responses to “Monetary regimes in your review mirror may be closer than they appear.”

  1. Gravatar of dwb dwb
    30. November 2011 at 15:32

    from your blog to Bernanke’s ears.

    why exactly do we have to wait for another crisis to be upon us to switch? The #1 reason to do it is to prevent the crisis in the first place. ugh. in any event, the Euro crisis is HERE, now.

  2. Gravatar of dwb dwb
    30. November 2011 at 15:38

    oh, incidentally, the WSJ “Heard on the Street” commented that the ECB is preparing to target government bond yields if a pact on fiscal discipline is agreed. Have not seen this elsewhere, no not sure how accurate it is.

    still…. god forbid the ECB should dissapoint. The market is clearly pricing ECB action. If the ECB disappoints, anyone want to take the over/under on the 10 yr UST hitting 0%. I take the under.

    http://online.wsj.com/article/SB10001424052970204012004577069930543489756.html

  3. Gravatar of Mike Sax Mike Sax
    30. November 2011 at 15:41

    Good job Scott-assuming that’s what’s going on-LOL.

    To celebrate read my analysis of the days events

    http://diaryofarepublicanhater.blogspot.com/2011/11/what-did-central-banks-do-today-second.html

    http://diaryofarepublicanhater.blogspot.com/2011/11/worlds-central-banks-unite.html

  4. Gravatar of Manny C Manny C
    30. November 2011 at 16:14

    I sent this to a friend after Fed statement

    My reading of Fed statement was that they ruled out price level targeting.

    However, they left open NGDP (level?) targeting (“could promote stronger economic recovery”) but don’t want to change framework to NGDP targeting because:
    1. fed’s ability to make credible commitment to an ngdp target – particularly when ngdp is largely inflation and political pressure is on to tighten policy.
    2. operational hurdles – what target level?

    They concluded by saying that it “would not be advisable” to change under those circumstances. I read that as saying: we are not ruling out the ngdp targeting idea (like they did with price level targeting) but:
    1. On first point, we haven’t quite convinced ourselves as to whether we can credibly do ngdp targeting. We need more time.
    2. On second point, even if we did go ngdp targeting, we aren’t quite sure what target to use. We need more time.

    Summary: Price-level targeting is ruled out. We need more time on ngdp targeting.

    I think my summary together with Sheets’ suggestion of nominal consumption etc suggests I was right. NGDP targeting is not out. But they are thinking about it.

  5. Gravatar of Manny C Manny C
    30. November 2011 at 16:17

    Oh, and I think the “would not be advisable to make such a change under present circumstances” means that they might consider it if things get materially worse. So agree with what your saying Sage of Market Monetarists.

  6. Gravatar of Benjamin Cole Benjamin Cole
    30. November 2011 at 16:19

    It is remarkable, this gathering strength of Market Monetarism.

    Only several months ago I wrote Marcus Nunes that it was better to light a single candle than curse the darkness. That’s how it felt to sit around the flicker of Market Monetarist bloggers.

    Now, Fed minutes contain recurring discussions about Market Monetarism, and the John Taylors of the world feel compelled to craft rebuttals (rebuttals noticeable for their flimsiness). The New York Times runs op-eds from Romer that Market Monetarism is the way to go.

    Now we must somehow get the Fed on board.

  7. Gravatar of marcus nunes marcus nunes
    30. November 2011 at 16:21

    But Consumption Targeting could end up being an unhelpful “distraction”:
    http://thefaintofheart.wordpress.com/2011/11/30/nominal-consumption-targeting/

  8. Gravatar of Cthorm Cthorm
    30. November 2011 at 16:25

    Really DWB? 206 basis points? I’m pessimistic on the ECB and I might take the over on that. I don’t think UST 10yrs would fall below 1%; I think you’d see the distress show up more in the USD/EUR exchange rate. I’d put the over/under at 0.90.

    I want to vent a bit about stock picking for a moment. I bought some ADRs of one of Germany’s largest exporters about 2 months ago. At the time it was trading at like 25% of where it was trading in early 2008, despite robust revenue growth, industry-leading profitability and strong exposure to emerging markets. It’s P/E was about 4, and it’s had revenue growth of about 20% in recent years. Since then it’s been down about 5%. Macro is clearly dominating the hell out of equities, but it still puzzles me. Even if the Euro collapsed this company would still do well, not to mention it is a big exporter so appreciation in emerging market currencies would boost it’s own earnings. The company is Volkswagen, by the way.

  9. Gravatar of ssumner ssumner
    30. November 2011 at 17:08

    dwb, I wonder about that too. Krugman said Italian bonds are still over 7%. Why so high if pegging is expected?

    Mike, No time to celebrate. Tell me the punch line.

    Thanks Manny, Those are good observations.

    Ben, I’ve also been surprised by the momentum.

    Marcus, I need to give it more thought, but I tend to agree with you. Especially about the politics of it.

    Cthorm, I’m shocked VW is so low, especially given that it is a popular brand in China. I assumed dwb, was joking about the 0%, for dramatic effect.

  10. Gravatar of Integral Integral
    30. November 2011 at 17:59

    Marcus has an interesting post on this topic.

    I’m a bit conflicted. My initial thought was: if NGDP and NC (nominal consumption) are cointegrated, it doesn’t matter which one you target. But if there is is a structural shift in the proportion of NGDP that goes to consumption, “targeting” nominal consumption will have adverse effects on NGDP growth.

    And AD comes from NGDP, not from nominal consumption alone. So the conclusion is obvious: for any given policy rule, NC targeting can be no better than NGDP targeting.

    It seems like an unnecessary complication. Yes, under NC targeting the Fed gets to keep talking about the PCE price index; but is that really an “advantage”?

  11. Gravatar of dwb dwb
    30. November 2011 at 18:30

    Why so high if pegging is expected?

    If by expected you mean probable, seems to me even a small chance of a very large disaster will keep yields high (I say pricing in, in the mathematical/game theoretic sense). If no framework is agreed, Euro collapses, yields climb to junk territory or far worse (or equivalently, lira devaluation vs Euro when it collapses). To game one extremely optimistic scenario that still gets to 7%: only 15% chance of portugal like yields (18%) and 85% chance ECB sets a ceiling of 5%. And thats the optimistic case….

  12. Gravatar of Bob Murphy Bob Murphy
    30. November 2011 at 18:36

    But once it gets to the point were we are debating which type of NGDP targeting, then the game is almost over.

    You got that right, Scott. I hope to have my bunker fully stocked by that point.

  13. Gravatar of Dustin Dustin
    30. November 2011 at 19:00

    Don’t forget your tin foil hat, Murphy.

  14. Gravatar of Mike Sax Mike Sax
    30. November 2011 at 19:02

    Well Scott telling you the punchline doesn’t help me none, it’s like getting a free download. Whatever you feel like you can’t slum that’s cool, Greater lights than you have read my blog-Delong, Bernstein, even Nick Rowe, so whatevs.

  15. Gravatar of Tommy Dorsett Tommy Dorsett
    30. November 2011 at 19:21

    Marcus Nunes is exactly right: the whole point of a NGDPLT is to have the Fed offset AD shocks, NOT to choose which components of NGDP will grow at some specified rate. Such a thing would take the Fed into a politically dangerous zone. This ‘idea’ is obviously a thinly veiled attempt to jump on the NGDP targeting bandwagon, but with a twist he can call ‘his own’. Sorry, bad idea. Go away now.

  16. Gravatar of Doc Merlin Doc Merlin
    1. December 2011 at 02:45

    Consumption targeting would be a problem, as it would fail to contain bubbles. NGDP targeting would contain bubbles more than consumption targeting would.

  17. Gravatar of Doc Merlin Doc Merlin
    1. December 2011 at 03:12

    Sorry, I mean it would fail to contain investment and credit bubbles (like the one from the late 1920′s)

  18. Gravatar of Morgan Warstler Morgan Warstler
    1. December 2011 at 07:09

    Manny explains perfectly why the NGDP target will be 4% or less.

  19. Gravatar of 123 123
    1. December 2011 at 09:30

    OK,
    but what about the supposed advantages of nominal consumption level targeting?

    “Mr Sheets reckons that nominal consumption has several advantages over nominal GDP as a target:
    It keeps the focus on consumer prices as the measure of inflation rather than the GDP deflator. That is closer to what consumers actually experience and to what the Fed does now thus reducing the communications challenge.
    A stable path for consumption, rather than a stable path for GDP, is what consumers want and thus is closer to maximising their welfare.
    Consumption is less volatile than GDP making it easier to target. Implied but not stated is that this would lead to less volatility in monetary policy.
    Targeting consumption excludes components of GDP over which the central bank has no influence, notably government spending.
    It might be easier to rally political support for stimulative policies in a crisis: “If politicians see that consumption is well below a sustainable level—meaning that their constituents are consuming less than they could be—this might help mobilize political support for stimulative monetary policies and perhaps also incentivize supportive fiscal policies.”

  20. Gravatar of 123 123
    1. December 2011 at 09:31

    oops, Marcus has already nailed it.

  21. Gravatar of Liquidationist Liquidationist
    1. December 2011 at 10:59

    I think the evident flaws that Nunes has identified in targeting consumer spending highlights deeper flaws in NGDPT targeting itself.

    If the fed targets consumer spending and meanwhile consumers decide that in fact they would rather spend more of their money saving for the future then the pattern of investment will clearly be distorted. Similarly if the fed chooses to target NGDP then whatever tools they choose to steer towards the target (lowering interest rates so that banks will lend more money, Quantative Easing to force AD up, increasing the inflation rate so that the demand for money falls etc) will cause deviations in the patterns of investment and consumer spending from what would have occurred in a free market. Beyond the short-term such “solutions” will simply move us further away from a healthy economy.

    If we took away all constraints that hamper the market tomorrow then a crisis that has lasted 3 years would be over by next summer.

  22. Gravatar of Cthorm Cthorm
    1. December 2011 at 11:06

    Scott -

    Before my latest gig I was an automotive industry analyst. VW isn’t just popular in China, it has more sales in China than any other foreign automaker. It’s number one in Europe by a long shot. They’re effectively tied with Toyota and GM for number one global automaker by sales, but they have a minimal presence in the US. They’re investing big in production in TN and Mexico for the US market. On every real metric VW is killing the competition. The only automaker that comes close in terms of growth is Hyundai-Kia group. But none of that matters when the ECB beats it’s chest to show how tough on inflation it is.

  23. Gravatar of Cthorm Cthorm
    1. December 2011 at 11:07

    I’m sorry: how tough on NGDP it is.

  24. Gravatar of James in London James in London
    1. December 2011 at 13:40

    I don’t think Trichet would have said this.
    “The ECB has created an enormous amount of liquidity, and we see now that this liquidity is being redeposited with the ECB deposit facility,” Draghi said. “Which means it is not so much the amount of liquidity that is the matter, but it’s the fact that this liquidity is not actually circulating.”
    http://www.bloomberg.com/news/2011-12-01/draghi-says-ecb-bond-purchases-can-only-be-limited-pushes-fiscal-union.html

  25. Gravatar of Jason Odegaard Jason Odegaard
    1. December 2011 at 13:43

    What about the point brought up about saving? Isn’t the variability in saving mean nominal consumption targeting is more difficult? Or that by association it also influences saving rates? Isn’t the effects on savings more concerning?

    Or is it just they in a flight to liquid savings, nominal consumption targeting implies that enough asset purchases or negative IOR would be applied to restore consumption, this the mass-flight to liquid savings is broken by the “hot potato effect” on money?

  26. Gravatar of Britmouse Britmouse
    1. December 2011 at 13:53

    AEP takes no prisoners this time:

    http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100013558/you-are-all-wrong-printing-money-can-halt-europes-crisis/

  27. Gravatar of Matt Waters Matt Waters
    1. December 2011 at 15:08

    The issue with targeting nominal consumption (or GDP excluding government) vs. all of NGDP is that it would theoretically keep monetary policy loose even if government deficits increase the rate of inflation. Theoretically, outside of a liquidity trap, more government spending should crowd out private consumption through higher interest rates for private loans. If monetary policy offsets the crowding out, then it will have to create higher inflation.

  28. Gravatar of JimP JimP
    1. December 2011 at 16:24

    Clearly AEP is a regular reader of this blog. He should give Scott more credit – any bets on whether the ECB will do what he says?

  29. Gravatar of ssumner ssumner
    1. December 2011 at 19:04

    Integral, I’m also skeptical, although I’m not quite yet willing to dismiss the idea. It depends which one correlates better with average hourly nominal wages.

    dwb, Yes, I suppose you are right.

    Bob, Don’t forget to bring some rolls of toilet paper, or at least a copy of the General Theory.

    Mike, You said;

    “Well Scott telling you the punchline doesn’t help me none, it’s like getting a free download. Whatever you feel like you can’t slum that’s cool, Greater lights than you have read my blog-Delong, Bernstein, even Nick Rowe, so whatevs.”

    I’ve read your blog too. That’s why it’ll take an exciting punchline to draw me back. :)

    Seriously, I get requests to look at 10 times as much as I’d like to read. But there are only so many hours in the day. It’s hard for me to even keep up with my blogroll.

    But I do answer all comments, and you are free to have links over here.

    And yes, those guys are “greater lights.”

    Liquidationist, Your comment makes no sense unless you specify the monetary policy in a “free market.” You assume NGDP targeting would be more expansionary. But if I were free to print money (counterfeit) I’d print quite a bit. I’m joking of course, but what exactly is a free market monetary policy?

    Cthorm, Based on what you say the P/E of 4 seems like a steal, but I really don’t know enough to have an intelligent opinion. It’s hard to believe the ECB is the only factor, but I suppose it’s possible. What about P/Es for companies like Siemens?

    James, He has to be an improvement over Trichet.

    Jason. Here’s what makes the proposal so hard to evaluate. We are all tempted to think in terms of the effect on various types of spending/saving. But the real question is which does a better job of stabilizing the labor market. And that’s a much tougher question, because the effect is indirect. You can get the same average inflation rate with either target.

    Britmouse. Thanks for the link.

    Matt, That’s a good point.

    JimP, As long as I’m still “eminence grise” it’s OK if he leaves me out.

  30. Gravatar of Morgan Warstler Morgan Warstler
    2. December 2011 at 07:16

    I still think we’re going to end up with Greece and the other southern states all forcing themselves to live with no more than 3% deficits.

    And that’s just so damn awesome.

    http://apnews.myway.com/article/20111202/D9RCBH800.html

    Its all going to be worth it.

    Countless entrepreneurs and small businessmen will gain power and status and the social govt. leaches will lose power and status, and that is really all that matters, isn’t it?

  31. Gravatar of Liquidationist Liquidationist
    2. December 2011 at 10:29

    There would be no monetary policy within a free market as there would be no CB to implement it.

    In a recession caused by decreased AD then a combination of increased lending by banks and relative price changes to increase profitability will bring the market back to equilibrium.

    NGDPT can simulate to a limited extent only the first piece (bank lending) and even then only as long as we are not at the zero-bound. NGDPT discourages changes in relative prices as firms will not take the tough decisions needed to improve profitability if they know the CB will boost AD by increasing the money supply.

    The end result can only be a flabby economy unable to respond to supply shocks without constant CB intervention.

  32. Gravatar of ssumner ssumner
    2. December 2011 at 18:22

    Liquidationist, You said;

    “In a recession caused by decreased AD then a combination of increased lending by banks and relative price changes to increase profitability will bring the market back to equilibrium.”

    Why should banks care about macro equilibrium?

  33. Gravatar of Liquidationist Liquidationist
    3. December 2011 at 14:46

    They don’t , but decreased AD is probably caused by increased demand for money and increased demand for money will give banks higher reserves to lend out.

  34. Gravatar of ssumner ssumner
    3. December 2011 at 20:57

    Liquidationist, I don’t understand how increased demand for money gives banks more money to lend out.

  35. Gravatar of Liquidationist Liquidationist
    4. December 2011 at 12:51

    Increased demand for money means that the banks customers will tend to hold larger balances (I’m assuming a free banking regime here where the banks operate on a fractional reserve system).

    The banks can then use those extra reserves to lend out to new customers. This will trend to stabilize AD (A sort of “free market” NGDPT regime).

  36. Gravatar of Scott Sumner Scott Sumner
    10. December 2011 at 09:14

    Liquidationist, I’ve seen lots of fre banking types make that argument, but I’ve never seen any convincing arguments put forth. Why would banks provide just enough to stablize NGDP?

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