Be careful what you wish for

Suppose you have a crystal ball, and are given one peak at the future, say May 2011.  But you are only allowed to look at one variable—and it’s not the Dow, it’s the fed funds rate.  Now suppose I tell you the following, it will be one of these two numbers:

a.  0.25%

b.  3.75%

Which one are you rooting for?  Which number do you hope to see as you look into the crystal ball?  I know what I’d like to see, but before giving you my answer, let’s look at some expert opinion.  Mankiw linked to the following SF Fed article today:

Like many private forecasters, FOMC participants foresee persistently high unemployment and low inflation as the most likely outcome over the next few years. The recommended future policy setting of the funds rate based on the estimated historical policy rule and these economic forecasts is given as the dashed line in Figure 2. This dashed line shows that, in order to deliver a degree of future monetary stimulus that is consistent with its past behavior, the FOMC would have to reduce the funds rate to -5% by the end of this year—well below its lower bound of zero. . . .

According to the historical policy rule and FOMC economic forecasts, the funds rate should be near its zero lower bound not just for the next six or nine months, but for several years. The policy shortfall persists even though the economy is expected to start to grow later this year. Given the severe depth of the current recession, it will require several years of strong economic growth before most of the slack in the economy is eliminated and the recommended funds rate turns positive.

Economic theory suggests that it is useful for the Fed to communicate the likely duration of any policy shortfall. Monetary policy is in large part a process of shaping private-sector expectations about the future path of short-term interest rates, which affect long-term interest rates and other asset prices, in order to achieve various macroeconomic objectives (McGough, Rudebusch, and Williams 2005). In the current situation, the FOMC (2009) has noted that it “anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” Other central banks have been even more explicit about the duration of low rates. For example, the central bank of Sweden has recently stated explicitly that it expects to keep its policy rate at a low level until the beginning of 2011. Rudebusch and Williams (2008) describe how such revelation of central bank interest rate projections may help a central bank achieve its policy goals.

Last February, FOMC participants also started to publish their long-run projections for output growth, unemployment, and inflation—in keeping with a trend toward greater transparency (Rudebusch 2008). Such long-run projections can help illuminate the FOMC’s policy strategies and goals, and these revealed that most FOMC participants would like to see an annual inflation rate of about 2% in the longer run. Such an expression of a positive inflation objective may help prevent inflationary expectations from falling too low and forestall any excessive decline in inflation.

What a dreary discussion.  Gloom and doom for years out into the future.  And how do we improve things?  We credibly promise an expansionary monetary policy that will persist for years into the future.  Long time readers of this blog will note that I continually harp on the idea that what matters isn’t the current setting of monetary policy, but rather the expected future path of policy.  So in that respect I am with Mr Rudebusch—we need to commit to a highly expansionary monetary policy for an extended period of time.  But here’s where he loses me, unlike most economists I don’t equate near zero interest rates with monetary ease, I equate them with monetary failure, and more specifically with ultra-tight money.

Now let’s return to the crystal ball question.  If I looked into the ball and saw 0.25% fed funds rates in 2011, I would have a sickening feeling—like I’d been punched in the solar plexus.  Krugman would be right, we’d be another Japan.  After catching my breath I’d rush out to sell all my stocks.  I’d put 50% into 30 year T-bonds, and the other 50% into HK/China equities, in the hope that the Chinese aren’t as foolish as we are.  In contrast a 3.75% fed funds rate would put a big smile on my face, as it would indicate nominal GDP growth had bounced back strongly.  It would have been a V-shaped recovery.

But obviously I am in the minority here.  Krugman and Mankiw keep linking to these studies again and again, so I have to assume they see something that I don’t.  In my view, promising year after year of near zero rates is like promising year after year of sub-par nominal growth.  The central bank should adopt a policy that is expected to produce a quick recovery from recession, not years more of economic misery.  A policy that if successful will result in much higher nominal interest rates in the future.

To paraphrase frequent commenter JImP, it is not the Fed’s job to predict failure; their job is to create success.  When the economy is severely depressed, backward looking Taylor Rules are nothing but failure rules.  The thing I find so frustrating is that the Fed doesn’t seem to have any ideas about how to create faster nominal GDP growth.  FDR was able to create inflation expectations in a far worse economic environment.  A Fed policy of targeting NGDP futures contracts at a 5% premium would immediately energize the asset markets.  I don’t know if it’s a failure of will, or a failure of imagination, but something is very wrong when after 76 years of dramatic improvements in macroeconomics, we aren’t even able to recreate the successes of the spring of 1933.

We’ve retrogressed since the Great Depression, despite all our smug textbooks that tell us how much smarter we are than the policymakers of the 1930s.  “Oh no, we’d never raise reserve requirements in the middle of a depression.”  Of course we might adopt a policy of paying banks to hoard excess reserves just as the economy is about to fall off a cliff, which has an identical impact on the multiplier.  And at least in the 1930s they had the excuse that the gold standard constrained their actions.

This post is related to an earlier post criticizing Krugman’s argument that in order to be effective monetary stimulus would have to create high inflation expectations.  I think that argument is profoundly wrong, and seems to be based on these frequent Taylor rule studies that Krugman and Mankiw keep linking to.  The inflation numbers cited imply a completely implausible estimate of the slope of the SRAS.  In reality, we don’t need high inflation, we need rapid NGDP growth.  If fear of inflation is holding us back, then we have made a very costly miscalculation.

That post only received 2 comments, about 25 below my average, despite being one of the two or three most important posts that I have ever done.  I’d like to see the blogosphere spend more time discussing this important issue.  To put it as simply as possible, does rapid nominal growth (say 5-7% for example) require high inflation as Krugman seems to assert, or can we get by with relatively low inflation because of the depressed condition of the economy?  I believe that inflation would stay low, even if monetary policy was expansive enough to generate brisk NGDP growth.

For many years now the new Keynesian elite has been assuring us that we would never make the same mistake as the BOJ, that our Fed would not sit by for year after year with sub-par NGDP.  They assured us that the BOJ had weapons they were not using.  If so, then why are we planning years of the same failed policy of near zero interest rates and grudgingly inadequate QE?  Why not pull out one of those foolproof escapes right now?  Why wait?



26 Responses to “Be careful what you wish for”

  1. Gravatar of Nick Rowe Nick Rowe
    27. May 2009 at 06:39


    To make the same point another way, since expectations of success or failure help determine success or failure, central banks need to find a policy lever where actual success, expected success, and the central bank’s attempt to achieve success, all move the lever in the same direction.

    Nominal interest rates don’t have that property. Success, and expected success, move them up; while trying to achieve success means moving them down.

    Real asset prices do have that property. Rising nominal GDP, and expected rises in nominal GDP, would raise asset prices. And if the central bank were loosening monetary policy by buying real assets, it would be trying to raise asset prices.

    Your nominal GDP futures targeting idea comes very close to what we need. My hesitation comes from the fact that, strictly speaking, the nominal GDP futures price is more of an intermediate target than a policy instrument or lever in your proposal.

  2. Gravatar of Alex Alex
    27. May 2009 at 07:10

    You want inflation? Ask Argentina how to do it. Inflation in

    Dec-2001 = -1%
    Jan-2002 = 31%
    April-2002 = 227%

    Now… NGDP growth does not guarantee RGDP growth.

  3. Gravatar of Thruth Thruth
    27. May 2009 at 08:32

    Nick: “Your nominal GDP futures targeting idea comes very close to what we need. My hesitation comes from the fact that, strictly speaking, the nominal GDP futures price is more of an intermediate target than a policy instrument or lever in your proposal.”

    Are you advocating the Fed explicitly target a particular level for the futures market? For example, suppose the Fed announces target index level of 105 for 12 months time (100 = last quoted NGDP). Each day traders announce long/short demands at that price. Fed would then meet the shortfall, which would directly inject money into the system in the event of a net short demand, or remove money in the event of a net long demand. The Fed could also supplement these actions with other OMOs if it felt the need to minimize NGDP trading.

  4. Gravatar of 123 123
    27. May 2009 at 08:33

    “I’d like to see the blogosphere spend more time discussing this important issue. ”

    Kling says in his blog that as the economy has grown much more complex and labour force is more heterogeneous than before, any stimulus will be less effective than previously assumed.

  5. Gravatar of Alex Golubev Alex Golubev
    27. May 2009 at 08:52

    This is meant to go in the Backseat drivers post, but i want to make sure you read it and i’m not sure if your’e down with that one.

    “Scott, this is getting less and less productive. It’s hard to comment on 5 posts and track 100 comments on the same NGDP topic. I suggest you create a Wiki type 1-2 pager that you continually revise (every x weeks) to reflect the latest, most accurate, less ambiguous version of your theory. You can create a FAQ adressing 10-15 of the key concerns that people have. Otherwise I think THIS ship has been scrapping icebergs lately. Maybe it’s the wind :)

    As far as your analogy backseat driver analogy. Once again, you can’t prove your point by debunking a wrong point and particularly with a flawed analogy. It’s a lot harder to blame a firefighter for not putting out the fire correctly than a ship captain for running it ashore. There’s no way you can argue that the firefighter analogy fits worse :) I’m sure there are wrong ways to fight a fire, but what’s the use in thinking up analogies in a physical world with much less unknowns, complexity, self-reinforcing processes, irrational rationalizing agents, and politics. First paragraph is far more important if you want to make progress with your NGDP idea.”

  6. Gravatar of Dilip Dilip
    27. May 2009 at 08:59


    Every comment you leave on any of Scott’s post probably ends up in his Inbox of whatever e-mail he has set up for his blog engine. It doesn’t matter where you drop your comments — they will always show up on his e-mail. So its better not to sidetrack a discussion with a comment related to another post.

  7. Gravatar of Nick Rowe Nick Rowe
    27. May 2009 at 09:02

    Thruth: That is the right question to ask. I wish I felt confident enough to give an answer.

    Let’s leave aside the question of whether NGDP is the right ultimate target (part of me still leans towards CPI) because that’s a separate question.

    For example, if you want to target the price of gold at $1,000 per ounce, the Fed stands ready to buy unlimited quantities of gold at $999, and sell unlimited quantities at $1,001. And does a few OMOs on the side if it thinks that all the trading is going one way, so its gold reserves don’t get too big or small. Why not do the same thing with NGDP futures?

    Maybe there’s the circularity argument.

    Alternatively, stick to NGDP as the ultimate target, the NGDP futures price as an intermediate target, and buy the S&P500 index as an instrument, rather than bonds. In other words, OMOs in stocks, not bonds. We know that stock prices should head up if expectations of NGDP head up.

    I still don’t know. I should have raised these issues back at the “spot the flaw” post.

  8. Gravatar of Bill Woolsey Bill Woolsey
    27. May 2009 at 12:24


    “A Fed policy of targeting NGDP futures contracts at a 5% premium would immediately energize the asset markets.”

    Don’t call this a premium.

    Premiums are above par, above face value.

    I presume you are advocating that the Fed trade NGDP futures contract at a price that reflects a target for NGDP that is 5% greater than the current value of NGDP.

  9. Gravatar of ssumner ssumner
    27. May 2009 at 12:50

    Nick, I almost included a discussion of the pole analogy, but my posts already run too long. It would have been very appropriate and I kind of feel guilty about not using it. You are right about real asset prices.

    Alex, Argentina is a perfect example of a central bank that almost always does the wrong thing. They never target aggregates like inflation or NGDP, but rather always play around with fixed exchange rates or printing money to pay government bills etc. Thus they get deflation or high inflation.

    Thruth, Yes, but the term “announce” is a bit misleading for the version I usually use. The traders simply trade contracts with the central bank. And each trade leads to a change in the monetary base.

    123, I haven’t read the specific piece by Kling, but there are two very different versions of policy ineffectiveness:

    1. Nominal ineffectiveness–but I believe structural changes don’t prevent the Fed from being able to target nominal aggrgates.

    2. Real ineffectiveness–in which case neither monetary nor fiscal expansion may be appropriate. But I don’t think this is much of a problem either, at best recent structural changes might have slightly impacted the slope of the SRAS, but not very much in my view.

    Alex, The criticism you make might be fair, but it applies more to the causality issue, not the backseat driver issue.

    Regarding causality, I said there had to be superior policies available to the central bank (captain) at the time.

    Nick#2, I agree with your idea, and did mention it somewhere, but should have done so more forcefully. Not only can the Fed set an initial money supply before trading starts, but they could also do some “discretionary” OMOs on their own, as long as the market got the “last word.” Does that make sense? And every day is a new contract, so there are lots of chances to balance things out and reduce risk.

    If they do this, if they give the market the last word, then there is no circularity problem–as the market ultimately sets the MB.

    I have mixed feelings about the S&P idea. With NGDP targeting, I think it would be a fifth wheel. Without NGDP targeting, I think it would be imperfect, but probably a vast improvement over current policy. You can take that lukewarm endorsement any way you’d like. Since NGDP futures targeting is pretty unlikely in the near future, it’s actually a pretty positive statement from a guy who who normally doesn’t like seeing corporate America bought up by the government.

  10. Gravatar of Bill Woolsey Bill Woolsey
    27. May 2009 at 12:53

    Nick and Alex:

    When the Fed trades futures contracts, it has no impact on the quantity of money. The Fed is making promises to pay
    money based on the difference between the actual value of the targetted variable and the target–when the contract is settled. If the Fed is wrong, it pays out money regardless of whether the variable was too high or low.

    If there are some kind of margin requirements, then regardless of how the Fed trades, there is a “decrease” in the quantity of money (or whatever collateral is accepted for margin requirements) when the Fed trades.

    Fundamentally, index futures convertibility creates a financial motivation for the monetary authority to hit the target. If it fails, and there is reason for outsiders to believe it will fail, then they are motivated to trade and make money. And the monetary authority will lose money.

    It must hit its target through ordinary open market operations. Well, they can trade what they want, but other sorts of futures contracts won’t help. It has to be an actual asset. And bonds are probably the best bet.

    If the monetary authority keeps its position on the contract at zero, then it cannot suffer a loss.

    Well, perhaps this was all obvious to you all

  11. Gravatar of Joe Calhoun Joe Calhoun
    27. May 2009 at 13:02

    Nick and Thruth,

    I like the idea of using real assets rather than an NGDP futures contract as I’ve always believed the Fed’s balance sheet should be more diverse. There are a couple of questions though: Would the Fed always buy front month contracts and keep rolling if need be or could the Fed signal the market about the length of time they believed the loosening (tightening) was required by buying contracts further out on the curve? Do you think the Fed should have an approved list of markets in which they can conduct open market operations or should they keep the market guessing?

    Here’s what bothers me about this whole idea though. I think Scott and you guys are right that the Fed can target a level of NGDP and achieve it with monetary policy, but you seem to be assuming that real GDP will just follow along. Doesn’t fiscal policy matter? Doesn’t tax policy matter? If the Fed targets 5% NGDP right now, which would entail a massive expansion of their balance sheet, how will our creditors react? If they react by dumping dollars, won’t most of the 5% NGDP growth be inflation? What will that accomplish other than stiffing creditors? As I’ve said before, I think if the Fed used a policy like this consistently over a long period of time, we would reach your goal of 3% real growth, but what happens in the interim?

  12. Gravatar of Bill Woolsey Bill Woolsey
    27. May 2009 at 14:07


    Stop worrying about the circularity argument.

    Just accept that traders only trade because they expect to disagree with the market. The Fed free rides.

    The circularity argument appears to assume homogeneous expectations. So the market all agrees. And if it is only the Fed trading “against” the market, and it adjusts base money so that the market always uniformly aggress that the target will be met, then no one can ever expect to make money.

    But, if you start of by realizing that the policy is market driven, then you are betting against the rest of the market. You trade because the other traders are going to keep money too tight or too loose.

    Anyway, if the Fed actually trades on its own account, and takes a position, then there is no cicularity either. But, the Fed will suffer losses for its errors.

    The notion that the Fed sets base money in the morning, and then they hold some kind of auction, and then the Fed adjusts base money at the end of the day, based on the “auction” is just… well, odd to me.

    My “vision of this, is that at 9:00 the Fed opens for trading and all day, they buy or sell futures to all comers. There is no auction. People call the Fed and say, I want 500 contracts. Another calls and sells, I want to sell 1000 contracts.

    Depending on how the trading goes, the Fed will have a short or long position. It may become more short as the day wears on, then less short, and suddenly go long.

    Your “rule” about T-bills, then, is that the guys down the hall, are watching the Fed’s position on the contract and they are busy trading T-bills all day based on some multiple of the Fed’s short or long position. Maybe, before the bond traders can buy enough bonds to match the growing longs, it will turn, and they will have over bought and have to start selling.

    So, I see base money as changing all day. If the guys at the bond desk go home for the night and they still need to buy more bonds.. well, tomorrow is another day.

    My view is that there should be no mechancial rule at all.
    The bond traders buy or sell bonds how they want with the general instruction keep the net position on the contract equal to zero.

    The futures trading desk operates all day. The bond traders down the hall watch the Fed’s position on the contract. They trade bonds to try to keep it at zero. Sell if the Fed is short and buy if the Fed is long.

    Again, people trade because they disagree with the rest of the market.

    (If everyone agrees how much open market operations in bonds it takes to hit the target, then that includes the Fed, and they should just do it.)

    If the Fed starts trying to do something else other than hit the target, and outsiders figure it out, then the Fed will suffer financial losses.

    If it is trying to hit the target, then the market can bet with the Fed. If the Fed is better than the market, it makes money. If it is worse, it loses money. If the Fed free rides, then it never loses money, and then each trader in the market is betting against other traders.

    Maybe a fixed rule between open market operations and the short or long position is better. Maybe making the market even less like an ordinary futures market is necessary.

    But I think giving the open market trading desk (with bonds) the same sort of discretion they have with hitting the Federal Funds target is appropriate.

    The FOMC sets the Fed funds rate periodically. They don’t call in orders for bonds to hit it.

    Now, it may be that keeping the Fed’s position on the contract near zero is more difficult. And certainly, if there is to a be a decision to hold a position because the “market” is wrong, then should be done by the FOMC.

    Well, I hope this clarifies how I think about this.

    I would appreciate it if you would explain more about the actual mechanics you have in mind. Bond trading until 12? Orders taken on the contract and then, all traded at once at 2? Then trading bonds in the afternoon according to the multiple of the short or long position?

  13. Gravatar of Bill Stepp Bill Stepp
    27. May 2009 at 15:56

    Monetary policy is in large part a process of shaping private-sector expectations about the future path of short-term interest rates, which affect long-term interest rates and other asset prices, in order to achieve various macroeconomic objectives

    Exactly right comrade~! All hail the wise and all-knowing Fed Soviet politboro member and distinguished Comrade Bernanke!~
    May he succeed beyond his wildest planning dreams and expectations–then we can declare him a true Hero of the United States Peoples Soviet Republic.

  14. Gravatar of Nick Rowe Nick Rowe
    27. May 2009 at 16:00

    Scott: Pole! Pole! Pole! Pole! ;)

    The analogy works much better for you than it does for me, since you have a clear idea about which string attached to the top of the pole you want to pull (it’s the string marked “NGDP futures”), while I’m still not sure which string I want to pull on. It might help some of your readers get the point about interest rates better.

    Bill @ 12.53.

    No it wasn’t obvious to me. It should have been! It’s more obvious now.

    But there’s more than one way to run the market in future NGDP.

    I forget the terminological difference between a forward and futures market.

    Think of the horse race. There’s a betting market in whether the horse will cross the finish line before or after 1.05pm. And a mechanism to move the finish line back or forward ( increase or decrease the money supply) depending on which way the bets are running.

    The central bank could be the totaliser, not making bets itself, just keeping track of other people’s bets, and moving the finish line (doing an OMO) according to how the odds change. (Scott’s plan).

    Or the central bank could be the bookie, actually buying or selling bets that the horse will finish in less than 1.05, (with a small spread between the two “gold points” perhaps). This is what I was thinking about, though I’m not sure it’s a good idea, especially since the Fed would need to collect cash from people if it won the bet. But the money supply would then increase or decrease automatically, if the Fed were the bookie, or market-maker, rather than the totaliser or middle man.

    I’m not as clear on this in my mind as I should be. Just trying to think through the analogy to the case where the Fed targeted the price of gold by actually buying and selling gold.

    Bill @ 14.07:

    I think you might be right. As I’ve said before, the circularity argument seems very much like the Grossman Stiglitz argument of why financial markets can’t work at all. (If market prices reflect full information, why should traders collect the information? And if traders don’t collect the information, prices won’t reflect it). It’s more an interesting conundrum, like the Modigliani Miller argument that firms really don’t care about the debt/equity ratio, rather than a proof that markets don’t work.

    Joe Calhoun: my mind is still far too fuzzy on the idea of the Fed buying the S&P500 to have any opinion on the details of how it would work best. Your view would be at least as good as mine.

    Regarding your second point, on GDP vs NGDP. Monetary policy cannot target a real variable, like GDP or unemployment, in the long run. The attempt to do so, as we discovered in the 1970′s is either accelerating inflation (if you try to target real output or employment above the long run equilibrium) or deflation (if below long run equilibrium). You have to target a nominal variable, like NGDP, and hope the rest of government, and the rest of the economy, does the best it can with real GDP.

  15. Gravatar of JimP JimP
    27. May 2009 at 18:23

    Yes – one has the clear impression that no-one really knows what to do- that lives are being ruined just for the simple reason that the Fed doe not know how to act – and that it will just go on and on.

    Bernanke – helicopter Ben – unknowingly running the tightest money since Mellon. It is really stunning.

    They don’t target success and just don’t care one way or another if they are successful or not. It doesn’t bother them. If it did they would say so. They think they are doing the best they can and we will just all have to suffer and die and that is that.

  16. Gravatar of Bill Woolsey Bill Woolsey
    27. May 2009 at 19:25


    There are two basic flavors of the free banking argument.

    Hayek’s argument, in the Denationalization of Money, argued that it should be legal to create alternative monetary schemes in parallel to one another.

    Most libertarians (and most free bankers tend to be libertarians) say that yes, that should be permitted. For what it is worth, U.S. banks were limited to issuing dollar-denominated accounts. You couldn’t have a alternative denominated account in the U.S., though I suspect the laws were specified in terms of foreign currencies. No swiss franc deposits in U.S. banks.

    Anyway, there are plenty of free bankers who see the “free entry” by alternative monetary systems as something that should be permitted by right, but not a very practical scheme of disciplining an incumbent or replacing a poor performer.

    As for your “trademark” notion–so, all contracts denominated in terms of a countries unit of account can be regulated at will? I am not sure I care about the answer to that question. But I really don’t think using an analogy with a trade mark really reflects the notion of the relationship between the unit of account and contracts. Banknotes and transactions accounts don’t look to me to be the same thing as counterfeiting the fiat currency that serves as medium of account. They look like contractual promises to pay that fiat currency. Anyway…

    The other approach takes free banking as a reform proposal. The status quo should be reformed to work better. There are the “micro” issues. Banks should be permitted to issue banknotes on the same terms as transactions accounts. Banks should not be required to hold reserves against banknotes or checkable deposits. The Fed should get out of the hand-to-hand currency business and leave it to the market. Deposit insurance should go. And with it, capital requirements. Holding bank deposits is risky and banks that fail should go bankrupt and depositors should take loss. If banks want to return to publicizing their capital holdings or utilize option clauses–that is fine.

    Then, there is the macro issue. Rather than have the central bank manipulate the quantity of base money, some alternative scheme should be used. Selgin argues that freezing the quantity of base money would work. Of course, there is a gold standard. I guess Dowd is still going with indirect redeemability into a commodity bundle. I would like to see index futures converitibility.

    In my view, the key element of the nonHayekian version of free banking is that the money used by the public should be made up of the financial instruments issued by banks and that these should be “controlled” by redeemability of some sort or other. This redeemability would tie them all into a common unit of account. Rather than operating in parellel to the official unit of account, it would be implemented by legislation changing the meaning of the official unit of account. For example, defining the dollar in terms of gold.

  17. Gravatar of ssumner ssumner
    28. May 2009 at 05:25

    Bill, Yes, I meant 5% above current levels. BTW, just a heads up so people don’t accuse me of shifting my view. I started the blog in February, so I’ll use 2009:1 as my base. I favor level targeting. So if we get 6% growth I’ll favor 4% the next year, and vice versa. My hunch is that we’ll have less that 5% this year, and thus I will be calling for more that 5% next year. I don’t want anyone accusing me of being an “inflationist” as I took my base quarter at a point far below normal. David Glasner argued quite persuasively that I could have started the first year with a higher number, to catch up to trend. And I recall you estimated some trend numbers which indicated that by 2009:1 we were below trend. I picked a very conservative strategy—which shows you how ultra-reactionary the rest of the profession is right now.

    Bill#2, I agree that the futures transactions don’t directly change the base. But just to be clear, they do trigger parallel OMOs.

    Joe, Creditors would be thrilled by 5% NGDP growth. Tight money has destroyed many trillions in wealth due to lost output. How do you think the creditors of GM feel about auto sales tanking? The biggest creditor of the US is China, and they are 10 times more concerned about jobs for their people, than they are concerned about capital gains or losses in T-bonds. Ditto for Japan. It’s not a zero sum game—growth means more for everyone.

    Bill#3, I may have given the wrong impression, I am not concerned about the circularity problem for my plan. I agree that trading goes on all day, so I didn’t mean to suggest a single auction. I am not concerned about the exact details of what the Fed allows, but the following seems reasonable:

    Let the Fed trade OMOs on its own account until 1/2 hour before the end of the trading day. Make sure that the market gets the “last word” in setting the monetary base. Giving the Fed this ability would help them better manage their risk. The Fed could also be allowed to trade futures contracts on their own account. If this action helped improve monetary policy, then the Fed would presumably make a profit on these trades. I have no problem with that, unless they start losing lots of money. Then as a taxpayer I do have a problem.

    Bill Stepp, You should name who you are quoting, otherwise people will think you are calling me a commie. It isn’t clear who made that statement.

    Nick, There are two types of circularity issues that are discussed. One is applicable to any market, and is resolved by the fact that investors have heterogeneous views (as Bill Woolsey pointed out.) Some commenters got mad when I accused them of this fallacy. Then there is the Bernanke and Woodford version, which can occur even with heterogeneous expectations. If the policy is credible, then the NGDP futures price should always stay at the the target. Hence futures markets don’t provide price signals to the Fed. That’s why Bernanke and Woodford emphasized that what you need are instrument setting signals, which is what my proposal (and also an alternative version with Aaron Jackson) are designed to do.

    Yes, I’ll try to remember to use the pole example–it does exactly fits my “anti-interest rate” perspective. By the way, has anyone yet done a post on the country music song by Merle Hazard making fun of how economists can’t decide whether we will have deflation or hyperinflation? I’ve got a title, if you want to do a post: Call it “The Merle Hazard Problem.”

    Bill#4, Interestingly, this came up in the next post as well, and I made some similar points in the comment section (although you are much more knowledgeable about free banking than I am.)

  18. Gravatar of Nick Rowe Nick Rowe
    28. May 2009 at 08:15

    Bill: Now I have found your comment again…I admit those are cogent critiques of the argument I made about free banking….in another thread ;)

    My “trademark” argument could certainly be pushed too far, in a very illiberal direction. Not sure where I would draw the line with it, which is perhaps a problem with it.

    Scott: I hadn’t heard thee Merle Hazard song. But it would illustrate the underlying problem: any given interest rate can be compatible with hyperinflation (it’s too low) and deflation (it’s too high).

  19. Gravatar of TGGP TGGP
    28. May 2009 at 14:20

    I haven’t heard the song either but believe he was thinking of Merle Haggard rather than Merle Hazard.

  20. Gravatar of ssumner ssumner
    28. May 2009 at 16:56

    Nick and TGGP, No, it is Merle Hazard. Here’s the link.

    That’s why I couldn’t resist the bad pun. I haven’t heard the song but read a few lyrics. It might be pretty funny.

    Nick, It’s “Highway 51 Visited” for me. I catch up in a week or so.

  21. Gravatar of Lawton Lawton
    31. May 2009 at 14:03

    I second the call for a wiki or FAQ.

  22. Gravatar of Bring back Scott Sumner « Left Outside Bring back Scott Sumner « Left Outside
    14. June 2011 at 00:03

    [...] back Scott Sumner Trawling through the archives… Suppose you have a crystal ball, and are given one peak at the future, say May 2011.  But [...]

  23. Gravatar of John John
    7. July 2011 at 23:47

    How are you handling that sickening feeling? More than 2 years later and still 0.25%. it raises the question, how about instead of trying to prop up overindebted businesses with ultra low rates, why not keep them in a normal range so there’s some incentives to save of payoff debt? Wouldn’t that be a better solution to the liquidity trap? Or how about the novel idea of not interfering with interest rates so that they actually reflect the amount of savings available in the economy?

  24. Gravatar of ssumner ssumner
    8. July 2011 at 17:35

    John, You are right that the low rates give me a sickening feeling, just as I predicted. But the solution is easier money, leading to faster NGDP growth.

  25. Gravatar of No tipping point in sight (unfortunately!) | This is Ashok. No tipping point in sight (unfortunately!) | This is Ashok.
    10. March 2013 at 14:02

    [...] believe this argument misses the real chain of causality. This is an argument Scott Sumner has previously made. Here are a few reason yields are [...]

  26. Gravatar of “Wish I had kept my mouth shut”! | Historinhas “Wish I had kept my mouth shut”! | Historinhas
    18. March 2013 at 14:11

    [...] At that time Scott Sumner had just started saying quite the opposite! [...]

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