Can we be confident about the benefits of more NGDP?

[Readers already convinced should skip this long post.]

David Andolfatto offers the following challenge:

Proponents of NGDP targeting, however, like Scott Sumner and David Beckworth, for example, seem to believe very strongly in the vast superiority of a NGDP target–not just as a policy that would mitigate the effects of future business cycles–but also as a policy that should be adopted right now by the Fed to cure (what they and many others perceive to be) an ongoing “aggregate demand deficiency.”

What I am curious about is not that they believe this, but how strongly they believe in it. I respect both of these writers a lot, so naturally I am led to ask myself how they came to hold such a strong belief in the matter. What is the theoretical underpinning for NGDP targeting? And what is the empirical evidence that leads them to believe that an NGDP target right now is a cure for whatever ails us right now?

One way to seek answers to these questions is to spend hours perusing their past blog posts. I’m sure they must have answered these questions somewhere. But I figure it will be more efficient for me to just state my questions and have them (or somebody else) point me in the right direction for answers.

My approach to economics is very different from that of my thesis adviser (who was Robert Lucas.)  I think one does actually have to peruse those thousands of old blog posts to get a sense of why I am so confident.  That’s because I think the situation is very complicated, and must be examined from multiple perspectives.  For instance, I believe that more NGDP right now would modestly lower the unemployment rate, which would cause Congress to shorten the maximum number of weeks people can collect unemployment insurance, which would lower the natural rate of unemployment.  I don’t recall seeing that argument in any Lucas models.  It’s not that I think there is any single overwhelmingly persuasive case for faster NGDP growth, but rather that there are many arguments, of varying persuasiveness, all pointing in the same direction.

But let’s start with Lucas, as I imagine David (wisely) respect his views more than mine.  Lucas says the 50% crash in NGDP between 1929 and 1933 was the proximate cause of the Great Contraction, and he says Friedman and Schwartz are the people that convinced him of that fact.  Lucas taught us (back in the 1970s) that he saw his job as providing a model with micro-foundations for the sorts of stylized facts explained by Friedman and Schwartz.  Recall that F&S thought that unstable monetary policy produced fluctuations in NGDP.  In the short to medium run these NGDP changes were partitioned between changes in prices and changes in output, but only prices changed in the long run.  So I believe NGDP is important for basically the same reason that Friedman, Schwartz, and Lucas do—there’s lots of empirical evidence that it’s important in the short run, but not the long run.  Do I have a model?  No, but I can point to dozens of different NK models that all reach the same general conclusion—minimize nominal shocks.  We don’t know which one is right; my hunch is that there are multiple reasons why nominal shocks matter, so most of the models are catching some aspect of reality.

The recent (2008-09) NGDP crash was the largest since the 1930s, and Lucas has argued that the Friedman and Schwartz story applies to the steepest part of that crash, in late 2008 and early 2009.  However he also believes that the slow recovery is better seen as an example of the sort of stagnation that hit Europe after the 1970s, when natural rates of unemployment rose to a much higher plateau.  That’s not an entirely unreasonable hypothesis; after all, inflation has fallen by less than most NK models would have predicted.  So it does look like we have some supply-side issues (even more so in Britain.)

David’s query breaks down into two separate questions:.  First, does one accept the basic “nominal shocks have real short run effects” approach of everyone from Krugman to Lucas.  I do, but won’t defend that here.  And second, the much harder question of whether the original (late 2008) nominal shock has now morphed into a real (or “supply-side”) problem.  As I indicated with the UI example, I think demand and supply-side factors can get entangled, but I have other reasons for continuing to favor faster NGDP growth.  I’ll name just a few, and this list is by no means comprehensive:

1.  I favor level targeting much more than I favor NGDP targeting.  Recent macro models (Woodford, etc.) suggest that current NGDP is strongly impacted by future expected NGDP.  In that case level targeting offers two big advantages.  If the Fed had promised in late 2008 to eventually return NGDP to the original trend line, then the short term crash would have been much smaller.  This goes against the common sense of elite macroeconomists like Jim Hamilton.  It seemed like things were falling off a cliff in late 2008 and that there was nothing the Fed could do about it.  But one of the major factors causing that perception was crashing asset prices, which were making the financial crisis much worse.  With level targeting people would expect asset prices to be higher in the future, which would tend to make current asset prices higher, and that would lessen the severity of the financial crisis.  One reason I favor more NGDP now is that even a belated shift toward level targeting would help to restore Fed credibility in future recessions, which is especially important if they again run up again the zero bound (as Woodford has emphasized.)  It’s easier to prevent NGDP from plunging in the short run if markets expect it to return to trend in the not-too-distant future.  The second advantage is that it makes policymakers more accountable.  They can’t keep sweeping past errors under the rug (as the BOJ does.)

2.  But does it still make sense to go back to the pre-2008 trend line?  Probably not, recently I’ve been calling on the Fed to go about 1/3 of the way back to that trend line, and then start a new policy trajectory (hopefully explicit in this case.)  Obviously that’s a subjective judgment, which weighs the costs and benefits of a bit more stimulus now.  In a perfect world the Fed would have an explicit NGDP target trajectory, and we wouldn’t have to make those sorts of discretionary decisions.  But the fact is that the Fed currently uses discretion, and hence ANY ADVICE that any macroeconomist gives the Fed is inherently discretionary.

3.  Are there any other factors besides inefficient government policy (40% higher minimum wages, extended UI benefits, etc) that can explain the fact that inflation has fallen less than expected?  Yes, energy prices have been quite high.  Most macro models suggest that NGDP and price level targeting are identical in the presence of demand (or velocity) shocks, but NGDP does better when there are supply shocks.  However, even from the perspective of price level targeting, one can make a strong case for more monetary stimulus, faster NGDP growth.  The inflation rate since July 2008 is the lowest since the mid-1950s, well under the Fed’s 2% goal.  Admittedly the Fed does inflation rate targeting, not level targeting, but economists like Woodford and Bernanke have argued that level targeting does better at the zero bound.  So we need some extra inflation (and hence NGDP) just to catch up to a 2% inflation trajectory from July 2008.  Doesn’t it seem slightly crazy to undershoot our inflation target in the midst of the biggest global debt crisis ever?  What purpose could that possible serve, even if we didn’t face an elevated rate of unemployment?

4.  Some argue that the problems are “structural,” related to Obama’s big government policies.  I oppose those policies, but see no evidence they have much impact on the business cycle.  I’m old enough to remember Johnson’s Great Society, which was really big government.  That had no cyclical effect at all, indeed the economy boomed throughout the entire 5 and 1/2 years LBJ was in power.  I do accept the studies that the 40% jump in minimum wages and the extended UI has slightly boosted the natural rate, but the huge NGDP crash caused the UI extension, and made the ratio of the minimum wage to NGDP much higher that Congress had anticipated.

5.  I put much more weight on market reactions to policy than most other macroeconomists.  Liberals often assume markets are irrational, and conservatives love the EMH except when it tells them their pet macro theories are wrong (as when old monetarists predict high inflation despite the TIPS markets telling them it won’t happen.)  I recall that back in the 1970s higher inflation hurt equity prices (and that’s been confirmed in at least one study.)  More recently, studies by David Glasner and others have showed that beginning around 2008 equity prices actually began to be positively correlated with expected inflation.  Those two studies suggest the market doesn’t like very high NGDP growth, presumably because it results in higher inflation, and thus higher real tax rates on capital.  But markets also don’t like very low NGDP growth, presumably because it depresses RGDP for a few years.  I’m reassured that the markets seem to currently root for at least slightly higher NGDP growth during precisely the same time periods where market monetarist models say it’s needed.

6.  Because I’m a big fan of ratex and the EMH, it is with great reluctance that I have come to accept that there is some money illusion in the labor market.  In 2009 everyone at Bentley got a 0% pay raise.  Why not some other number, like negative 0.5%?  It could be because the zero raise was optimal, but zero raises are waaaaaay more common than negative 0.5% raises, and I can’t see any other explanation than money illusion.  So I think one reason why unemployment remains elevated is that nominal wage growth slowed but then leveled off at about 2%, which reflects some workers getting 0% raises (who should get negative nominal raises) and some in healthier industries getting 4% raises.  It is true that some workers do get nominal pay cuts, but that doesn’t mean that money illusion isn’t making the labor market at least slightly more inefficient at this moment.  It’s a complicated world out there, and not all labor markets need be inefficient for this to be a problem.

7.  In the 1990s we had lots of good luck, lower energy prices and increasingly cheap imports from China.  Now Chinese wages are soaring, and Chinese growth is boosting world commodity prices.  Thus it’s baked in the cake that Americans must accept a lower living standard, or at least a lower rate of increase than in the 1990s.  With NGDP targeting that is effected through modestly higher inflation, and stable nominal wage growth.  With inflation targeting you get stable inflation, and wage cuts.  Given my read on our labor market, I think the modestly higher inflation approach is the easiest way to make the needed living standard adjustments.  I understand it’s hard to model this claim, and others may disagree.  But that’s how I read the empirical evidence going all the way back to my study of the Great Depression–sticky wages are a bigger problem than sticky prices.

8.  Suppose it’s a coin toss as to whether my macro arguments are correct.  Maybe we get a better path of real GDP, maybe we don’t.  We also face a severe global debt crisis, so I think that also at least slightly tips the balance toward faster NGDP growth, especially since inflation has averaged well under 2% since mid-2008.  BTW, David Beckworth has argued that foreign monetary policies are linked to US policy.  Hence it’s likely that faster growth in the US would lead to at least slightly faster growth in Europe.  Notice that the strongly positive reaction of US equity markets to Fed easing initiatives is echoed in foreign equity markets as well.  And the effects are so strong I doubt it is merely reflecting their exposure via exports to the US.

9.  The widespread perception that we have a demand shortfall has created all sorts of inefficient government policies.  For instance, many economists have argued for more government spending to boost demand.  I fear that will lead to lots of waste.  If we target NGDP forecasts, there is no longer any argument for (wasteful) fiscal stimulus.  GM was bailed out partly because many feared GM workers would not be able to find jobs elsewhere, due to the recession.  If we knew that any extra spending on GM cars would mean less spending on other US produced output, and less jobs in other companies, the case for bailing out GM (which I opposed anyway) would be much weaker.  Ditto for too-big-to-fail, which is often defended on the grounds that a banking panic would depress AD.

These are the arguments that I was able to immediately recall, but if you are crazy enough to pour through 1000s of my old blog posts, you’ll find dozens of others.  I’m an eclectic pragmatist, not someone who believes we can build “the model” and get useful policy advice from that model.

My National Affairs article has lots of arguments against inflation targeting.  Here’s two that many macroeconomists overlook:

1.  The measured CPI inflation rate doesn’t measure the sort of inflation that is useful for purposes of macroeconomic stabilization.  For instance, housing is 39% of the core CPI, and it actually rose, even in relative terms, between mid-2008 and mid-2009.  The reason deflation is bad is because companies can no longer profitably produce output, and therefore lay off workers.  We know that housing prices plunged between mid-2008 and mid-2009, and that’s why far fewer houses were built.  But our wonderful CPI told us that housing prices were rising faster than other goods, hence firms should have been rushing out to build more new houses!

2.  The public doesn’t understand inflation targeting, because they aren’t able to distinguish between supply-side inflation, which reduces real income, and demand-side inflation, which raises real income in the short run.  Hence when Bernanke announced in 2010 that he wanted to boost core inflation back up from 0.6% to 2.0%, he had in mind higher AD which would boost both inflation and real income.  But people who heard this on the news could only picture supply-side inflation.  They thought Bernanke wanted to raise their “cost of living.”  There was a firestorm of criticism which made the Fed’s job much harder.  NGDP targeting is easier to explain, you are trying to make the incomes of Americans rise at a rate consistent with prosperity, but not excessive inflation.  I think that policy could be sold to the public.  I don’t think they’ll ever buy a symmetrical inflation target.  They think inflation is bad.  Indeed so much so that when I point out that plunging housing prices should have reduced inflation, I get nothing but puzzled looks.

Andolfatto concludes as follows:

I have not even touched upon the practical feasibility of NGDP targeting–I’ll save this for another day. But for now, I’d like to know the answers to my questions above. Who knows, I too may become one of the faithful!

I find that a very refreshing attitude.

HT:  David Beckworth

Update: Nick Rowe provides three pretty good arguments for NGDP targeting, and one absolutely irrefutable argument.


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51 Responses to “Can we be confident about the benefits of more NGDP?”

  1. Gravatar of Jon Jon
    28. April 2012 at 11:47

    Some argue that the problems are “structural,” related to Obama’s big government policies.  I oppose those policies, but see no evidence they have much impact on the business cycle.

    What you mean to say here is that you don’t think obama’s policies are coupling into confidence. The stronger interpretation of a critique of Obama is that his policies are interacting adversely with the inflation target monetary regime we’re in. Namely, that the policy changes since 2006 have steepening the AS curve. What we’ve seen is that an increasing share of GDP is in the Federal government sector. That’s lowering trend growth and keeping unemployment higher. There is also an effect of nudge policies–direct spending such solar energy projects and regulatory nudges like the threat of sharp coal restrictions in the future that are driving private sector decisions to be less optimal. The net of which is again steeper AS.

    Now we don’t see inflation booming from these policies because we have a inflation targetting CB, what we are seeing instead is a slow down in real growth because the current target is too low given the market changes, meaning policy is tight.

    Ngdp level targeting might win here, but only because we need more inflation to accommodate the destructive policies now in effect. We’d still have these effects if we had been on trend, and so it is merely a coincidence that ngdp targeting would help today.

  2. Gravatar of Morgan Warstler Morgan Warstler
    28. April 2012 at 11:52

    “Thus it’s baked in the cake that Americans must accept a lower living standard, or at least a lower rate of increase than in the 1990s.”

    This is wrong. If you say it again, you look retarded.

    Last week, I wandered into a 2000 sqft. house in SoCal rented and lived in by large extended family ($1500 mo). Nice lawn, well kept, nice furnishings.

    They have been renting this this house for 12 years.

    2 of 3 bathrooms DO NOT WORK. Haven’t for two years.

    Electric in half of house DOES NOT WORK. Candles burning in kitchen.

    WTF right?

    Easy peasy…. owner didn’t pay mortgage for 3 years – but cashed the rent checks. AND fought bank foreclosures tooth and nail on multiple props… thanks Obama.

    Near as I can tell, owner not really owning a $1 of equity ever, used long term renter revenue to get a couple HUNDRED THOUSAND in free money on this house to buy and refi in 2007.

    ——

    BUT, renter has big screen TVs. Renter has high speed broadband computer enough to have researched new owner of house and is so excited to get house fixed

    Renter has beef in fridge, large meal cooking on stove, and mentions dis-ability check that covers rent.

    AND ALL OF THIS, no matter hoe screwed up, if a better life for the family than 1996.

    THIS is what the housing crisis created.

    This is a real accurate snapshot of the “there was no housing crisis” world the Scott waves away.

    STFU.

    The entire Sumner story only works if the above doesn’t happen.

    Stop lying about what happened in 2004-2007.

    8-12M homes just like this.

    change. your. narrative.

  3. Gravatar of Morgan Warstler Morgan Warstler
    28. April 2012 at 11:55

    Scott, you need to ask yourself what policy choices you want to about if 2M scumbags,

  4. Gravatar of Morgan Warstler Morgan Warstler
    28. April 2012 at 11:56

    were responsible for 80% of the properties like I described above.

    Does your policy screw those 2M into the ground, and END THEM, or not?

  5. Gravatar of Benjamin Cole Benjamin Cole
    28. April 2012 at 12:15

    I am already convinced, but I still enjoyed this long and thoughtful post.

    Go Market Monetarism!

  6. Gravatar of Bill Woolsey Bill Woolsey
    28. April 2012 at 12:36

    Jon:

    I don’t agree that these policies make the short run aggregate supply curve steeper. That would imply that a decrease in nominal spending would have a larger effect on prices and a smaller effect on real output.

    The usual notion is that anti-productive policies shift the short run aggregate supply curve to the left and up, not that they make the curve steeper.

    It isn’t that growing expenditure generates only a little more output and alot higher prices. It is rather that higher prices go with any level of real output.

    With an inflation targeting regime that requires lower nominal incomes. Lower profits immediately, lower wages, and lower interest rates on new loans.

    With nominal GDP targeting, the price level shifts to a higher growth path, so that a given growth path for nominal incomes involves a lower growth path of real incomes.

    Still, I think the bigger problem is that bad supply side policies might result in a lower natural interest rate. With interest rate targeting, this causes a problem.

    Further, since we don’t have “the” interest rate, greater worries about future economic conditions might cause an increase in risk adjusted interest rates and a decrease in lower risk and short assets.

    Targeting short and low risk assets, like the Federal Funds rate, is expecially problematic.

  7. Gravatar of Jon Jon
    28. April 2012 at 12:50

    Bill writes: “With nominal GDP targeting, the price level shifts to a higher growth path, so that a given growth path for nominal incomes involves a lower growth path of real incomes.”

    Right you mean rate targetting. I agree.

    Bill then writes: “Still, I think the bigger problem is that bad supply side policies might result in a lower natural interest rate. With interest rate targeting, this causes a problem.”

    That’s a nice way to look at it. We need policies to raise the natural rate…

    While I do support the idea that policy is effective at the zero bound, I also see policy as being more effective above the zrb. Nick Rowe says this is just a social construction of course–policy is more effective above the zero bound because we have a habit of communicating in rates and thus the strongest coupling of the future to the present is through this mental habit. Expectations are a powerful tool on there own… But the price of hot money today with respect to the natural rate is even more potent.

  8. Gravatar of Becky Hargrove Becky Hargrove
    28. April 2012 at 13:26

    Nick sounded a little hesitant today, but NGDP is “still rock and roll to me”:)

  9. Gravatar of Major_Freedom Major_Freedom
    28. April 2012 at 13:45

    Lucas says the 50% crash in NGDP between 1929 and 1933 was the proximate cause of the Great Contraction, and he says Friedman and Schwartz are the people that convinced him of that fact.

    What does Lucas say was the cause of the drop in money supply that led to the drop in spending?

    It’s not that I think there is any single overwhelmingly persuasive case for faster NGDP growth, but rather that there are many arguments, of varying persuasiveness, all pointing in the same direction.

    Of course when one starts with the notion that aggregate demand is the primary driver of the economy, i.e. we assume that the NGDP targeting models are valid, then of course one can then pretend to engage in a series of seemingly independent, disparate, “complex” pseudo-mosaic analysis that, my oh my, for some inexplicable reason, ends up back where one starts, namely that NGDP targeting is where it all “ends up.”

    Aggregate demand is not the primary driver of the economy, and prices are not so sticky downward in the absence of inflation and other state intervention that unemployment and output are permanently reduced. Prices do adjust, and the pain can be felt sooner, when it is smaller, or the pain can be felt later on after inflation is used to stave off the pain, in which case the pain will be even greater.

    Tens of millions of people became painfully unemployed post 2008 because the Fed and the Treasury did not let the market correct in the recession of 2001. If the Fed and Treasury did not print or spend any money to “stimulate” the economy after 2001, then we would not have had such high, tens of millions sized, unemployment post 2008.

    And, because the Fed and Treasury did not let the economy correct post 2008, because the pain was avoided yet again, the next bust is going to be even worse, and the pain is going to be even greater.

    It’s no solution to the pain of a hang-over to get even more drunk, but that seems to be the solution of market monetarists, who believe that the fall in aggregate demand that is crucially important to market corrections, is “unnecessary” and “painful.” They are causing more pain by trying to eliminate the pain with faulty methods.

    But let’s start with Lucas, as I imagine David (wisely) respect his views more than mine.

    Do you accept the general intuition behind the Lucas Critique, which is the reification fallacy? Goodhart’s law states that any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes. In other words, the seeming statistical regularity between NGDP and employment and output, say in Utopian Australia, will tend to collapse once NGDP is explicitly controlled.

    This is what has already happened to price targeting and the seeming but no longer statistical regularity between prices and employment/output.

    Lucas taught us (back in the 1970s) that he saw his job as providing a model with micro-foundations for the sorts of stylized facts explained by Friedman and Schwartz. Recall that F&S thought that unstable monetary policy produced fluctuations in NGDP. In the short to medium run these NGDP changes were partitioned between changes in prices and changes in output, but only prices changed in the long run. So I believe NGDP is important for basically the same reason that Friedman, Schwartz, and Lucas do—there’s lots of empirical evidence that it’s important in the short run, but not the long run. Do I have a model? No, but I can point to dozens of different NK models that all reach the same general conclusion—minimize nominal shocks. We don’t know which one is right; my hunch is that there are multiple reasons why nominal shocks matter, so most of the models are catching some aspect of reality.

    So you want the Fed to treat the economy like a laboratory, where millions of people are to be like lab rats, who are going to show you in the future what you are not sure of today, that NGDP targeting will “work.” This is sociopathology. If empirical evidence is truly accepted, then the empirical evidence of 18 recessions including the Great Depression and the current Great Recession, 2,241% cumulative consumer price inflation, and an increase in the money supply of 12,230%, all since 1913, shows the Fed to be a failure. It is time to give up the dream of turning stone into bread, and lead into gold, and paper money into stability and real wealth. The next religious sect of NGDP targeting is just the same failure dressed in new clothes.

    1. I favor level targeting much more than I favor NGDP targeting. Recent macro models (Woodford, etc.) suggest that current NGDP is strongly impacted by future expected NGDP. In that case level targeting offers two big advantages. If the Fed had promised in late 2008 to eventually return NGDP to the original trend line, then the short term crash would have been much smaller.

    Yes, it would have, but the future crash we are going to experience because of that “inadequate” inflation, is going to be smaller and less painful than it otherwise would have been had the Fed inflated even more post 2008. It is precisely because of the pain we experience today because of only “some” inflation, that the future pain is going to be worse. Of course this is all else equal, so that could change tomorrow if the Fed loses its mind and inflates so much so as to bring NGDP back to pre bubble proportions.

    This goes against the common sense of elite macroeconomists like Jim Hamilton. It seemed like things were falling off a cliff in late 2008 and that there was nothing the Fed could do about it. But one of the major factors causing that perception was crashing asset prices, which were making the financial crisis much worse. With level targeting people would expect asset prices to be higher in the future, which would tend to make current asset prices higher, and that would lessen the severity of the financial crisis.

    Why in the world should bubble priced assets remain in bubble price territory? That’s madness.

    One reason I favor more NGDP now is that even a belated shift toward level targeting would help to restore Fed credibility in future recessions, which is especially important if they again run up again the zero bound (as Woodford has emphasized.)

    That’s not what Bernanke believes. He recently spoke out against Krugman’s call for more inflation, by saying more inflation today would tarnish the Fed’s credibility.

    It’s easier to prevent NGDP from plunging in the short run if markets expect it to return to trend in the not-too-distant future. The second advantage is that it makes policymakers more accountable. They can’t keep sweeping past errors under the rug (as the BOJ does.)

    Even if annual price inflation has to be 10%, 15%, 20% in a correction/recession period, in order to prevent NGDP from falling? Even if it means even more wealth transfer from those who receive the new money last, to those who receive the new money first?

    2. But does it still make sense to go back to the pre-2008 trend line? Probably not, recently I’ve been calling on the Fed to go about 1/3 of the way back to that trend line, and then start a new policy trajectory (hopefully explicit in this case.) Obviously that’s a subjective judgment, which weighs the costs and benefits of a bit more stimulus now. In a perfect world the Fed would have an explicit NGDP target trajectory, and we wouldn’t have to make those sorts of discretionary decisions.

    5% NGDP level growth is discretionary and subjective.

    And which costs and benefits are you referring to? Costs and benefits only exist at the individual level, so obviously you can’t be talking about anyone’s costs and benefits except your own, or, what’s more likely, you’re talking about the costs and benefits to the reified, platonic concept “man”, or “society”, or “humanity”, where this imaginary thinking and feeling entity that “represents all humans” is the one to experience the costs and benefits, and the actual, real world people are mere cells that compose this “person.” Of course you’re the messenger for this entity, and you experience revelations from this entity as to what should be done going forward in its name.

    This concept of “social” costs and benefits, is nothing but a modern day version of attributing costs and benefits to god. The name is different, but the form is identical. The individual is eradicated, ignored, and used as means to the end that is god/man. The individual is to be sacrificed in the name of this abstract concept. The fed is to inflate, and give money to its friends, and for the individuals whose incomes don’t rise, but the prices for the goods they buy do rise, they are to be sacrificed. The banks, the treasury, and the military industrial congressional complex among others are to be awash with Federal Reserve inflation first, and everyone else are to be drained of purchasing power.

    All in the name of god/society. Market monetarist priests consider themselves taking the role of intellectually disseminating and maintaining this new religion. Any questioning of it is met with hostility, hand waving, and accusations of dogmatism.

    But the fact is that the Fed currently uses discretion, and hence ANY ADVICE that any macroeconomist gives the Fed is inherently discretionary.

    Great, so the subjective, discretionary 5% NGDP growth advice should be treated exactly the same as all the other subjective, discretionary advice the fed currently receives: It should be spit at, stomped on, driven over, burnt, buried, exhumed, spat at, stomped on, driven over, reburnt, then launched into deep space.

    Oh wait, I forgot, THIS new subjective, discretionary advice of inflating to force NGDP to rise at a constant rate, is different than all the others. In a world of complexity, of change, of dynamic preferences and demands for money, people are supposedly better off if their aggregate spending patterns are absolutely and rigidly unchanging come hell or high water. 5% is the magic number. Other subjective, discretionary priests believe that 4.5% is magical, and still other priests believe 0% is magical. But no priest wants -0.1% or below. That would be Satanic, because falling prices are evil. Yes, cell phones, televisions, computers, and iPhones are all evil because they are decreasing in price, thus enabling more and more people to buy them. That’s Satanic and should be treated as aberrations, not the natural result of free market activity.

    3. Are there any other factors besides inefficient government policy (40% higher minimum wages, extended UI benefits, etc) that can explain the fact that inflation has fallen less than expected? Yes, energy prices have been quite high.

    Quite high based on what standard? Subjective discretionary claims of what they should be, for example status quo, or status quo plus rate of consumer price inflation, or some other non-human mechanistic process?

    Most macro models suggest that NGDP and price level targeting are identical in the presence of demand (or velocity) shocks, but NGDP does better when there are supply shocks. However, even from the perspective of price level targeting, one can make a strong case for more monetary stimulus, faster NGDP growth. The inflation rate since July 2008 is the lowest since the mid-1950s, well under the Fed’s 2% goal.

    Sure, when we ignore food, energy, and everything else that is rising in price by more than 2%, and if we ignore the change in methodology that took place in between the 1950s and today, which biases the inflation number downwards. If the same methodology for calculating inflation was used today as was used in the 1950s, then consumer price inflation would be roughly 6%.

    Admittedly the Fed does inflation rate targeting, not level targeting, but economists like Woodford and Bernanke have argued that level targeting does better at the zero bound. So we need some extra inflation (and hence NGDP) just to catch up to a 2% inflation trajectory from July 2008. Doesn’t it seem slightly crazy to undershoot our inflation target in the midst of the biggest global debt crisis ever? What purpose could that possible serve, even if we didn’t face an elevated rate of unemployment?

    Doesn’t it seem even more crazy to compare 1950s inflation rate to today’s inflation rate and base one’s call for inflation on that, when the method of calculating inflation has changed, where if the same method was used as in the 1950s, that price inflation would be OVERSHOT today?

    4. Some argue that the problems are “structural,” related to Obama’s big government policies. I oppose those policies, but see no evidence they have much impact on the business cycle.

    The evidence exists, you’re just not looking at it because your religion says it’s all NGDP.

    I’m old enough to remember Johnson’s Great Society, which was really big government. That had no cyclical effect at all, indeed the economy boomed throughout the entire 5 and 1/2 years LBJ was in power.

    And look at the recession and unemployment of the 1970s that took place.

    Maybe you missed the 1970s because you were stoned at the disco?

    I do accept the studies that the 40% jump in minimum wages and the extended UI has slightly boosted the natural rate, but the huge NGDP crash caused the UI extension, and made the ratio of the minimum wage to NGDP much higher that Congress had anticipated.

    Why did NGDP crash, despite the fact that the fed never stopped printing money?

    5. I put much more weight on market reactions to policy than most other macroeconomists. Liberals often assume markets are irrational, and conservatives love the EMH except when it tells them their pet macro theories are wrong (as when old monetarists predict high inflation despite the TIPS markets telling them it won’t happen.)

    TIPS investors can be wrong, just like MBS investors were wrong.

    I recall that back in the 1970s higher inflation hurt equity prices (and that’s been confirmed in at least one study.) More recently, studies by David Glasner and others have showed that beginning around 2008 equity prices actually began to be positively correlated with expected inflation.

    That’s because since 2008, the distorted market is now almost completely dependent on the Fed. You should see the correlation between the Fed’s balance sheet and stock prices since 2008.

    Those two studies suggest the market doesn’t like very high NGDP growth, presumably because it results in higher inflation, and thus higher real tax rates on capital. But markets also don’t like very low NGDP growth, presumably because it depresses RGDP for a few years. I’m reassured that the markets seem to currently root for at least slightly higher NGDP growth during precisely the same time periods where market monetarist models say it’s needed.

    Reassured by what? By whom? From where?

    6. Because I’m a big fan of ratex and the EMH, it is with great reluctance that I have come to accept that there is some money illusion in the labor market. In 2009 everyone at Bentley got a 0% pay raise. Why not some other number, like negative 0.5%? It could be because the zero raise was optimal, but zero raises are waaaaaay more common than negative 0.5% raises, and I can’t see any other explanation than money illusion.

    You mean people who grew up in an inflationary economy, where prices for almost everything keeps rising, will tend to sign contracts in such a way that sees very few pay decreases and very many pay increases? Get out! That means prices are sticky downward, and therefore inflation is justified. Hello circular logic.

    So I think one reason why unemployment remains elevated is that nominal wage growth slowed but then leveled off at about 2%, which reflects some workers getting 0% raises (who should get negative nominal raises) and some in healthier industries getting 4% raises. It is true that some workers do get nominal pay cuts, but that doesn’t mean that money illusion isn’t making the labor market at least slightly more inefficient at this moment. It’s a complicated world out there, and not all labor markets need be inefficient for this to be a problem.

    It’s made easy to understand when you realize that the reason people tend to contract by non-decreasing, or increasing prices, is that they accommodate for the fact that they live in an inflationary economy where prices tend to rise, not a gold standard where prices tend to fall.

    In a world of gradually falling prices on the basis of higher productivity, and gradually falling wage rates on the basis of population growth, you will almost certain see prices and wage rates being “sticky upwards.” Who knows, if we were living in that world, there’d probably be market monetarists calling for even more deflation by the state hoarding or destroying gold, so as to avoid the problems associated with sticky upwards prices and wage rates, hahaha.

    7. In the 1990s we had lots of good luck, lower energy prices and increasingly cheap imports from China. Now Chinese wages are soaring, and Chinese growth is boosting world commodity prices. Thus it’s baked in the cake that Americans must accept a lower living standard, or at least a lower rate of increase than in the 1990s.

    We didn’t have lots of luck in the 1990s. We had a bunch of moron nations importing inflation from the US in exchange for exporting real goods and services. Since China’s Yuan is pegged to the dollar, that has resulted in increasing prices in China. Of course since China has such a higher savings rate as compared to the US, and since they adopted market reforms, their economy grew very fast. The higher wages have accompanied higher worker productivity and capital invested per worker.

    With NGDP targeting that is effected through modestly higher inflation, and stable nominal wage growth. With inflation targeting you get stable inflation, and wage cuts. Given my read on our labor market, I think the modestly higher inflation approach is the easiest way to make the needed living standard adjustments. I understand it’s hard to model this claim, and others may disagree. But that’s how I read the empirical evidence going all the way back to my study of the Great Depression–sticky wages are a bigger problem than sticky prices.

    Wages were sticky in the early years of the Great Depression because of a deliberate policy instigated by Hoover of not cutting wage rates, which did not exist during the 1920 recession and hence wage rates fell, and would have kept falling had the Fed not re-engaged in monetary inflation in 1922.

    8. Suppose it’s a coin toss as to whether my macro arguments are correct. Maybe we get a better path of real GDP, maybe we don’t. We also face a severe global debt crisis, so I think that also at least slightly tips the balance toward faster NGDP growth, especially since inflation has averaged well under 2% since mid-2008. BTW, David Beckworth has argued that foreign monetary policies are linked to US policy. Hence it’s likely that faster growth in the US would lead to at least slightly faster growth in Europe.

    It’s amusing how you make yourself appear somewhat unsure when you’re talking to those open to NGDP, but when you’re talking to hard core critics of NGDP, it’s all certainty and sureness. It’s very much like Catholics and Christians using more humble language with each other, but when they both speak to atheists, they turn into absolutists who know god’s will.

    Why is that?

    Notice that the strongly positive reaction of US equity markets to Fed easing initiatives is echoed in foreign equity markets as well. And the effects are so strong I doubt it is merely reflecting their exposure via exports to the US.

    The fact that the stock market is so strongly correlated to fed inflation, should be setting off dire warning bells to you, not a reason for self-righteous “aha, told you so” gloating.

    Am I the only one on this board who sees that because the fed bought 61% of all treasury debt issued last year alone, and because the stock market is moving in tandem with the fed’s balance sheet, that maybe, just maybe, inflation that has taken place for so long has turned the economy into a non-self-sustaining economy, that can no longer be sustained without continuous inflation, which will just make consumer prices rise even faster than the 6% clip they are currently rising at today, if the 1990 method of calculating inflation was used? It is highly fallacious to infer that because reported inflation is “low”, that actual price inflation is low. Actual price inflation is now high, much higher than the number the BLS reports.

    9. The widespread perception that we have a demand shortfall has created all sorts of inefficient government policies. For instance, many economists have argued for more government spending to boost demand. I fear that will lead to lots of waste.

    Why does inflation financed treasury spending lead to waste, whereas inflation financed bank spending not lead to waste?

    Why are you ignoring the fact that targeting NGDP requires equivalent fiscal spending, since you are advocating for the Fed to buy treasuries? What, did you think that when the Fed buys treasuries, that somehow that isn’t the fed financing government spending? NGDP targeting, since it requires government spending, is therefore “wasteful” according to your own worldview.

    If we target NGDP forecasts, there is no longer any argument for (wasteful) fiscal stimulus.

    What do you think government debt financed spending, which is itself financed by the fed when they buy treasuries – 61% in 2011 alone – really entails? It’s government spending!

    Every time you say the fed should buy treasuries to “stimulate” the economy by inflation, to target NGDP, you are calling for wasteful fiscal stimulus.

    GM was bailed out partly because many feared GM workers would not be able to find jobs elsewhere, due to the recession. If we knew that any extra spending on GM cars would mean less spending on other US produced output, and less jobs in other companies, the case for bailing out GM (which I opposed anyway) would be much weaker. Ditto for too-big-to-fail, which is often defended on the grounds that a banking panic would depress AD.

    Don’t look now but you just weakened NGDP targeting.

    If you knew that the fed buying treasuries and the resulting government acquisition of scarce resources would mean less resources available to everyone else, the case for buying treasuries would be much weaker.

    These are the arguments that I was able to immediately recall, but if you are crazy enough to pour through 1000s of my old blog posts, you’ll find dozens of others. I’m an eclectic pragmatist, not someone who believes we can build “the model” and get useful policy advice from that model.

    You’re not eclectic. You advance an 5% NGDP targeting, very non-eclectic model.

  10. Gravatar of Confidence in NGDP Targeting « Increasing Marginal Utility Confidence in NGDP Targeting « Increasing Marginal Utility
    28. April 2012 at 13:59

    [...] Scott Sumner, Andolfatto writes, What I am curious about is not that they believe this, but how strongly they [...]

  11. Gravatar of Beckett Beckett
    28. April 2012 at 14:29

    Scott, I have become one of the faithful!

    Now, to celebrate: http://www.youtube.com/watch?v=YgYEuJ5u1K0

  12. Gravatar of Benjamin Cole Benjamin Cole
    28. April 2012 at 14:39

    BTW, I do take issue with the idea that China’s higher wages and push on global commodity prices will mean (even) relatively lower living standards for USA’ers.

    Let’s imagine the Chinese soar to living standard triple ours–and start to farm out jobs to the USA that only pay double our living standard.

    Of course, I have exaggerated to make a point, but some version of this could happen. Already, US manufacturers are restoring jobs that had been in China, leading to higher living standards for the factory workers they hire.

    Add on: As the productivity of USA works rises, our living standards should rise also (setting aside distributional issues).

  13. Gravatar of Hugh D’Andrade Hugh D'Andrade
    28. April 2012 at 15:37

    Scott,
    What do you mean by “money illusion”?
    Hugh

  14. Gravatar of Major_Freedom Major_Freedom
    28. April 2012 at 16:08

    This is what going off the gold standard has done to real wages.

    NGDP growth was “stable” during this entire period.

    The hypothesis that NGDP growth brings about real wage growth is inconsistent with the empirical data, and the hypothesis that going off the gold standard and introducing fiat money brings about real wage stagnation is consistent with the empirical data.

  15. Gravatar of Matt E. Matt E.
    28. April 2012 at 16:18

    If we accept that wages are “sticky” (and I think there’s a large body of evidence supporting this), NGDP targeting helps with the unemployment in this regard. People are very reluctant to accept a lower wage, but can put up with a smaller nominal raise, or even no raise in bad economic times. With NGDP targeting, if RGDP isn’t growing, inflation is, bringing real wages down while nominally staying the same. This is the effect of lowering wages bringing the cost of labor closer to its market-clearing price. Wages stay sticky, but more closely resemble what would happen in a normal free market without sticky prices. Unemployment is helped in the short run.

    When RGDP is growing faster than normal, inflation will be lower than normal, and people’s wages will effectively rise faster again, even if they nominally rise at a “normal” rate. When inflation is 2%, the “standard” 3% raise, common throughout corporate America, is effectively a 1% raise. With NGDP targeting, if RGDP moves to 4%, inflation is lowered to 1%, making the standard 3% raise effectively a 2% raise, double the amount during times with a “normal” 2% inflation rate.

    Just another armchair argument supporting NGDP targeting (or level targeting).

  16. Gravatar of Bonnie Bonnie
    28. April 2012 at 16:24

    MF:

    Capping how much money there can be caps everything. You bury the real difference in opinion here in obfuscation, but it all boils down to whether caps on money to cap government are appropriate versus capping government through the political system and allowing private sector growth within the monetary system.

    There is not one shred of evidence “easy money” causes bad behavior when people are left to weigh investment choices on equal footing, free of government incentivizing the markets to do things they would otherwise not do. Your base theory relies heavily on the fallacy of composition and the bias of information in the midst of a crisis regarding things that occur when government is highly active in the financial sector with regulatory incentives.

    Government had to do multiple things over the course of a decade, try really really hard, to get the results it wanted from the markets regarding housing. These things included participation of the GSE’s, the CRA, changes to the Recourse Rule, looking the other way on CDS, corruption in credit ratings, etc… These things sucked most of the oxygen out of the investment markets, but there were other things going on that we don’t hear about, productive things that are taken very much for granted, that no one can really tell how many people have jobs today because of them or if we are not just barely surviving through the disaster because those investments were made; much fewer of them would have been made in your model because the money would not have been there to do it with.

    On the flip side of the opportunity cost to society in your model is the real economic damage government WILL inflict on the economy through the supply side anyway, the propriety of which is not for us to choose, but is left to the political system that generally reflects the desires of society as a whole. That is the very thing that is hidden in all the obfuscation – you want what the people want to hurt, and hurt so badly that they ought not do it, all the while telling them half truths about the price level so that they believe it is for their own good and will be resigned to not miss what they will never have. If you think inflation is theft, this is likely a much bigger one.

  17. Gravatar of Major_Freedom Major_Freedom
    28. April 2012 at 16:34

    Matt E.:

    If we accept that wages are “sticky” (and I think there’s a large body of evidence supporting this), NGDP targeting helps with the unemployment in this regard.

    Don’t tell that to Brito. He’ll say you have no idea what you’re talking about, hahaha.

  18. Gravatar of Major_Freedom Major_Freedom
    28. April 2012 at 16:57

    Bonnie:

    Capping how much money there can be caps everything.

    False. Prices can fall as production increases.

    And nobody said there should be a cap on how much money there is.

    You bury the real difference in opinion here in obfuscation, but it all boils down to whether caps on money to cap government are appropriate versus capping government through the political system and allowing private sector growth within the monetary system.

    Obfuscation? Not a chance.

    And it all boils down to more than what you say here. I don’t see this choice as a choice I am presenting.

    There is not one shred of evidence “easy money” causes bad behavior when people are left to weigh investment choices on equal footing, free of government incentivizing the markets to do things they would otherwise not do.

    There is a COPIOUS quantity of evidence that shows easy money causes bad behavior. It’s the inflation itself that generates its own moral hazard, it generates its own malinvestment, and it generates the business cycle, and all the garbage associated with it.

    Your base theory relies heavily on the fallacy of composition and the bias of information in the midst of a crisis regarding things that occur when government is highly active in the financial sector with regulatory incentives.

    There is no fallacy of composition in my base theory, and there is no information bias in my base theory. Your base theory is actually relying on the fallacy of composition and information bias.

    Your base theory relies on the fallacy of composition in that you conflate what’s true for a single company: “A single company relies on increasing monetary demand to hire more workers and increase production” and you then infer that this is true for the economy as a whole: “An economy relies on increasing aggregate demand to enable hiring of more workers and increasing production.”

    Your base theory relies on information bias as you fail to take into account the information that precedes the correlation between aggregate demand and output/employment, thus incorrectly inferring that the correlation shows a causation.

    Government had to do multiple things over the course of a decade, try really really hard, to get the results it wanted from the markets regarding housing.

    The government’s regulations only determined where the bubble was concentrated. It doesn’t cause bubbles and busts. Without a single government regulation, a credit expansion based economy will STILL experience booms and busts.

    These things included participation of the GSE’s, the CRA, changes to the Recourse Rule, looking the other way on CDS, corruption in credit ratings, etc… These things sucked most of the oxygen out of the investment markets, but there were other things going on that we don’t hear about, productive things that are taken very much for granted, that no one can really tell how many people have jobs today because of them or if we are not just barely surviving through the disaster because those investments were made; much fewer of them would have been made in your model because the money would not have been there to do it with.

    Artificially low interest rates from the Fed, and credit expansion from the commercial banks, were NECESSARY to the housing boom. Without them, there simply could not be a housing bubble, even with the CRA and GSEs. The profit and loss system would have made it impossible. The housing market would have resembled medicare or some other subsidized portion of the market. It would not have boomed then busted.

    On the flip side of the opportunity cost to society in your model is the real economic damage government WILL inflict on the economy through the supply side anyway, the propriety of which is not for us to choose, but is left to the political system that generally reflects the desires of society as a whole.

    Utterly false. You are ignoring the fact that inflation FACILITATES bigger government. It’s not immune from it. It’s not independent from it. The Treasury is one of the major beneficiaries of easy money, since the Fed eases the money by buying the Treasury’s bonds.

    Tighter money will NOT bring about more economic damage from the government. You are fallaciously assuming that the extent of government involvement will somehow remain the same with tighter money, and will therefore take up a larger portion of the total pie. That’s ridiculous. Looser money is what unleashes bigger government, since it is far easier for the government to finance itself with inflation, than it is with borrowing and taxation, which have far stricter constraints, politically and economically.

    That is the very thing that is hidden in all the obfuscation – you want what the people want to hurt, and hurt so badly that they ought not do it, all the while telling them half truths about the price level so that they believe it is for their own good and will be resigned to not miss what they will never have.

    Wrong. It is precisely you that is advancing a destructive, harmful worldview that hurts people. Your worldview is what has kept real wages stagnant for nearly 40 years. Your worldview of inflation misleads the people, it hurts the people, it deludes people into believing that they are richer than they really are, it harms capital accumulation by artificially boosting profits which are needed to replace the more expensive capital goods but are instead taxed away, it harms worker productivity and thus the worker’s interests, and it puts millions of people out of work when the inflation bubbles burst.

    If you think inflation is theft, this is likely a much bigger one.

    So you admit that inflation is theft? And you advocate for it? You advocate for theft and you have the gall to tell me that my worldview is harmful to the people’s interests?

    Your worldview is incredibly destructive, incredibly harmful, and is the exact opposite of what you believe it is because you don’t understand the monetary system and its connection to the size and extent of government activity.

    Did you know that the Fed secretly sent $40 billion to Iraq from 2003-2008 to finance the war? Now suppose that Congress called to raise taxes to finance that unpopular war. They probably would not have been able to do it. In other words, your advocacy for inflation has indirectly led to the deaths of a hundred thousand innocent Iraqis, and the deaths of thousands of US soldiers.

    Go look in the mirror you deluded inflationista. You’re wasting my time trying to convince me that I’m a monster, when you’re the monster.

  19. Gravatar of ssumner ssumner
    28. April 2012 at 18:20

    Jon, Obama’s policies aren’t significant enough to have a major impact on unemployment (which soared while Bush was president, BTW.)

    Morgan, NGDP targeting doesn’t solve all problems.

    Thanks Ben.

    MR, If money doesn’t have real effects, as you claim, then let those of us who think it does control monetary policy, and you go off and focus on something else. After all, if no real effects then no harm can be done.

    Beckett, If only they were chanting NGDPLT.

    Ben, Yes, I suppose the China argument is debatable. But I could point to other problems, like the huge increase in government under President Bush.

    Hugh, It means confusing real and nominal variables. Thinking in nominal terms instead of real terms.

    Matt E. I agree.

  20. Gravatar of flow5 flow5
    28. April 2012 at 18:40

    Given an output gap, the concept of “ngDp targeting” is very simple. Coming out of a recession economists agree that the economy experiences “re-flation”, but by using the same logic, the economy also experiences “re-growth” (an increase in the “growth rate” of goods & services). Thus, ceteris paribus, it is true that: whenever the target for ngDp is below trend, then “ngDp targeting” is applicable.

    However in the case where aggregate monetary demand proceeds pari passu with real-gDp, a nominal gDp target is moot.

  21. Gravatar of Steve Steve
    28. April 2012 at 18:59

    Scott,

    Your National Affairs #1 point is really important (CPI doesn’t measure a useful sort of inflation)

    My intuition right now is that whenever we get job creation, we start to get household formation which puts upward pressure on rents. This shows up in core PCE inflation (as owner’s equivalent rent) which creates the illusion of supply-side problems.

    But the only supply side problem today is the relative lack of rental housing. This is caused by two factors: 1) the tightness of credit today vs. during the housing ‘bubble’. AND 2) People *no longer expect house prices to rise*, and choose to rent more.

    The issue is that rent-own parity never really got fixed post-housing crash. Houses adjusted to the downside, which restricted supply, but rents never rose. Now, whenever rents rise, the Fed objects to “supply side inflation” but their only lever to restrict that inflation is to stop job creation.

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. April 2012 at 19:04

    I chose to respond to David Andolfatto’s specific questions concerning fixed nominal debt obligations. Here is what I wrote over there.

    David wrote:
    “First of all, as I alluded to above, people can and do renegotiate the terms of nominal debt obligations if things get too far out of whack. True, renegotiation (including outright default) is costly and imperfect, but it happens nevertheless. And to the extent it does, nominal debt is not as “fixed” as some make it out to be. It would be good to know how much renegotiation does or does not happen out there.

    Second, even if renegotiation is quantitatively unimportant, we should consider the dynamics of debt creation and retirement. At any point in time there is an outstanding stock of nominal debt, with terms negotiated in the past on the basis of future price level paths (among other things, of course). We should also keep in mind that new debt agreements are being formed, and old agreements are being retired continuously throughout time. How big are these flows relative to the outstanding stock of debt?”

    This is a large question that demands dividing it into more managable portions. Let’s consider just the household sector for now.

    At the end of 2011, there was some $13.2 trillion in household debt outstanding. Of that nearly three quarters, or about $9.8 trillion, consisted of home mortgages (Table D3):

    http://www.federalreserve.gov/releases/z1/Current/z1r-2.pdf

    Let’s consider home mortgage debt.

    NGDP and RGDP both reached a trough in 2009Q2, so to answer the question we would need to find out how much home mortgage debt had been renegotiated, defaulted, retired and nwly created since then. The Mortgage Banker’s Association (MBA) keeps track of the number of originations subdivided into new originations and refinances. Assuming there is no double counting (multiple refinances on the same mortgage) if one takes the sum value of those originations and subtract it from the outstanding mortgage debt we should have a rough estimate of the value of all the mortgage debt that was negotiated prior to 2009Q3. (We needn’t worry about the principle balance since that will barely change in a new loan after 10 quarters.) Mortgage originations totaled roughly $3.5 trillion in 2009Q3 through 2011Q4, of which about 60% consisted of refinances (Figure 8):

    http://www.mortgagebankers.org/files/Research/IndustryArticles/FratantoniKan_0112.pdf

    So after 10 quarters (not counting 2012Q1) about 36% of outstanding home mortgage debt has been negotiated since the attainment of the new NGDP trajectory.

    What about the remaining $3.4 trillion in household debt?

    Well, according to the NYFRB, it falls into the following categories (rounded, Page 5):
    1) Home Equity 18%
    2) Auto Loan 21%
    3) Credit Card 21%
    4) Student Loan 25%
    5) Other 11%

    http://www.newyorkfed.org/research/national_economy/householdcredit/DistrictReport_Q32011.pdf

    Assuming HE loans are newly created, retired, defaulted and refinanced at the same rate as mortgages then about 36% of HE debt has been negotiated in the ten quarters through 2011Q4.

    Theoretically there is an auto loan refinance industry. In practice it rarely happens because banks look at resale value. Thus for auto loans we only need to consider the rate at which they are paid off and newly created. Assuming a typical auto loan is for five years and assuming that the auto loan origination rate is proportional to the value of motor vehicles and parts expenditures in BEA Table 2.3.5 then approximately 43% of outstanding auto loan debt has been taken out since 2009Q3. For auto loans, given their short life, we have to consider principal balances. Taking that into account one comes up with a an estimate of 70% for the amount of outstanding auto loan debt taken out since 2009Q3.

    Credit card debt is revolving. The question really is how much of the principal balance has been incurred since 2009Q3? Who really knows? I don’t even think banks keep track of such numbers.

    Student loans are generally speaking not renegotiable. So then the question becomes how much has been retired and newly created in 10 quarters. Given that student loan debt is a lot like a mortgage these days, although with a somethat shorter term, I would guess roughly 20% of the outstanding student loan debt has been originated since 2009Q3.

    Which leaves Other, which is probably unsecured debt similar to credit card debt. For sake of argument let’s suppose that of the outstanding credit card debt and Other about half has been originated since 2009Q3.

    Now, a simple weighted average results in an estimate of 44% for the proportion of non-mortgage debt that has been originated/refinanced in the ten quarters through 2011Q4, or approximately $1.5 trillion.

    Thus a total of perhaps $5 trillion in debt has been originated/refinanced since the new NGDP trend has been established. Which means that about $8.2 trillion or approximately 64% was negotiated before the new trend was established.

    Assuming that the rate of origination/refinancing is linear (dubious) then it will take a least another five years before all household debt conforms to current NGDP growth expectations.

    One major caveat remains however. Just because one chooses to refinance a debt does not mean that the new terms are compatible with one’s nominal income expectations going foreward. In many cases people are simply exercising an opportunity to modestly reduce their mortgage payments and/or hold on to their homes. And many of the people who might benefit the most from refinancing cannot because of underwater mortgages, reduced earnings, degraded credit ratings and tightened lending standards.

    Thus I suspect this is a very optimistic estimate of the degree of adaptation to new circumstances.

  23. Gravatar of Ron Ronson Ron Ronson
    28. April 2012 at 19:23

    I am new to economics. When I first heard about NGDP targeting it all made sense but a few weeks later I have the following concerns:

    - NGDPT targets spending on final goods (both investment and consumption) and will increase the money supply until the target is met. Final goods are not the only things people spend money on. They also buy assets (stocks, property etc). If people don’ t want to buy consumer and investment goods and the CB increases the money supply to encourage them to do so then they may spend the new money on these other assets which will cause booms in those areas. I’m not sure what effect this would have but it seems like it could be harmful.

    - NGDPT increases the money supply by taking actions that increase increase the reserves that banks have available to lend out. This may increase debt-levels and have negative effects.

    There may be simple answers to these concerns – if so please let me know.

  24. Gravatar of Major_Freedom Major_Freedom
    28. April 2012 at 19:41

    ssumner:

    MR, If money doesn’t have real effects, as you claim, then let those of us who think it does control monetary policy, and you go off and focus on something else. After all, if no real effects then no harm can be done.

    I didn’t claim money doesn’t have real effects. I said precisely the opposite. I said money does have real effects.

    Why are you straw manning me so blatantly?

  25. Gravatar of Morgan Warstler Morgan Warstler
    28. April 2012 at 19:50

    Mark,

    $1.2T (12M homes) have to be liquidated and loses assigned.

    The good thing is that no homeowners eat any of those losses. Nobody in those 12M has a dime of equity, many if not most are living for free.

    I do suspect many of the refi you mention were for folks who weren’t underwater, just using their great credit to take advantage of ultra low rates.

    Anyway, I don’t think this is about refinancing the past debts, this is about putting the defaulted 12M back into the market at auction, and keeping that stock from crushing homes values.

  26. Gravatar of Tim Condon Tim Condon
    28. April 2012 at 23:32

    Isn’t the answer to the question “why target NGDP right now?” that it would be a positive velocity shock? Fearing the inflationary erosion of their currency holdings, people would spend, which would boost NGDP “right now.”

  27. Gravatar of Mike Sax Mike Sax
    29. April 2012 at 00:48

    “Some argue that the problems are “structural,” related to Obama’s big government policies. I oppose those policies, but see no evidence they have much impact on the business cycle. I’m old enough to remember Johnson’s Great Society, which was really big government. That had no cyclical effect at all, indeed the economy boomed throughout the entire 5 and 1/2 years LBJ was in power. I do accept the studies that the 40% jump in minimum wages and the extended UI has slightly boosted the natural rate, but the huge NGDP crash caused the UI extension, and made the ratio of the minimum wage to NGDP much higher that Congress had anticipated.”

    “The widespread perception that we have a demand shortfall has created all sorts of inefficient government policies. For instance, many economists have argued for more government spending to boost demand. I fear that will lead to lots of waste. If we target NGDP forecasts, there is no longer any argument for (wasteful) fiscal stimulus. GM was bailed out partly because many feared GM workers would not be able to find jobs elsewhere, due to the recession. If we knew that any extra spending on GM cars would mean less spending on other US produced output, and less jobs in other companies, the case for bailing out GM (which I opposed anyway) would be much weaker. Ditto for too-big-to-fail, which is often defended on the grounds that a banking panic would depress AD.”

    Scott as you acknowledge that there was no cyclical effect to LBJ’s Great Society-glad you also acknowledge that Obama hasn’t spent on that level, not that I wouldn’t like him to-then what is this concern over “waste?” What kind of waste do you have in mind?

  28. Gravatar of foosion foosion
    29. April 2012 at 03:58

    Obama’s big government policies? What are you talking about?

    Consider public employment:
    http://graphics8.nytimes.com/images/2012/04/25/opinion/042512krugman4/042512krugman4-blog480.jpg

    http://krugman.blogs.nytimes.com/2012/04/25/american-austerity/?pagewanted=all

  29. Gravatar of flow5 flow5
    29. April 2012 at 04:19

    Other things being equal.
    Given:

    (1)a discrepancy between the growth of ngDp & its target;
    (2)any ratio between the composition of ngDp (inflation vs. real-output);
    (3)a correction to aggregate monetary demand to adjust the growth of ngDp

    Then: the resultant change to real-growth will be disproportionately greater than the change to the inflation component.

  30. Gravatar of Jon Jon
    29. April 2012 at 06:26

    Jon, Obama’s policies aren’t significant enough to have a major impact on unemployment (which soared while Bush was president, BTW.)

    Like I said in my original post–2006. Last I checked Obama was elected in 2008. He certainly is not the only culprit in the parade of policy changes.

  31. Gravatar of Saturos Saturos
    29. April 2012 at 06:36

    Ron Ronson,

    Actually, we want asset prices to rise, because that will increase consumption and investment through the “wealth effect” and “Tobin effect”. Output prices are correlated with asset prices, which are of course claims on real resources. As they rise it will increase spending on service flows, by both businesses and households. And when real assets are purchased it increases demand for labor. When asset prices rise to the appropriate level so will the level of prices and output. The fact that they are low now is because the markets expect below trend NGDP growth.

    Scott said:

    “but if you are crazy enough to pour through 1000s of my old blog posts”

    Well lock me up and throw away the key, because I must have read at least a few hundred by now. It’s really good stuff, even if you aren’t an NGDP obsessive.

    “most of the models are catching some aspect of reality”

    Oooh! Scott the pragmatist believes in “reality”! What next, objective truth? Gosh, if you aren’t careful, you might even start to take a naive view of things: http://yudkowsky.net/rational/the-simple-truth

    I know you’re going to say that I haven’t accurately represented your pragmatism. Sorry, I just wanted to take a dig at you. For what it’s worth, I actually think William James was a great philosopher. Though I’m not so sure about Rorty…

  32. Gravatar of ssumner ssumner
    29. April 2012 at 07:57

    Steve, That worries me too–the rental equivalent is a poor indicator of housing prices.

    Mark, Thanks for all that info on debt, that confirms what I would have expected.

    Ron You said;

    “If people don’t want to buy consumer and investment goods and the CB increases the money supply to encourage them to do so then they may spend the new money on these other assets which will cause booms in those areas. I’m not sure what effect this would have but it seems like it could be harmful.”

    This is a very common misconception. Spending more money on assets doesn’t cause their price to rise. October 19, 1987 saw the biggest spending on stocks in history (up to that date) and yet stocks plunged 500 points.

    Regarding debt, if there is too much lending the issue should be addressed via regulation–monetary policy cannot address that problem, as it is a real problem, and monetary policy only controls nominal variables in the long run.

    MR, If you think falling NGDP has real effects, then why don’t you want stable NGDP like Hayek does?

    Tim, Yes, that’s right.

    Mike, There’s lots of waste in our spending on health care (which mostly goes to services that do not boost health) and subsidies of intercity rail, or solar panel makers, or lots of other examples.

    Foosion, Never link to Krugman graphs, they are often misleading. That graph doesn’t show what you think, it mostly shows changes in state and local employment. I was talking about Obama’s policies. In addition, his biggest policy (Obamacare) hasn’t yet kicked in.

    Jon, I don’t see how that responds to my claim.

    Saturos, When I say ‘reality’ or ‘truth’ I am using the terms in the Rortian sense. What will eventually become seen as being reality, or being the truth. Of course they are all just models. It’s not turtles all the way down, it’s models all the way down. And that’s the truth–or at least things will be seen that way someday.

  33. Gravatar of Greg Ransom Greg Ransom
    29. April 2012 at 08:42

    I win. You’ve now adopted my position.

    About time.

    Scott Sumner writes,

    “But does it still make sense to go back to the pre-2008 trend line? Probably not.”

  34. Gravatar of Jason Rave Jason Rave
    29. April 2012 at 09:28

    Scott,

    What is the Woodford model you are referring to? You don’t have a reference or just the year for the paper at all do you? Would be very much appreciated.

  35. Gravatar of Saturos Saturos
    29. April 2012 at 10:31

    Ron, actually NGDPLT would reduce the current burden of debt, by boosting nominal incomes. And if you’ve got the time, you may want to read this: http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/08/money-and-debt.html

  36. Gravatar of Ron Ronson Ron Ronson
    29. April 2012 at 10:36

    “Spending more money on assets doesn’t cause their price to rise. October 19, 1987 saw the biggest spending on stocks in history (up to that date) and yet stocks plunged 500 points.”

    Presumably that was because there was also a record amount of selling (to match the buying) but overall the total amount of money invested in the stock money fell that day.

    I don’ think that addresses my point though. If there is an increasing money supply and people don’t want to hold cash balances (perhaps they fear inflation) and don’t want to buy final goods they may want to hold other assets instead. Surely this will drive the price of these assets up ? Of course the number of sellers would match the buyers but price may still rise.

    On the debt issues I really am a bit confused (or perhaps just ignorant) . Can the CB increase the money supply without increasing lending ? My research (such as http://en.wikipedia.org/wiki/Quantitative_easing) seems to indicate not.

    The reason that I am concerned about these things is that if inflating asset prices and/or increased debt are side-effects of NGDP-stabalization policies then I worry that if these policies are implemented then we may see a re-occurrence of the same symptoms that were a precursor of the original NGDP-crash.

    I have seen proposals that NGDP could be stabilized via fiscal policies (Russ Abbott’s paper “Regaining the Great Moderation” – I think you mentioned this on your blog). This proposal seem to have the potential to stabilize NGDP through non-monetary means. Why are MMist generally opposed to this approach ?

  37. Gravatar of Declan Declan
    29. April 2012 at 17:52

    Scott,

    Nice post. As Dr Johnson said “mankind needs to be reminded more often than they need to be instructed”. Or something like that.

    “Most macro models suggest that NGDP and price level targeting are identical in the presence of demand (or velocity) shocks, but NGDP does better when there are supply shocks.”

    Are you thinking of Svensson and McCallum/Nelson?

    Jason,

    I think Scott is talking about ‘Interest and Prices’, Woodford’s 2003 book.

    (I have nitpicked Scott before that Woodford doesn’t explicity argue that current NGDP depends on future expected NGDP, indeed the book hardly mentions NGDP at all. But he does use a New Keynesian IS curve where present real consumption/income depends on expected future consumption/income and the expected real interest rate, which in turn depends on expected inflation, so near enough.)

  38. Gravatar of Why NGDP Targeting? « Uneasy Money Why NGDP Targeting? « Uneasy Money
    29. April 2012 at 18:06

    [...] any alternative nominal target. I am probably the wrong person to offer an explanation (and anyway Scott Sumner and Nick Rowe have already responded, probably more ably than I can), because I am on record (here [...]

  39. Gravatar of Major_Freedom Major_Freedom
    29. April 2012 at 18:30

    ssumner:

    MR, If you think falling NGDP has real effects, then why don’t you want stable NGDP like Hayek does?

    Because I don’t want a stable real economy. I do not want to be dictator. I do not want to support dictators. I do not want to force millions of people to spend a certain amount of money collectively.

    I want an economy that is the collective outcome of individual private property owner preferences, which means ANY real outcome. If that means the general population cutting their losses because the economy is distorted, which results in a period of correction, temporarily declining output, and temporary unemployment, then so be it. If it means the general population deriving a lower time preference, which manifests itself in a higher saving and investment relative to consumption, and growth in real output, then so be it.

    Stability is an absurd standard for subject matter that is NOT stable, i.e. human action. Stability as a goal is an ancient superstition from societies that couldn’t deal with the ceaselessly changing world, and found joy in death, the afterlife, etc, where there is no longer any change.

    You’re seeking death, not life. For death is where stability resides. Life is where change and instability resides. Is economics the science of human action, that is not stable, or is economics is the science of death, which is stable?

    Real output should not be stable, unless the collective decisions of individual private property owners result in real output stability. It’s not an ideal for me, it’s a happenstance. Forcing stability on a system that flourishes on instability and change, is destructive and counter-productive.

    The Fed should not be in the business of micromanaging the economy to make it “stable.” They should not be in the business of stabilizing anything, either output, employment, or money exchanges. They should not be in the business of these things because it attacks voluntary individual preferences that would otherwise result in opposite outcomes.

    Plus, there is the fact that forcing aggregate spending to rise by 5% each year requires inflation, and in our monetary system a substantial portion of inflation takes the form of credit expansion and its concomitant boom and bust generating low interest rates.

    PS Hayek did not advocate for stable spending controlled by the Fed. This is what he wrote about NGDP:

    “The theory which has been guiding monetary and financial policy during the last thirty years, and which I contend is largely the product of such a mistaken conception of the proper scientific procedure, consists in the assertion that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level. Among the various theories advanced to account for extensive unemployment, this is probably the only one in support of which strong quantitative evidence can be adduced. I nevertheless regard it as fundamentally false, and to act upon it, as we now experience, as very harmful.” – F.A. Hayek, Nobel Prize lecture, 1974.

    Hayek would say that acting on your belief of NGDP targeting would be “very harmful.”

    (BTW, I’m MF, not MR)

  40. Gravatar of Greg Ransom Greg Ransom
    29. April 2012 at 19:02

    MF, Hayek here is arguing against a full employment target, not against a pre-announced total money expenditure target, i.e. he’s arguing against manipulating the total money expenditure up and down to achieve a full employment target:

    Hayek wrote,

    “the assertion that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services .. leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level.”

  41. Gravatar of Major_Freedom Major_Freedom
    29. April 2012 at 19:43

    Greg:

    Your interpretation is incomplete. Yes, the context is employment and its relation to aggregate spending, but Hayek clearly said that deliberately maintaining aggregate expenditure, to “act on it” is “very harmful.”

    That is sufficient for my claim that Hayek would have rejected NGDP targeting.

    But this is neither here nor there. I truly do not care what Hayek thought on this matter, or on any other matter, because I am not here defending his ideas. I have my own ideas and those are what I prefer to have criticized.

    I think Hayek was wrong about many things, and so should Sumner or you point out what Hayek said or didn’t say, has no bearing on what I am saying.

    Bringing up Hayek is a diversion.

  42. Gravatar of Mike Sax Mike Sax
    30. April 2012 at 07:16

    Actually Morgan Bernanke probabaly at this point does want Obama to win if you read Greg IP’s article

    “even if Mr Bernanke’s views prevail while he remains chairman, the odds are that he no longer will be after January, 2014. He is unlikely to be reappointed even if Barack Obama is re-elected (even if wanted the job, a big if, he probably couldn’t be confirmed), and certain not to be if Mitt Romney wins.”

    http://www.economist.com/blogs/freeexchange/2012/04/ben-bernanke-and-what-federal-reserve-does-next?fsrc=gn_ep

  43. Gravatar of D R D R
    30. April 2012 at 08:10

    “We know that housing prices plunged between mid-2008 and mid-2009, and that’s why far fewer houses were built. But our wonderful CPI told us that housing prices were rising faster than other goods, hence firms should have been rushing out to build more new houses!”

    House prices aren’t even in the CPI. HousING prices are– rents and owners’ equivalent rents. You’ve mistaken a signal to supply relatively more rental units (for consumption) for a signal to supply relatively more houses (for investment).

    But even then, relative to what? Not relative to apparel. Not relative to alcoholic beverages. Not relative to new vehicles. Pretty much only relative to gasoline. Because what you’re seeing is collapsing oil prices.

  44. Gravatar of Greg Ransom Greg Ransom
    30. April 2012 at 09:41

    The point is that fixing the employment level permanently at a full employment level by manipulating the level of total money expenditure is impossible.

    Also, targeting a total money expenditure level is very different than manipulating the total money expenditure level up and down to “maintain it” at whatever (changing) level is perceived to required to gain full employment.

  45. Gravatar of MMJ MMJ
    30. April 2012 at 10:48

    “Regarding debt, if there is too much lending the issue should be addressed via regulation”

    What makes you think that would be successful? Surely you believe that incentives trump regulation…

  46. Gravatar of Ron Ronson Ron Ronson
    30. April 2012 at 15:16

    Saturos,

    Thanks for your replies.

    I can see merit in your answer about assert price increases being beneficial to NGDP targeting.

    I read the link to the Nick Rowe article. Like all his stuff its interesting but I don’t follow his logic here. Sure, governments are borrowers and in theory new money creation may held them to reduce how much they need to borrow. But, they are not he only borrowers and new money creation that adds to banks reserves will also lower interest rates and encourage private borrowing. Money supply increased steadily during the ‘great moderation’ and this seems the most likely explanation for the large increase in debt that took place during that time.

  47. Gravatar of Bill Woolsey Bill Woolsey
    2. May 2012 at 04:25

    Rob Ronson:

    Total debt doesn’t have to increase for the quantity of money to rise.

    If you assume that the only debt in the economy is funded by the monetary liabilities of banks, (and all money is the monetary liabilities of banks) then changes in the quantity of money necessarily match changes in total lending.

    However, if banks fund their loans with both monetary and nonmonetary liabilities (checking accounts and C.D.s for example,) then the quantity of money can change without any change in total bank lending. The banks can expand the quantity of money and reduce the amount of CD’s without any change in lending.

    Further, if bank loans are not the sole source of credit, there being commercial paper and corporate bonds, for example, then banks can expand the quantity of money and the quanity of bank lending while total lending is unchanged. For example, those who were borrowing by selling commercial paper can get bank loans. Or, the banks can buy existing corporate bonds.

    This analysis is important to understand because it is possible to reduce total debt (that is, more people pay off debts than borrow new funds) while expanding the quantity of money. The opposite is true as well. It is possible for credit to expand, while the quantity of money falls.

    Your theory of excess money going into the stock market is a bit careless. The money doesn’t go into the stock market and get used up there. To the degree people do choose to hold more stock, those who sell the stock end up with the money. It doesn’t go away.

    What would actually happen is that the greater demand for stocks leads to higher stock prices, and perhaps people whose stocks are worth more are willing to hold more money. The demand to hold money must accomodate itself to the quantity somehow or other. The only equilibrium way is a uniformly higher price level.

    Of course, if these stock prices are “too high” relative to the fundamentals, then people who paid those high prices or failed to sell have made a mistake. No one is forcing them to do this.

    In the special scenario where an excess demand for money has already forced real output below potential, and this condition is expected to be maintained, then the fundamentals imply low stock prices because of low profitability. If this problem is fixed by an increase in the quantity of money, and this creates an excess supply of money given the demand to hold money at the reduced current level of output, to the degree some of this excess money is immediately used to buy stocks, the higher prices would simultaneously be reflecting improved fundamentals due to increased production and profitability. Even if there were no people who just shoved excess money into the stock market because they had no better use, and everyone followed fundamental analysis and only held stock as a claim on future profits, then stock prices would rise.

    With interest rates, the situation is different. If increased money is shoved into credit markets because there is nothing better to do with it, or those issuing money expand loans and everyone else keeps on loaning the same, this tends to expand credit and lower interest rates. (You assume this is basically the only possibility.) The lower interest rates create incentives to spend more on output.

    But in the situation where there is an excess demand for money and depressed output for that reason, then to the degree that people realize that output will rise, then there can be a decrease in lending and so lower bond prices and higher interest rates. Basically, those who have been holding securities of various sorts because of poor investment prospects, can sell them to fund the purchase of capital goods. If these sorts of sales are larger than the expansion in the quantity of money, interest rates rise into the recovery. That implies at least slighly lower bond prices.

  48. Gravatar of Ron Ronson Ron Ronson
    2. May 2012 at 09:10

    Bill,

    Thanks very much for your detailed response.

    I am in agreement with Market Monetarists that stabilizing NGDP is the correct way to stabilize the economy. I disagree however with the MMist focus on monetary policy as the best way to achieve this. I believe market-orientated fiscal policy (for example subsidizing all transactions including sales of labor when AD is deficient) is a much more direct way of achieving the same goal.

    In regards to your reply: The first part describes how lending and the money supply can (in theory) move in opposite directions. I don’t disagree – but this doesn’t change my view that during the “great moderation” the upwards trend in money supply was largely drive by monetary policy which then had a direct bearing on the increased debt-levels during that period that have surely had a negative effect on the ability of the economy to get out of the great recession.

    The second part is a great analysis of how monetary policy works to increase NGDP including its affect on asset-process and interest rates. This corrected some errors in my earlier analysis. However there still seems to be a lot of moving parts that may not works exactly as predicted. I also worry that if the expectations-part does not work well and the money supply needs to increase a lot to drive the required change in NGDP then it may be hard to avoid inflation when confidence finally does return and it is necessary to reduce the money supply in a hurry.

    Again I think that the appropriate market-orientated fiscal policy could avoid this.

  49. Gravatar of ssumner ssumner
    2. May 2012 at 18:24

    Greg, I haven’t changed my views.

    Jason, Check out his book, or his papers with Eggertsson.

    Ron, You said;

    ““Spending more money on assets doesn’t cause their price to rise. October 19, 1987 saw the biggest spending on stocks in history (up to that date) and yet stocks plunged 500 points.”

    Presumably that was because there was also a record amount of selling (to match the buying) but overall the total amount of money invested in the stock money fell that day.”

    Every sale is a purchase. Money doesn’t get “invested in” the stock market. Money is a medium of exchange.

    I do agree that if people don’t want to hold money it’s inflationary.

    DeClan, The NGDP literature goes way back–the supply-shock argument is an old one. I’d guess McCallum discussed it.

    DR, I know they aren’t included in the CPI, that was precisely my point.

    MMJ, I don’t think it would be successful if it was more regulation. I want to see it addressed through less regulation.

  50. Gravatar of MMJ MMJ
    3. May 2012 at 07:16

    “MMJ, I don’t think it would be successful if it was more regulation. I want to see it addressed through less regulation.”

    Please explain. The discussions I have seen — from the national CBs, IMF, etc. — of “macroprudential regulation” are about giving more power to regulators to create more regulations, not less.

  51. Gravatar of TheMoneyIllusion » Do you remember when low inflation was good news? TheMoneyIllusion » Do you remember when low inflation was good news?
    13. June 2012 at 06:26

    [...] so confident that market monetarist policies would help the economy.  It’s partly based on all the macro evidence that other economists look at, such as the fact that countries began recovering from the Great [...]

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