It’s not about credit, it’s about NGDP

Because Raghu Rajan’s posts on macroeconomics tend to drive me nuts, let me start off on a positive note, where I partly agree with him:

1.  It’s probably not a good idea to set a 4% inflation target.  (In my view targeting NGDP would be a much better idea.  If we must target prices, let’s level target the CPI on a 2% trend line from July 2008.   We are currently well below that trend line.)

2.  I don’t think Keynesians should be arguing that lower real interest rates are the key to recovery.  A bold and credible monetary stimulus that was expected to produce much faster NGDP growth might well raise long term risk-free interest rates.

3.  At times Keynesians overstate the extent to which all our problems are demand-side, and ignore the structural problems in the economy.

Having said all that, Rajan grossly underestimates the demand-side problem that we still face.  Here’s one example:

Second, household over-indebtedness in the US, as well as the fall in demand, is localized, as my colleague Amir Sufi and his co-author, Atif Mian, have shown.* Hairdressers in Las Vegas lost their jobs because households there have too much debt stemming from the housing boom. Even if we can coerce traditional debt-free savers to spend, it is unlikely that there are enough of them in Las Vegas.

If these debt-free savers are in New York City, which did not experience as much of a boom and a bust, cutting real interest rates will encourage spending on haircuts in New York City, which already has plenty of demand, but not in Las Vegas, which has too little. Put differently, real interest rates are too blunt a stimulus tool, even if they work.

This is the wrong way to think about macro issues.  Start from the fact that the Fed controls aggregate demand, or NGDP, whether they want to or not.  The least bad policy is one that provides macro stability and low inflation (NGDP targeting, in my view.)  When the least bad policy is in effect, policy will necessarily be a bit too expansionary for 50% of cities, and a bit too contractionary for the other half.  There’s no way of avoiding the one-size-fits-all problem in a common currency area.  Right now most cities have way too little demand.

And is it even true that NYC doesn’t face a demand shortfall?  How would Rajan know?  I don’t doubt that most of the people he knows are employed—the same is true for me.  But what does the data show?  It took me 15 seconds to Google this report.   The NYC unemployment rate is currently 9.7%, or 1.5% above the national rate.  Perhaps NYC has a very high natural rate of unemployment, then his argument about “plenty of demand” might be defensible.  But at a minimum Rajan should provide some evidence, as most economists would regard a 9.7% rate as well above the natural rate.

Rajan concludes with this observation:

With a savings rate of barely 4% of GDP, the average US household is unlikely to be over-saving. Sensible policy lies in improving the capabilities of the workforce across the country, so that they can get sustainable jobs with steady incomes. That takes time, but it might be the best option left.

Perhaps a Keynesian can chime in and correct me if I am wrong, but I don’t think the Keynesian argument (which he is attacking) is that the US saving rate is too high.  I had thought that the Keynesians made a distinction between planned saving and actual saving.  Thus when people become pessimistic and try to save more, they don’t actually succeed.  Instead income falls until macro equilibrium is restored.  Indeed the fall in income might well lead to lower investment, and in a closed economy model that means lower realized saving.  Conversely an expansionary policy that made Americans richer might actually lead to an increase in realized saving and investment, even though the initial stages of the expansion might involve an attempt by the public to save less.

My bigger problem with Rajan’s entire approach to macro is that he’s always talking about finance, credit, lending, saving, etc.  The problem is much more basic.  We have far too little NGDP to employ everyone who wants to work at the current salary levels.  We need either much more NGDP or the same NGDP and much lower salaries.  You know which one I favor.   (Hint: it’s the only solution that has a prayer of actually being implemented in the near term.)  If the Fed provides the right amount of NGDP, all those finance issues will take care of themselves.  Real interest rates will find their Wicksellian equilibrium.  Saving, lending, borrowing, etc, will be determined by the public.

The Fed shouldn’t be trying to encourage either consumption or saving.  They should encourage stable growth in NGDP, and let the market allocate that spending according to the preferences of the public.  Since mid-2008 NGDP has grown at the slowest rate since Herbert Hoover was President.  Rajan’s had all sorts of interesting things to say about all sorts of issues, but he doesn’t see the elephant in the room.  Not enough nominal spending for anything close to full employment.

HT:  Oli


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68 Responses to “It’s not about credit, it’s about NGDP”

  1. Gravatar of John Becker John Becker
    9. May 2012 at 03:56

    Scott,

    Do you worry that a fixed nominal GDP target would be considered too “inflexible” if it’s adopted and another crisis rolls around?

    If rules are better than discretion in the realm of monetary policy, why not tie the central bank’s hands further with a commodity standard?

    Why is a system of central planning so popular among economists when it comes to money production when centrally planned industries are so unpopular among economists in any other area?

  2. Gravatar of Brian K Brian K
    9. May 2012 at 04:38

    This is a great example of the difference between Scott’s blog and Krugman’s blog. Scott takes the time to explain his problems with Rajan’s writings. Krugman shoots from the hip, calls it garbage and picks at one thing.

    Scott could you explain, or point me to a post that explains how monetary debasement affects international trade? I’ve always thought that free floating exchange rates would adjust so international trade would be relatively unaffected. In another post one of your commentators indicated that this is not the case. Thanks.

  3. Gravatar of dwb dwb
    9. May 2012 at 04:47

    good post. do people actually look at data? this does not look localized to me:

    http://www.calculatedriskblog.com/2012/04/state-unemployment-rates-decline-in-30.html


    When the least bad policy is in effect, policy will necessarily be a bit too expansionary for 50% of cities, and a bit too contractionary for the other half.

    the same can be said of industries as well.

    Also: NV I think is largely tourism, so yes some of those people in NY fly out to NV to spend money.

    I am just not sure why people want to believe this story so much that they have blinders on.

  4. Gravatar of W. Peden W. Peden
    9. May 2012 at 04:50

    John Becker,

    The danger of people valuing flexibility over rules is present for all policy systems, including (especially?) commodity standards.

    There is a distinction between central banking and central planning, which one can recognise even if one opposes them both. That famous inflationist and statist Friedrich von Hayek understood the difference-

    http://uneasymoney.com/2011/08/09/hayek-on-central-banking-and-central-planning/

  5. Gravatar of Becky Hargrove Becky Hargrove
    9. May 2012 at 05:20

    This post brings up a number of issues for me. First, if only I could remember the source, a recent map showed in high detail the degree of unemployment across the country. What was striking was that unemployment was highest in highly populated areas and cities, lowest in the less populated areas of the interior. In other words, the exact inverse of the Great Depression. It certainly would be good to hear some explanations in that regard!

    Ryan Avent posted last night on something that could possibly help with framing perception, “Crowding out, brought to you by the Fed”. One takeaway IMO was the fact that a government job is by far a more substantial commitment than a private job that affects figures accordingly.

    And framing is really at issue here. I think that’s why Rajan got some progressives so upset, because he took the territory which some make needlessly complex and simplified it for his own purposes. To be sure, it’s the wrong focus as you said. I am starting to think what I appreciated about his writing was that he refused to make it overly complex even if he was off base. And it’s obvious why some would just as soon keep economics too complex for the lay person right now.

  6. Gravatar of Morgan Warstler Morgan Warstler
    9. May 2012 at 05:54

    “We need either much more NGDP or the same NGDP and much lower salaries. You know which one I favor. (Hint: it’s the only solution that has a prayer of actually being implemented in the near term.) ”

    ONCE AGAIN.

    Sumner admits:

    1. The Fed is in charge
    2. The Fed gets what it wants

    Scott doesn’t like:

    1. The Fed is politicized
    2. Level growth starting today

    Scott will ACCEPT:

    1. The Fed is politicized
    2. Level growth starting today

    Rajan and the rest of the conservatives COUNT…

    So, IF NGDPLT was to be adopted it would be far more likely to be adopted where;

    the same NGDP and much lower salaries.”

    This isn’t about where the problems are structural or not, this is about:

    Half the people, the folks who own this country, think the problems are structural…

    So Scott is ASKING FOR MORE than he really cares if he gets.

    And Rajan et al, will take NGDPLT as long at is starts at 4.5% TODAY.

    And Scott woud take that trade and do a victory lap, because in the long run, wh really cares?

  7. Gravatar of James in London James in London
    9. May 2012 at 05:59

    Good post. I think you are getting around to talking about the difference between money and credit. Thanks.

    It does mark you out as different to Keynesians who line up with the banksters and call for more credit, government or private, as a solution to the recession.

  8. Gravatar of dwb dwb
    9. May 2012 at 05:59

    @Becky,

    I think you saw it on Hamilton’s blog?

    http://www.econbrowser.com/archives/2012/04/the_geography_o.html

    Just want to add: if you actually look at the job openings data by sector, there is no consistent pattern of one sector doing better than another. job openings in for example construction and manufacturing have increased on par with hospitality, retail services, etc.

    that said, there is certainly a geographic distribution (which there always is) and issued with labor mobility.

  9. Gravatar of Alex Godofsky Alex Godofsky
    9. May 2012 at 06:26

    John Becker:

    Why is a system of central planning so popular among economists when it comes to money production when centrally planned industries are so unpopular among economists in any other area?

    Becuase a commodity standard is just as central planning as a price level target or an NGDP target or anything the central bank does. The central bank controls the money supply and so you can’t actually tell it not to plan. WHATEVER the central bank does is a “plan”. Therefore, we need to pick the best one.

  10. Gravatar of Becky Hargrove Becky Hargrove
    9. May 2012 at 06:50

    Thanks dwb, and interesting that you brought up the lack of pattern in job openings by sector, because that was definitely on my mind.

  11. Gravatar of Negation of Ideology Negation of Ideology
    9. May 2012 at 06:52

    Alex Godofsky,

    Great minds think alike! I made almost the exact same point on the last thread. Although I think you made it more succinctly.

  12. Gravatar of Dave Schuler Dave Schuler
    9. May 2012 at 07:22

    You might want to compare unemployment rates among large cities rather than just between New York or Las Vegas and the national average. Unemployment is local in two different senses: some areas of the country, e.g. the Southwest, have higher areas than others, and major cities frequently have higher unemployment rates than their surrounding counties, e.g. the unemployment rate for Chicago is 9.8% while the unemployment rate for Cook County (which includes Chicago) is 9.1% (which would suggest that the Cook County unemployment rate ex Chicago is lower).

  13. Gravatar of Dave Schuler Dave Schuler
    9. May 2012 at 07:23

    s.b. “the Southwest, have higher rates of unemployment than others”

  14. Gravatar of Major_Freedom Major_Freedom
    9. May 2012 at 08:14

    ssumner:

    When the least bad policy is in effect, policy will necessarily be a bit too expansionary for 50% of cities, and a bit too contractionary for the other half. There’s no way of avoiding the one-size-fits-all problem in a common currency area. Right now most cities have way too little demand.

    This is a case of you overstating the extent to which our problems are demand-side, and ignoring the structural problems in the economy, exactly like you are correctly stating is the case with Raghu Rajan.

    No city has a “demand-side problem” at all. Every city has more than enough demand to clear the entire market of goods and labor.

    No, the problem is not lack of demand, it’s that the prevailing prices in each city are not justified in accordance with the prevailing capital structures. The reason prices are not justified is because the Fed is currently, and has been for many years, manipulating the money supply and interest rates, and this is preventing investors from knowing what the correct prices should be for the capital in each capital structure stage. These structural problems manifest themselves in an apparent “lack of spending” problem. More spending appears to be needed to make the current capital structure profitable, when in reality it’s the real capital itself that needs correcting, not the money supply.

    For example, suppose in a city there was a series of construction projects where all the master builders believe they have more bricks than they actually have. They each believe they have 50,000 bricks, when in reality each has only 40,000 bricks. Their plans do not match the available capital. Interest rates are lower (thanks to the Fed) than what is justified given the actual amount of real saving in each city (which would have otherwise made interest rates higher).

    As the construction projects are gradually completed, each master builder notices that the prices of bricks and the prices of complimentary resources are going higher and higher than they originally thought. Their projects have a given demand, but it appears that the demand is not high enough. Each builder concludes that the problem is lack of money demand for their projects, when in reality the problem is structural. They started the wrong projects. They should have started projects that require 40,000 bricks, not 50,000 bricks.

    The master builders need more capital, so they desire lower interest rate loans, when what should happen is liquidation of the wrong projects, and correcting into newer, sustainable projects that can be completed with 40,000 bricks.

    Now, given the above, does it make any sense to believe that the optimal solution to the above problem should be for the monopoly money producer to print money, and to lower interest rates, so as to avoid correction and to delude the master builders into believing they really do have 50,000 bricks so that no corrections occur and nobody has to be laid off, and the seeming lack of money demand can be solved?

    Market monetarists are looking at the economy totally backwards. You keep making the same mistake that the apparent lack of demand is somehow a primary cause of the problem of not enough bricks (hello!), when in reality the lack of demand is merely an EFFECT of the problem of the wrong projects being started that was itself caused by the very thing you are advocating right now as a “solution”, namely more money inflation which deludes investors!

    You market monetarists look at the economy in a mechanical manner, instead of understanding it to be a HUMAN creation. You see prices, you see spending, you interest rates, and other nominal data, and you try to find secret control mechanisms that can make this consequential data “stable”, while totally ignoring the real structure and human aspect of the economy. You don’t ever study the human element. You only ever look at the consequences of human choices, and believe that by changing “undesirable” outcomes to be “desirable”, that you’ve somehow solved the problems that led to those “undesirable” outcomes, as if you can go backwards from effect to cause.

    You’re like mad scientists who believe that you can fix an unsustainably expanding boiler, by changing the location of the gauge needle on a boiler via directly touching and changing the temperature of the gauge, as if the expanding boiler is getting more and more pressurized BECAUSE of the gauge needle moving up, instead of being a CAUSE for the gauge needle going up.

    Stable money spending is a result of a sustainable capital structure, the same way a stable gauge needle is the result of a sustainable pressure in the boiler. Changing spending, or changing the gauge needle, aren’t solving the problems that are in fact the causes for why the spending and why the gauge needle are going haywire.

    The economy doesn’t need more spending, the same way the boiler doesn’t need a gauge that has a higher upper limit. What is needed is to fix the errors WITHIN the economy, the same way what is needed is to fix the errors WITHIN the boiler.

    Just like locally changing the gauge needle on the boiler misleads the technician as to what is happening in the boiler, so too is locally changing “spending” misleads investors as to what is happening in the capital structure of the economy.

    For the love of people’s health, let the errors in the boiler be fixed by the technicians by leaving the gauge needle alone to do its job, and let the errors be fixed by investors in the economy by leaving money alone to do its job.

    The reason why the economy continues to slag if because the Fed continues to print money continues to keep interest rates low by printing money into the banking system, continues to prevent the prevailing errors from being corrected by investors. How can investors correct the errors when they are prevented by the Fed from knowing what real interest rates are that is a result of real saving? How can they possibly know what projects to choose going forward when your beloved Fed makes it impossible for them to know what the pressure gauge really says as a result of the true state of the boiler?

    You may believe that the Fed targeting spending doesn’t disturb interest rates, but it does, because giving lenders more money than what they otherwise would have from real saving alone, affects interest rates, and thus obscures regulating free market interest rates from view.

    When will you learn? The information is freely available, and you’ve been told this many times. There is no excuse for you to continue to be ignorant like this.

  15. Gravatar of StatsGuy StatsGuy
    9. May 2012 at 08:28

    “bold and credible monetary stimulus that was expected to produce much faster NGDP growth might well raise long term risk-free interest rates.”

    I know you’ve said this many times, but the world still doesn’t get it… I think what the other guys mean is they want to lower the real rate _for any given level of real future growth_. But they don’t say that.

  16. Gravatar of Benjamin Cole Benjamin Cole
    9. May 2012 at 08:35

    All sensible economists want to remove structural impediments, and (relatively) lower taxes on productive behavior, people and businesses.

    Good luck with that. Both parties in the USA are stock full of sacred cows.

    How about we de-license lawyers—you only have to convince 50 different state legislatures to do that. Easy–structural reforms here we come.

    Let’s get rid of ethanol. Let’s radically cut rural subsidies. Let’s wipe out unemployment insurance. Let’s radically scale back the $1 trillion a year military-VA-homeland security complex. Let’s wipe out the USDA. Wipe out the home mortgage interest tax deduction.

    I could go on, but everyone knows this is hopeless.

    Okay, so what can we do now? Market Monetarism.

  17. Gravatar of Major_Freedom Major_Freedom
    9. May 2012 at 08:40

    Benjamin Cole:

    The structural impediment I am referring to IS inflation.

  18. Gravatar of Don Geddis Don Geddis
    9. May 2012 at 08:44

    MF writes: “Each builder concludes that the problem is lack of money demand for their projects, when in reality the problem is structural. They started the wrong projects. They should have started projects that require 40,000 bricks, not 50,000 bricks. … delude the master builders into believing they really do have 50,000 bricks”

    You really don’t understand nominal problems, do you? You think of everything in terms of the real economy.

    There exist problems in the real economy. You’re correct about that. Sumner doesn’t talk much about the real economy.

    What you miss, is that there can ALSO be problems in the nominal economy, ON TOP OF any real economy problems.

    To be more concrete: if the problem is that the builders are trying to make a building with 50K bricks, but the real economy only has 40K bricks, then you really are screwed. You can’t create the missing 10K bricks out of nothing. There is real scarcity in the real economy.

    In contrast, if the builder took out a loan, with an expectation of getting a future revenue of $50K, but today instead finds that he’s only getting a revenue of $40K, that also is a shortfall … but one that potentially CAN be fixed by creating an additional $10K of cash in the economy. The Fed can create new money for zero cost, which is not possible in your real-world brick example.

    Now, some economic problems cannot be fixed by simply printing more money, and in normal times the result is merely greater inflation. But Sumner has presented mountains of evidence that these are not such normal times.

    But in any case, you do yourself a disservice when you attempt to think about nominal problems by making an analogy to physical scarcity. The logic of money supply is different from the logic of bricks.

  19. Gravatar of ChargerCarl ChargerCarl
    9. May 2012 at 09:12

    Tyler Cowen wrote this today in his post about Rajan:

    “Still, any given dollar must be spent somehow and “the stimulus model” and “the long-term investment model” are indeed competing visions for the allocation of resources.”

    This confuses me though. Is there a shortage of ink and paper that I don’t know about?

  20. Gravatar of Morgan Warstler Morgan Warstler
    9. May 2012 at 09:13

    Don, you are correct.

    But that’s not really the realistic Austrian argument.

    The real argument is that if we refuse to let anyone fix the monetary issue right now, awe are more LIKELY to fix the structural real economy problems.

    Whether it is 2% inflation and no more. Or A NGDPLT starting now with no make up…

    The real reason to these is to FORCE the govt. to push people put of the wagon.

    The point is that bricks were misallocated, and three years ago I was banging on Scott’s noggin to get him to scream to liquidate the banks.

    And he wouldn’t talk about it.

    But that’s the EXACT reason for NGDPLT, so that you can nuke bad banks, gut the equity owners, sell off all their assets to the highest bidder and it has NO discernible effect on growth.

  21. Gravatar of Charlie Charlie
    9. May 2012 at 09:14

    “Alternatively, low interest rates could push her (or her pension fund) to buy risky long-maturity bonds. Given that these bonds are already aggressively priced, such a move might thus set her up for a fall when interest rates eventually rise.”

    I find this very strange, especially coming from a finance professor at Booth. What does it mean for a bond to be “aggressively” priced? That makes no sense to me. Longer bonds do have risk, but the investor is compensated for that risk. It’s possible that the trade-off is bad for any investor, but is it bad for the market as a whole? Is he talking about bubbles? Is he arguing there is a bond bubble? It just seems like it’s not well thought out. As far as I know, Rajan thinks the price system works well. When Booth professors run from the “market” part of “market monetarism,” it is a strange day indeed.

  22. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    9. May 2012 at 09:23

    ‘Both parties in the USA are stock full of sacred cows.’

    It’s worse in a lot of countries. France for instance;

    http://www.businessweek.com/articles/2012-05-03/why-france-has-so-many-49-employee-companies

    ———–quote————-
    “What holds back hiring in France is the lack of clarity on how to legally cut jobs,” says Déborah David, a labor lawyer at Jeantet Associés in Paris who has followed the case. If the decision is upheld, Viveo will have to take back the workers and hand over two and a half years in back pay, she says.

    When courts don’t intervene, politicians often do. After the owners of the Lejaby lingerie factory in Yssingeaux won court approval in January to fire about half their 450 employees in France and shift production to Tunisia, the company found itself thrust into the center of this year’s campaign. Sent by Hollande to visit the plant, Socialist legislator Arnaud Montebourg told the workers they “symbolized the situation of the country.” He promised his party would work to bring back jobs that have gone abroad over the past decade if it won the election. Sarkozy vowed to save the plant and took credit for orchestrating its takeover by LVMH Möet Hennessy Louis Vuitton (MC), which is converting it to leather goods production.
    ————–endquote————–

  23. Gravatar of MMJ MMJ
    9. May 2012 at 09:28

    Why July 2008?

    Since the recession ended in June 2009, CPI has increased 2.31% annualized.

    Since Bernanke became Chairman, CPI has increased 2.22% annualized.

    Over the cycle to date, i.e. recession and recovery (12/2007 to 04/2012), CPI has increased 1.93% annualized.

    Seems like you are cherry-picking numbers to suit your purposes.

  24. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    9. May 2012 at 09:35

    Unrelated to Rajan, but worth pondering;

    http://www.voxeu.org/index.php?q=node/7955

    ————-quote————-
    Substituting public reserves for ‘private’ reserves

    This second source of our sanguinity comes from the nature of the reserve creation. The enormous increase in bank reserves reflects a substitution of monetary base largely for highly liquid government securities in private-sector portfolios. But as government securities serve as collateral in the private-credit market, the effective size of the market liquidity fulcrum is unchanged by such operations. Little wonder then that market liquidity conditions remain tight despite the increase in bank reserves. That is, although quantitative easing which merely swaps bank reserves for US Treasury bills increases the textbook monetary base and “should” lead to an increase in market credit, in our view this accomplishes virtually nothing in terms of easing liquidity pressures. It merely changes the composition of assets within a given sized liquidity fulcrum.

    In this view, a central bank open market purchase changes the size of the liquidity fulcrum only if it swaps monetary base for assets that are no longer accepted at full value as collateral in the market. Such moves go beyond a pure swap of ‘private reserves’ for public reserves and ease effective liquidity by increasing the overall market liquidity fulcrum.

    Indeed, the ‘private reserve’ stock took a big hit with the evaporation of previously acceptable collateral asset classes (e.g. private label CMBS) and, in reaction, the market liquidity fulcrum collapsed during the 2008/09 Global Crisis. This collapse was been only partially offset by the substitution of monetary base for collateral no longer traded in the market.

    Conclusion

    Those schooled in the conventional money multiplier approach are understandably worried about the potential impact on inflation of expanding bank reserves. Nevertheless, there is good reason not to fear the money multiplier. Post-war US credit expansion – and, by inference, inflation””has not been dependent on an expansion of bank reserves and there is no reason to expect there will arise now a causal impact of the latter on the former. The liquidity fulcrum of a modern financial system is more complex than the monetary base and its size is determined by market conditions which continue to show signs of strain despite comparatively massive central bank injections of bank reserves.
    —————endquote————-

  25. Gravatar of Benjamin Cole Benjamin Cole
    9. May 2012 at 09:57

    Major F-

    Of what of the extensive structural impediments to which I referred?

    Can we de0license lawyers? Radically reduce the $1 trillion-a-year Defense-VA-Homeland Security boondoggle? Wipe out the ethanol program and corn subsidies–the latter one is a doozy.

    First, we subsidize corn production, and then we mandate its use in gasoline. A purely socialist, pink-o economic sector, to the max.

    And how exactly do you propose we precisely measure inflation?

  26. Gravatar of Lars Christensen Lars Christensen
    9. May 2012 at 10:51

    Scott, I am afraid University of Chicago is not what it used to be…

  27. Gravatar of Liberal Roman Liberal Roman
    9. May 2012 at 10:53

    Speaking of driving you nuts, here is Tyler Cowen’s latest Twitter post:

    “I have met many smart Italians this trip, not one believes that insufficient spending is their country’s main problem.”

    UGHHHHHHH, it’s like there is something in conservatives and libertarians’ DNA that make them unable to come to grips that there is an AD problem. And this is Tyler Cowen, a guy that we thought was on our side.

  28. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. May 2012 at 10:55

    There’s been a number of pro/con postings on structural unemployment lately so I’ve been pouring over the statistics. Consequently this really caught my eye:

    “Hairdressers in Las Vegas lost their jobs because households there have too much debt stemming from the housing boom.”

    and

    “If these debt-free savers are in New York City, which did not experience as much of a boom and a bust, cutting real interest rates will encourage spending on haircuts in New York City, which already has plenty of demand, but not in Las Vegas, which has too little.”

    Is there an epidemic of unemployed barbers, hairdressers and beauticians in the country? Was Las Vegas particularily hard hit? Have you noticed an increase in shaggy unkempt coiffures where you live? The answer to these questions is no, no, and probably, no.

    Barbers, hairdressers and beauticians are part of the Personal Care occupational category which, along with Healthcare Support and Food Preparation/Service occupational categories saw one of the smallest rates of increase in unemployment. (It was about the same as the national average before the recession and is running about one percentage point below the national average now.) In fact hairdresser employment barely dipped this recession and was one of the first occupations to fully recover. Hairdressers historically also have a relatively high rate of unit labor cost increase indicating a relative lack of labor market slack (and low productivity growth).

    In a recession people typically cut back on big ticket items. Consequently it should come as no surprise that durable goods consumption fell over 13% from peak to trough this recession. Services consumption on the other hand barely budged, declining by less than 2%. People might stop going to a high price salon and go to Supercuts instead but they usually don’t do without haircuts entirely.

    Moreover, Personal Care employment is forecast to be one of the ten fastest growing industries in the next decade. Why? It’s an industry with virtually no improvement in productivity and there’s absolutely no way it can be outsourced to China or India.

    So what on earth is Raghu Rajan thinking? Well, presumably our country is suffering from structural unemployment and this must be due to a lack of education and training. The problem is we are overrun with barbers, hairdressers and beauticians when what we need are engineers, scientists and mathematicians. Except that when one looks at the numbers what one finds is the hairdressers are more or less securely employed and it is the engineers, scientists and mathematicians who are finding it much harder than usual to find employment (their rate of unemployment is still low, just much, much higher than normal).

    My take from all of this is that Rajan has a very poor intuition when it comes to macroeconomics. And probably a lot of this has to do with the fact that he doesn’t spend a lot of his time immersed in those issues. He is after all a finance professor.

    And personally, when I have a problem starting my car, I don’t call a plumber.

    P.S. And yes, average hairdresser pay nationally is quite low (in the low $20,000s). But in some parts of the country (e.g. Charleston, San Francisco, Washington) average hairdresser pay is in the $40,000-$50,000 a year range.

  29. Gravatar of Benjamin Cole Benjamin Cole
    9. May 2012 at 10:59

    Mark S-

    Rajan also says we don’t make things, when USA industrial output has doubled since 1985, and is present in a revival….I think Rajan got his facts from talk radio….

  30. Gravatar of Bill Woolsey Bill Woolsey
    9. May 2012 at 11:20

    Scott:

    If we have to target prices…

    Why the CPI? Why not the GDP deflator?

  31. Gravatar of Major_Freedom Major_Freedom
    9. May 2012 at 11:21

    Don Geddis:

    MF writes: “Each builder concludes that the problem is lack of money demand for their projects, when in reality the problem is structural. They started the wrong projects. They should have started projects that require 40,000 bricks, not 50,000 bricks. … delude the master builders into believing they really do have 50,000 bricks”

    You really don’t understand nominal problems, do you? You think of everything in terms of the real economy.

    You really don’t understand real problems, do you? You think of everything in terms of the nominal economy.

    There exist problems in the real economy. You’re correct about that. Sumner doesn’t talk much about the real economy.

    It goes further. The real problems are CAUSED by the very policies enacted on the basis of a fear of a demand problem.

    What you miss, is that there can ALSO be problems in the nominal economy, ON TOP OF any real economy problems.

    At any given time, there are never any demand problems. The entire money supply that exists, the cash balances that each person has, the current spending each individual engages in, are all entirely, fully and completely capable of clearing a practically limitless-sized market.

    To be more concrete: if the problem is that the builders are trying to make a building with 50K bricks, but the real economy only has 40K bricks, then you really are screwed. You can’t create the missing 10K bricks out of nothing. There is real scarcity in the real economy.

    Now you know why inflation doesn’t work, and why we see boom and bust all the time, even after the creation of the Fed that was supposed to end it. And no, it’s not because they print enough, but then don’t print enough. It’s the printing itself that makes continued printing perceived as necessary, when it isn’t, and only adds to the problems that are manifested in an apparent lack of demand. Inflation (into the banking system) makes people think there are 50k bricks when there are really only 40k bricks. This is why continued inflation to solve this problem is madness.

    In contrast, if the builder took out a loan, with an expectation of getting a future revenue of $50K, but today instead finds that he’s only getting a revenue of $40K, that also is a shortfall … but one that potentially CAN be fixed by creating an additional $10K of cash in the economy. The Fed can create new money for zero cost, which is not possible in your real-world brick example.

    No, that is exactly what not to do, even though it appears so tempting and so obvious. The reason why he is getting $40k rather than the $50k he expected is because his particular investment should not have been made at all, and some other investment should have been made that would make $40k revenues a profitable investment.

    You want the master builder to keep building believing he’s got 50k bricks by redirecting even MORE resources into that project, by way of enticing it with inflation to boost demand from $40k to $50k.

    This will just stretch the economy into an even more unsustainable configuration than before, because now other projects that were started by other master builders, find that they lack the requisite resources to complete their projects.

    See, what you are taking for granted is the mistaken belief that resources are infinite. You consider one master builder and you point out that redirecting more resources (bricks) into his 50k project could potentially be done, but boosting his sales revenues so that he can go out and buy more bricks. But this is a privilege you have made for yourself by assuming there are enough bricks elsewhere to buy.

    But when you start to view the economy as a whole, where the economy can be represented by one master builder and one construction project, NOW you no longer have luxury of depending on resources being redirected away from other deployments, towards this one master builder’s project. For this project is the only project there is. So if the master builder needs more bricks to finish his project, but doesn’t have any, then it would be silly to do ANYTHING that would delude him into thinking he does have 50k bricks.

    This is what inflation does. Yes, it appears that the master builders can keep doing what they are doing if they only got $10k more in revenues. But the economy is not just about covering costs and earning profits. It is about the real resources as well. By inflating the money supply with the intention of each master builder getting $10k of new money, will cover their ongoing costs, yes, but you can’t change the fact that there aren’t enough bricks! What printing money does is POSTPONE the errors from being exposed. Sure, printing money may get the master builders to keep building believing they have 50k bricks, but they cannot be COMPLETED, no matter how much money is being printed.

    The connected between this, which you agree with, and your example of the $50k and $40k revenue example, is that if spending is increased from $40k to $50k, then all you will have done is waste more bricks in the project that needs 50k bricks, but there are only 40k. The boom bust cycle we observe is like the master builder putting one more layer of brick around the perimeter, believing he has more than he really does (boom period), then he realizes he doesn’t have enough (bust), but then oops, the Fed prints even more money to coax him into continuing on like everything is fine (new boom), so he puts on another layer of bricks, and then he realizes once again he is short of bricks (bust), but then once again the Fed reinflates, and coaxes the master builder into continuing on with the same wrong project.

    This process is very long term, and if the Fed really did use inflation to never allow ANY correction (meaning if there were no busts at all, and only a permanent boom), then at some point, when the master builder is on his last layer of bricks, and realizes he only has 40k bricks, then NO AMOUNT of more money printing can fix the economy. No matter how much money is printed, the economy is at its physical, scarcity limit. Any more money printing will be useless. It won’t be able to trick him any more. This is hyperinflation.

    But because the Fed avoids hyperinflation, what we see are instead a series of booms and busts, as the construction project that should never have been started, is worked on (boom, full resource use, full employment), then the master builder halts the project because he knows there are not enough resources (bust, idle resources, etc), but then he is deluded once more by the Fed into continuing on like nothing happened (re-boom, reduction in idle resources, increasing employment, etc).

    See, every time demand falls as the master builder realizes he made a mistake, you market monetarists are inferring that the problem is the central bank isn’t printing enough to delude him into continuing on like everything is fine as before. You want total spending to keep going up up up, which deludes investors into believing their projects are sustainable, but in reality are not and there needs to be a market determined level of spending to fix it.

    Now, some economic problems cannot be fixed by simply printing more money, and in normal times the result is merely greater inflation. But Sumner has presented mountains of evidence that these are not such normal times.

    That’s always the stupid excuse. All inflationists think like this. All inflationists who want more inflation always say “now’s different.” No, now is not different. Economic laws don’t change over time. They are ubiquitous. The law of scarcity is permanent.

    But in any case, you do yourself a disservice when you attempt to think about nominal problems by making an analogy to physical scarcity. The logic of money supply is different from the logic of bricks.

    Look in the mirror. You do yourself a disservice when you attempt to think about real problems by making an analogy to nominal scarcity. The logic of money supply is NOT different from the logic of bricks. Money is a commodity just like bricks are. Because central bank monopoly money production is outside the sphere of profit and loss, it messes up a system based on profit and loss, i.e. the market!

  32. Gravatar of Bill Woolsey Bill Woolsey
    9. May 2012 at 11:23

    Scott:

    We can imagine how imperfections in credit markets reduce real output.

    But if the problem were simply too little spending on output, logic tells us that prices (including wages) would all be lower–exactly low enough so that real expenditure equals the productive capacity of the economy.

  33. Gravatar of Bill Woolsey Bill Woolsey
    9. May 2012 at 11:24

    As for Tyler’s remark about Italy, too little spending, too much spending, it comes and goes, but the structural problems remain.

  34. Gravatar of Major_Freedom Major_Freedom
    9. May 2012 at 11:25

    Morgan:

    Don, you are correct.

    No, Don is incorrect. He is ignoring the law of scarcity in his example by pretending that printing more money can enable the completion of any projects started, even ones that requires more resources than actually exist!

    But that’s the EXACT reason for NGDPLT, so that you can nuke bad banks, gut the equity owners, sell off all their assets to the highest bidder and it has NO discernible effect on growth.

    Can’t do that, because targeting a “stable” growing spending requires accelerating money supply, and it is that money that bails bad investments out.

  35. Gravatar of Major_Freedom Major_Freedom
    9. May 2012 at 11:28

    Benjamin Cole:

    Of what of the extensive structural impediments to which I referred?

    It’s the ones caused by inflation I am referring to.

    Can we de0license lawyers? Radically reduce the $1 trillion-a-year Defense-VA-Homeland Security boondoggle? Wipe out the ethanol program and corn subsidies-the latter one is a doozy.

    Sure, do all of that too. But it won’t solve the business cycle.

    And how exactly do you propose we precisely measure inflation?

    I don’t think it should be measured at all, because no seller and no investor sells into or invests into anything that IS the price level. The collective outcome of separate investors and sellers, in their own particular markets, is sufficient. No aggregate measurements of anything are relevant to economics. It only seems that way to central planners who need to maximize tax revenues without revolt, and inflate without revolt. To market participants, they’re all useless.

  36. Gravatar of Bill Woolsey Bill Woolsey
    9. May 2012 at 11:29

    I don’t entirely agree with the 50% of the cities have too little spending and 50% too much.

    Part of the goal is to motivate people to move to the correct locations.

    I sure don’t think that monetary policy is too tight for 50% of the industries and too loose for the other 50%. Shifts in demand between industries should cause some to contract and others grow.

    The problem occurs when resources can’t move, then having different units of account and flexible exchange rates is better. For example, if “all” the industries in the U.S. contract relative to those in China, this is a useless signal that people should pick up and move to China.

    But if there is high unemployment in Las Vegas, that is a good signal to not move there and instead move to North Dakota.

  37. Gravatar of ssumner ssumner
    9. May 2012 at 11:37

    John, Commodity standards are a horrible idea for the modern world, and shouldn’t even be considered.

    The term ‘central planning’ is not relevant to this debate. Most countries use the meter to measure length. Would you suggest that each person in those countries use a different measuring stick? Obviously not. So we need one measuring stick of value in the US. Call it the dollar. As for the supply of dollars and the level of interest rates, those should be determined by the markets, not the Fed. The length of the dollar should be a given fraction of NGDP futures.

    If that makes me a fan of “central planning” then so be it.

    Brian, Expansionary monetary policy reduces exchange rates, giving a short term boost to trade, but that advantage erodes as inflation offsets the gain from devaluation.

    dwb, Yes, I’ve noticed that many industry specific explanations of the recession rely on anecdotes, not hard data.

    W. Peden. Good point.

    Becky, that’s partly because the interior states benefit more from high commodity prices, especially North Dakota. I seem to recall that some interior states like Nebraska have lower natrural rates of unemployment, but am not certain.

    Morgan, You said;

    “And Scott would take that trade and do a victory lap, because in the long run, wh really cares?”

    I’m so pessimistic right now that you just might be right

    Thanks James.

    David, Yes, but in my defense I did point out that NYC might have a higher natural rate, which is related to your point. But I doubt it’s that high. Does anyone have NYC unemployment data from before the recession?

    MR, AD matters.

    Statsguy, Yes, but if they are talking about how savers might get screwed by easy money, they ought to know that that argument is making a claim about the actual real rate, not the conditional rate.

    Ben, That’s right.

    ChargerCarl, He’s talking about fiscal policy. He agrees with me on the need for monetary stimulus, although he is slightly les optimistic about what it could accomplish.

    MMJ, I pay no attention to inflation numbers. The CPI claims housing prices are up 8% since January 2006, whereas Case Shiller says they are down 35%. Do you believe housing is 8% more expensive than in 2006? Is there anyone in the world outside the BLS that believes that?

    So my first answer is to pay attention to NGDP, not the CPI.

    Second, Let’s say the 1.93% figure is correct, that would imply the Fed is a bunch of sadists, who take pleasure in making the unemployed suffer. That’s because 1.93% is too low even if they were callous bastards who didn’t care either way about the unemployed, and only cared about 2% inflation. But they do have a dual mandate. If people don’t like the law, then change the law. Otherwise run above 2% inflation when unemployment is high and below 2% inflation when unemployment is low. They do the opposite.

    Patrick, There may be some truth to that, although I’ve always believed QE2 was more about signalling than actual money printing–the IOR makes reserves similar to T-bills.

  38. Gravatar of ssumner ssumner
    9. May 2012 at 11:50

    Lars, Unfortunately you are right.

    Liberal Roman. Don’t judge him by twitter feeds–he does support some additional monetary stimulus. He believes there is both supply and demand side problems.

    Italy’s had roughly 10% unemployment for decades, and slow growth, so it’s not a stretch to claim the supply-side is their biggest problem.

    Mark, You said;

    “My take from all of this is that Rajan has a very poor intuition when it comes to macroeconomics.”

    That’s my reaction too. Tyler says he has been brilliant of the debt crisis, and I have no reason to doubt that. But the way he discusses macro makes my hair hurt. A macroeconomist would focus on optimal monetary policy rules, and the identification of demand shocks. There doesn’t seem to be any structure to his macro arguments, he seems to be going with gut instincts.

    I’m not as negative as some on the left because I have less faith in fiscal stimulus than they do, and more doubts about the supply-side–especially in southern Europe. But as far as demand shocks are concerned, Rajan just doesn’t seem to get it.

    Bill, I’m fine with the GDP deflator.

    And yes, you may want people to move, but that can occur at full employment. You don’t want to cause inefficent levels of unemployment via sticky wages. However it’s a moot point, as neither of us favors local currencies (in the US–Europe is another matter.)

  39. Gravatar of MMJ MMJ
    9. May 2012 at 12:20

    So if you pay no attention to “inflation numbers”, how do you know what the split between real/nominal GDP is? Or is that also irrelevant?

  40. Gravatar of MMJ MMJ
    9. May 2012 at 12:21

    OK, I see you’re “fine with the GDP deflator”. Why is that so much better than the CPI?

  41. Gravatar of MMJ MMJ
    9. May 2012 at 12:26

    “Does anyone have NYC unemployment data from before the recession?”

    http://research.stlouisfed.org/fred2/series/NYUR?rid=112

    One good turn (comment) deserves another!

  42. Gravatar of Morgan Warstler Morgan Warstler
    9. May 2012 at 12:27

    “I’m so pessimistic right now that you just might be right”

    Good lord man, why is it so hard to get everyone to stop posturing and cut a deal?

    WHY can’t you bring yourself to say out loud your bottom line and argue that it is OK too?

    It isn’t a a noble argument.

    How can you really let your natural opposition from DeKrugman, to Karl, to Matty, to even Sax, not understand what you REALLY mean?

    How far you’ll really go?

    Once it isn’t about a burst of make-up inflation, it is just about NGDPLT starting NOW, you have only one natural ally – the conservatives.

    And at that exact moment, DeKrugman et al will have nothing good to say about you again.

  43. Gravatar of Morgan Warstler Morgan Warstler
    9. May 2012 at 12:28

    It isn’t a a noble argument.

    (scratch that)

    You aren’t arguing nobly.

  44. Gravatar of Morgan Warstler Morgan Warstler
    9. May 2012 at 12:33

    You people need to just admit that Aggressive Monetary policy WILL ONLY be a reward for Austerity.

    And when I say Austerity that means cutting govt. spending.

    If you just ACCEPT IT, we can get on with our lives.

    It is the logical inference of saying the Fed moves last.

    Get over it.

  45. Gravatar of Jim Glass Jim Glass
    9. May 2012 at 12:45

    OK, I see you’re “fine with the GDP deflator”. Why is that so much better than the CPI?

    It’s for everything produced in the economy, not just a subset of selected consumer items.

  46. Gravatar of Jim Glass Jim Glass
    9. May 2012 at 13:04

    …Tyler Cowen’s latest Twitter post: “I have met many smart Italians this trip, not one believes that insufficient spending is their country’s main problem.”

    Most people commonly have no idea what their real problem is.

    In the late 19th-early 20th century farm productivity rocketed upward. By arithmetic this meant there would be a lot fewer farmers. The mechanism by which this came to be was the least productive farmers not being able to afford to pay their mortgages. The farmers concluded their problem was greedy heartless bankers, the gold standard, etc., so we got the free silver movement, Bryan’s “Cross of Gold” speech, and a couple generations of novels and movies about heartless bankers driving good-hearted, wholesome farm families from their farms. But of course the same thing would have happened at any price level and with the most kind-hearted of mortgage lenders.

    In the 1930s NYC’s Madison Square Garden sold out a number of times to people believing their problem was a lack of governmental planning and leadership such as could be provided by Fascists and Communists.

    Maybe I should say that most people routinely, typically, have no idea what their real problem is.

  47. Gravatar of Becky Hargrove Becky Hargrove
    9. May 2012 at 13:46

    Lars put it well the other day:
    “I am tempted to say that fascism is always and everywhere a monetary phenomenon.”

  48. Gravatar of Philo Philo
    9. May 2012 at 14:34

    Rajan writes: “Before the financial crisis erupted in 2008, consumers buoyed US demand by borrowing heavily against their rising house prices. Now these heavily indebted households cannot borrow and spend any more.” Of course, it is only *certain* consumers who behaved this way. Many consumers were renters, or homeowners who did not use their homes as collateral for borrowing. Rajan is focusing on *a particular segment* of the population; let’s call it “A.”

    He should have borne equally in mind another segment: those who, before mid-2008, were *lending to the members of A*. Call this group “B.” Now that the As have greatly reduced their borrowing, to what alternative use are the Bs putting their money? Rajan offers no clear answer. If the members of B had now turned to consumption spending, this might exactly counterbalance the reduced consumption spending of A, producing no particular macro-economic effect. But Rajan raises the possibility that the Fed has not been able to lower real interest rates enough to “coerc[e] thrifty households into spending instead of saving.” That suggests that the members of B have instead increased their investing in capital goods, which would entail a shift in demand from consumption goods to capital goods, but not necessarily a recession.

    Is there any chance Rajan thinks that there really is no group B: that the lending to A was being done with *newly created money*, and that the great reduction in this lending since mid-2008 goes hand-in-hand with a great reduction in the creation of new money? That would be to assign a *monetary* cause to the recession””it would be an *old monetarist* account, since it ignores velocity. I don’t suppose this is really Rajan’s view, but at least it would make sense.

  49. Gravatar of dwb dwb
    9. May 2012 at 15:20

    I’m so pessimistic right now that you just might be right

    Goldman Sachs, through its wholly owned subsidiary the Federal Reserve Board, plans more QE:

    http://www.bloomberg.com/news/2012-05-09/gross-says-qe3-getting-closer-as-goldman-sees-easing.html

    Markets say not yet, of course, but as zerohedge likes to point out, Goldman front runs everybody and very effectively manipulates the market 😉

    there is always hope.

  50. Gravatar of Becky Hargrove Becky Hargrove
    9. May 2012 at 15:35

    Speaking of moving away from credit as a serious contender for describing monetary activity (more power to that idea), I have strange notions in my head as to what constitutes the ‘hot potato’ effect. It is making me nuts that I don’t hear people descibe what it is to them, because consequently I don’t know how to express what it is to me – something highly specific.

  51. Gravatar of MMJ MMJ
    9. May 2012 at 16:08

    “It’s for everything produced in the economy, not just a subset of selected consumer items.”

    Hi Jim – good to see a post on your blog again. My concern about the GDP deflator is that it probably has at least as many methodological problems as the CPI, hence my question.

  52. Gravatar of Morgan Warstler Morgan Warstler
    9. May 2012 at 16:51

    Goldman, Bloomberg, and Zerohedge are UNAFRAID to play Morgan’s “Ben gets one bite at the apple to win for Obama” game.

    You folks are really no fun.

    Do any of you play poker?

  53. Gravatar of Morgan Warstler Morgan Warstler
    9. May 2012 at 16:54

    They say June 19 to June 20…

    Perhaps not optimal, but the the least likely to raise the ire of the Tea Party nearer the election.

    This may indicate they aren’t sure about their ability to drag him over the line.

  54. Gravatar of Major_Freedom Major_Freedom
    9. May 2012 at 18:33

    ssumner:

    But at a minimum Rajan should provide some evidence, as most economists would regard a 9.7% rate as well above the natural rate.

    It’s really amazing how weak the foundation really is for those itchy inflation trigger fingers. Completely unscientific.

  55. Gravatar of Greg Ransom Greg Ransom
    9. May 2012 at 19:33

    Who cares what happens in a closed economy model?

    Nobody lives in a closed economy — not even close.

    What happens in a Keynes closed economy model is completely irrelevant to _anything_.

  56. Gravatar of Greg Ransom Greg Ransom
    9. May 2012 at 19:40

    Scott, a very simple request.

    Explain to us how a given NGDP rate magically & permanently connects to a given employment rate — that is, what it the direct mechanical lever which directly connects the two.

  57. Gravatar of Greg Ransom Greg Ransom
    9. May 2012 at 19:51

    This is essentially the same thinking which inspired Keynes in the late 1920s to call for inflating away Britain’s internationally uncompetitive wage rates. Keynes then invented a series of economically incompetent “models” to “scientifically” motive his pre-theoretical conclusion.

    We could have done without the incompetent “science”, and just stuck with the instinctive intuition — inflate way over priced wages to re-coordinate the economy, and damn any “theoretical” consequences “in the long run”.

    “We need either much more NGDP or the same NGDP and much lower salaries.”

  58. Gravatar of ChargerCarl ChargerCarl
    9. May 2012 at 20:47

    Greg you said:

    “Explain to us how a given NGDP rate magically & permanently connects to a given employment rate “” that is, what it the direct mechanical lever which directly connects the two.”

    At the risk of misrepresenting Sumner, I don’t think he has ever claimed that it connects to a given employment rate. Only that it gets us to the natural rate of employment, whatever it may be.

  59. Gravatar of flow5 flow5
    10. May 2012 at 03:26

    “The Fed shouldn’t be trying to encourage either consumption or saving”

    The FED should be trying to encourage the flow of savings thru the non-banks (& into real-investment). That means it would re-impose interest rate ceilings on the money creating depository institutions (commercial banks), gradually lowering them until the CBs are out of the savings business altogether. This is the non-inflationary growth path required to match savings with investment. Whereas savings held within the CB system are lost to investment, to consumption, & to any type of expenditure.

  60. Gravatar of Jeff Jeff
    10. May 2012 at 03:39

    @Greg,

    A good monetary policy is one that provides a stable macro environment in which individual people and firms can plan and reasonably expect to carry out their plans. The question then is what to stabilize. Scott’s answer is the expected path of nominal GDP. But he does not expect that such a policy cures all problems, just the ones that it can. He is not relying on a version of Okun’s Law.

    But like me, you’ve been following this blog for a long time, and you already know what Scott thinks. So I wonder why you ask.

  61. Gravatar of ssumner ssumner
    10. May 2012 at 05:29

    MMJ, I also think the split between the RGDP and NGDP is irrelevant for policy purposes. I suppose it might be relevant for estimates of standard of living, but as a practical matter that’s all guesswork anyway, as very few economists think the growth in RGDP/person in the US matches the growth in standard of living.

    Thanks for the unemployment data.

    Jim Glass, I agree about the deflator.

    And I agree about conventional wisdom being not very useful.

    Becky, Good line.

    Philo, Your guess is as good as mine.

    dwb, I sort of hope so, but on the other hand it would mean the economy has deteriorated further in the next 6 weeks.

    MF, Unemployment has no bearing on my call for monetary stimulus, as I’m sure you know.

    Greg, The global economy is a closed economy. Does the global business cycle not matter?

    You said;

    “Explain to us how a given NGDP rate magically & permanently connects to a given employment rate “” that is, what it the direct mechanical lever which directly connects the two.”

    NGDP affects RGDP, which affects employment. Which of those links do you deny?

    Jeff, Assuming Greg’s not stupid, he knows the answer. He just wants to see me say so.

  62. Gravatar of dtoh dtoh
    10. May 2012 at 16:13

    [i]My bigger problem with Rajan’s entire approach to macro is that he’s always talking about finance, credit, lending, saving, etc. The problem is much more basic. We have far too little NGDP to employ everyone who wants to work at the current salary levels. [/i]

    Yes…but, the Fed moves NGDP primarily through asset prices. More specifically OMP raises the price of financial assets (including credit) relative to the price of real goods and services. This causes economic players to buy more real goods and services (i.e. increases NGDP). People do not spend more because they have more money, they have more money because they want to spend more. What causes them to spend more is not the increase in the amount of money but rather the increase in the price of financial assets (e.g. credit) relative to real goods and services.

    When you talk about NGDP or credit, it’s really just two sides of the same coin. And to be clear, when I say spending I mean both consumption and investment.

  63. Gravatar of John Becker John Becker
    11. May 2012 at 09:57

    Don Geddis,

    Your response to Major Freedom was wrong. Your solution for the master builder only works in the intentionally simplified metaphor Major Freedom was using (taken from Mises in Human Action). Additional money does not create additional real demand as additional real demand can only come from supply increases. THE ABILITY TO CONSUME COMES FROM THE ABILITY TO PRODUCE. Money is only an intermediary between goods and printing more of it can only increase nominal demand. It cannot create new resources, only redistribute existing ones.

  64. Gravatar of Major_Freedom Major_Freedom
    11. May 2012 at 10:51

    John Becker:

    Your solution for the master builder only works in the intentionally simplified metaphor Major Freedom was using (taken from Mises in Human Action). Additional money does not create additional real demand as additional real demand can only come from supply increases. THE ABILITY TO CONSUME COMES FROM THE ABILITY TO PRODUCE. Money is only an intermediary between goods and printing more of it can only increase nominal demand. It cannot create new resources, only redistribute existing ones.

    You see, this is a great example of what happens when someone actually reads the source material: They understand it. Not saying they have to agree, but at least the arguments are characterized properly. Amazing how that works out.

    The problem with the “idle resource and unemployment means we must inflate” crowd is that they don’t understand that idle resources are idle for a very good reason, and that inflating the money supply to get these resources “moving” again in their original deployments that were allegedly all fine and dandy until demand “suddenly” disappeared, is to just hamper the redeployment process. I mean sure, if I had a money printing machine, I too could sustain a fake dog poop making factory, or a bankrupt bank, which would otherwise be temporarily “idle.” If an entire economy is full of such bad investments on the basis of prior inflation and non-market driven aggregate demand boosting, then aggregate nominal demand should fall, so that the economy can be purged of its bad investments, and the lower, market driven aggregate demand that remains can force the needed changes whilst leaving everything else alone.

  65. Gravatar of ssumner ssumner
    13. May 2012 at 14:41

    dtoh, No it’s not two sides of the same coin. Consider the transmission mechanism in an economy w/o credit. That mechanism is still there when you do have credit. The key is the hot potato effect, although asset prices also play a role.

    In any case, Rajan doesn’t seem to link asset prices to future expected NGDP. That’s the problem.

  66. Gravatar of dtoh dtoh
    13. May 2012 at 19:57

    Scott,
    I think you may be wrong. People hold the amount of cash that they need for transactions. If they have excess cash, they don’t spend it; they convert it into financial assets. The reason OMP works is not because it expands the money supply but because it causes a favorable shift in both the supply curve and demand curve for financial assets (e.g. credit), which leads to higher asset prices. When asset prices rise, people will exchange financial assets for real goods and services (both consumption and investment) thereby generating an increase in RGDP.

    When the real expected return on financial assets is identical to cash (i.e. at ZLB), then an increase in the money supply may not (I’m not sure) cause any change in the supply and demand curve for financial assets (or the price of financial assets relative to real goods and services) and therefore could simply lead to equal inflation of both financial assets and real good and services (i.e. no change in their relative value). If that were case, OMP might simply lead to inflation and no change in RGDP.

    Think about the case where money is only used as the medium of account and not the medium of exchange and all transactions are done on credit. The only way the central bank could impact RGDP would be injecting additional credit into the system or otherwise changing the terms (price) of credit relative to real goods and services.

    I’m pretty sure I’m right. Please think about it. I don’t think it changes any of the arguments about NGDPLT; it just clarifies the mechanism through which it works.

  67. Gravatar of dtoh dtoh
    13. May 2012 at 20:14

    Scott,
    And in a no-credit economy, the first time you increase the money supply you would get some increase in RGDP, but as soon as as there is an alignment of expectations any further increases in the money supply would just cause an instant increase in the price level.

    I think you are conflating the interest rate argument with the credit argument. You have repeatedly and correctly pointed out (and I completely agree) that nominal (or real) interest rates have little bearing on RGDP. Simply because this historical mis-perception is wrong doesn’t mean that credit is unimportant. If you instead consider the nominal expected cost of credit relative to expected NGDP growth, then it is much easier to see the central role that credit (or more specifically asset pricing) plays in the transmission mechanism.

  68. Gravatar of ssumner ssumner
    14. May 2012 at 17:37

    dtoh, You said;

    “And in a no-credit economy, the first time you increase the money supply you would get some increase in RGDP, but as soon as as there is an alignment of expectations any further increases in the money supply would just cause an instant increase in the price level.”

    I don’t see why. The stickiness of wages is what causes real effects, and wages could still be sticky in an economy with no financial markets.

    As far as excess cash, most cash is held in hoards, not as a medium of exchange. Indeed I’d guess that less that 20% of cash is widely circulating.

    I don’t disagree with your claim that asset prices may play a role in the transmission mechanism. I just don’t happen to see it as being fundamental. But I agree that there are no important policy implications that hinge on this difference of opinion.

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