Inflation targeting was always a means, not an end

Mark Carney had this to say in the FT:

Central banks are most effective when they operate with clear and stable objectives. The pursuit of temporarily higher inflation could only work if policy were anchored to a new target, such as nominal gross domestic product – total output at market prices, unadjusted for inflation.

However, the uncertain rewards of such a regime shift must be weighed against the risks of giving up what is arguably the most successful monetary policy idea in history: flexible inflation targeting.

This is wrong.  The Bretton Woods system was considerably more successful.  Here’s the flaw in Carney’s reasoning.  He’s thinking in terms of low and stable inflation as being the goal of monetary policy.  But it’s not.  There is no plausible macro model where fluctuations in inflation between -2% and 6% directly produce significant welfare losses.  The argument was always about aggregate demand.  Economists saw inflation instability leading to output instability (the famous expectations-augmented Phillips Curve) and decided stable inflation was the best way to stabilize AD, and hence output.  But by that criterion inflation targeting has been a disaster, as it lead to the greatest collapse in AD since the Great Depression, in both the US and Europe.  Admittedly Carney is a governor of the Bank of Canada, and Canada has done considerably better than the US and Europe during the current crisis.  But Carney’s piece isn’t just about Canada, he’s defending inflation targeting as the standard policy regime for developed economies.

I don’t favor a return to Bretton Woods, as we can do much better than either inflation targeting or fixed exchange rates.  Here’s Samuel Brittan, also in the FT:

At the other end of the spectrum some financial market types have taken fright at the trillions of dollars created by central banks for firewalls and in “quantitative easing”. I would not dismiss these fears out of hand. It is easy to imagine a long period of stagnation or recession followed by a breakout into rapid inflation.

Yet there is a way of sustaining an expansionary policy while minimising this threat. This is not through any financial market gimmick but by a different way of thinking. Long-time readers will not be surprised to learn that I have in mind something usually called a nominal GDP objective. One of the greatest obstacles is that its name is so off-putting. I seem to remember a former chancellor, Nigel Lawson, saying that it lacked sex appeal.

Yet the basic idea could hardly be simpler. The growth figures that dominate the headlines are of “real” gross domestic product, which means they are corrected for inflation. With nominal GDP they are uncorrected. The idea of targeting nominal GDP is to leave room for real growth, but damp any inflationary take-off.

That’s right.  There is an alternative to our current nightmare.

I hope to finish my grading today, and will then address the backlog of comments.

HT:  Bruce Bartlett and Nicolas Goetzmann


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70 Responses to “Inflation targeting was always a means, not an end”

  1. Gravatar of Saturos Saturos
    11. May 2012 at 06:30

    “He’s thinking in terms of low and stable inflation as being the goal of monetary policy. But it’s not. There is no plausible macro model where fluctuations in inflation between -2% and 6% directly produce significant welfare losses.”

    But price stability is an end in itself. All the textbooks show that high and variable inflation is correlated with severe drops in output – not just because of shoeleather costs, but because high inflation is variable and hence unpredictable, leading to distorted price signals and debtor-creditor redistribution. The standard argument against inflation isn’t against sustained rises in the price level per se (which causes only shoeleather and menu costs as well as other avoidable problems such as the non-indexed tax code) but rather an argument against a volatile price level. This is apart from the fact that unexpected inflation leads to sudden booms as firms run down spare capacity and workers work more than they would at the correct wages and prices, which must lead to a compensating variation later on (although I don’t see the problem with unexpected inflations tricking monopolistically competitive firms into temporarily producing closer to the efficient level of output).

    Of course, it’s true that “low and stable inflation” is only part of the story – we also want to avoid demand-side output gaps. Hence NGDP targeting, which gets to the root of both issues directly.

  2. Gravatar of Benjamin Cole Benjamin Cole
    11. May 2012 at 06:34

    “There is no plausible macro model where fluctuations in inflation between -2% and 6% directly produce significant welfare losses.”—Scott Sumner.

    Right, right, right, right, right and one thousand more “rights.”

    And yes—the goal of macroeconomic policy is real growth, not fighting inflation. It is a perversion to elevate price-stabiity to the rank of Supreme Goal.

    The ECB and BoJ would better serve their constituents if they had a single goal of GDP growth, rather than inflation targets.

    After all, if the ECB and BoJ obtained 3 percent steady real growth for 10 years, what would matter if inflation was 4 percent to even 8 percent? In 10 years, citizens would be 30 percent richer, in real terms. A nominal index of prices would be double what it was. What’s wrong with that?

    It is a dangerous perversion to fixate on inflation.

    One caveat: Sumner says negative 2 percent inflation (or mild deflation) does not directly produce welfare losses. Maybe so.

    The experience of Japan suggests that even mild deflation is deeply corrosive to economic output and optimism.

  3. Gravatar of dwb dwb
    11. May 2012 at 06:42

    actually I find Carney’s FT post a little puzzling and contradictory (see below). not too long ago I recall Carney hailing “flexible inflation targeting” in Canada. I have yet to figure out what he meant (thats why I remembered so clearly him saying it!), but in my mind FIT is just a version of the Taylor rule, where the CB allows a bit more inflation to offset a negative output gap.

    So i don’t really get it: a temporarily higher inflation target is FIT.

    My view (maybe i am wrong) but FIT is 3/4 of the way there to ngdp targeting already.

    http://www.bankofcanada.ca/2012/02/press-releases/flexible-inflation-targeting-appropriate-framework/

  4. Gravatar of Saturos Saturos
    11. May 2012 at 06:57

    I take back what I said about the Economist having grown wiser. It hasn’t: http://www.economist.com/node/21554197

    “Even so, Germany will find itself more isolated. It has pushed austerity too far and too fast. The myth of an expansionary fiscal contraction, the idea that deficit-cutting would boost growth, has been largely dispelled. The latest evidence is that in a downturn the multiplier effect of fiscal tightening can lead to deeper recession, making it even harder to cut the deficit. In the euro zone, moreover, countries cannot easily mitigate the impact through looser monetary policy or currency devaluation. Structural reforms may boost growth, but mostly in the medium term.”

    The “latest evidence” is apparently a new IMF paper (can’t find it). We do, however, have Draghi quoted as delivering this line: “We have had a fiscal compact. Right now what is in my mind is to have a growth compact”.

  5. Gravatar of dwb dwb
    11. May 2012 at 07:01

    actually i am with Yglesias: Germany needs some structural supply-side reforms that would raise full employment and reduce inflationary pressures there. this would give room for the ECB to loosen further.

  6. Gravatar of Mike Sax Mike Sax
    11. May 2012 at 07:15

    Interesting post. Scott in what way was the Bretton Woods superior-not that I disagree that’s my view as well but I’m wondering about your rationale.

  7. Gravatar of Gregor Bush Gregor Bush
    11. May 2012 at 07:25

    Scott,

    Sweden, Australia, Norway and Korea are all flexible inflation targeters. Would you say that that flexible inflation targeting has been a failure in those countries?

    My sense is that NGDP targeting would work better in large economies like the US, euro zone and Japan but that small open economies might be better off with flexible inflation targeting. And I think this could be particularly true in commodity-oriented economies where changes in the terms of trade can have big effects on NGDP. NGDP in Canada grew at 6.0% from mid-2002 to mid-2008 with no sign of overheating.

  8. Gravatar of TravisV TravisV
    11. May 2012 at 07:28

    Dave Rosenberg recently had this to say about negative interest rates. Sounds wrong to me but I can’t exactly explain why…..

    http://www.zerohedge.com/news/gold-%E2%80%98will-go-3000-dollars-ounce%E2%80%99-rosenberg

    Rosenberg says that it is not about being “bullish or bearish,” it is about “stating how you view the world” and he warns that the major central banks are all going to print more money and keep real interest rates negative “as far as the eye can see.”

    This is “critical” as one of the key determinants of the gold price are real short term interest rates.

    The longer they stay negative “the longer the bull market in gold is going to be.”

  9. Gravatar of Negation of Ideology Negation of Ideology
    11. May 2012 at 07:41

    Saturos –

    “The “latest evidence” is apparently a new IMF paper (can’t find it).”

    I thought the IMF had a recent paper that fiscal stimulus didn’t work, and in fact had a negative multiplier, when debt-to-GDP exceeded 60%. I think Scott commented on it in a previous post, or maybe my memory is faulty.

    I hope Greece decides to play hardball. They should propose that the ECB target 7% Eurozone NGDP growth for the next 4 years and 5% thereafter. If the other nations refuse, then Greece should pull out of the Euro, pocket the bond reductions already made, re-denominate all debts as one drachma for one Euro, then order its Central Bank to target Greece NGDP at 7% growth for 4 years and 5% thereafter.

    They shouldn’t pull out of the EU when they to do this. I don’t think there’s a formal mechanism to expel a country, they could just be like Britain. Some countries, may decide they support the proposal and Greece would then keep the Euro. Otherwise, Greece in better off out of the Euro.

  10. Gravatar of worthy worthy
    11. May 2012 at 08:08

    Scott Sumner for Fed chairman 2014! Too bad it could not happen in ’10. But now there’s still time to make a right choice.

  11. Gravatar of Brian Puj Brian Puj
    11. May 2012 at 08:10

    Prof. Sumner – Have you seen the monetary policy game from FRBSF?

    http://www.frbsf.org/education/activities/chairman/index.html

    Thought you might “enjoy” it, as the only tool available is interest rates, you’re supposed to be targeting the “dual mandate” with no mention of NGDP, and it seems like the game has a significant bias towards runaway inflation. I think the game also has a bias towards having the player lose, which has interesting implications.

    It would be very interesting to see what “model” they’re using.

  12. Gravatar of Mattias Mattias
    11. May 2012 at 08:35

    Hi Scott

    I know you are a bit interested in Svensson and the Swedish Riksbank, so I can give you this (google translated) link from a debate in the Stockholm School of Economics (my old school):

    http://translate.google.com/translate?sl=sv&tl=en&js=n&prev=_t&hl=sv&ie=UTF-8&layout=2&eotf=1&u=http%3A%2F%2Fdi.se%2FArtiklar%2F2012%2F5%2F11%2F267268%2FManga-tjuvnyp-i-Riksbanken%2F&act=url

    BTW, someone has to inform Google that the correct translation of “duva” in monetary issues is a “dove” and not a “pigeon”.

  13. Gravatar of Josh Josh
    11. May 2012 at 08:41

    “There is no plausible macro model where fluctuations in inflation between -2% and 6% directly produce significant welfare losses.”

    Scott this is wrong. Very wrong. There are an abundance of models that show that such fluctuations in inflation produce significant welfare losses. The entire concept of the Friedman rule is predicated on the notion that inflation reduces welfare because it places a tax on money balances. The insights of the Friedman rule apply to a wide spectrum of macro models. A more recent model, one that takes money seriously, is that of Lagos and Wright (JPE, 2005). They show that going from 10% inflation to 0% inflation would be worth 5% of consumption.

  14. Gravatar of J.V. Dubois J.V. Dubois
    11. May 2012 at 08:45

    I was also puzzled by this obsession with inflation – for instance while reading Draghi’s famous interview for Bild. I always thought for myself – did they all forgot why Central Banks exist in the fist place? What they are really supposed to do – like prevent and mitigate demand recessions? I really do not understand why this happened.
    .
    And by the way, ECB is especially monstrous caricature of a Central Bank. They not only reject the idea that they should do something against recession. They not only resign on their crucial role of lender of last resort. They even seem not to care if the currency they are actually tasked to watch will exist within a year anymore. They are like madmen able to focus only on the latest CPI number. This would be almost comic if it was not so serious. I really wonder how those men and women can look at their reflection in the mirror when they get up in the morning. I cannot fathom what could they think about when they go to work that seems to be about bringing plight and destruction to millions all over the Europe.

  15. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 09:12

    Mattias wrote:
    “BTW, someone has to inform Google that the correct translation of “duva” in monetary issues is a “dove” and not a “pigeon”.”

    Pigeons have a better sense of direction than doves or hawks. (Maybe they’re the NGDP level targeters.)

  16. Gravatar of Morgan Warstler Morgan Warstler
    11. May 2012 at 09:20

    6% inflation is THEFT.

    Govts. are meant to have a HARD TIME.

  17. Gravatar of Morgan Warstler Morgan Warstler
    11. May 2012 at 09:25

    No matter how many times I say this, no on ever argues:

    Money and Monetary policy are NOT Social Goods.

    Monetary policy does not exist to help all people “equally.”

    The reason is simple: Govt. use laws, taxes and spending to achieve their ends.

    MONEY is meant to exist for people who HAVE MONEY. Whether medium of exchange or storehouse of value….

    NEITHER of those have anything to do with “helping out the unfortunate.”

    —-

    This is a real argument. I’m asserting it.

    I want to see someone explain WHY they think this is not true.

    I suspect all you got is the dual mandate.

    Anybody got anything else?

  18. Gravatar of marcus nunes marcus nunes
    11. May 2012 at 09:42

    At least you are paired with Friedaman:
    Speaking of strange preferences, here are Scott Sumner’s preferences U(NGDP), where U(.) is strictly increasing and possibly convex. This tireless advocate of NGDP targeting has another post today on the subject: It’s not about Credit, It’s about NGDP.

    Of course, to Scott, everything seems to be about NGDP. Reminds me of Robert Solow’s famous quip regarding Milton Friedman’s obsession with the money supply:
    Everything reminds Milton Friedman of the money supply. Well, everything reminds me of sex, but I try to keep it out of my papers.
    With respect to Scott’s remarkable assertion
    If the Fed provides the right amount of NGDP, all those finance issues will take care of themselves.
    I am reminded of Pedro’s brilliant campaign promise in Napolean Dynamite.

    OK, enough silly thoughts for one day. Time to get working!
    http://andolfatto.blogspot.com.es/2012/05/this-n-that-and-other-silly-things-for.html?showComment=1336587318554

  19. Gravatar of Donald Pretari Donald Pretari
    11. May 2012 at 10:33

    I wish people would resist the urge to say “If I’m wrong, refute me.” Even though I’m retired, the days are short.

  20. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 10:47

    “He’s thinking in terms of low and stable inflation as being the goal of monetary policy. But it’s not. There is no plausible macro model where fluctuations in inflation between -2% and 6% directly produce significant welfare losses.”

    This made me go look for an intermediate macro book by Olivier Blanchard (2002, 3rd edition, Chapter 25). If Scott can quote intermediate textbooks by Frederic Mishkin on money, I figure I can quote Blanchard on macro.

    [Just keeping it simple (stupid).]

    Here is a summary of what Blanchard says:

    The Costs of Inflation:
    1) Shoe Leather Costs
    Higher opportunity cost of holding money leads to more frequent trips to banks.
    2) Tax Distortions
    Capital gains distortions and income tax bracket creek.
    3) The Money Illusion
    Systematic mistakes in assessing nominal versus real changes.
    4) Inflation Variability
    More variable inflation means that financial assets such as bonds become riskier.

    The Benefits of Inflation:
    1) Seignorage
    Money creation is an alternative for government to borrowing from the public or raising taxes.
    2) The Option of Negative Real Interest Rates
    An economy with a higher average inflation rate has more scope to use monetary policy to fight a recession.
    3) The Money Illusion
    The presence of inflation allows for downward wage adjustments more easily than when there is no inflation.

    The Optimal Inflation Rate:
    The debate is not settled but most economists appear to agree that low but positive inflation (i.e. between 0% and 4%) is optimal.

    Some literature that comes to mind in support of Blanchard’s summary is:

    Costs:
    2) Tax Distortions
    Feldstein, Martin. “The Costs and Benefits of Going from Low Inflation to Price Stability.”
    3) The Money Illusion
    Okun, Arthur. “Inflation: Its Mechanics and Welfare Costs”
    Modigliani, Franco, and Cohn, Richard. “Inflation and the Stock Market.”
    Carlton, Dennis. “The Disruptive Effects of Inflation on the Organization of Markets.”
    Hall, Robert. “Monetary Strategy with an Elastic Price Standard.”
    Benabou, Roland. “Inflation and Efficiency in Search Markets.”
    Tommasi, Mariano. “The Consequences of Price Instability on Search Markets: Toward Understanding the Effects of Inflation.”
    Katona, George. “The Psychology of Inflation.”
    4) Inflation Variability
    Okun, Arthur. “The Mirage of Steady Inflation.”
    Taylor, John. “On the Relation between the Variability of Inflation and the Average Inflation Rate.”
    Ball, Lawrence, and Cecchetti, Stephen. “Inflation and Uncertainty at Short and Long Horizons.”
    Sala-i-Martin, Xavier. “Comment.” NBER Macroeconomics Annual 6: 368-378.
    Fischer, Stanley. “The Role of Macroeconomic Factors in Growth.”
    Cukierman, Alex et al. “Central Bank Independence, Growth, Investment, and Real Rates.”
    Bruno, Michael, and Easterly, William. “Inflation, Crises and Long-Run Growth.”

    Benefits:
    3) The Money Illusion
    Tobin, James. “Inflation and Unemployment.”

    So, what did I learn from this exercise?

    1) Scott is clearly overstating his case, probably just to be provocative (this is normal for Scott).
    2) The Money Illusion is the only thing that is considered both a cost and a benefit of inflation (that ought to please Scott).
    3) What Morgan considers to be a cost of inflation (seignorage) Blanchard considers to be a benefit (that ought to raise Morgan’s cackles).

    P.S. Note also that many of these issues do not relate just to aggregate demand but also to aggregate supply.

  21. Gravatar of Major_Freedom Major_Freedom
    11. May 2012 at 11:17

    Inflation targeting was always a means, not an end

    Using NGDP targeting logic, inflation targeting can be held by its supporters as both a means AND an end.

    There is no plausible macro model where fluctuations in inflation between -2% and 6% directly produce significant welfare losses.

    The same holds true for fluctuations in NGDP.

    Economists saw inflation instability leading to output instability (the famous expectations-augmented Phillips Curve) and decided stable inflation was the best way to stabilize AD, and hence output. But by that criterion inflation targeting has been a disaster, as it lead to the greatest collapse in AD since the Great Depression, in both the US and Europe.

    But price inflation wasn’t even tried during and after 2008. This chart shows the CPI to have fallen well below 2%. It went from a peak of 5.5% to a low of -2%.

    I don’t think you in your position can say price targeting failed, because price targeting wasn’t tried.

  22. Gravatar of Mike Sax Mike Sax
    11. May 2012 at 11:22

    “This is a real argument. I’m asserting it.”

    “I want to see someone explain WHY they think this is not true.”

    Ok Morgan as it’s a slow news day and you insist fine I will tell you it’s not true. By the way silence far from always means agreement.

    First of all the dual mandate is really all we do need. It’s the law, what basis does Bernanke or anyone else have to ignore it?

    You can call the Fed “independent” as much as you like but it’s empowered by Congress and it can be disempowered. Incidentally Scott don’t know if you noticed it yesterday but there was a piece in the WSJ about how David Vitter is the one holding back Obama’s Fed nominees-true he could also do the recess appointment but for whatever reason wont.

    Vitter has been wined and dined buy Goldman Sachs and JP Morgan and they’ve urged him to give up his obstruction to no avail.

    For more please see

    http://diaryofarepublicanhater.blogspot.com/2012/05/david-vitter-holding-up-obama-fed.html

    Morgan as you’re an old buddy of Breitbart’s if only you guys were as worried about the truly sick actions of Vitter rather than the merely tawdry actions of Weiner we wouldn’t be in this mess now.

    However, Morgan, to your question as to what rationale should there be for monetary policy to do anything for anyone but the rich, see I think you are seduced by your own personal myth making too much.

    Even assuming that everyone were only about the rich like you, it would still be from the point of view of the rich themselves in their own self interest to do things to help the nonrich-the poor but also the middle class-now and again. If peoplle have no money they can’t buy the rich’s products.

    From a social optimization standpoint-even one who cared only about the rich something would have to be done for at least some of the people who are not rich. Put it this way, for an economy to work, for a society to work you can’t only have rich people.

    In a recession like now even many of the rich have suffered, etc. Then again there’s always the possible threat that if you’re not careful there could be widespread social disoreder and riots which at some point would at a minimum greatly reduce the quality of life of the rich.

    Monetary policy has to think of marcro, externalities not just narrow private concerns.

  23. Gravatar of Saturos Saturos
    11. May 2012 at 11:30

    Scott, this should probably interest you:

    http://www.npr.org/blogs/money/2012/05/08/152291793/if-teens-ran-the-fed

    Central planners in-waiting. Just imagine their happy faces.

    (Btw, none of them got the core vs. headline question right, did they? The real reason core is preferable is because it measures aggregate demand more directly, whereas headline suffers fluctuations which are heavily influenced by supply shocks, such as Middle-Eastern turbulence.)

  24. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 11:43

    @Mike Sax,
    “Vitter has been wined and dined buy Goldman Sachs and JP Morgan and they’ve urged him to give up his obstruction to no avail.”

    Forgive me my skepticism but stop and think about this for a moment.

    Who is the source of this information? Vitter’s staff. What is the benefit to Vitter of telling these tall tales? It gains him support among the tea party types without costing him any support from the financial industry (they really don’t care what is said about them as long as their bread is buttered).

    The financial industry is perfectly happy taking home record profits and earning risk free interest on bloated reserves. Why would they want those BOG seats filled? That would be risky. It could lead to an economic recovery.

  25. Gravatar of John John
    11. May 2012 at 11:45

    Scott,

    Nominal GDP for the past year was approximately 4.9% with the breakdown being 2.7% inflation and 2.2% real GDP growth.

    http://www.bea.gov/
    http://www.bls.gov/cpi/

    Most analysts and economists expect both US inflation and GDP to be in the 2-3% range for the remainder of the year.

    What on earth makes you think that bumping up nominal GDP by 0.1% (probably entirely through more inflation) is “an alternative to our current nightmare.”

    Our economy is in such bad shape because the economics profession is in such bad shape. Economists falsely think that there are direct causal links between nominal spending, unemployment, and output when there are only mild correlations. Unlike real scientists, economists haven’t figured out that correlation doesn’t equal causation.

    This idea of a correlation between economic health and nominal spending makes economists into political whores who tell the government exactly what they want to hear. Spend, spend, spend. The politicians are happy to spend since it lets them buy votes. The real businessmen get sucked dry through taxes and inflation while the government creates a growing class of dependents continually asking for bigger handouts.

    People out there need to wake up and fight against the government’s control of money. It is governmental control over money that causes nations all over the world to self-destruct through the welfare state, endless wars, and continual boom-bust cycles. Market chosen money (gold and silver in the past) is as the most important civil right and check on government power ever created.

  26. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 12:05

    John,
    You wrote:
    “Nominal GDP for the past year was approximately 4.9% with the breakdown being 2.7% inflation and 2.2% real GDP growth.”

    At least use the correct measure and get your numbers right. CPI isn’t computed using the NIPA accounts so adding CPI to RGDP growth does not give one NGDP growth. NGDP is easily looked up at the BEA (Table 1.1.5). NGDP grew by about 4.00% in the past year (2012Q1 over 2011Q1). Real GDP grew by about 2.08% and inflation (the GDP deflator) was about 1.87%.

  27. Gravatar of MMJ MMJ
    11. May 2012 at 12:05

    @ John,

    As I recall, when I posed a similar question, the response was along the lines of what’s below:

    The problem is that the Fed used to ensure NGDP growth steady ~5% (average over the last cycle was ~5.4%). Private sector plans were thus based on expectations of such NGDP growth. Instead, the Fed allowed -1.2% in 08 and 0% in 09, and only 4.7% in 10 and 3.8% in 11. Hence the problems.

  28. Gravatar of Saturos Saturos
    11. May 2012 at 12:11

    John,

    On this blog we support Nominal GDP Level Targeting. *Levels* of spending are way below trend, which is where the price level and fixed nominal debts have to adjust downwards from in the absence of a recovery in spending.

  29. Gravatar of Adam Adam
    11. May 2012 at 12:46

    Any idea where the President of the Minneapolis fed is seeing core inflation that has increased “notably?” (http://minnesota.publicradio.org/display/web/2012/05/11/narayana-kocherlakota-labor-market/)

    How damaging is having someone as clueless as him as a regional fed president? He’s not currently on the FMOC I don’t think, but do we just have to pray that everything better by the time his next rotation comes up?

  30. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 13:32

    Adam,
    Kocherlakota, who holds a PhD the University of Chicago, and is a specialist in money and macro, and whose CV makes most other economists incredibly jealous, made the following statement in August 2010:

    “Long-run monetary neutrality is an uncontroversial, simple, but nonetheless profound proposition. In particular, it implies that if the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent.

    To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation.”

    http://www.minneapolisfed.org/news_events/pres/speech_display.cfm?id=4525

    Now anyone whose taken Econ 102 knows that this is total baloney (insert stronger word if you prefer). But that is the whole problem. Kocherlakota has an undergraduate degree in math and then went straight to a PhD in econ. So he never took Econ 102. Kocherlakota got his result by taking the Fisher identity and adding monetary super-neutrality, never distinguishing between equilibrium and stability. His math is more or less correct but his economic intuition is completely missing in action.

    Now, with that rant out of the way, on to your question. Most likely Kocherlakota is thinking about graphs of year on year core PCE and CPI like these:

    https://research.stlouisfed.org/fred2/graph/?graph_id=66313&category_id=0

    https://research.stlouisfed.org/fred2/graph/?graph_id=75381&category_id=0

    which more or less support what he is saying. But CPI is next to useless, and core PCE shows inflation still below the Fed’s implicit target.

    Moreover who cares about rates when it is levels that matters?

    And even more importantly, who cares about prices when it is NGDP which matters?

    P.S. And just to be clear, my original background is in mathematics. But following graduate studies in math I went straight to the bottom again and got a BA in econ before I went on to the PhD. So I actually took Econ 102. I may not be one tenth as smart as Kocherlakota but at least I took intro to macro.

  31. Gravatar of marcus nunes marcus nunes
    11. May 2012 at 13:38

    Adam
    Did a post on Kocherlakota. He´s been playing that fiddle for at least two years now.
    http://thefaintofheart.wordpress.com/2012/05/11/kocherlakota-shoots-from-the-hip/

  32. Gravatar of Steve Steve
    11. May 2012 at 13:55

    @ Mark,

    I’m always amazed that the number one cited “Cost of Inflation” is “1) Shoe Leather Costs”.

    Will they ever get with times and call it “Mouse Click Costs”? And then acknowledge that these are effectively zero?

    That leaves us with tax creep and bond riskiness as the only two remaining costs of inflation. Basically, the creditors don’t like it. Harrumph!

  33. Gravatar of Steve Steve
    11. May 2012 at 14:04

    @ssumner

    I remember during the financial crisis, maybe 2009 or 2010, one of the major national apartment companies saying that they were willing to accept much lower occupancy in order to keep rents stable to up.

    I’m wondering if this behavior is more pervasive than in the past (more oligopolies) and more pervasive near zero inflation. It seems like this sort of behavior is one of the reasons inflation barely budges in response to AD shifts.

  34. Gravatar of Jim Glass Jim Glass
    11. May 2012 at 14:49

    Kocherlakota … made the following statement in August 2010:

    “Long-run monetary neutrality is an uncontroversial, simple, but nonetheless profound proposition. In particular, it implies that if the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic…”

    In all the brouhaha that followed, the most concise response making most clear K’s policy error (IMHO) was by … don’t remember, can’t find it in my clip file … but to this point, which I paraphrase:

    ‘Kocherlakota is entirely correct. If the Fed keeps an interest rate of only 0.25% permanently when higher rates are appropriate, then in the long run deflation indeed must result — from a price level vastly higher than the initial one, after prices rocket up to that level in the short and intermediate runs’.

    There was some detailed analysis of how the inflation would eventually cease and turn to deflation. I’m still looking to see if I can find it.

    Of course in practical application nobody (almost!) thinks of such too-*low* rates leading to deflation, because in the real world nobody would tolerate the preceding epic inflation, so the story ends there. K seems to have made the opposite cognitive jump, seeing only the ultimate deflation and not the preceding inflation.

  35. Gravatar of ssumner ssumner
    11. May 2012 at 14:51

    Saturos, You said;

    “But price stability is an end in itself. All the textbooks show that high and variable inflation is correlated with severe drops in output”

    You just contradicted yourself. Variable inflation is a problem to the extent that it leads to variable output. The transmission mechanism from variable inflation to variable output runs through variable AD. Which is exactly my point.

    If the variable inflation is caused by AS shocks, and AD is stable, then all the textbooks say the variable inflation tends to reduce output instability. That’s not just my view, it’s the mainstream model.

    Ben, Same response as to Saturos. It reduces output if associated with falling AD, as in Japan. But if NGDP is rising 5% a year (or even 3%), then 2% deflation would not be a problem.

    dwb, Good point.

    Saturos, I wish The Economist would stop talking so much about fiscal stimulus, and talk about what really matters–monetary policy.

    Mike Sax, It was better for at least 5 reasons. It did not include the years 2008, 2009, 2010, 2011, 2012.

    Gregor, I agree that NGDP targeting works better in bigger countries. I’d add that “flexible inflation targeting” can be quite close to NGDP targeting, it depends how it’s managed.

    TravisV, Low real interest rates certainly does help gold. And I agree that real rates will be low for quite some time. In my view the cause is tight money in 2008.

    Thanks worthy–of course it’s a pipe dream.

    Brian, Yes, I wasn’t impressed.

    Mattias, Thanks, I’ll take a look.

    Josh, You said;

    “Scott this is wrong. Very wrong. There are an abundance of models that show that such fluctuations in inflation produce significant welfare losses. The entire concept of the Friedman rule is predicated on the notion that inflation reduces welfare because it places a tax on money balances. The insights of the Friedman rule apply to a wide spectrum of macro models. A more recent model, one that takes money seriously, is that of Lagos and Wright (JPE, 2005). They show that going from 10% inflation to 0% inflation would be worth 5% of consumption.”

    I’m afraid it’s you that is wrong. You are confusing volatility with levels. If inflation is more volatile but NGDP is less volatile, and the average inflation rate is unchanged, then the welfare costs are not significantly higher. (Not at all higher in my view, BTW.) I’ll be glad to argue this point till I’m blue in the face. Don’t confuse high levels of inflation with greater volatility.

    JV, I agree.

    Marcus, I can’t get enough of those Friedman comparisons.

    Mark, You definitely misunderstood what I was trying to say. Read my comment to Josh. I was not arguing that higher inflation doesn’t have welfare costs, it clearly does.

    Saturos, Thanks, but I no longer have time for that sort of thing. I always seem to be busy these days.

    John, Those numbers are wrong. And even if right they’d have no bearing on my proposal–which is level targeting.

    Steve, Yes, prices do seem stickier, but there could be many reasons. Also keep in mind that actual rents are far different from rents measured by the BLS. Actual rents often include things like 2 free months during recessions. That’s a price cut that the BLS ignores.

  36. Gravatar of J.V. Dubois J.V. Dubois
    11. May 2012 at 14:56

    Mark: I wonder how much fear of inflation is relevant for NGDP level targeting. If we assume that on average we will have 3% inflation and 2% real NGDP growth, lets target 5% NGDP level path target. So by the time your capital taxes are due, givent that RGDP does not fluctuate much you will not experience much difference in taxes then under explicit inflation targeting. Or am I missing something?

  37. Gravatar of Morgan Warstler Morgan Warstler
    11. May 2012 at 16:14

    “You just contradicted yourself. Variable inflation is a problem to the extent that it leads to variable output. The transmission mechanism from variable inflation to variable output runs through variable AD. Which is exactly my point.

    If the variable inflation is caused by AS shocks, and AD is stable, then all the textbooks say the variable inflation tends to reduce output instability. That’s not just my view, it’s the mainstream model.”

    I see what you did there…

    The point is that HIGH long term inflation reduces output. It makes people stop saving. It increases the power of the state.

    Which gets me back to Sax:

    Dude, I read your response twice, and I don’t see ANY kind of reasoned argument that Money and Monetary policy ought to or should be a social good.

    My arguments:

    There is a CLEAR and DISTINCT path for socials goods… an elected Congress which passes laws, taxes and spends the money.

    If you want people to have X,Y,Z you accomplish that through those means. General Welfare and all that.

    BUT, MONEY according to just about everyone is for two things:

    1. medium of exchange
    2. storehouse of value

    That’s WHAT everyone says, it is what everyone understands.

    (Again, Mike this is an ARGUMENT, it has reasons behind it)

    Neither of those functions of money are concerned with “does everyone have a job?” So, it SEEMS OFF.

    —-

    What you do say is a bunch of handwaving about the “the rich” – which I’m NOT CONCERNED WITH AT ALL.

    I preach a gospel of allowing the 80-99% to tear down the 1%, and keep the spoils they deserve.

    This is not a “pro-rich” position.

    More importantly, as I noted above, INFLATION is a form of TYRANNY. Money ceases to be a storehouse of value. And as such, the population ceases to “save.”

    Ask yourself why countries that had high inflation rates have an overwhelming addiction to Versace and Gucci?

    When the avg. schmuck figures he had better start spending all of his paycheck instead of saving up his rubles, lira, etc. because that shit is going to be worth less next month, next year – it CHANGES their relationship with the state and not in a good way.

    The point is that when it comes to money, we should want to make saving as easy as “cash hoarding” and not imagine that there is new “demand” for money, there is new “demand” for not buying anything.

    Look, just step back and look at it rationally… it is one thing to argue that Macro has its place…

    It is entirely another to IMAGINE that you can use Monetary policy to affect achieve social good, that the holders of money will stand for it (without setting limits like 2%), and that you will not ruin your credibility in the log run.

  38. Gravatar of Josh Josh
    11. May 2012 at 16:54

    Scott, you wrote:

    “I’m afraid it’s you that is wrong. You are confusing volatility with levels.”

    No, I am not. The insight of the Friedman rule is that inflation represents a tax on money balances. As such individuals economize on money balances and spending is lower than it would be without inflation. The methodology used by Lagos and Wright and Lucas before them (and many others) is to compare the different levels of spending that correspond with different levels of inflation.

    In other words, suppose that a particular level of inflation is associated with $X of spending and a higher level of inflation is associated with $Y of spending. With an explicit welfare criteria, say W, you can measure the welfare loss from a higher level of inflation as:

    W(Y) – W(X)

    This has absolutely nothing to do with volatility.

  39. Gravatar of dtoh dtoh
    11. May 2012 at 17:07

    @Morgan
    “More importantly, as I noted above, INFLATION is a form of TYRANNY. Money ceases to be a storehouse of value. And as such, the population ceases to “save.””

    Not correct. They just keep less of their saving in money and instead put it in assets such as real estate, stocks, short term government bonds, floating rate notes, etc., where the real return is not impacted by inflation.

    This argument keeps showing up on the blog and it’s really stupid. Long term fixed low interest bonds are not the only asset available for savings.

  40. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 17:12

    @Steve,
    You wrote:
    “Will they ever get with times and call it “Mouse Click Costs”? And then acknowledge that these are effectively zero?”

    Yes, I agree, Shoe Leather Costs are being driven to zero by technology.

  41. Gravatar of John John
    11. May 2012 at 17:14

    At Scott, Saturos, MMJ, and Mark,

    Sorry for adding unseasonably adjusted core inflation to Q1 2011-Q1 2012 GDP growth to get an approximation for NGDP growth. How unscientific of me since national income accounting is so scientifically precise. Note the sarcasm.

    You all didn’t address my bigger point because quite frankly I don’t think you can. There are no direct causal links between inflation or NGDP, employment, and output. You can have high NGDP and high unemployment, low GDP and high employment, high NGDP, high employment and low output, etc. The macro approach is pure junk pseudo-science.

    As far as the benefits of stabilization, that idea dates back to Irving Fisher. Fischer famously thought the economy was fantastic in 1929 and stocks had “reached a permanently high plateau” because the Fed has been able to keep inflation around 0. Stabilization does nothing to protect against the development of financial crises.

    Once again the macro approach is broken. In order to know if additional money will increase employment, you’d have to follow the money through the economic system. If it gets parked in a vault at the Fed, it won’t do much. All it does is prove that there are no constant relations in economics. If you want to understand economics, look at it from the point of view of individual actors not fictional macro entities.

  42. Gravatar of John John
    11. May 2012 at 17:14

    At Scott, Saturos, MMJ, and Mark,

    Sorry for adding unseasonably adjusted core inflation to Q1 2011-Q1 2012 GDP growth to get an approximation for NGDP growth. How unscientific of me since national income accounting is so scientifically precise. Note the sarcasm.

    You all didn’t address my bigger point because quite frankly I don’t think you can. There are no direct causal links between inflation or NGDP, employment, and output. You can have high NGDP and high unemployment, low GDP and high employment, high NGDP, high employment and low output, etc. The macro approach is pure junk pseudo-science.

    As far as the benefits of stabilization, that idea dates back to Irving Fisher. Fischer famously thought the economy was fantastic in 1929 and stocks had “reached a permanently high plateau” because the Fed has been able to keep inflation around 0. Stabilization does nothing to protect against the development of financial crises.

    Once again the macro approach is broken. In order to know if additional money will increase employment, you’d have to follow the money through the economic system. If it gets parked in a vault at the Fed, it won’t do much. All it does is prove that there are no constant relations in economics. If you want to understand economics, look at it from the point of view of individual actors not fictional macro entities.

  43. Gravatar of John John
    11. May 2012 at 17:16

    Sorry for the double post. I didn’t think it went through the first time.

  44. Gravatar of Mike Sax Mike Sax
    11. May 2012 at 17:33

    Morgan I’ll be back later for a more in depth response-got ot eat dinner right now-but just to be clear my “handwaving about the rich” is predicated on what you always say-”no free stuff for poor people” you always frame it as about the undeserving poor-in your mind-who can’t be allowed to get anything.

    That’s how you always define the issue. You also to about Krugman and Delong or though in case you really don’t know this-neither of those guys are even a little poor. Eoither one can probably buy and sell you.

    I guess your point is that somehow your ideology is supposed to benefit not the 1% at the expense of everyone else but the “81-99) in other words the uppoer middle class. I get it though I thinnk you misconstrue what the interests of the upper middle class are-their biggest problem is not poor people who are benefitting from a welfare state-as if we even have one in America.

  45. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 17:57

    Scott,
    You wrote:
    “Mark, You definitely misunderstood what I was trying to say. Read my comment to Josh. I was not arguing that higher inflation doesn’t have welfare costs, it clearly does.”

    Mostly, I just wanted to put out what the textbook version was in order to give your claim some context. And secondly, I was waiting for you to clarify your claim.

    Steve already shot down Shoe Leather Costs. Let me address the other costs.

    2) Tax Distortion can be eliminated through indexing, so this is less a technical matter than a political one.

    3) The Money Illusion costs are all proportional to long run average rates of inflation. So if NGDP growth is maintained at a steady rate of growth that keeps the average rate of inflation low then this is not a problem either.

    4) This leaves inflation variability. Okun, Taylor, Ball and Cecchetti all argue that inflation variability is correlated to the average level of inflation. The association through the effect of inflation on policy. The higher inflation is the less concensus there is on the need to keep it low. The implication is that AD or the rate of NGDP growth is more variable the higher its average rate of growth. But if NGDP level targeting is in effect this is rendered moot.

    Sala-iMartin argues that the causality runs from policy to inflation. Specifically, policies that are detrimental to long run growth lead to higher rates of inflation and thus ultimately lead to higher inflation variability through the above mechanism. But again, if the rate of NGDP growth is fixed this too is moot.

    Lastly, if we are practicing NGDPLT then the source of variability must be shocks to AS. If so monetary policy will act as a stabilizing force to productivity induced booms and busts. Rather than increasing financial asset risks, in this case it would actually reduce them.

  46. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 18:06

    J.V. Dubois,
    You wrote:
    “If we assume that on average we will have 3% inflation and 2% real NGDP [RGDP?] growth, lets target 5% NGDP level path target. So by the time your capital taxes are due, givent that RGDP does not fluctuate much you will not experience much difference in taxes then under explicit inflation targeting. Or am I missing something?”

    Under NGDPLT there would be less variability in nominal incomes so yes, I believe there would be less variability in taxes due.

  47. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 18:11

    Scott,
    Correction at 17:57 on point 4):

    “The association through the effect of inflation on policy.”

    should read

    “The association is through the effect of inflation on policy.”

    (Makes more sense with a verb doesn’t it?)

  48. Gravatar of Mike Sax Mike Sax
    11. May 2012 at 18:30

    Ok Morgan I’m back. In your answer to me you say it’s all about a medium of exchange and a store of value. That’s what “everyone” agrees on.

    But then you seem to have a certain agenda as far as distribution you think monetary policy should benefit those who have money at the expense of those who don’t-again that’s why I said you’re about the rich. I know you think you’re about the upper middle class probabaly that’s your background or whatever, I’m from Long Island New York I know the type.

    Just hearing your reacation about 6% inflation makes me thing that would be a very good thing. I mean the bull market for bondholders has to end some time.

    So anyway you want it to benefit the 81-99% so it’s not just a wholly neutral agenda on your part eihter. The Fed has changed it’s mandate through the years. At one time-from the time of Eccles Marriner till the 70s it did care about unemployment. Bernanke claims he still does though he doesn’t do much about it.

    The Fed is a political body and the mandate can be whatever we tell it to be. In recent years there’s been the fetish for “price stabliity” which beenfits few people other than bondholders and maybe some old coupon clippers. no matter how you look at it there will be winners and losers. You’re definition of monetary policy is no more puerer than mine.

    I say it should do what is best for the marcoeconomy. You say it should benefit the bondholders and the coupon clippers and screw everyone else. It’s the same thing.

    As to your idea that the upper middle class are most threatened from some mythiical welfare queen Reagan dreamt up you don’t even udnerstand the true interest of the 81-99%.

    The whole Tea Party movement always was confused-remember that old woman who declared “keep your dirty government hands off my Medicare?”

    Keevin Phillips does a good job at showing us reality. From teh postwar period to till the late 70s all 5 income brackets gained. Since the late 70s only the top 1% has. Your idea that the upper middle class have more to fear from the poor than the top 1% is your delusion.

  49. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2012 at 18:54

    John,
    If you’re going to critique NGDPLT I think it’s important you first get your facts straight and understand what it is. Everything else is just garnish. (And if you don’t believe the facts then there’s really not much to talk about, is there?)

    I will address the following however:

    “As far as the benefits of stabilization, that idea dates back to Irving Fisher. Fischer famously thought the economy was fantastic in 1929 and stocks had “reached a permanently high plateau” because the Fed has been able to keep inflation around 0. Stabilization does nothing to protect against the development of financial crises.”

    Fisher’s pronouncement on Oct. 17, 1929 is famous, however I don’t ever recall him connecting this to Fed policy or the inflation rate. Fisher had based his statement on strong earnings reports, the low number of industrial disputes, and evidence of high investment in research and development (R&D) and other intangible capital. Recent research shows that Fisher was correct, that based on the fundamentals that were true at the time, the stock market was appropriately valued.

    Once the Great Depression was in full force, Fisher warned that the ongoing deflation was the cause of the cascading insolvencies then plaguing the American economy because deflation increased the real value of debt. This of course is now known as the debt-deflation theory of economic cycles.

    The stock market crash in and of itself did not constitute a financial crisis. But the failure to stabilize NGDP in its wake did eventually lead to one. And this is in fact is the usual direction of causality. It is declines in NGDP that normally lead to financial crises and not the other way around.

    Furthermore there’s no reason why stock market crashes have to lead to depressions, otherwise we would have had one in 1987.

  50. Gravatar of ChargerCarl ChargerCarl
    11. May 2012 at 19:17

    Scott, someone told me today that expansionary monetary policy will fail because investors would just take their money overseas and into commodities.

    I pointed out that fed easing would likely boost asset prices making investment in the U.S. more desirable and as evidence of this I pointed out the stock markets’ positive reaction towards QE.

    Am I correct?

  51. Gravatar of dtoh dtoh
    11. May 2012 at 19:28

    @Sax

    “From teh postwar period to till the late 70s all 5 income brackets gained. Since the late 70s only the top 1% has. Your idea that the upper middle class have more to fear from the poor than the top 1% is your delusion.”

    All of figures are based on reported AGI, which is poor measure of actual income for a whole bunch of reasons including the fact that it doesn’t include unreported cash income, non-taxable health insurance benefits, and because it reports once a large amount capital gains accrued over many years only in the year it is realized. To take an extreme example, if all income was capital gains and the average holding period was 33 years, the AGI would show every year that 3% of the population earned 100% of the income even if actual income was completely evenly distributed.

  52. Gravatar of Mike Sax Mike Sax
    11. May 2012 at 19:58

    dtoh I know there are a million ways to spin the numbers that try to make it seem like wages haven’t stagnated though none I find persausive. A common argument is that per capita income is for some reason more accurate a guage.

    If you say all the studies are based on reported AGI what would you suggest to evaluate the data-is it per capita income?

    In general your argument seems like yet another supply side argument where the sun rises and sets on capitagl gains taxes.

  53. Gravatar of Mike Sax Mike Sax
    11. May 2012 at 20:09

    For supply siders the capital gains rate is always too high though for now they are at historical lows.

  54. Gravatar of dtoh dtoh
    11. May 2012 at 20:10

    @Sax

    1. The problem is that there is not any good data.

    2. You will never get good data, because you can’t get honest responses from those not reporting cash income and there is no requirement for reporting of assets.

    3. IMHO equality of consumption is a lot more important than equality of income. I would favor a progressive consumption tax.

    4. Uneven wealth (as opposed to consumption) distribution doesn’t bother me a bit. Everyone in society is better off if wealth is concentrated in the hands of those who can efficiently allocate it (this probably means those who have had large capital gains in the past).

    5. I do believe capital gains taxes have a huge impact economic growth and job creation. Because of the asymmetry of returns, even low rates can result in negative average expected after tax returns. Think of it as Laffer Curve for capital gains where the maximum occurs at a very low tax rate.

    6. Per capita income is in my opinion worthless for the purpose of measuring income distribution.

  55. Gravatar of Charles Charles
    11. May 2012 at 20:37

    Scott,

    Isn’t the point of money to lower transaction costs to contracts.

    Isn’t the point of “monetary policy” to reduce the number of times people need to renegotiate longterm contracts, thus keeping transaction costs low.

    We should pick targets that reduce the likelihood of having to renegotiate a bunch of long term contracts.

    NGDP target seems suitable for that reason.

  56. Gravatar of W. Peden W. Peden
    11. May 2012 at 21:12

    It’s interesting how many monetarists and Post-Keynesians- both with some justification- claim Irving Fisher’s work in the 1930s. Back then, he was somewhat of an outcast. Today, he’s almost back in fashion.

    Though hopefully his eugenicist and prohibitionist views will forever be museum pieces as case studies of the hubris of the 1920s.

  57. Gravatar of Saturos Saturos
    11. May 2012 at 23:35

    Scott,

    So to revise your earlier sentence,
    “There is no plausible macro model where fluctuations in inflation between -2% and 6% directly produce significant welfare losses – provided they are not also fluctuations in aggregate demand.”

    With supply shocks, it’s a one-off jump in prices, so there is no further volatility in the price level, unless the Fed clamps down on AD creating further distortions and making the situation worse.

    John, you said,
    “You can have high NGDP and high unemployment, low GDP and high employment, high NGDP, high employment and low output, etc. The macro approach is pure junk pseudo-science.”

    Your second sentence doesn’t follow from the first. You are confusing demand and supply side factors (spending and production side factors). And even Austrians believe that printing money causes inflation in the long run – that’s a constant relation. It’s also common sense.

    Mark, you said,

    “Recent research shows that Fisher was correct, that based on the fundamentals that were true at the time, the stock market was appropriately valued.”

    Could you point me to where I could find that research?

  58. Gravatar of ssumner ssumner
    12. May 2012 at 04:32

    Josh, You still aren’t seeing my point. I’m not calling for higher inflation. I agree there are welfare costs of higher inflation, but that’s not what I was discussing. An inflation rate that fluctuates between -2% and 6% is obviously not higher than 2% inflation, on average.

    John. You said;

    “You all didn’t address my bigger point because quite frankly I don’t think you can. There are no direct causal links between inflation or NGDP, employment, and output.”

    Please tell me you are joking. If we repeated the 1929-33 experiment of cutting NGDP by 50%, there’s no loss of RGDP? What planet are you living on?

    Does NGDP always affect RGDP? Obviously not. There are also supply-shocks (Zimbabwe, etc) but to argue there is no effect is just silly.

    ChargerCarl, You said;

    “Scott, someone told me today that expansionary monetary policy will fail because investors would just take their money overseas and into commodities.”

    You are right, but it’s far worse. Money doesn’t get invested “into” markets. Money is a medium of exchange. When you buy a stock or commodity the money goes into the market and a billionth of a nanosecond later it comes back out into the hands of the guy who sold you the stock. Money doesn’t go into markets.

    Charles. That’s one important goal. In my view the number one goal of monetary policy is to NOT create recessions. But reducing transactions costs is another important goal.

    W. Peden, I’m surprised the post-Keynesians like him, given he was a quantity theorist.

    Saturos, I’ve seen that research on 1929 as well. If you could go back to 1929 and buy stocks and hold them until today it would be a great investment, even risk adjusted, wouldn’t it?

  59. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. May 2012 at 05:50

    @Saturos,
    You wrote:
    “Could you point me to where I could find that research?”

    I was thinking specifically of this paper. (I love the title.)

    The 1929 Stock Market: Irving Fisher Was Right
    Ellen R. McGrattan
    Edward C.Prescott

    Abstract:
    “Many stock market analysts think that in 1929, at the time of the crash, stocks were overvalued. Irving Fisher argued just before the crash that fundamentals were strong and the stock market was undervalued. In this paper, we use growth theory to estimate the fundamental value of corporate equity and compare it to actual stock valuations. Our estimate is based on values of productive corporate capital, both tangible and intangible, and tax rates on corporate income and distributions. The evidence strongly suggests that Fisher was right. Even at the 1929 peak, stocks were undervalued relative to the prediction of theory.”

    http://www.cfr.org/content/thinktank/Depression/Fisher_McGrattenPrescott.pdf

    @W. Peden,
    I find it extremely odd that Post-Keynesians deride “Neoclassical” economics and then turn around and claim several Neoclassical economists, such as Fisher, as their own. If Fisher were alive today he probably would have changed his views on eugenics and prohibition as the facts changed (a la Keynes).

  60. Gravatar of Saturos Saturos
    12. May 2012 at 07:23

    Mark,

    Awesome. Thank you so much.

  61. Gravatar of W. Peden W. Peden
    12. May 2012 at 13:27

    Scott Sumner and Mark A. Sadowski,

    As I understand them, the PKs that like Fisher and his work on debt-deflation think that Fisher had a huge turn-around in the 1930s. While they are right that Fisher had a change of FOCUS in that period (as he correctly inquired deeper into the transmission mechanism than before) there was no fundamental change in his economic views and he was still within the mainstream of American neoclassical economics (which he had done so much to construct) at the time, e.g. he signed petitions with the likes of Frank Knight. He was just personally discredited by his comments in 1929.

    I suspect the confusion is this: many people, especially those who have read little inter-war economics other than the GT, have a caricature vision of what American neoclassical economics was like during that period. They conflate the neoclassicals with what Keynes called “Classical Economics”, but it is hard to find anyone who fitted what Keynes meant by that label. However, they also know that they like debt deflation as a well-articulated account of a disequilibrium process that requires government intervention.

    So Fisher is transformed from being a “Classical Economist” (which he never was) to being a proto-MMT/PK type, which he also never was.

    Having said that (and in a rather haughty way) I am still a bit confused by Irving Fisher’s rather crankish solutions to the problems of the 1930s. Perhaps, having realised the connection between asset prices and money creation, he didn’t delve far enough into the transmission mechanism to see that monetary policy has a (potentially) overwhelming impact on asset prices and the money creation process generally. To be fair to him, this is a very common flaw.

    (Also, Keynes sometimes feels like a quantity theorist, even in the General Theory e.g. doesn’t Keynes talk about increasing the money supply and its effects- or lack thereof- on interest rates, especially long-term interest rates? That’s how I always understood Keynes’s liquidity trap: it’s when an increase in the quantity of money cannot reduce the yield on long-term government bonds, because people’s liquidity preference is infinite. I have no idea how to frame the liquidity trap if the money supply is wholly endogenous and central banks can only control interest rates.)

    Mark A. Sadowski,

    Re: eugenics and prohibitionism, I’m sure you’re right. I think that Fisher had an unhealthy credulity in the power of expertise, which was common in the Progressive Era, and took the noble and respectable claims of eugenicists and prohibitionists at their word as opposed to suspending judgement until good evidence/arguments were presented.

    Were he transplanted to today, I fear that Fisher would campaign with equal vigour for tougher restrictions on civil liberties based on what security experts say about terrorism. It was a bad intellectual habit of his rather than any unsavoury authoritarian/racialist instincts- as far as I can tell, he was basically a good person, as was Keynes.

    Also, that paper looks like it’s going to be a lot of fun. I remember Friedman arguing that Fisher would have been right or closeer to right, had the Fed not mishandled the crisis so badly.

  62. Gravatar of John John
    13. May 2012 at 01:26

    Saturos,

    I never said you could have high inflation and low NGDP, the two are practically synonymous. I simply said that there was no direct causal relation between NGDP/Inflation and real GDP/Employment. If you want me to be precise I would have to add in the medium to long run.

    Mark,

    I understand NGDPLT perfectly you keep the nominal economy growing at 5% forever and don’t let it get knocked off course. I’m not gonna dig it up right now but Fisher’s big monetary idea was stabilization (much like Friedman and Sumner) and he did get what he wanted in the late 1920s. This view prevented him from seeing what was clearly a speculative episode in the stock market.

    In any case, non of you are seeing my point that links between nominal factors (NGDP and inflation) and the real economy are not the basis of a sound theory. The two can have short run influences on each other but what you really have is a weak correlation and proposed mechanisms for direct causation that are only short run (sticky wages) and therefore have nothing to add in the study of multi-year crises. Economies can be healthy at any level of nominal spending and trying to marry nominal spending to output as economic law is like astrology.

  63. Gravatar of Saturos Saturos
    13. May 2012 at 07:44

    John,

    You must hate empirical evidence. Today’s recession and the Great Depression are the closest things we’ll ever have to controlled experiments demonstrating that big nominal shocks do cause multi-year recessions – especially when compounded with supply-side distortions. No other theory comes close to matching all the evidence.

  64. Gravatar of ssumner ssumner
    13. May 2012 at 14:29

    W. Peden, Very good comments. I would add that Fisher was worried about debt problems because he saw them contributing to deflation via a reduced money multiplier. In principle that could have been avoided with his compensated dollar plan, but he knew that there were huge political obstacles in the way—and hence favored systems where velocity would be more stable.

  65. Gravatar of Saturos Saturos
    13. May 2012 at 22:27

    Also, Keynes sometimes feels like a quantity theorist, even in the General Theory e.g. doesn’t Keynes talk about increasing the money supply and its effects- or lack thereof- on interest rates, especially long-term interest rates? That’s how I always understood Keynes’s liquidity trap: it’s when an increase in the quantity of money cannot reduce the yield on long-term government bonds, because people’s liquidity preference is infinite.

    That seems to me to be the opposite of a quantity theory way of looking at things. The quantity theorist should use MV = PY to look at the overall volume of flows of nominal spending, so that if M rises then V must fall equally to prevent a rise in nominal spending. So if infinite liquidity preference is the desire to hold any amount of money, not just as a replacement for zero-yielding bonds but regardless, then shouldn’t nominal income fall and fall forever, as money demand always exceeds money supply? Again, the interest rate-centric view fails doubly: it first of all assumes that the only increase in spending from a monetary injection must be the rise in borrowing and dissaving due to lower interest rates, and can’t see how more money leads to more spending otherwise; and secondly it fails to clearly visualize the temporary nature of all money demand, such that any “liquidity preference” explanation cobbled together as to why more money doesn’t mean more nominal spending in general could only mean a permanent sterilization of monetary injections – which is equivalent to a refusal by the public to utilize their own purchasing power, or alternatively a lack of credibility in the permanence of the injection.

    Nick Rowe’s post is very good and related:
    http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/05/identity-economics.html
    as are my comments at the bottom.

  66. Gravatar of Adam Adam
    14. May 2012 at 08:19

    Mark – Thanks. The way you started out I was worried you were going to give a credentials-based defense, but instead that was very informative.

    Marcus – yeah, I knew this wasn’t new for him, but it still amazes me every time. He says things that seem obviously wrong to me. Granted, I’m no macro economist, but it’s often hard to square what he says with what I read elsewhere. And worse, it gets reported in the press like what he’s saying is non-controversial and likely correct.

  67. Gravatar of Major_Freedom Major_Freedom
    14. May 2012 at 08:48

    ssumner:

    “You all didn’t address my bigger point because quite frankly I don’t think you can. There are no direct causal links between inflation or NGDP, employment, and output.”

    Please tell me you are joking. If we repeated the 1929-33 experiment of cutting NGDP by 50%, there’s no loss of RGDP? What planet are you living on?

    Does NGDP always affect RGDP? Obviously not. There are also supply-shocks (Zimbabwe, etc) but to argue there is no effect is just silly.

    You’re implicitly saying there is one RGDP, and the only thing it can do is get “higher” or “lower.”

    What you are missing is that not all RGDP is created equal. If NGDP fell by 50%, then yes, there will be a change in RGDP, but it would be misleading to say RGDP “fell.” For that would imply that the current, inflation induced RGDP is “normal” and is the new standard. It would be like calling 50,000 brick houses the new normal and new standard in a world with only 40,000 bricks.

    What a market driven decline in NGDP will do is result in a reduction of malinvestments, and an increase in sustainable investments, which we observe as a decline in “output”, the same way a person recovering from alcohol poisoning will reduce “output” in the present, but is on track for increasing sustainable output in the future.

    It is therefore “silly” to call for inflation with the intention of increasing “spending” so that “output” doesn’t fall, as if whatever current output exists, unsustainable as it is, is somehow the new normal.

    The only way to know how much money should exist would be if money production were integrated into profit and loss based on private property exchanges. Monopoly money creators who are not subject to profit and loss based on private property, will almost always get it wrong. Ergo the endless line of candidate “anchors” for money printing, prices, NGDP, etc. No economist says “It is optimal if bicycle sales increase at 5% per year, every year, by state decree.”

    And yet we have economists saying this for money production. Why? Because they have no recourse to actual market information of profit and loss. If there are losses being incurred in bicycle production, economists know that investors should reduce investment in and thus the production of bicycles. But when losses are incurred in monopoly money printing, what do market monetarists recommend? More monopoly money printing. It would be as if they recommended an increase in bicycle production when losses are incurred in bicycle production, because it is sacred that bicycle sales increase 5% per year.

  68. Gravatar of ssumner ssumner
    14. May 2012 at 17:25

    MF, Yes, when I say RGDP falls, I mean it falls. Nothing more, nothing less.

  69. Gravatar of Mr Blanchflower, Your Country Needs You « uneconomical Mr Blanchflower, Your Country Needs You « uneconomical
    16. May 2012 at 02:58

    [...] that revolution without more high-profile advocates for NGDP targeting.  We’ve already got Samuel Brittan, Will Hutton and Vince Cable.  Can we add David Blanchflower to that list? Share [...]

  70. Gravatar of Major_Freedom Major_Freedom
    17. May 2012 at 23:46

    ssumner:

    MF, Yes, when I say RGDP falls, I mean it falls. Nothing more, nothing less.

    I know what you mean, but my point is that when I see you using RGDP, I see you treating unsustainable RGDP as equivalent to sustainable RGDP.

    As an analogy, it would be like you treating a semi-finished 25,000 so far laid brick house that requires 50,000 bricks, as equivalent to a semi-finished 25,000 so far laid brick house that requires 40,000 bricks, in a world where there is only 40,000 bricks available.

    You would treat “RGDP” as the same in both cases, because in both cases there are 25,000 brick semi-finished houses, whereas I would distinguish between the two, and say that these RGDPs are not the same. One is “bad”, and the other is “good.” One is unsustainable, the other is sustainable.

    You would call for inflation just to keep the unsustainable house project going, so that “spending” on that house doesn’t fall, whereas I would say it needs to be corrected ASAP, so employment, output, and “spending” should temporarily fall and not be hampered by printing money which will only mislead the master builder into continuing his unsustainable plan like nothing is wrong.

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