When Evan Soltas first asked me to add his blog to my blogroll, I politely declined. I thought it was cute that a high school senior was attempting blogging, but come on, let’s be serious.
Big mistake. Unfortunately, his blog is so consistently good that it can no longer be ignored. A few days ago Evan provided six arguments in favor of NGDP targeting. Nick Rowe pointed out that the sixth (which Evan thought up himself) was a sort of refutation of Schumpeterian economics. Evan follows up with a post that quotes from an appalling piece in the Boston Globe:
Today, few mainstream economists share Schumpeter’s belief in the unerring regularity of business cycles. And some point out that there’s plenty of room for creative destruction when the economy is strong – witness the turmoil over the past few years in the music industry, or the airlines, or, for that matter, the newspaper industry.
Economists do agree, however, that recessions help to right economies that have lost touch with reality. Recessions not only cull unhealthy companies, they expose financial gimmickry. They punish groundless optimism and the rampant speculation it feeds – in fanciful Internet ventures in the 1990s, for example, or in housing over the past few years.
Economists do agree?!?!?!? God I hope it’s not so. Evan criticizes the Globe article and then cites Robert Lucas’s 1972 paper that looked at business cycles as a signal extraction problem. Evan concludes the post with this gem:
If you don’t believe the idea that firms in pool A have imperfect information, try it yourself. Here’s a simple case: the level of employment and the number of firms in the manufacturing industry have been in secular contraction in the United States for decades. However, since 2008, there has been unusual employment growth in manufacturing. To what extent does this reflect cyclical conditions, given that the 2008 recession was very deep and eliminated a large fraction of manufacturing jobs in the United States? To what extent, conversely, does it represent a secular recovery in that industry? The fact that any answer would contain a significant amount of uncertainty means that firms in the first pool face a signal extraction problem under conditions of imperfect information.
By this logic, which embraces as did Schumpeter the central importance of creative destruction, recessions do not assist the process. In fact, by corrupting the signal by which firms decide to enter or exit industries, recessions make the creative destruction process slower, less efficient, and more costly.
When I was his age . . . well I’d rather not even think about how far behind I was. I got a C in freshman English at Wisconsin, and I can’t even imagine how badly written my blog posts would have been back then. For some odd reason Evan reminds me of a younger Mankiw, or a younger Mishkin. I took a class from Mishkin in the 1970s, and also briefly met Mankiw many years ago. Both seemed like young men on the fast track to great success—possessing that mysterious intangible that I never seemed able to find. When I was young I had some personal “issues” (I believe the clinical term is “complete loser.”)
But enough about me, I’d like to now explain the title of this post. No, the best argument is not the 6 points listed by Evan, although they provide an excellent argument for NGDP targeting. Instead, the best argument is that Evans Soltas is attracted to the idea. Unlike all us older economists who come to the table with all sorts of ideological and methodological baggage, Evan is able to look out over the macro landscape like a diner examining a beautiful buffet table. And what sort of framework seems most appealing to the best and the brightest of generation Z? NGDP targeting! I’d make the same claim about Matt Yglesias, another extremely bright blogger who approached this issue as an outsider (he’s got a philosophy background.) The NGDP approach provides an intuitively appealing framework for what’s gone wrong since 2008, and what needs to be done to fix it.
Recently I had dinner with a co-author of one of the popular intro textbooks. We discussed various ideas (he was interested in my market monetarist approach.) When I explain my AS/AD ideas his eyes really lit up. I argued that no intro student can possible understand the “3 reasons” why the textbook AD curve slopes downward (I forgot about Evan) and that it should be replaced with a rectangular hyperbola representing a given amount of nominal expenditure. THIS is what we mean by aggregate demand; no other definition matches our profession’s fixation on the classical dichotomy—the idea that nominal shocks affect both prices and output in the short run, but only prices in the long run. Call it the NE curve (nominal expenditure) and explain to students that macro’s mostly the study of how nominal changes get partitioned between prices and real output.
And this is also why people like Jan Hatzius, Brad DeLong, Christy Romer and to a lesser extent Paul Krugman are all drawn to NGDP targeting. Once you start thinking in NGDP terms, it’s hard to go back. It’s just so damn intuitive.
So the fact that Evan Soltas, likely winner of the 2030 John Bates Clark award, is drawn to NGDP targeting is an incredibly positive sign, and dare I say not just for the policy itself, but also for the market monetarist group that championed the policy when almost no one was paying attention to the collapse in NGDP.
Part 2. Did base growth help during the Great Depression?
Since I’ve heaped so much praise on Evan, it’s time to mildly criticize one of his recent blog posts. In this post Evan provided some graphs:
And then added these comments:
The first graph shows that even the most massive amounts of monetary expansion are ineffective medicine for NGDP expansion. What matters is expectations; growth in the medium run is conditional on expectations — not on the monetary base or price level.
The second graph shows the extent to which monetary policy seems to have forgotten this. Nominal income growth expectations have been right at zero since the recession, when before that they had been stable at the 5 percent level for decades. The findings come from this study by the Chicago FRB, which I found through this Chicago Magazine article. Paging Scott Sumner…
I mostly agree, and very much like the second graph, but I’d like to slightly quibble with the first graph. I redrew it setting both the base and NGDP equal to 100 in 1933, not 1929:
Notice that the base rose in the early 1930s while NGDP fell sharply. That’s because base demand was engorged by two factors, banking distress and ultra-low interest rates. The ultra-low interest rates continued between 1933 and 1944, but banking distress fell sharply after dollar devaluation and the creation of FDIC. Thus after 1933 the base and NGDP rose at roughly similar rates, both nearly quadrupling over those 11 years. As you know, I don’t regard the base as a reliable indicator of the stance of monetary policy, because base demand can be highly volatile under certain conditions. But the supply of base money is still very important; indeed it’s the major factor driving NGDP over the long term.
Of course things get even more complicated when you add interest on reserves, and when base injections are viewed as temporary. So I certainly endorse Evan’s argument that it’s NGDP expectations that we should focus on, not the monetary base. But we shouldn’t forget that those NGDP expectations are themselves driven by beliefs about expected long run path of the monetary base (and perhaps IOR.)