The latest on NGDP targeting from the WSJ

Here’s Simon Nixon writing in the WSJ:

Excessive praise for central bankers from politicians is rarely a healthy sign. The whole point of making these guardians of monetary policy independent was so that they could be a restraint on the inflationary tendencies of politicians.

So when the U.K. Treasury referred to Mark Carney last week as “the outstanding central banker of his generation” —before the Bank of Canada chief has even taken up his new post as Governor of the Bank of England—alarm bells rang in some quarters of the City of London.

After all, politicians used to say similar things about the Federal Reserve’s Alan Greenspan until his reputation collapsed along with the global economy. These days, it’s his predecessor, Paul Volcker, who stood up to politicians as he stamped out inflation in the 1980s, whose reputation now stands tall. Meanwhile Bank of Japan governor is expected to lose his job following Sunday’s election having resisted political demands to be more aggressive at inflating the economy.

Paul Volcker tried to reduce inflation in late 1979 and early 1980, and then gave up when a small recession hit the US in the first half of 1980.  He then slashed short term interest rates sharply, and NGDP growth surged to a 19% rate in late 1980 and early 1981.  Next time he tried he stuck with it, and inflation was running about 4% by 1982.  But then Volcker got complacent—mission accomplished.  Inflation stayed close to 4% all the way up to 1987 when Greenspan took over.  But Greenspan wasn’t content with 4% inflation, and drove the rate down to 2%.  And from this Nixon infers that Volcker is an anti-inflation hero, and Greenspan a villain?

Then there’s his comment on Japan.  I thought the one thing all economists agreed on, both liberals and conservatives, was that the BOJ’s deflationary policy was utter madness.  Even Japan’s NGDP has been falling in recent decades.   And now Nixon criticizes those who favor a more expansionary monetary policy in Japan.  Is Japan the new model for the WSJ editorial page?

Sure, a nominal GDP is superficially beguiling because it forces central banks to weigh their decisions explicitly through the prism of growth. It allows them to look through periods of high inflation when real economic growth is low.

But it is a dangerous path. Gross domestic product is hard to measure and prone to substantial revisions. Choosing an appropriate nominal-GDP target is problematic. It depends on assumptions about how fast output can grow without causing inflation.

Yes, NGDP is hard to measure, although NGDI is somewhat easier and is exactly the same concept.  So the problem with revisions is not as severe as it first seems.  But if NGDP is hard to measure, what are we to make of the CPI?  Economists cannot even agree as to what the CPI is supposed to measure.  Is it the size of a raise the average person would need to maintain constant utility?  If not, what is it, and how could we possible measure it in the era of Facebook and smart phones?

And no, the NGDP target does NOT depend on estimates of how fast output can grow.  We target NGDP because it is NGDP that matters for maximizing social welfare, and inflation does not matter.  The problems that are assumed to represent the welfare costs of inflation; actually represent the welfare costs of high and volatile NGDP growth.

If the public sees prices rising, it may simply assume the central bank has lost control and react accordingly. The idea that central banks will act to dampen growth during a boom if inflation is low will strike many as particularly unrealistic.

No they won’t react accordingly, because wage demands depend on expected NGDP growth, not expected inflation.  And the second sentence makes no sense at all.  I thought the entire objection to Greenspan’s bubble era policy was that he targeted inflation during the housing bubble, and didn’t try to tighten enough to prevent overheating.  That’s inflation targeting.  But a few sentences back Nixon just bashed Greenspan’s policy.  Does Nixon favor inflation targeting, or not?  If he thinks Greenspan was too inflationary, then why not advocate NGDP targeting, as Friedrich Hayek did?

Besides, many suspect the BOE has already been covertly targeting nominal GDP, given it continued printing money even when inflation rose above 5% in 2011. The only reason for making the change is if one believes the central bank has somehow been excessively cautious in spending the mere equivalent of 30% of GDP to fund the purchase of 40% of the U.K. government bond market.

I don’t follow this at all.  Central banks tend to run large balance sheets as a share of GDP when interest rates and inflation are low, not high.  Look at the Bank of Japan, which has also monetized vast quantities of government debt.  And the BOJ actually did so, using non-interest bearing base money (until 2008), unlike the BOE, which didn’t really monetize debt, it just exchanged one form of interest-bearing government debt for another.  If Mr. Nixon wants smaller central bank balance sheets as a share of GDP, he should favor higher nominal interest rates and inflation, not lower.

Mr. Carney’s openness to further large-scale money printing will disappoint those who blame the lackluster U.K. economy on the inaction of politicians in facing up the U.K.’s deep structural problems. These supply-side challenges include an unproductive public sector that accounts for more than 50% of GDP; a welfare system that undermines labor mobility; a deficit reduction strategy that is barely reducing the deficit; and dysfunctional banking and planning systems.

Yes, Britain’s biggest problems are structural, but I favor more monetary stimulus because those structural problems are easier to address when the economy in not suffering from a lack of AD.  As we saw in the US during the 1930s, Argentina in the 2000s, and much of the world today, bad demand-side policies lead to bad supply-side policies.  Nothing discredits conservative economics so thoroughly as a demand shortfall, which looks like the “failure of capitalism” to the average person.  Boost employment and the US will cut back on the excessive duration of unemployment benefits (which were boosted from 26 weeks to 99 weeks in the US during the current recession, before being reduced to 73 weeks.)  It will be easier for Cameron to reduce the excessive taxes if Britain’s budget deficits are not bloated by the recession, and it will be easier to reduce excessive welfare spending if the public believes the economy can offer a job to any willing able-bodied worker.  Was it a coincidence that America’s welfare reform was passed in 1996?

Matt O’Brien pointed me to another WSJ article on monetary policy.  This one suggests that Poland avoided the Great Recession with a tight money policy (Mark Sadowski just had a heart attack, and is spinning in his grave.)  Here’s how Matt responds:

What’s the secret of Poland’s mini-economic miracle? Matthew Kaminski of the Wall Street Journal interviewed former Polish central banker Leszek Balcerowicz to find out just how exactly the country managed to avoid a recession back in 2009. The answer is … well, it’s completely wrong. Kaminski says Poland’s “hard-money policies” from 2001 to 2007 deserve the credit, but doesn’t say a word about what happened afterward. That’s curious, because the global financial crisis was an equal opportunity destroyer of economies. Avoiding a bubble hardly guaranteed avoiding a recession. So, again, what did Poland do?
You probably know where this is going. It wasn’t hard money that saved Poland. It was really, really, really easy money that saved Poland. Just look at the chart below of the exchange rate between the Polish zloty and the euro the past five years. That’s a 33 percent drop starting in late 2008.

Throughout much of the WSJ article low interest rates are equated with easy money.  Now Milton Friedman is spinning in his grave.

HT:  David Gulley


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61 Responses to “The latest on NGDP targeting from the WSJ”

  1. Gravatar of Doug M Doug M
    18. December 2012 at 09:50

    Greenspan takes it on the nose for his failure to regulate.

    He was a strong advocate for the increased use of derivatives, believing that they diversified risk and increased efficiency. He was also an advocate of sub-prime mortagage lending.

    Then, he perhaps gets too much credit for allowing the dot com bubble to inflate and then burst, then inflating a housing bubble to counteract the affects of the dot bomb.

    He, of course retired before the housing/MBS bubble burst.

  2. Gravatar of Squarely Rooted Squarely Rooted
    18. December 2012 at 10:43

    You snuck this in there a little, but this one sentence:

    “I favor more monetary stimulus because those structural problems are easier to address when the economy in not suffering from a lack of AD.”

    is just absolutely gold. This is a big part of what drives me bananas re: the insanity behind Europe’s policies of holding AD hostage in order to enact structural change, which is politically cancerous.

    I would also go further and say AD shortfalls don’t just make structural problems harder to address, they make them harder to diagnose. Lots of things that we think are “structural” problems magically vanish when the economy is performing at or around capacity.

  3. Gravatar of Major_Freedom Major_Freedom
    18. December 2012 at 10:45

    From WSJ:

    These days, it’s his predecessor, Paul Volcker, who stood up to politicians as he stamped out inflation in the 1980s, whose reputation now stands tall.

    Did the WSJ shut down its operations 1982-1987, when Volcker re-ignited the inflation burner?

    ———————-

    ssumner:

    We target NGDP because it is NGDP that matters for maximizing social welfare

    Well that is just more evidence of why it is a bunch of nonsense. Every crank policy ever conceived has been presented under the guise of “maximizing social welfare.”

    There is no such thing as “social welfare.”

    There is only individual welfare, for it is individuals who feel, think, gain, lose, and act. Social welfare cannot be measured. It cannot even be given a coherent description. It’s always communicated as a list of criteria, which of course is not a definition.

    If one person is impoverished, while another’s standard of living has more than doubled, then has “social welfare” gone up? Yes? No? All we can say is that one individual is impoverished, while another individual doubled his standard of living. You know, how we originally understood what is going on. There is no way to add up these two individuals’ outcomes to give a “social welfare” description. If you say “social welfare” has gone up, then the impoverished guy will know that characterization doesn’t apply to him.

    How in the world did NGDP targeting even make it past the whimsical thought stage? It’s like the more it is analyzed, the more evasive “the other guy’s scheme is just as bad or worse!” and discoveries of being grounded on an irrational foundation, come to the fore.

  4. Gravatar of Major_Freedom Major_Freedom
    18. December 2012 at 11:03

    ssumner:

    “If the public sees prices rising, it may simply assume the central bank has lost control and react accordingly. The idea that central banks will act to dampen growth during a boom if inflation is low will strike many as particularly unrealistic.”

    No they won’t react accordingly, because wage demands depend on expected NGDP growth, not expected inflation.

    Oh so that’s why everyone’s wages went up with Bernanke’s announcement to finance an additional $45 billion a month in bonds. The increased expected NGDP did it. Because every business takes expected NGDP into account when setting a nominal demand for labor in the present. Never are employers backward looking and responsive to past price and demand signals in an uncertain market. Nope, they all utilize NGDP in their forecasting. Every employer is perfectly informed about where money inflation will go in the future with an increased NGDP, and will set their prices and demands accordingly in the present.

    Or not. NGDP has been going up since the early 1970s, and yet wages have not kept up since the early 1970s. Wage earners by the end of the 1960s were earning almost a 54% share of NGDP. It has since declined to under 44%.

    Could it be that not all equal NGDPs are equal in content? Could it be that just because NGDP goes up or down, it doesn’t mean wages will go up and down? Could it be that NGDP can rise by virtue of a shift in the real economy and relative spending that inflation itself has caused, which leads to some incomes rising more than other incomes? Say it ain’t so, Joe.

  5. Gravatar of jknarr jknarr
    18. December 2012 at 11:03

    This is WSJ FUD (fear, uncertainty, and doubt). I would not assume that they are engaging in reasoned discussion. This is likely because NGDP targeting threatens the business model of the Fed and primary dealers — it’s the Wall Street journal after all. Politicians praise power.

    The problems he describes were cured by gold at one point, to great avail. No CPI calculation sophistication, no NGDP measurement — just a relatively fixed stock-to-flow and near-infinite longevity of the medium. Come to think of it, why not let demand for money set the price at a fixed quantity? Yes, it implies NGDP/1 currency strength over time. Yet why is this a bad thing? Somebody otta create a system…

    But then, I hear that the WSJ has problems with gold too. Bad faith doesn’t need to be intellectually consistent.

  6. Gravatar of marcus nunes marcus nunes
    18. December 2012 at 11:15

    Poland´s “tight money policy in 2001-07″? Quite the contrary.
    http://thefaintofheart.wordpress.com/2011/02/27/poland-didn%C2%B4t-miss-many-beats/

  7. Gravatar of Doug M Doug M
    18. December 2012 at 11:17

    “But if NGDP is hard to measure, what are we to make of the CPI? Economists cannot even agree as to what the CPI is supposed to measure.”

    CPI measures the price of a fixed basket of goods! It is quite straightforward to measure.

  8. Gravatar of Felipe Felipe
    18. December 2012 at 11:26

    We target NGDP because it is NGDP that matters for maximizing social welfare, and inflation does not matter. The problems that are assumed to represent the welfare costs of inflation; actually represent the welfare costs of high and volatile NGDP growth.

    Scott, do you have a post on what these costs are and how the confusion with inflation arises? What is precisely the confusion?

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    18. December 2012 at 11:29

    “This one suggests that Poland avoided the Great Recession with a tight money policy (Mark Sadowski just had a heart attack, and is spinning in his grave.)”

    On the contrary Scott. The Matt O’Brien article made my day.

    However I’m deeply disappointed in Leszek Balcerowicz’s comments. He was of course famous as the architect of the Balcerowicz Plan:

    http://en.wikipedia.org/wiki/Balcerowicz_Plan

    My opinion of him has just been obliterated.

  10. Gravatar of Major_Freedom Major_Freedom
    18. December 2012 at 11:36

    ssumner:

    “But if NGDP is hard to measure, what are we to make of the CPI?”

    That it and NGDP are impossible to accurately measure?

    NGDP is not really what we’re after. We’re after wage targeting, but that is politically infeasible. No wait, we’re actually after NGDI. Actually, scratch that. I am after whatever you choose not to criticize. Not telling what, yet. I’ll wait for the criticisms, and hopefully we’ll have more inflation by then. Just….more inflation. Any target will do. As long as it is higher than what it is now. Pizza? Sure. Target pizza. As long as more fixed income folks experience lower standards of living for the sake of the oligarchs and the treasury.

  11. Gravatar of brendan brendan
    18. December 2012 at 11:39

    The Investors Business Daily published an even worse piece the other day. And of course wrongly implied that Milton Friedman agreed w/ all their absurdity.

    I’m a long time reader (seldom commenter) of Scott’s and Marcus Nunes’. I took a shot at trying to explain the investment and economic forecasting implications of Scott and Marcus’s ideas here:

    http://ramblingsonmicrocapstocks.blogspot.com/2012/12/the-feds-last-mover-power-and-changing.html

    I think all the recent false positive recession predictions by the ECRI and similar groups is good evidence in your favor. But you’re all much better informed than me and I’d appreciate any feedback.

  12. Gravatar of Scott Sumner Scott Sumner
    18. December 2012 at 11:54

    Doug, You said;

    “CPI measures the price of a fixed basket of goods! It is quite straightforward to measure.”

    It would be easy if that were true, but it’s not. The quality of goods changes over time. Nothing is “fixed.” What is the “inflation” of computer prices? How about TVs? And which “basket” should we use?

    Felipe, Take a look at my National Affairs article, link in the right margin as “defense of NGDP targeting.”

    Marcus and Mark. Amazing, it’s as if the WSJ doesn’t even care to check the facts.

    Thanks Brendan, I’ll take a look.

  13. Gravatar of Don Don
    18. December 2012 at 12:13

    Finance people are ignorant when it comes to central banking policy. It seems their jobs would depend on being knowledgable, but the ones in the Media are just dumb. I heard another analyst earlier today talking about how the Fed was stealing money from those on fixed incomes. “Your savings are paying near zero, because of Fed policy”. Argh! This website needs a “Common Myths” section to that can be used as a response to these masters of misinformation.

  14. Gravatar of Major_Freedom Major_Freedom
    18. December 2012 at 12:19

    Don:

    I heard another analyst earlier today talking about how the Fed was stealing money from those on fixed incomes. “Your savings are paying near zero, because of Fed policy”. Argh! This website needs a “Common Myths” section to that can be used as a response to these masters of misinformation.

    To the extent the Fed holds rates lower than they otherwise would have been in the absence of inflation, and to the extent that such low interest rates do not give as much real return as they otherwise would have given, then while “stealing money” is inaccurate, there is a sense in which that statement is true. Journalists are more or less uninformed, and get things second and third and fourth hand, like a game of telephone, but when you trace back what they say to the actual academic argument, then it’s not totally out to lunch.

  15. Gravatar of Scott Sumner Scott Sumner
    18. December 2012 at 12:40

    Brendan, That’s an excellent post. Is there any way to get links to the Hussman prediction post, and then the later one making fun of the MM view that higher rates can mean easy money.

  16. Gravatar of "As we saw in the US during the 1930s, Argentina in the 2000s, and much of the world today, bad demand-side policies lead to bad supply-side policies." « Economics Info "As we saw in the US during the 1930s, Argentina in the 2000s, and much of the world today, bad demand-side policies lead to bad supply-side policies." « Economics Info
    18. December 2012 at 13:00

    [...] Source [...]

  17. Gravatar of brendan brendan
    18. December 2012 at 13:03

    Thanks Scott! Yeah, here is Hussman’s archive:

    http://www.hussmanfunds.com/weeklyMarketComment.html

    Here is his 6/28 recession forecast:

    http://www.hussmanfunds.com/wmc/wmc100628.htm

    Here he is mocking MM’s bizarre mental gymnastics:

    http://www.hussmanfunds.com/wmc/wmc101227.htm

    He’s a brilliant and good guy, with a great long-term track record, but he’s gotten ruined the last few years because of some wrong ideas he has about monetary policy.

  18. Gravatar of Brian Donohue Brian Donohue
    18. December 2012 at 13:08

    Scott,

    “…why not advocate NGDP targeting, as Friedrich Hayek did?”

    Can you point me toward what you have in mind here?

    Thanks.

  19. Gravatar of ssumner ssumner
    18. December 2012 at 13:13

    Brendan, Great. I’ll do a post, although it might be delayed because this time of year is busy. But I’ll get to it eventually.

    Brian, Hayek favored NGDP targeting. Larry White and George Selgin have published articles discussing this topic.

  20. Gravatar of Michael Michael
    18. December 2012 at 13:18

    From this link:

    http://macromarketmusings.blogspot.com/2008/05/debunking-liquidationist-myth.html

    Lawrence White is quoted:

    “Hayek’s monetary policy norm in fact prescribed stabilization of nominal income rather than passivity in the face of its contraction.”

  21. Gravatar of Becky Hargrove Becky Hargrove
    18. December 2012 at 13:19

    David Glasner just swatted at yet more WSJ silliness with this post “The Prodigal Son Returns: The Wall Street Journal Editorial Page Rediscovers Root Canal Economics”. Although some might call such silliness purposeful obfuscation of reality. Does the WSJ still hedge their bets when it comes to public opinion? Perhaps not.

  22. Gravatar of brendan brendan
    18. December 2012 at 13:27

    Great. On a somewhat related topic, market timing models based on the idea of “not fighting the fed” have worked quite consistently over many decades (various specifications based on same idea work). Yes, I know, EMH violation. But given the near-linear market advances AFTER QE1, QE2 and operation twist in the last few years I think we’ve got plenty of evidence that important Fed related news is not incorporated into stock prices immediately.

    That to me is consistent w/ the idea that forecasters have been systematically biased to underestimate Fed power. (Your work probably contributes to making that anomaly disappear soon as people trade on your advice.)

    Anyway, no need to respond, just thought it might be relevant.

  23. Gravatar of Major_Freedom Major_Freedom
    18. December 2012 at 13:49

    Brian,

    You won’t find any discussion about the following on this blog, so I will let you know: Hayek was inconsistent. He advocated contradictory things. Yes, he did argue what looked like an inflationist policy that prevents national aggregate incomes from falling, and in that sense, NGDP targeting advocates use Hayek as a springboard to advance their own programs. But upon closer inspection of his work, you will find other statements that are totally at odds with NGDP targeting.

    For consider the following statements of Hayek:

    “Here my aim has merely been to show that whatever our views about the desirable behaviour of the total quantity of money, they can never legitimately be applied to the situation of a single country which is part of an international economic system, and that any attempt to do so is likely in the long run and for the world as a whole to be an additional source of instability. This means of course that a really rational monetary policy could be carried out only by an international monetary authority, or at any rate by the closest cooperation of the national authorities and with the common aim of making the circulation of each country behave as nearly as possible as if it were part of an intelligently regulated international system.

    “But I think it also means that so long as an effective international monetary authority remains an Utopian dream, any mechanical principle (such as the gold standard) which at least secures some conformity of monetary changes in the national area to what would happen under a truly international monetary system is far preferable to numerous independent and independently regulated national currencies.” – Monetary Nationalism and International Stability, pg 93.

    and prior, in the same book:

    “I have now concluded the negative part of my argument, the case against independent national currencies. While I cannot hope in the space of these few lectures completely to have refuted the theoretical basis of Monetary Nationalism, I hope at least to have shown three things: that there is no rational basis for the separate regulation of the quantity of money in a national area which remains a part of a wider economic system; that the belief that by maintaining an independent national currency we can insulate a country against financial shocks originating abroad is largely illusory; and that a system of fluctuating exchanges would on the contrary introduce new and very serious disturbances of international stability.” – pg 73

    Now, these statements are in direct contradiction to your typical national NGDP targeting schemes of the sort Sumner is advocating. For here Hayek is saying it would be destabilizing to the local and world market if a single country engaged in unilateral NGDP targeting at the national level, and is a part of the world market. Thus, each country should have nationally fluctuating money and spending in response to world market changes. Further, IF national currency systems are to exist, then Hayek said they should behave AS IF they are all a part of a world monetary order. In other words, the total quantity of money and volume of spending should fluctuate at national levels.

    Also, IF a world central bank is out of the question, then Hayek further elaborated and said a mechanical system such as a gold standard, the supply and volume of spending of which can at least fluctuate at national levels much like a world central banking system would contain fluctuations in money and spending at national levels, is far preferrable to numerous independent and independently regulated national currencies, which is what we have now, and is precisely what NGDP targeting advocates are presuming is incontrovertible.

    So when you look at the quotes Selgin, White, et al are referencing, you cannot take those statements as “the” Hayekian position (nor can you take the statements I cited above as “the” Hayekian position, for the same reason). You should take Hayek as eliciting contradictory statements, at least as it pertains to NGDP targeting schemes being advocated by MMs.

  24. Gravatar of Doug M Doug M
    18. December 2012 at 14:02

    Don,

    This is a trope that has been in play for 30 years. The Fed does manipulate rates, and some people will be disadvantaged by a lower rate.

    But since Fed fund rates have been low for most of the last 20, anyone living on a fixed-income who has the bulk of their assets in cash is a bit of an idiot. The duration of your assets should match your cashflow needs. i.e. if you expect you might live for at least 10 more years, you should have some assets with more than 10 years to maturity. If the Fed cuts short term rates, your yield is not affected.

    Of course if the Fed let inflation get above 2% they would also be accused of stealing from people living on a fixed income. And that may be close to the truth.

  25. Gravatar of Tommy Dorsett Tommy Dorsett
    18. December 2012 at 14:46

    brendan, great takedown of hussman. However, I would challenge your view of him as a ‘good’ guy. He’s an arrogant bully constantly calling out the those who have been right while he’s been very very wrong, using his website as a foil for his cowardice. Basically, he’s been calling for a recession/bear market every year since 1995. all one needs is a broken clock for that. and we already have one Roubini.

  26. Gravatar of Brian Donohue Brian Donohue
    18. December 2012 at 14:46

    Hey Scott,

    I know you’re impatient with those who aren’t quite able to gulp the NGDP kool-aid, but I submit that it is not at all obvious or intuitive that a move by the Fed to buy a mess of Treasury bonds pushes interest rates up.

    I can’t help but wonder if this phenomenon is a peculiarity of our present circumstances, in which US Treasury bonds are a “safe haven” for the “risk off” bet. This accounts for the extraordinary events of 2011, for example, where a downgrade of US debt led to a furious rally in Treasuries.

    Could the recent movement in rates be thought of as rotating out of the “reserve currency” into more of a “risk on” bet, in which it just so happens that the reserve currency is the US dollar?

  27. Gravatar of Outsider Trading Outsider Trading
    18. December 2012 at 15:01

    [...] The Latest on NGDP Targeting From the WSJ via Money Illusion [...]

  28. Gravatar of Tyler Joyner Tyler Joyner
    18. December 2012 at 15:49

    Brian:

    His reasoning is intuitive, in my opinion. The Fed buying treasuries is a monetary injection. Monetary injections, other factors notwithstanding, increase inflation and expectations of inflation. Thus the real return of a bond investment goes down, and so its price relative to other assets goes down. Interest rates go up. Or you could say that investors demand a higher return for a given level of risk, in a higher inflation environment.

    What he’s impatient about is the supply and demand effect of purchasing treasuries, which as far as I can tell he doesn’t admit exists.

    That effect which would intuitively push bond prices upward, and indeed has done so in the recent past. I haven’t seen him propose a model which rationalizes the interaction between inflation expectations and the S/D effect of bond purchasing, but there is no reason that I can see why the two effects would be equal, nor why one would always be stronger than the other.

    Complicating things is credit risk, which historically has been considered zero in the case of US treasuries, but clearly the ratings agencies think otherwise now.

    Anyways, as a finance guy I feel like Scott definitely ignores some important practical considerations in his policy recommendations, but the intersection of finance and economics has always been awkward, as someone pointed out earlier.

  29. Gravatar of Benjamin Cole Benjamin Cole
    18. December 2012 at 18:34

    Excellent post.

    Rose-colored lenses with blinders and political dogma seem to inform the WSJ editorial pages these days. Hagiography has replaced biography. The WSJ, sadly, is becoming irrelevant, and economics debate has migrated into the blogs.

    And I am an old newspaperman who said, “Cut me and I bleed ink.”

    It is sad day for me when newspapers become irrelevant. And they are.

    We Market Monetarists are fighting Theomonetarism.

    What was once a sensible policy—tight money in the 1970s to fight inflation—has ossified into dogma, currency worship, a perverted genuflection to gold and a “strong dollar.”

    Even good goal—that of a smaller federal ghpvernment—in unwittingly conflated with the unrelated goal of “tight money.”

    Tight money does not shrink federal outlays in relation to GDP. Europe has had tight money for decades and the share of government spending there in relation to GDP is higher than in the USA.

    In fact, in the present context, tight money makes it hard to grow the economy, making it hard to cut welfare outlays, and decreasing the size of GDP in relation to federal outlays.

    Tight money advocates should read this: We have met the enemy, and he is us.

  30. Gravatar of Bob Murphy Bob Murphy
    18. December 2012 at 23:18

    Scott, I have three questions for you (please):

    1) Are you endorsing the use of Polish zloty’s exchange rate vis-a-vis the euro as a measure of monetary policy?

    2) Using what I thought were your preferred metrics–NGDP growth and inflation rate–was Polish monetary policy tighter from 2004-2008, or from 2008-2012?

    3) Does it matter that I think Matt O’Brien misread the chart, and actually the big drop started in late 2007? The forex markets rationally expected Bernanke’s stupidity one year later…?

  31. Gravatar of Brian Dell Brian Dell
    19. December 2012 at 03:19

    If there are no “assumptions about how fast output can grow without causing inflation” involved then why not say it doesn’t matter if you base your starting point for your NGDP growth target henceforth off of 2010 or 2007? Fact is you cannot run away from having to decide at some point where “equilibrium” is. The arguments about ease or tighten keep coming back to the question of where real GDP is relative to potential, either now, in the past, or in the future.

    re dampening a boom when inflation is low I remember the Fed waving a red flag in front of the market bull circa summer 1999 because the hot growth at the time was supposed to be sustainable in the New Economy.

  32. Gravatar of Hugh Hugh
    19. December 2012 at 04:44

    I have a few questions on QE and how it relates to NGDP. The Fed is now buying $85BN per month of bonds, let’s say $1 Trillion per year to keep the arithmetic simple. With US GDP now $15.8 BN that means that QE is 6% of GDP.

    My questions:

    1) Is there some algorithm by which we can translate this 6% into NGDP growth?

    2) If not, can you illustrate in words the transmission process from QE to NGDP growth?

    3) If the resultant marginal NGDP increase is, say, in the order of 1%, do you think that the trade-off with the risk inherent in the Fed’s increased balance sheet is one that prudent policy-makers should commit to?

    4) What is your plan for unwinding the Fed’s balance sheet once NGDP growth achieves your 5% target?

    I am attracted by NGDP targeting, but concerned about QE. Any help in resolving this quandary would be much appreciated.

  33. Gravatar of ssumner ssumner
    19. December 2012 at 05:48

    Brendan, You said;

    “Your work probably contributes to making that anomaly disappear soon as people trade on your advice.”

    Wait, I’ve been advocating the EMH, and all this time I had inside information on Fed policy? :)

    BTW, Thanks for the links.

    Brian, I agree that rates don’t always rise with easy money. What I say is that looking back over Fed history, strongly expansionary Fed policies generally raise long term rates. I think that’s pretty much beyond dispute.

    As you know, I don’t regard Fed purchases as being a good indicator of whether money is easy or tight, although more purchases is usually more expansionary than less.

    Bob, 1. It’s an indicator, but not the best.

    2. NGDP is the best, it shows Polish monetary policy being highly expansionary before 2008, and somewhat expansionary (but less so after 2008.

    3. Efficient markets follow a random walk, it doesn’t matter where a big drop starts, it matters where it happens.

    Brian Dell, I meant the long run steady state policy doesn’t matter, I agree it matters in terms of where you start the trend line, but that’s a minor issue compared to the merits of NGDP in general.

    Hugh, I don’t think there is a algorithm, and I agree that QE is not really the best policy. NGDP targeting would be far superior. On the other hand, there are no significant risks to QE. The Fed is part of the Federal government, so “balance sheet risk” is a myth, it’s basically a wash.

  34. Gravatar of Major_Freedom Major_Freedom
    19. December 2012 at 06:02

    In the EUR-PLN chart, it looks to me that the Polish zloty started rapidly depreciating vis a vis the Euro around 30 July 2008.

    NGDP in Poland peaked in January 2008 at $529.4 billion. It fell to $430.9 billion by 2009.

  35. Gravatar of Major_Freedom Major_Freedom
    19. December 2012 at 06:04

    I used this chart, BTW:

    http://www.ecb.int/stats/exchange/eurofxref/html/eurofxref-graph-pln.en.html

  36. Gravatar of Major_Freedom Major_Freedom
    19. December 2012 at 06:18

    Oh, and I got the NGDP for Poland here:

    http://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&met_y=ny_gdp_mktp_cd&idim=country:POL&dl=en&hl=en&q=poland%20gdp

    I know where Murphy is going with this. As the NGDP chart shows, the fact that NGDP in Poland peaked in January 2008 at $529.4 billion, and then fell to a low of $430.9 billion by 2009 (which is a decline probably somewhere in the ball park of, oh I don’t know, THE HOOVERSKI ADMINISTRATION), means that according to MM criteria of when money is “loose” and when money is “easy”, Poland engaged in ULTRA TIGHT monetary policy, not very, very, very loose money as per O’Brian.

    Yet here we have Sumner joining in the cheers with O’Brian that Poland is a success story which avoided the great recession, because he THOUGHT they engaged in ultra loose money as per Matt’s claim. How’s that for a perfect example of “How one’s mind is a priori structured determines how one perceives the world”!

    You got to chuckle at this. Two MMs who say almost daily that the proper gauge of monetary policy is NGDP, and they see the success story Poland, and then, to show their theory is true, they…look at exchange rates instead of NGDP and conclude money was loose because the zloty depreciated against the Euro? This is bizarro world.

    The first comment in the Atlantic pretty much nails it:

    “This chart says absolutely nothing about Polish Central bank expansion… All it says is that Poles and other holders of Zlotzy rushed to the perceived safety of the Euro in a time of economic crisis. You left the question totally unanswered: why has Poland performed so much better than the US and Eurozone? Show us their central bank balance sheet and export growth if you are going to claim that monetary easing was the the cause.”

    I would only suggest that instead of saying “show us their central bank balance sheet”, I would say “Do what Sumner suggests and look at Polish NGDP.”

    Oops.

  37. Gravatar of Major_Freedom Major_Freedom
    19. December 2012 at 06:19

    Bob, 1. It’s an indicator, but not the best.

    Abort, abort!

  38. Gravatar of Daniel Daniel
    19. December 2012 at 07:19

    Major_Freedom

    I know I shouldn’t be doing this (namely, “feeding the troll”)

    And I know you’re also an American – and thus, probably think Jesus spoke English – but you do know that Poland’s NGDP is denominated in zlotys (and not US dollars), right ?

    http://thefaintofheart.wordpress.com/2011/02/27/poland-didn%C2%B4t-miss-many-beats/

    But you go on right ahead accusing others of intellectual dishonesty …

  39. Gravatar of Major_Freedom Major_Freedom
    19. December 2012 at 08:29

    Daniel,

    I wasn’t accusing anyone of intellectual dishonesty. I was flabbergasted that anything other than NGDP was considered, that’s all.

    While I am a total and complete idiot for looking at the chart I looked at, instead of the chart you looked at, it’s still ridiculous that after being told constantly that NGDP is the correct measure, that the exchange rate would be looked at for proof Poland had very, very, very loose money. It looks like it had regular, not too loose and not too tight, if NGDP is the gauge.

  40. Gravatar of Bob Murphy Bob Murphy
    19. December 2012 at 13:30

    I’m going crazy trying to make sense of this graph:

    http://www.ecb.int/stats/exchange/eurofxref/html/eurofxref-graph-pln.en.html

    Is the devaluation happening in 2007 or 2008? Does the hash mark on the charts correspond to the middle of the year in question?

  41. Gravatar of Bob Murphy Bob Murphy
    19. December 2012 at 13:32

    MF I think Scott would have to say they slightly tightened going into the crisis, but fortunately not too tight. And how do we know it wasn’t too tight? Because they didn’t go into recession.

  42. Gravatar of Bob Murphy Bob Murphy
    19. December 2012 at 13:34

    MF (or Daniel), that World Bank chart of Polish GDP was what I looked at first, but realized that couldn’t be right because we’re trying to understand why Poland avoided a crash.

    So what’s the deal? That World Bank chart is taking Polish GDP denominated in dollars? Or I guess equivalent, it’s what, PPP GDP or something like that? (I get mixed up.)

  43. Gravatar of Bob Murphy Bob Murphy
    19. December 2012 at 13:36

    I’m not being a wiseguy, can Scott or one of his high priests translate his answer to me when he wrote:

    “3. Efficient markets follow a random walk, it doesn’t matter where a big drop starts, it matters where it happens.”

    I honestly don’t know what that means. I tried the fortune cookie technique of adding “…in bed,” but that didn’t clarify it either.

  44. Gravatar of Suvy Suvy
    19. December 2012 at 14:25

    “NGDP is hard to measure”

    Inflation is even harder to measure. Different goods respond differently to increases in the money supply. Assets will respond differently from commodities which respond differently from consumer prices, etc etc. This is the central reason why inflation targeting doesn’t make sense. CPI could be relatively high when real inflation is much lower and vice versa. CPI is a bad variable to target.

  45. Gravatar of Major_Freedom Major_Freedom
    19. December 2012 at 14:29

    Murphy:

    I’m going crazy trying to make sense of this graph

    I think the hash marks are the beginning of the year in question, and where the slidey arrows are underneath the graph, those hash marks are two year increments.

    I clicked and dragged the left slidey arrow to the start of 2007, and then I passively moused over the graph itself and the automatic popup message shows 30 July 2008 as the date the massive depreciation began.

  46. Gravatar of Suvy Suvy
    19. December 2012 at 14:30

    Ssumner,

    “3. Efficient markets follow a random walk, it doesn’t matter where a big drop starts, it matters where it happens.”

    Real world markets do not follow a random walk. Look at the Hurst exponent for any real market over time; it actually fluctuates. This was known since the 1960s when Mandelbrot did a lot of work on this. The volatility actually fluctuates over time and to assume that markets behave like a random walk is a complete joke. There are periods that have strong trend structure. It does matter where a big drop starts when you have correlations in the data. In fact, where a drop starts is critical.

  47. Gravatar of Major_Freedom Major_Freedom
    19. December 2012 at 14:31

    Nope, my bad, the hash marks are the END of the year. So where you see 2007 and 2008 along the x-axis, those are 31 dec dates of those years.

  48. Gravatar of Suvy Suvy
    19. December 2012 at 14:39

    Here are some papers/books on the Efficient Markets Hypothesis. Also note that the Hurst exponent is probably one of the most robust measurements when it comes to measuring long-term memory.
    http://en.wikipedia.org/wiki/Hurst_Exponent

    http://arxiv.org/pdf/1203.4979.pdf

    Fractal Market Analysis by Edward Peters

    The (Mis)Behavior of Markets by Benoit Mandelbrot

    http://cdn.intechweb.org/pdfs/17366.pdf

    The reason the “fat tails” exist in the data is because of the correlations between the data. That is the primary reason why the efficient markets hypothesis fails.

    Note: If anyone is still not convinced, I can send Excel spreadsheets of work that I’ve done. I can send way more papers and refer to way more works on this topic.

  49. Gravatar of Doug M Doug M
    19. December 2012 at 15:03

    Suvy,

    “Real world markets do not follow a random walk. Look at the Hurst exponent for any real market over time.”

    These are not exclusive of one annother.

    Certainly some convetions, such as the Black-Scholes option pricing forumla assume that price changes are IID and lognormally distributed. However, it is not a necessary condition of a random walk. Volatility can be change overtime or be auto correlated and still be a random walk. The EMH can be true and Black-Sholes be bull at the same time.

  50. Gravatar of Suvy Suvy
    19. December 2012 at 15:12

    Doug M,

    “Certainly some convetions, such as the Black-Scholes option pricing forumla assume that price changes are IID and lognormally distributed. However, it is not a necessary condition of a random walk. Volatility can be change overtime or be auto correlated and still be a random walk. The EMH can be true and Black-Sholes be bull at the same time.”

    You certainly could have a correlated random walk(Fractional Brownian Motion, actually what Mandelbrot argued for), but Prof. Sumner said “it doesn’t matter where a big drop starts, it matters where it happens”, which is not true. It does matter where the big drop starts when the data are correlated. From the data, I think it is clear that there are correlations between price movements.

    Also, I actually just finished some work for one of my graduate classes where I actually develop a way to price options by using a stochastic volatility component using a Monte Carlo simulation. It gave very interesting results and the implied volatility actually increased as you reach the tails.

  51. Gravatar of Bob Murphy Bob Murphy
    19. December 2012 at 21:24

    MF are you kidding me? That is the stupidest labeling convention I’ve ever heard.

  52. Gravatar of Muddled Media Macro Musings « azmytheconomics Muddled Media Macro Musings « azmytheconomics
    20. December 2012 at 06:56

    [...] Scott Sumner tears apart Simon Nixon’s recent article (gated) in a recent blog post. But there is nothing special about Nixon in particular. Journalists in general who don’t get that (a) central banks only target one variable and (b) they don’t control relative prices write things which highlight their ignorance. Even in the WSJ, even in the Financial Times, and even in the NYT. People need to hold institutions accountable for their failures, and part of that is to understand what those institutions control and what they do not. Particularly incompetant central banks, such as the Bank of Japan, don’t seem to even know what their own target is, and so drift aimlessly creating chaos in their economies. Likewise, central banks with explicit targets sometimes miss those targets, such as the ECB. Central banking in practice can be quite complicated, but the basic principles couldn’t be simpler: pick a price and put it where you want it. Share this:TwitterFacebookLike this:LikeBe the first to like this. from → Macroeconomics, Teaching ← The Fiscal Cliff No comments yet [...]

  53. Gravatar of John Papola John Papola
    20. December 2012 at 07:21

    Scott,

    On what grounds have you decided that the UK has insufficient nominal spending? I’m curious to see what the model for making that determination looks like.

  54. Gravatar of Doug M Doug M
    20. December 2012 at 08:04

    Suvy,

    “Also, I actually just finished some work for one of my graduate classes where I actually develop a way to price options by using a stochastic volatility component using a Monte Carlo simulation. It gave very interesting results and the implied volatility actually increased as you reach the tails.”

    Isn’t that what traders call the “smile”

  55. Gravatar of Suvy Suvy
    20. December 2012 at 08:15

    Doug M,

    Yea, that’s exactly what it is.

  56. Gravatar of flow5 flow5
    20. December 2012 at 10:00

    “Volcker tried to reduce inflation….then gave up….then slashed short term interest rates”

    Your chronology & economic logic are wrong. It was “tight” money, not “easy” money that brought interest rates down in early 1980. Monetary flows (our means-of-payment money X’s its transactions rate-of-turnover) fell. Rates fell only after the roc in M*Vt fell. When Volcker eased (mid June), rates immediately started climbing. Note: 3 month bill yields peaked at .16% on 3/25/80. 3 month bill yields bottomed @ 6.18% on 6/13/80.

  57. Gravatar of ssumner ssumner
    20. December 2012 at 17:18

    Bob Murphy, You said:

    “I think Scott would have to say they slightly tightened going into the crisis, but fortunately not too tight. And how do we know it wasn’t too tight? Because they didn’t go into recession.”

    So as long as Zimbabwe has fast NGDP growth, they can’t have a recession? Never thought I’d hear that argument from an Austrian.

    Suvy, We have many other posts debating the EMH.

    flow5, Can’t argue with that logic–I’ve used it many times.

  58. Gravatar of ssumner ssumner
    21. December 2012 at 06:59

    John, After mid-2010, the rate of NGDP growth in Britain plunged sharply, from about 5% to barely over 1% by early 2012. (IIRC) That’s probably the cause of the mild double dip.

  59. Gravatar of Chuck E Chuck E
    21. December 2012 at 08:33

    Interesting information from this morning:

    A good detective always looks for a motive when beginning an investigation. And so, when Nick Colas discovered that the number of $100 bills printed last year suddenly spiked, the chief market strategist at ConvergEx Group decided to figure out what was going on.
    The first thing he discovered, as we discuss in the attached video, is that “$100 bills are still wildly popular and growing in popularity.” On the other hand, the use of smaller denomination bills ($1, $5, $10 and $20) has been declining for over a decade, as the number of cashless transactions has steadily gone up. In fact, in the fiscal year that just ended in October, Colas writes in a recent note to clients, the U.S. Bureau of Engraving and Printing cranked out 3 billion, $100 notes.
    “That’s substantially higher than the run-rate of the past couple of years,” Colas points out, and 50% more than the 2 billion $1 bills that were inked up. “It’s actually a record amount of production,” he says.

  60. Gravatar of petar sisko petar sisko
    24. December 2012 at 04:38

    Friedman has been spinning in his grave since his funeral…

  61. Gravatar of UK NGDP Targeting: Sceptics Round-Up « uneconomical UK NGDP Targeting: Sceptics Round-Up « uneconomical
    11. January 2013 at 04:10

    [...] been comprehensively debunked by many right-minded individuals around the globe; see responses from Scott Sumner, and more recently Frances Coppola and Simon [...]

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