Generation Depression –> Generation Inflation –> Generation Bubble

People form their views of politics and economics when they are young, and are given the reins of power when in their late fifties.  Any thoughtful person in the 1930s could have easily predicted what would go wrong in the 1960s.  The generation that grew up in the Great Depression would have a single-minded obsession with boosting AD to prevent mass unemployment.  They would see everything as a demand issue, and ignore the supply side.  Thus the “Liberal Hour” of 1961 turned into the Great Inflation.

Any thoughtful person in the 1970s could have easily predicted the policy mistakes of the 2000s.  The generation that came of age during the 1970s would be obsessed with the threat of inflation—seeing it just around the corner whenever there was a spike in the money supply, a dip in interest rates, or a blip in the CPI from commodity prices.  The 1970s generation (including me) would overreact until NGDP growth was driven so low that interest rates fell to zero, making conventional monetary policy impotent.  The inflation targeting consensus turned into the Great Recession.

The young people today have grown up in a world dominated by two giant bubbles.  To see how strange this is, consider that as late as 1998 the economics profession paid almost no attention to bubbles.  After all, the EMF said markets were efficient, and the policymakers of 1998 had experienced exactly zero real estate bubbles in the past 60 years, and the only stock market bubble (1987) crashed without even a tiny blip in GDP growth.  Bubbles?  Who cares?

Any thoughtful person today can predict that the macroeconomics policy failures of 2040 will be produced by a generation of late middle-aged policymakers obsessed with preventing bubbles.  And boy will they have lots of bubbles to worry about!  The coming Asian century will produce a tsunami of savings and a crash in population growth, which will drive real interest rates to ultra-low levels. Perfect for endless bubble formation. (Of course I still believe in the EMH, so whenever I say ‘bubble’, I actually mean “bubble” with scare quotes.) Yes, bubbles don’t actually cause macro instability, but what matters is that they appear to.

Right now that future generation of mischievous policy-makers are still young—in a sort of embryonic state—studying in our graduate schools.  But someday they’ll be in power.  And then watch out!

What strange beast slouches . . .

PS.  Many commenters have sent me a post by M.C.K. at Free Exchange.  Some perceive it to be critical of NGDP targeting.  I see it as supportive, pointing out that NGDP targeting during the late 1990s might well have been preferable to Greenspan’s actual (inflation targeting) policy.  But the post does express some concern that central banks might refrain from implementing NGDP targeting during a period of strong productivity growth.  I don’t happen to share that fear.  If they decide that NGDPLT is to be the target, they’ll do a pretty good job of hitting the target.

PPS.  Imagine a sci-fi movie with hoards of young Austrian economics in giant test tubes . . . waiting for their chance.

Or will it be MMTers?


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83 Responses to “Generation Depression –> Generation Inflation –> Generation Bubble”

  1. Gravatar of Philo Philo
    20. December 2012 at 18:31

    “[T]he macroeconomics policy failures of 2040 will be produced by a generation of late middle-aged policymakers obsessed with preventing bubbles. “ Specifically, what unwise policies will they adopt (other than direct, *ad hoc* governmental meddling in markets that have big price rises)?

  2. Gravatar of Steve Steve
    20. December 2012 at 18:50

    I think your argument makes sense. The problem I have is that the anti-bubble crowd is split between statists and austrians. Basically the debate is still controlled by aging 70s and 80s offshoots. I’m not convinced young people have found their voice yet.

  3. Gravatar of jknarr jknarr
    20. December 2012 at 18:57

    They will target NGDP and let leveraged entities (banks) fend for themselves. Boring NGDP, exciting banking. Leverage will be the new bugbear.

    Note that this crop of policymakers will have huge (nondischargable) student loan burdens to work off.

    Sounds almost a bit Strauss-Howe-ish, too. You are a “prophet” pointing the way for the new “hero” generation.

  4. Gravatar of Neal Neal
    20. December 2012 at 19:03

    Question about productivity surges: High productivity growth is a positive supply shock. This pushes down prices – in particular, wages. Since individual wages are sticky, this pushes up unemployment and causes a recession. How would NGDPLT alleviate the resulting higher unemployment?

  5. Gravatar of Michael Michael
    20. December 2012 at 19:16

    Thoughts on this from David Andolfatto:

    http://andolfatto.blogspot.com/2012/12/the-hawkish-nature-of-evans-rule.html

    The Hawkish Nature of the Evans Rule

    “What role is the 6.5% threshold playing in the Evans Rule? One could make a case that its role is to dictate a tighter monetary policy over a greater range of circumstances.”

  6. Gravatar of jknarr jknarr
    20. December 2012 at 19:35

    I’d note that we also have something approaching NGDP futures — the corporate bond market. Spreads there fit the NGDP collapse in 2008 — you don’t need any LEH or other extraneous factor to fit the two. Currently says that 4% yoy NGDP is the new normal.

  7. Gravatar of Benjamin Cole Benjamin Cole
    20. December 2012 at 21:29

    So pleasant to read Scott Sumner. I have also wondered about Depression babies and Stagflation babies and their impact on monetary policy. There is a tie-in with institutional prerogatives and inertia.

    The Pentagon is still set up to fight the Cold War; the War on Poverty is ever fighting 1950s style deprivation. We are a nation of fatties armed with food stamps.

    Rural American is heavily subsidized, and the USDA boasts we have the world’s best and most productive farmers—and why do than we have a USDA?

  8. Gravatar of Brett Brett
    20. December 2012 at 21:35

    @Scott

    (Of course I still believe in the EMH, so whenever I say ‘bubble’, I actually mean “bubble” with scare quotes.)

    You don’t have to call them “bubbles”, then. You could just call them really intense boom-and-bust cycles of aggregate demand/supply rising and falling from all those savings being fed into new risky asset classes by people desperate for higher returns in the face of a rapidly aging population.

  9. Gravatar of W. Peden W. Peden
    20. December 2012 at 21:48

    Neal,

    Why would a productivity surge reduce wages?

  10. Gravatar of Steve Steve
    20. December 2012 at 22:01

    Looks like the WSJ Editorial Board had a hand in nixing Boehner’s tax deal.

    Press reports have said that the “Club For Growth” was influential in preventing conservative republicans for voting for the tax deal.

    Well, the Club for Growth was founded by none other than Stephen “hard money” Moore, the frequent editorial writer for the WSJ.

    So it seems that the WSJ has its hand not just in the hard money crash of 2007-201?. The WSJ is also pushing us over the Fiscal Cliff, and giving the dems much more leverage for higher taxes.

  11. Gravatar of Don Geddis Don Geddis
    20. December 2012 at 22:19

    Neal: NGDPLT is not designed as a cure for all macroeconomic ills. In particular, it isn’t really intended to undo supply shocks (e.g. an oil crisis). All it’s intended to do, is not to add _additional_ unforced demand shocks, on top of whatever supply shocks the real world will force on resource allocation.

    So, we shouldn’t expect it to “fix” a productivity positive supply shock. All that said, your predicted consequence of a positive supply shock seems highly implausible. So it doesn’t seem like you’ve identified a real problem.

  12. Gravatar of jknarr jknarr
    20. December 2012 at 22:26

    Steve — Murdoch has clearly cut a deal with the Dems. Fiscal policy, gun regulations, taxes, and others. The change in tone across his media empire is striking. Odd, too how Demint simply walked away from being a senator. I think that we are seeing the formation of a Baldwin-like Post-bubble depression-era establishment coalition government between dems and reps. Call it the new Tories. The new left/right libertarian independents barely know what they are: the new opposition party. Exhibit A is todays failed vote on “Plan B” – one half of the house republicans are now in an opposition party.

  13. Gravatar of Steve Steve
    20. December 2012 at 22:46

    jknarr, good point, although I didn’t notice a change in tone at Murdoch Inc. The WSJ has been advocating going over the cliff to spite Obama last I saw.

    PS

    Who knew that the Mayans were Republicans who foresaw the end of the Party of Lincoln? I guess Mayans did believe in ritual bloodletting…

  14. Gravatar of marcus nunes marcus nunes
    21. December 2012 at 01:04

    MCK´s article on NGDPT is confusing and misleading:
    http://thefaintofheart.wordpress.com/2012/12/19/matthew-klein-mck-could-have-talked-to-ryan-avent-ra-before-writing-foolish-things-about-ngdp-targeting/

  15. Gravatar of Tomasz Wegrzanowski Tomasz Wegrzanowski
    21. December 2012 at 03:01

    Bubbles might not matter much, but inflation matters even less than that.

    Old people obsess about preventing inflation in 5-10% range in spite of zero evidence such kind of inflation causes any significant real negative effects.

    Just keep printing money until NGDP grows at 10% a year, why the hell not?

  16. Gravatar of cucaracha cucaracha
    21. December 2012 at 03:17

    “Or will it be MMTers?”

    Note: The only thing that can really be associated with MMT (if you (if you meant Modern, and not Market, Monetary Theory) is the view that money is government debt that is used as a means of payment backed by taxes and legal rules (like the ones that forcefully establish that money can be used to pay debts), something that is almost intuitive and was voiced by chartalism against the view that money could only be backed by a correspondent quantity of commodities.

    The rest are multiple opinions and ideas that are attributed to MMT which do not have any necessary link with that theory.

  17. Gravatar of Saturos Saturos
    21. December 2012 at 03:59

    Tomasz, nominal stability is very important, the markets can’t work without it. And even 10% inflation is quite damaging given the US tax code.

    Glad to be alive, guys!

  18. Gravatar of cucaracha cucaracha
    21. December 2012 at 04:45

    P.S.: A practical example of the different consequences of adopting the Austrian view on money and the M(modern) Monetary Theory aproach:

    1 – Austrian: You have lots of spare capacity, lots of people unemployed and lots of raw material unused in the economy, but no more gold: you can’t run a deficit to revive the economy, even with a lot of resources unused, just because there is no more gold left (even if gold has no industrial use at all);

    2 – MMT: If you see that there are lots of unused resources, start issuing money until those resources are used if you think that you stay within a tolerable rate of inflation. The lack of gold doesn’t necessarily mean that you can’t issue money and have no or little inflation doing it…

  19. Gravatar of Neal Neal
    21. December 2012 at 04:47

    W Peden-

    Wages are a price. A positive supply shock pushes down prices, hence it pushes down wages. Is this not right?

  20. Gravatar of Bill Woolsey Bill Woolsey
    21. December 2012 at 06:25

    Neal:

    No.

    Not unless the positive shock is to the supply of labor.

    Then total wage payments continue to grow, but the average hourly wage will grow more slowly or shrink, as will costs and product prices.

    Other sorts of supply shocks–improved provision of oil, productivity enhancing technology, good weather for growing crops–will result in lower prices for products. With nominal GDP targeting, total wage payments and average hourly wage continue growing. Real wages rise more quickly because product prices grow more slowly or fall.

  21. Gravatar of Major_Freedom Major_Freedom
    21. December 2012 at 06:38

    ssumner:

    Any thoughtful person today can predict that the macroeconomics policy failures of 2040 will be produced by a generation of late middle-aged policymakers obsessed with preventing bubbles. And boy will they have lots of bubbles to worry about! The coming Asian century will produce a tsunami of savings and a crash in population growth, which will drive real interest rates to ultra-low levels. Perfect for endless bubble formation. (Of course I still believe in the EMH, so whenever I say ‘bubble’, I actually mean “bubble” with scare quotes.) Yes, bubbles don’t actually cause macro instability, but what matters is that they appear to.

    According to Austrian theory, bubbles don’t form on the basis of interest rates simply being low (because of savings). Rather, they form on the basis of interest rates being low because of central banks pushing them down below where savings would have put them, thus throwing investment and consumption into discoordination. This can even be the case if NGDP is rising 5% per year. The “savings glut” theory of bubbles is untenable and breaks down upon closer analysis.

    This whole blog post looks to me like an argument that the Fed has made mistakes in the past, sometimes too much inflation, sometimes too little inflation (STMI/STLI theory), where the standard is of course NGDP growth. While at first blush the STMI/STLI theory does make a lot of sense, it can only tell us something about the real world if we use the right real world standard.

    According to Austrian theory, the right real world standard is individual action, which of course doesn’t tell us much, because that includes every standard that can be acted upon (like NGDP). But according to the laissez-faire capitalism theory, the right real world standard is individual private property rights. In that context, each individual would be legally free to utilize his means to produce or trade with others, without violating the property rights of anyone else. Here, whatever commodities are most highly valued, that make them more marketable, and by them becoming more marketable they become more highly valued, money can arise.

    Questions like “What is the right quantity of money?”, and “What is the right volume of spending?”, and “What is the right price level?”, and “What is the right supply of goods?”, etc, all these questions are answered practically according to individual valuations in the market process itself. These questions cannot be answered academically, by sitting in one’s arm chair, scribbling on paper or typing on one’s PC, and “calculating” that the current supply of wheat or the current supply of gold is too much, or too little, relative to some arbitrary standard. The right standard is the collective outcome of individual based private property, production and exchange.

    Thoughtful people know it’s wrong to use violence against others. Central banking is grounded upon some people (state) using violence against other people (civilians), and so central banking rules, such as NGDP targeting, really isn’t something a thoughtful person would base his ideal world on, even if they are only being “pragmatic”. They are pragmatic based on a thoughtless foundation, which of course implies central bank pragmatism is a thoughtless endeavor.

    ————————

    cucaracha:

    1 – Austrian: You have lots of spare capacity, lots of people unemployed and lots of raw material unused in the economy, but no more gold: you can’t run a deficit to revive the economy, even with a lot of resources unused, just because there is no more gold left (even if gold has no industrial use at all)

    No more gold? You’re talking like Suvy. He said he was afraid of spending falling to zero in a free market. You’re afraid of the money supply falling to zero in a gold standard. Wow. I guess we should all be afraid that because food can fall to zero, thus killing everyone, the government should monopolize and control that too. You and other socialist tending people may be physically upright and tall, but you have the minds of small children who want mommy and daddy in government to take care of them

    I mean, it’s too scary to take self-responsibility, especially in money making where most of us grew up getting allowance money from mommy and daddy at home in exchange for doing chores at their determination, so why not have all civilians into adulthood play the role of children at home, and those technocrats in the central bank can play the role of mommy and daddy giver of allowances! It’s perfect. One big happy family! All us children have to do is “chores” for the Treasury crazy cousins, doesn’t matter what those chores are, because as long as those crazy cousins borrow and spend money on ANY chore, mommy and daddy Fed will buy the bonds from Uncle Banker, and his lending will ensure enough money flows to all of us doing chores for the crazy cousins!

    It’s perfect. Even if the crazy cousins hired ALL the children, even to dig holes in the ground only to fill them back up, mommy and daddy will ensure there is a sufficient allowance stream.

  22. Gravatar of Becky Hargrove Becky Hargrove
    21. December 2012 at 06:41

    With a little luck, many of these arbitrary “bubbles” may “pop” and coming generations would gain free markets in living accomodations choices, as well as skills of all kinds.

  23. Gravatar of ssumner ssumner
    21. December 2012 at 06:56

    Philo, The tight money policy of 1929 is an example of an unwise policy aimed at bursting a bubble. It did, but it also caused WWII and the Holocaust.

    Neal, Productivity growth pushes down prices, but not wages.

    jknarr, Interesting point about bonds.

    cucaracha, MMT is what MMT does. Nothing in the universe has any sort of intrinsic characteristics.

    I don’t think money needs to be backed by taxes or commodities. It’s useful. Wallets are useful, and are not backed by anything.

  24. Gravatar of Saturos Saturos
    21. December 2012 at 07:00

    Was hoping for an NGDP chart from Jim: http://www.aei-ideas.org/2012/12/the-7-most-illuminating-economic-charts-of-2012/

  25. Gravatar of Saturos Saturos
    21. December 2012 at 07:00

    Scott, I see you’ve been reading Leibniz…

  26. Gravatar of Saturos Saturos
    21. December 2012 at 07:01

    Or perhaps Wittgenstein.

  27. Gravatar of Gregor Bush Gregor Bush
    21. December 2012 at 07:55

    Scott,

    Of course it will be the MMTers! After all, they’re the only ones who understand how the banking system really works. Or so I’ve been (repeatedly) told.

    The thought of spending my golden years caught in the crossfire of a MMT/neo-Austrian macro civil war dystopia is not brightening up my Friday. It sounds like the economic version of living in Spain in 1936 (although, admittedly, living in Spain in 2016 might not be a whole lot better).

  28. Gravatar of Greg Ransom Greg Ransom
    21. December 2012 at 07:57

    Read a book, Scott.

    This will not create a bubble.

    Sure wish this part of the logic of choice hadn’t been cut out of the Grad School textbooks.

    Scott writes,

    “The coming Asian century will produce a tsunami of savings and a crash in population growth, which will drive real interest rates to ultra-low levels. Perfect for endless bubble formation.”

  29. Gravatar of Greg Ransom Greg Ransom
    21. December 2012 at 08:18

    As Ed Leamer has explained macroeconomists again and again, there have been been a constant stream real estate / housing booms and busts over the last 60 years, tied to every recession.

    The fact that macroeconomists don’t know anything about the real world doesn’t change the facts of reality.

    There was indeed a prominent housing boom and bust linked with the business cycle in Southern California in the late 1980s and early 1990s

    And there as a famous little asset boom and bust in Japan if I recall correctly …

    Scott writes,

    “the policymakers of 1998 had experienced exactly zero real estate bubbles in the past 60 years”

    That is false.

    Macroeconomists are simply “Bubble Boys” — they live in an Ivy Tower bubble and have zero hands on knowledge of the real economy.

    Macroeconomists don’t do field research — unlike geologists, biologists, zoologists, botanists, and every other real scientist in the University.

  30. Gravatar of Major_Freedom Major_Freedom
    21. December 2012 at 08:23

    ssumner:

    The tight money policy of 1929 is an example of an unwise policy aimed at bursting a bubble. It did, but it also caused WWII and the Holocaust.

    I guess the rise in power of the Nazi Party during the 1920s, in Germany, was due to the German people, in Germany, just knowing that the Fed, in the US, would dramatically increase inflation during the late 1920s, in the US, before tightening in 1928-1929, in the US. Yup, that makes sense.

    WW2 and the holocaust were caused by insufficient inflation? This blog really is an insane asylum.

    If central bank errors really were the cause of WW2 and the holocaust, then why in the world are you not shouting from the rooftops to end central banking now? Do they not pose such a risk to civilization that only a lunatic would want to keep them?

    “Money is too important to be left to central bankers. You essentially have a group of unelected people who have enormous power to affect the economy.” – Milton Friedman.

  31. Gravatar of Major_Freedom Major_Freedom
    21. December 2012 at 08:29

    Now the inflation fetishism on this blog makes sense. Sumner is trying to stop fascist totalitarianism. An admirable goal, but unfortunately completely backwards. It was the hyperinflation during the 1920s, the crushing deflation in the early 1930s, the war reparations on the German people that made them feel unjustly responsible for WW1, the popular philosophy prevailing in Germany at the time (Nietzsche, Fichte, Carlyle, Rousseau, etc), that so roused up the German people that they wanted a strong leader to bring them to the promised land. So many pieces had to be in place, that to blame it on ONE thing: lack of inflation, is madness.

  32. Gravatar of mpowell mpowell
    21. December 2012 at 08:33

    Are low real interest rates really as bad as low nominal rates for creating bubbles? It seems to me that since different assets will experience an inflationary environment in different and unpredictable ways, low real rates in an inflationary environment will not push asset prices up as much. Or maybe they will and it will just be specific asset prices which are growing robustly with inflation. But if not, this is, in my view, a good argument for targetting higher NGDP growth, if you think bubbles need to be addressed by monetary policy.

  33. Gravatar of Victor Victor
    21. December 2012 at 09:03

    Scott,

    “But the post does express some concern that central banks might refrain from implementing NGDP targeting during a period of strong productivity growth. ”

    I really don´t understand how having a period of strong NGDP growth can be charactarized as anti-growth? Maybe is because Mr. Jordan compares to how a Central Bank would react if under IT.

    We can say the same of Inflation Targeting, if the economy is hit by a adverse supply shock the CB would have to increase the target rate to keep inflation on target, so the CB would in fact worsen economic activity, charactarizing the CB, in my opninion, as anti-growth too.

  34. Gravatar of jnkarr jnkarr
    21. December 2012 at 09:06

    Scott — I’d love to dig into the shape of a world where corporate bond spreads substitute for NGDP futures and NGDPLT is the norm.

    My own take is that it would have S&L utility-like banks, other banks would look like private bank/hedge funds, reserves are eliminated, and savings takes place largely in bonds. Hence, as a major savings vehicle, corporate bonds take a center stage in the NGDP forecast.

    http://research.stlouisfed.org/fred2/graph/?g=dY4

  35. Gravatar of jknarr jknarr
    21. December 2012 at 09:06

    Scott — I’d love to dig into the shape of a world where corporate bond spreads substitute for NGDP futures and NGDPLT is the norm.

    My own take is that it would have S&L utility-like banks, other banks would look like private bank/hedge funds, reserves are eliminated, and savings takes place largely in bonds. Hence, as a major savings vehicle, corporate bonds take a center stage in the NGDP forecast.

    http://research.stlouisfed.org/fred2/graph/?g=dY4

  36. Gravatar of cucaracha cucaracha
    21. December 2012 at 09:19

    “Wages are a price. A positive supply shock pushes down prices, hence it pushes down wages. Is this not right?”

    It may happen if the money and quasi-money supply is held unchanged…

  37. Gravatar of Philo Philo
    21. December 2012 at 09:58

    Saturos wrote: “Scott, I see you’ve been reading Leibniz . . . Or perhaps Wittgenstein.” But more likely he’s just been listening to American athletes and sports commentators—“It is what it is.”

  38. Gravatar of Felipe Felipe
    21. December 2012 at 10:10

    MF:
    I guess the rise in power of the Nazi Party during the 1920s

    From Wikipedia:

    March 20, 1928 NSDAP gains 2.6% of the vote in Reichstag elections.

    Sep 14, 1930 – In a milestone election, Nazis gain 6 million votes in national polling to emerge as the second largest party in Germany.

    Apr 10, 1932 Hindenburg reelected to Reichspresident with over 40% of the vote. Hitler gains 37% and the communist candidate Thälmann gains 10.2%

    Doesn’t look like the rise of Nazism was during the 1920s, but rather around 1930 (and pretty rapid indeed).

  39. Gravatar of Felipe Felipe
    21. December 2012 at 10:11

    MF:

    If central bank errors really were the cause of WW2 and the holocaust, then why in the world are you not shouting from the rooftops to end central banking now?

    He is, actually. He wants central banks replaced with a NGDP futures market.

  40. Gravatar of W. Peden W. Peden
    21. December 2012 at 10:11

    Neal,

    “Wages are a price. A positive supply shock pushes down prices, hence it pushes down wages. Is this not right?”

    An aggregate positive supply shock pushed down aggregate prices, but not each and every individual price.

    Also, as Bill Woosley suggested, if the positive supply shock is labour productivity, then the marginal value of labour is going up, not down. More productive workers can command higher wages, given the higher demand for them.

    There are positive shocks to capital productivity (though, as in the 1920s, these tend to be closely followed by labour productivity) which could make capital substitution a more profitable strategy. However, increased capital productivity doesn’t lead to either the need for falling wages or increased unemployment: capital productivity has increased dramatically over history without falling wages or increased unemployment. Furthermore, I’m not convinced that capital productivity/labour productivity differentials are an issue for which monetary policy makers should be responsible; they already have too many objectives and only one instrument!

    Anyway, in general there is no reason why things getting cheaper means that work gets scarcer, and we can see this in the high-employment, extremely high-productivity decade of the 1920s in the US.

  41. Gravatar of Philo Philo
    21. December 2012 at 10:36

    Another possible source:

    “Every thing is what it is, and not another thing.” — Joseph Butler.

  42. Gravatar of John Brown John Brown
    21. December 2012 at 10:47

    I am an 18 year old college student with a strong interest in economics. With regret, I have to say that, based on what I’ve seen, you are totally correct in your assessment of our generation.

    When I talk to other people in my age group about economics, there seem to be two groups. One group sees easy money as the root of all economic problems. These are the Ron Paul supporters who talk about gold all the time. They read Mises on a regular basis and constantly use the world “fallacy” (usually accompanied with something about a broken window).

    The other group reads Krugman on a daily basis. In their view, the ultimate problem with our economy is that the government isn’t running large enough deficits and that underregulation of the banking industry was the only major cause of the financial troubles in 2008. On top of this, this group scoffs at the thought that high marginal tax rates, overregulation, and even trade protectionism have any negative effect on long term GDP. According to them, the large tax/transfer systems and tightly regulated labor markets had nothing to do with the relative decline of GDP in Western Europe.

    There are very few, if you will, centre-right or centre-left economists. I would consider myself centre to centre-right, all things considered. I am a staunch believer in free trade and free markets, but I also support NGDP targeting. Like you, Mr. Sumner, I am of the view that we should have the fed boost AD while we continue to partake in pro growth, neoliberal reforms in the rest of our economy.

    Unfortunatley, if nothing changes, I would predict we will have a generation of economic policy managed by goldbugs who want to abolish the fed (or peg it to gold) and hard left statists who think 90% tax rates are good and free trade is bad.

  43. Gravatar of Cthorm Cthorm
    21. December 2012 at 11:14

    The proletarians will take to the zealotry of a Rothbardian view.

    The thoughtful people of this generation will favor automatic policies like NGDP targeting. There are few things more irritating to my generation than bad service and low productivity processes. We’ve seen the light in automatic systems via online content and goods delivery, why should we tolerate error prone manual processes in monetary policy or govt? Whether you choose to spend the time savings on wealth or leisure is the individual’s business, but there is no good excuse for low productivity.

  44. Gravatar of Felipe Felipe
    21. December 2012 at 11:16

    Maybe just Forrest Gump? Stupid is as stupid does.

  45. Gravatar of Floccina Floccina
    21. December 2012 at 12:21

    @Neal by keeping spending up even while prices fall.

  46. Gravatar of Mike Sax Mike Sax
    21. December 2012 at 12:32

    “If you see that there are lots of unused resources, start issuing money until those resources are used if you think that you stay within a tolerable rate of inflation.”

    Cucuracha I’d tend to agree with this though what do you say to those who say that in the 70s with staglfation we weren’t able to both stay within a tolerable rate of inflation and do countercylcial policy at the same time?

    Greg Ransom, it’s a minor quibble but your points would be easier to follow if you quoteed first and then answer it. The way you do it the reader reads your asnwer to the quote before even knowing what it’s in response to.

  47. Gravatar of Mike Sax Mike Sax
    21. December 2012 at 12:39

    “WW2 and the holocaust were caused by insufficient inflation? This blog really is an insane asylum”

    Well WW2 and the holocaust have been blamed on all kinds of things, some more ludicrous than that. There is a narrative that the Third Reich was caused by the hyerinflation of the Weimar Republic.

    What that ingores is that the period of hyperinlfation was well prior to the Depression and the rise of Hitler. In fact by the early 30s German monetary policy was quite tight.

    For the record I certainly am not necessarily saying too low inlfation whether within Germany or abroad caused Hitler. At least is wasn’t the only cause. There were some major political causes as well totally unrelated to this.

  48. Gravatar of flow5 flow5
    21. December 2012 at 12:48

    No student of monetarism could have guessed how badly Bernanke would misdiagnose & misguide our economy. It was horrific. The depth of Bernanke’s miscalculations haven’t reached the public.

  49. Gravatar of TheMoneyIllusion » Noah Smith on the state of macroeconomics TheMoneyIllusion » Noah Smith on the state of macroeconomics
    21. December 2012 at 13:20

    [...]  My nightmare scenario is nicely described by a recently commenter named John Brown: I am an 18 year old college student with a strong interest in economics. With regret, I have to [...]

  50. Gravatar of RebelEconomist RebelEconomist
    21. December 2012 at 13:45

    My taxonomy would be slightly different. It would go:

    bubble => financial crisis => slump => inflation => recession => bubble => financial crisis => slump => inflation and so on.

    Two sorts of boom, alternating, and two sorts of bust, alternating, each boom driven by revulsion for problems thrown up by the previous cycle, but also wanting to avoid the mistakes that were evident in the previous recovery. Obviously modulated by other events such as war and exogenous supply shocks, and perhaps with a few mini-cycles in the inflation / recession phase.

    From here, the next step is inflation, because, as Reinhart and Rogoff tell us, the fallout from a financial crisis type bust is so deep and long lasting that, inflation looks like a risk worth taking. That, Scott, is your part in this sequence.

    If we can take a long enough view to understand this, we can mitigate the cycle, but human nature (the ambition of politicians and the gullibility of voters) and the length of direct human memory make that hard.

  51. Gravatar of Evan Soltas Evan Soltas
    21. December 2012 at 15:44

    I can’t say I agree with you here. Your thesis, as I understand it, is that the foundational experience of a generation of thinkers gives them a persistently biased worldview and leads them to make predictable errors on the basis of that worldview.

    Isn’t this just one big exercise in hindsight bias? Pythagoras’ laws are simple enough, it seems, for example, that your average elementary schooler could have figured it out. So why did it take a Pythagoras? Clearly what we need to do is place ourselves in Pythagoras’ original condition of ignorance, in the same way that I find the very cutting edge of math today baffling.

    In other words, the way to test this rigorously, rather than anecdotal historical analysis, would be to sample the historical literature for 100 or so moments of shock, “anonymize” them in terms of era, and then see if you can predict the response with any accuracy from the shock. (I.e. that there will be no statistically significant relationship.) And I would take pretty good odds that you can’t, and that there won’t be.

    You also have big problems with Popper’s critique of historicism here.

  52. Gravatar of cucaracha cucaracha
    21. December 2012 at 15:57

    “Cucuracha I’d tend to agree with this though what do you say to those who say that in the 70s with staglfation we weren’t able to both stay within a tolerable rate of inflation and do countercylcial policy at the same time?”

    It is not a mistery, Mike.

    The 70′s stagflation was caused by a sharp rise in oil prices, so there was no spare capacity, on the contrary: you had less fuel and energy to run the economy. With less fuel and energy, you can produce less goods than you could before, you have to raise prices to keep profits and at the same time you don’t need so many workers to do the job (because you are producing less), hence the rising unemployment and the aparent contradiction of high inflation with rising unemployment.

  53. Gravatar of ssumner ssumner
    22. December 2012 at 08:26

    Greg, You are confusing fluctuations in housing output, which do occur but do not cause recessions, with price bubbles. The 2006 national real estate price bubble was the first.

    Mike Sax, Zero inflation would probably have been high enough to keep the Nazis out of power. I take if from your comment that MF thinks that would have been too high, risking another hyperinflation.

    Evan, Good post. Given my belief in the EMH, I was going a bit overboard here, just trying to be provocative. So let’s try to see why the markets missed these errors:

    1. The markets in the 1960s assumed the continuation of Bretton Woods, with the $35/oz gold peg. The new information was that Bretton Woods broke down. So it was the interaction of the failure of Bretton Woods and the bias towards inflation that created the Great Inflation. Of course the breakdown of Bretton Woods was endogenous, but much harder to forecast ex ante (as compared to the inflation bias.)

    2. The markets in the Great Moderation assumed that real interest rates would stay positive, or at least close to zero. That would be enough to keep us out of a liquidity trap as long as we avoided Japanese style deflation. Then we were blinded-sided by ultra-low interest rates and the interaction of those low interest rates with interest rate targeting/inflation targeting produced the Great Depression.

    So this is a long winded way of saying you are right, we probably cannot predict what sort of specific mistakes the current young generation is likely to make. However I still do believe they are likely to err on the side of being too focused on stopping bubbles, as the vast majority of them see recent history though the lens of serial bubbles. And I still think they are wrong. By the way, I think most older people make this mistake as well. And obviously I exclude you from this generalization.

    Milton Friedman came of age during the 1930s, and rose above it.

  54. Gravatar of Mike Sax Mike Sax
    22. December 2012 at 11:33

    Curacha don’t get me wrong I want to believe. However, there are many who argue that it wasn’t just the oil shocks. That the Fed should have pursued a tighter policy and that even in the early 70s-prior to the first shock there was a rise in inflation.

    Even Skidelsky seems to think that the Keynesians of the time were too unconcerned with inflation. Skidelsky if you don’t know is more or less the authority on Keynes these days-doesn’t make him right of ocurse. But he certainly isn’t one to do a hatchet job on Keynesianism.

  55. Gravatar of Greg Ransom Greg Ransom
    22. December 2012 at 12:19

    Scott, the late 1980s early 190s housing bubble in Southern California was a full blown bubble.

    Japan had a rather famous real estate bubble a few decades back, I’m surprised you’ve forgotten.

    It’s just weird denial of empirical facts to pretend this phenomena never happened.

    Scott writes,

    “Greg, You are confusing fluctuations in housing output, which do occur but do not cause recessions, with price bubbles. The 2006 national real estate price bubble was the first.”

  56. Gravatar of cucaracha cucaracha
    22. December 2012 at 13:00

    “However, there are many who argue that it wasn’t just the oil shocks”

    Yes, Mike. There could be many reasons, perhaps some policies were applied at the wrong time (loose monetary policy) and others were simply wrong themselves (like gas price controls), and some other facts might have contributed (the US getting out of Bretton Woods – helped oil prices to go up in dollar, anyway).

    However, just think about oil prices quadrupling in less than one year after the Yon Kippur of 1973…

  57. Gravatar of Bob Murphy Bob Murphy
    22. December 2012 at 14:42

    Scott, suppose you encountered an economist who said that he didn’t actually believe there was an unemployment problem in the 1930s, or that there was an inflation problem in the 1970s, and yet he still thought the public and policymakers were all tricked into thinking these were major issues, and consequently implemented the wrong policies when they took power. Wouldn’t that be kind of weird?

    If you agree, then you can see how it’s weird when you tell us that not only do you not believe in the housing bubble (which is weird enough), but this non-existent thing has such power that it will mislead a generation of policymakers down the road–even though it never occurred…

  58. Gravatar of ssumner ssumner
    22. December 2012 at 15:18

    Greg, Read what I said. Local bubbles don’t count, it’s national “bubbles” that people care about.

    Cucaracha, How do oil shocks cause 11% NGDP growth, per year, between 1972 and 1981?

    Bob, You don’t need to convince me that you view my opinions as weird, I’m convinced.

    Meanwhile I’ll keep trying to convince you that there is no evidence the housing crash caused the recession, and massive evidence that plunging NGDP caused by tight money caused the recession.

    If a housing slump caused recessions, there would have been a huge increase in unemployment between January 2006 and April 2008. Instead they was almost no change in unemployment.

    And then NGDP started plunging due to the hard money policies favored by so many of my commenters.

  59. Gravatar of Brian Dell Brian Dell
    22. December 2012 at 17:03

    “I don’t happen to share that fear [that central banks might refrain from implementing NGDP targeting during a period of strong productivity growth].”

    Yet everybody does (or should) admit that when it comes to Keynesian fiscal policy in the real world it’s invariably asymmetrical: expansionary fiscal policy during recessions does not get matched by contractionary policy during expansions.

    At the end of June 1999 the Fed raised rates a measly quarter point and then changed its bias to suggest even odds the next move could be another raise or a cut. The Dow Jones shot up more than 150 points on the dovish move (relative to market expectations). It’s quite clear in hindsight the Fed was too soft. But would have NGDP targeting have led it to be harder? Looking at the minutes from that meeting:
    “…the members of the Committee and the Federal Reserve Bank presidents not currently serving as members had provided individual projections of the growth in nominal and real GDP… With regard to the growth of nominal GDP, most of the forecasts were in ranges of 5 to 5-1/2 percent for 1999 as a whole and 4 to 5 percent for 2000.”

    You see the problem? NGDP targeting would have just reinforced the arguments of those calling for a neutral bias instead of a tightening bias (assuming a 5% target). Meanwhile, the hawks noted “that the trend in average hourly earnings appeared to have tilted up in recent months… anecdotal reports of faster increases in labor compensation also appeared to have multiplied. In addition, improving economic conditions abroad, among other factors, had induced a firming in oil and other commodity prices, and had supported the foreign exchange value of other currencies relative to the dollar. As a consequence, the declines in commodity and other import prices that had helped to suppress inflation and inflation expectations over the last two years were not likely to be repeated.”

    So you’ve got trends in prices (or an inflation analysis as opposed to a NGDP analysis) supporting the hawks, and NGDP supporting the doves at a time when the U.S. was running at its hottest in the last two decades.

  60. Gravatar of Brian Dell Brian Dell
    22. December 2012 at 18:49

    Just to anticipate a response here, it might be argued that a NGDP targeting Fed would not have just gone neutral in the summer of 1999 based on its NGDP projection at that time because what matters is how far away the economy is believed to be from its long term NGDP trend.

    But for the Fed to have recognized that the economy was running notably over potential in mid-1999 the starting point chosen to start the NGDP trend line would have had to have been at a point prior that would have entailed a significant cumulative gap over potential by mid-1999.

    Look at the candidates for a starting point and how the Fed felt about whether the economy was at that time:
    mid-1998:
    “With regard to the growth of nominal GDP, most of the forecasts were in ranges of 4-1/2 to 5 percent for 1998 and 4-1/4 to 5 percent for 1999.”
    mid-1997:
    “…5 to 5-1/2 percent for 1997 and 4-1/2 to 5 percent for 1998.”
    mid-1996:
    “…5 to 5-1/2 percent for 1996 and 4-1/4 to 5 percent for 1997.”
    mid-1995:
    “…4-1/4 to 4-3/4 percent for 1995 and 4-3/4 to 5-3/8 percent for 1996.”
    mid-1994:
    “…5-1/2 to 6 percent for 1994 and 5 to 5-1/2 percent for 1995.”
    mid-1993:
    “…5 to 5-3/4 percent for 1993 and 5 to 6-1/2 percent for 1994.”

    In the alternate history where the Fed correctly recognizes a need to tighten in mid-1999 (if not before) via NGDP targeting, it would have had to have chosen a target some time prior such that it would have then recognized in mid-1999 that it was over. But would it have chosen 1998? No, because (assuming a 5%) target, in mid-1998 it was believed that nominal GDP for that year would come in under 5%, and no increase the following year. 1997 or 1996? No, because it was believed the economy was running only marginally over 5% and likely to go under the following year. In 1995 it was believed that 4.75% would be the high end for that year. In 1994, yes, it was agreed that the economy would run as much as 1% over 5% nominal GDP that year, although 1995 was expected to be moderate, suggesting that there would have been several voices in mid-1994 saying that there was still some cyclical demand deficiency lingering from the early 1990s recession such that henceforth aiming for 5% NGDP would be lowballing.

    But even if we lowball it anyway and start the target from mid-1994, five years later the cumulative change in nominal GDP would have been less than 3% over what a 5% average annual nominal GDP growth would indicate. A 5.5% target would have the economy right on trend in mid-1999 and one can easily imagine arguments in mid-1999 to the effect that that trendline should be stuck to instead of trying to contract back to 5% in light of expectations for the following year’s NGDP coming in below 5%, apparently permanent productivity gains that would support a 5.5% trendline, or, in the alternative, arguments that there was still an output gap in 1994 (as suggested by the IMF’s reckoning that there was an output gap over 3% in 1993 and that that output gap persisted for years such that it was still well over 1% in 1994).

    So where does that leave us? With the conclusion that NGDP targeting likely would not have been adopted in the 1990s with a 1994 trend start, the argument being that it that would be too low, and a higher starting point would have provided arguments for not tightening in mid-1999 despite traditional arguments noting trends in prices (including asset prices like the stock market) flashing warnings. Even if the “traditional” Fed ended up ignoring those warnings at least the price analysis was acknowledged as relevant.

    Even if it would have been “better” monetary policy as an alternate history, it doesn’t follow that 5% then means 5% now is appropriate, given the slide in productivity and labour force participation since 1999.

  61. Gravatar of cucaracha cucaracha
    23. December 2012 at 05:39

    “Cucaracha, How do oil shocks cause 11% NGDP growth, per year, between 1972 and 1981?”

    Actually, between december 1973 and december 1974, the US GDP shrank about two percentage points. The unemployment rose from 4.6% in october 1973 to 9% in May 1975. Very much, if not almost of all those changes were due to the first impact of the shock

    NGPD includes inflation and growth. Real GDP growth in the period 1972/1980 was about 2.5-3 percentage points on average. It a reasonable average gdp growth, but it was not, in any fashion, a great average.

    Maybe the loose monetary policy of those days helped the economy to readapt and start growing in the new environment of (much) higher oil prices.

  62. Gravatar of cucaracha cucaracha
    23. December 2012 at 05:40

    “Cucaracha, How do oil shocks cause 11% NGDP growth, per year, between 1972 and 1981?”

    Actually, between december 1973 and december 1974, the US GDP shrank about two percentage points. The unemployment rose from 4.6% in october 1973 to 9% in May 1975. Very much, if not almost of all those changes were due to the first impact of the shock

    NGPD includes inflation and growth. Real GDP growth in the period 1972/1980 was about 2.5-3 percentage points on average. It was a reasonable average gdp growth, but it was not, in any fashion, a great average.

    Maybe the loose monetary policy of those days helped the economy to readapt and start growing in the new environment of (much) higher oil prices.

  63. Gravatar of Philo Philo
    23. December 2012 at 09:24

    @ Evan Soltas:
    From Wikipedia: “In his Poverty of Historicism, he [Popper] identified historicism with the view that there are ‘inexorable laws of historical destiny’, which view he warned against.” Scott’s thesis is a lot less grand than “inexorable laws of historical destiny”; it’s more like “influential trends occasioned by historical context.” (Besides, how effective is Popper’s attack on “historicism”?)

  64. Gravatar of cucuracha cucuracha
    23. December 2012 at 12:20

    P.S.:(Scott)

    I didn’t say (in my answer to Mike) that the oil shocks alone were to blame for the high inflation of the 70′s. I only said that oil prices were the factor that explained the concomitance of high inflation with high unemployment/low growth.

    And after studying the data about that time, I see that the high inflation was a very necessary evil back then…

  65. Gravatar of ssumner ssumner
    23. December 2012 at 15:25

    Brian; 1985 to 2007 is exhibit A for the benefits of stable NGDP growth. It stacks up well against any other period in US history. And that’s without the Fed even trying to even doing NGDPLT. Had we been pursuing NGDPLT, presumably we might have even done a bit better.

    2008-09 is Exhibit B for the benefits of NGDP targeting–it shows what happens when you move away from the trajectory of fairly stable NGDP growth.

    I’m not sure how to interpret the thrust of your comments. If the Fed had good reason to do something, presumably it was a wise move, unless it was likely to lead to excessive NGDP growth. If, ex ante, it was not likely to lead to excessive NGDP growth, then one can’t really blame the Fed, even if ex post a particular action looks foolish. In contrast, the 2008 policy looks horrible even ex ante.

    cucaracha, The 1972-81 period might well have been better with 3% inflation rather than 8%. And 1982 would have been much better.

  66. Gravatar of Brian McElroy Brian McElroy
    24. December 2012 at 11:02

    Scott,

    That last bit about MMTers is truly creepy and unnerving -in the way M. Night Shamalan used to be able to pull off.

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    24. December 2012 at 13:18

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  68. Gravatar of Doug M Doug M
    26. December 2012 at 10:35

    On bubbles,

    The way to stop bubbles is to create inefficiency. Or, more to the point, increasing efficiency creates a susceptiblity to bubbles.

    The network distributes stresses from one node to neigboring nodes. If there is excess capacity (inefficency) in the network, then this changing stress load doesn’t create any problems. Any one node can collapse, and the rest of the network picks up the load. However, if the network is already stressed, and near capacity, then damage to one node threatens the entire network.

    The solutions —

    The state insures all of the members of the financial network. If one fails, the state holds the sytem together. But, what happens when the state doesn’t have the resources to make good on the guarantees. See Spain and Ireland.

    The state breaks up the biggest members. Too big to fail is too big to exist. While it may be a good answer, there will be hystrionics every time an institution is targeted to be broken up.

    Caveat Emptor — if there are no guarantees, then every player must make an assessment of wich counterparties with which they are willing to do business and absorb the losses if a counterparty fails. It opens the system up to bank runs. But bank run at the retail level were a problem of the ’30s. The ’00s were a bank run at the institutional level. Institutions are assumed to be a little bit more sophisticated.

  69. Gravatar of Major_Freedom Major_Freedom
    29. December 2012 at 10:22

    Had we been pursuing NGDPLT, presumably we might have even done a bit better.

    Lucas Critique says otherwise.

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  78. Gravatar of Eugene Eugene
    17. February 2013 at 11:33

    Dear Mr. Samner,

    Where can I read essentials of your great idea on targeting NGDP?
    I am pretty old man, an immigrant from Russia arrived to the US in 1995. I am a kind of economist as well, whiting in Russian on the history of economic ideas.
    Now I work on a book named rather ambitiously ‘From Prophets to Professors’. My book is supposed to contain 5 parts named as Adolescence of the Science, Maturity of the Science, Transfiguration of the Science, Expansion of the Science, and Degradation of the Science.
    There is, after all said, supposed to be Conclusion on what we can expect regarding future developments. It is for the Conclusion that I want to know about your idea which is said as saved our economy.
    Thank you for your consideration.

  79. Gravatar of Eugene Eugene
    17. February 2013 at 11:35

    Sorry, not ‘whiting’ but ‘writing’.

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