A Financial Times op ed recommends NGDPLT

Here’s the latest from the Financial Times:

Some fear that inflation will become unanchored if we move to NGDP targeting. In fact, most of the problems that people associate with inflation are more closely linked to high and unstable NGDP growth. Wages tend to follow growth in national income. As long as NGDP growth is low and stable, wages and core inflation will remain well anchored.

A stable path for NGDP growth will also produce better policy decisions in other areas. Fiscal spending will have to be justified on a cost-benefit basis, once it is no longer expected to boost nominal demand. The cost of bailing out failed companies will be more transparent, as it will be obvious that more jobs in the rescued company are offset by fewer jobs elsewhere. Those claiming that Chinese exports cost jobs will have to provide a mechanism other than “less demand”, and won’t be able to do so. And, most importantly, countries will be able to address the public debt problem, as they should, without fear that austerity will cost jobs.

Read the whole thing.

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62 Responses to “A Financial Times op ed recommends NGDPLT”

  1. Gravatar of Tyler Joyner Tyler Joyner
    2. January 2013 at 07:44

    I can’t help but wonder if you’re baiting the commenters by failing to mention that you wrote the op ed. Don’t go all Mary Rosh on us, Scott.

  2. Gravatar of Saturos Saturos
    2. January 2013 at 07:44

    The second line gave it away, I knew it was you before I even clicked the link. Congratulations.

  3. Gravatar of ssumner ssumner
    2. January 2013 at 07:55

    Tyler, Maybe I got too cute—I thought I see if anyone “reads the whole thing” when I suggest doing so.

    Thanks Saturos.

  4. Gravatar of RebelEconomist RebelEconomist
    2. January 2013 at 07:57

    As usual, your argument is based on your flawed or misleading idea that “Once a central bank sets an inflation target, they have essentially set a path for aggregate demand”. The fact is that inflation targeting is about the value of money, nothing more, nothing less. If the UK invents fusion power tomorrow, and real output is boosted, the BoE is not going to keep NGDP to some previously-set path – it will allow it to rise, at on-target prices. And, in the UK’s case, the inflation target is not so much a point as a band, with a little further wiggle room provided by targeting the inflation forecast and letter-writing, so there is already a little scope for the BoE to use monetary policy to mitigate busts, but that finishes when the inflation target is no longer being credibly met.

    The hope of inflation targeting was, that deprived of their central bank crutch, politicians would be forced to turn their attention to structural ways of raising NGDP, or regulatory ways of dampening volatility in prices not within the central bank target. It would have been nice if they had done this during the good times, but they did not, and the whole point of the binding inflation target is to drive them to do so, so now, when it is actually binding, is not the time to remove the constraint.

  5. Gravatar of Jon Jon
    2. January 2013 at 08:10

    Yes Scott, this is an opposition editorial not an editorial. A few words of clarity there would be due. Still congratulations on getting a new platform.

    The weakest point I think comes in your discussion that inflation targetting failed. The long that you want to make–but perhaps is too controversial–is that rate targetting failed un 2007-2008 by turning a AS shock into a demand shock that sent real-rates tumbling.

    The next failure came not from inflation targetting but from interest rates as a communication tool in the 2008-2009 period and the view that the crisis was primarily in the bank sector rather than an AD shock crippling the banking sector. This gave us an expanding balance sheet as the Fed tried to steer funding of the banks through TAF and the central bank swaps while sterilizing with the interest on reserves policy.

    The third and final failure came in communicating that the Fed interpetted NGDP under trend as OKAY and revert to a policy of steady growth rather than catchup growth.

  6. Gravatar of Tyler Joyner Tyler Joyner
    2. January 2013 at 08:48

    Yeah, I figured your “read the whole thing” made it clear that you weren’t actually trying to fool anyone, but rather just having a little fun with the commenters.

    Glad to see your ideas continuing to be published and become more widespread. Have much have you fleshed out possible specifics on the futures market portion of your proposal? My family is in the futures business, so that part is of particular interest to me.

    I would imagine other financial professionals might be intrigued by the idea of a new financial product as well, whereas your NGDP proposals can come across as economist voodoo at first (the finance world is chock full of what you call “internet Austrians”, at least it seems that way to me).

  7. Gravatar of Doug M Doug M
    2. January 2013 at 08:54

    Rebel,

    “The hope of inflation targeting was, that deprived of their central bank crutch, politicians would be forced to turn their attention to structural ways of raising NGDP, or regulatory ways of dampening volatility in prices not within the central bank target.”

    The hope of NGDP targeting is, that without the expectation of stimulating demand, politicians would be forced to turn their attention to structural ways to improve productivity. Fiscal policy would be all supply-side all the the time.

    Whether the central bank can actually peg NGDP is a point of difference I have with the professor.

  8. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 09:12

    how can you spread such a bunch of lies Sir?

    http://theyogirock.com/2013/01/02/make-nominal-spending-the-new-target-or-just-a-bunch-of-lies/

  9. Gravatar of Geoff Geoff
    2. January 2013 at 09:59

    “Wages tend to follow growth in national income.”

    Hmmmm, that sounds too good to be true.

    Oh wait it is.

    Interestingly, wages to NGDP has persistently fallen since the early 1970s.

  10. Gravatar of W. Peden W. Peden
    2. January 2013 at 10:47

    Geoff,

    Yes, it’s closer to the truth to say that net employee compensation tends to follow GDP, though GDP is by no means the sole determinant of net employee compensation-

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=COE_GDP&scale=Left&range=Max&cosd=1947-01-01&coed=2012-07-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=1&ost=-99999&oet=99999&mma=0&fml=a%2Fb&fq=Quarterly&fam=avg&fgst=lin&transformation=lin_lin&vintage_date=2013-01-02_2013-01-02&revision_date=2013-01-02_2013-01-02

    The reason for the divergent graphs is that wages have gradually fallen as a proportion of total compensation during the postwar periods, perhaps due to tax incentives & demographic changes have encouraged more health insurance compensation rather than wages.

    TheYogiRock,

    If you’d linked to something other than a series of bald assertions and strawmen to back up claims that an argumentative opponent is a liar, I might have been convinced to read your blog again. As it is, I won’t, and I wouldn’t recommend it.

  11. Gravatar of W. Peden W. Peden
    2. January 2013 at 10:48

    I nearly forgot: wages and compensation data-

    http://research.stlouisfed.org/fred2/graph/?id=COE

  12. Gravatar of W. Peden W. Peden
    2. January 2013 at 10:49

    Rather: http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=COE_WASCUR&scale=Left&range=Max&cosd=1947-01-01&coed=2012-07-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=1&ost=-99999&oet=99999&mma=0&fml=b%2Fa&fq=Quarterly&fam=avg&fgst=lin&transformation=lin_lin&vintage_date=2013-01-02_2013-01-02&revision_date=2013-01-02_2013-01-02

  13. Gravatar of Brock Brock
    2. January 2013 at 11:01

    Scott,

    Do you think part of the reluctance by the Fed to embrace NGDPLT is driven by the knowledge of what those higher interest rates would do to the Federal government’s ability to make interest payments on the debt? Given we’re at 100% of GDP now, and that a lot of debt would have to be rolled over in less than a year, a 5% interest rate would be calamatous as a percentage of Federal revenues.

    Not to say we don’t deserve it, but the Fed could catch a lot of flak for that.

  14. Gravatar of Bill Woolsey Bill Woolsey
    2. January 2013 at 11:07

    I got to the second line as well, and thought, “did you write this?”

    The comments are pretty brutal.

  15. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 11:50

    @ W. Peden

    Mr. Peden,

    I do not see why an article whose basis is a set of unproved thesises, can’t be replied also in an argumentative way.

    I reference some FRED data proving that wages do not follow GDP growth. As for the rest of the argumentation, it is based on well known Austrian Business Cycle ideas that are part of mainstream monetary discussions.

    It does not harm either to keep in mind historical precedents of tinkering with the currency: from the Roman Empire, to John Law, to the Weimar Republic, to Zimbabwe, there are plenty of examples of what kind of result such policies achieve.

    I do not see why you describe my points as “bland” and Mr. Summers’, in my view, radical and unproved assertions just “argumentative”.

    In the end, I am not looking for readers per se, just venting my frustration at what I see as a destruction of our Western Civilization by crazy monetary and fiscal policy. I am worried about the future that is being created by such policies, and it will be our children who will pay most of their costs.

  16. Gravatar of Don Geddis Don Geddis
    2. January 2013 at 13:03

    TheYogiRock: try it this way. Your Austrian (mis)ideas are equally critical of any inflation. The last few decades of US central bank efforts have been to target inflation at around 2% annually. Sumner proposes a new target, which results in the SAME 2% annual inflation over the long run (but differs, depending on the economy, in the short run).

    We know you hate all inflation. But that’s not relevant in this discussion. This discussion is only about the difference between a 2% inflation target, and an NGDPLT target which also averages 2% long-run inflation.

    Do you have anything to say which is on topic, which distinguishes between the current US Fed target, and Sumner’s proposed target?

    Making criticisms which apply equally to both, doesn’t help to compare the two approaches.

  17. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 13:19

    @ Don Geddis

    1) targeting nominal GDP assumes there is natural nominal GDP rate. there isn’t.

    2) targeting nominal GDP and keeping it “stable” assumes that an already extremely lax central bank will restrict monetary policy when NGDP is “too high”…will the FED “do the right thing” when things “are good”? Sorry, but this is just a disguised policy to allow even higher inflation that with the current inflation targeting.

  18. Gravatar of Don Geddis Don Geddis
    2. January 2013 at 13:43

    @TheYogiRock: (1) of course there is no more “natural” NGDP rate than there is a natural inflation rate; both are arbitrary choices, and for small numbers, it doesn’t matter which choice you make.

    (2) Sumner has proposed a specific rule that the central bank follow, and your criticism is that .. it is not possible for a central bank to follow the rule? Don’t you think we should first discuss whether the rule would actually be a good idea if it were, hypothetically, followed, and only then talk about the practical realities of politics about whether we could trust a central bank to follow it?

    Assuming some magical hypothetical world where a central bank actually does follow NGDPLT @~5% annually, what is your criticism of the macro policy then?

  19. Gravatar of James in london James in london
    2. January 2013 at 13:44

    almost as good as you in the FT today, but much more Xmas’y

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/12/the-macroeco.html#

  20. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 14:00

    @ Don Geddis

    1) it is arguably much easier not to follow the NGDPT rule because it is based on something apparently good, growth. The choice of target is not innocent. What sounds worse Sir…”inflation is too high” or “growth is too high”? if you think this is a trivial distinction, it is your choice to do so, I don’t. Yes, it is about whether to give the FED a better “rationale” to cheat or not. NGDPT is a better “rationale” for that purpose.

    2) Assuming that magic world, and it is you that resort to such outlandish hypotheses, then NGDPT would be as good or bad as inflation targeting. According to my views it would be bad, since inflation targeting does not respect the principle of keeping the purchasing value of the currency.

    In the end it boils down to this: Inflation targeting already overshoots money creation by using distorted inflation measures (see http://www.shadowstats.com). NGDPT makes it even easier for a totally irresponsible central bank, the FED, to pursue even more damaging monetary policies, under the cover of “growth targeting”. You may love “a little inflation” that “stimulates the economy”. To me it only destroys the economic fabric and impoverishes most of the population.

  21. Gravatar of Geoff Geoff
    2. January 2013 at 14:07

    Don Geddis:

    “Sumner has proposed a specific rule that the central bank follow, and your criticism is that .. it is not possible for a central bank to follow the rule? Don’t you think we should first discuss whether the rule would actually be a good idea if it were, hypothetically, followed, and only then talk about the practical realities of politics about whether we could trust a central bank to follow it?”

    Since your position re: NGDP targeting is theoretical, then shouldn’t you be talking about that which is superior to NGDP targeting? How about something a little more market oriented, that sees the market produce money the way Ford produces cars?

    Or is that when “ideal theory” takes a backseat to “can it work”? When your own theory is critiqued?

    If you won’t even address whether NGDP targeting is politically feasible, then to be fair you can’t criticize free market radicals for proposing what you consider to be a politically unfeasible theory.

  22. Gravatar of Geoff Geoff
    2. January 2013 at 14:11

    W. Peden:

    Yes, it’s closer to the truth to say that net employee compensation tends to follow GDP, though GDP is by no means the sole determinant of net employee compensation-

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=COE_GDP&scale=Left&range=Max&cosd=1947-01-01&coed=2012-07-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=1&ost=-99999&oet=99999&mma=0&fml=a%2Fb&fq=Quarterly&fam=avg&fgst=lin&transformation=lin_lin&vintage_date=2013-01-02_2013-01-02&revision_date=2013-01-02_2013-01-02

    The reason for the divergent graphs is that wages have gradually fallen as a proportion of total compensation during the postwar periods, perhaps due to tax incentives & demographic changes have encouraged more health insurance compensation rather than wages.

    That’s a very funny way of saying “When the theory that wages tend to follow NGDP is empirically falsified, we still have to accept it is right anyway, and excuse the falsification by quibbling over why we didn’t see it occur, such as tax incentives, demographic changes, and X, Y, Z…”

    If your ideological enemies did what you are doing, you’d call them out, and yet you’re doing it yourself.

  23. Gravatar of W. Peden W. Peden
    2. January 2013 at 14:11

    TheYogiRock,

    You CAN reply in that way, but it isn’t very interesting to do so.

    It’s great to bring Austrian School ideas into a debate, but one has to first ask if they’re commonly held with one’s opponent. If not, they have to be argued for, which takes time and patience.

    Not all examples of tinkering have ended in hyperinflations. It’s true that just about every fiat currency has had a major inflation at one period, but this has usually been due to bad ideas, e.g. Historical School thinking in Germany in the early 1920s or Keynesianism in the 1970s. NGDP targeting puts a lid on possible inflation: the rate of inflation can only be as high as a contraction in real output.

    Actually, I said that your assertions were “bald”, i.e. they weren’t backed up with arguments. They’re interesting enough in themselves, I suppose. As far as ‘argumentative’ – by this I mean rhetorical, i.e. Scott Sumner is the person with whom you are disagreeing.

    I sympathise with your feelings and while I disagree with you on many of the details, I think you are fundamentally correct that we live in a time of gross collective irresponsibility. I am frustrated by how my own generation (the generation just coming into adulthood) tends not to take the time to grasp the magnitude and seriousness of the problems of our age.

    One way that you can adapt your criticisms and historical allusions into an argument is this: if NGDP targeting leads us to forget the long-run neutrality of money (by which I mean, in this context, that any given trend rate of increase in the money supply cannot boost real growth) then we might sleepwalk back into the precisely the kind of thinking that produces major inflationary policies. I worry that many Keynesians might see NGDP targeting as similar to a higher inflation target, i.e. a temporary expedient that might be replaced in the future by a higher inflation/NGDP target, then a higher one, then a higher one…

    NGDP targeting has merits as a policy, but it must be endorsed as a policy for all seasons, rather than a means to “boost growth”. In particular, I think that inflation targeting has become so “flexible” that it might cease to place a significant lid on variability and levels of inflation, just like money supply targeting in the UK in the late 1980s. Central banks are masters at forgetting the lessons of a fortnight ago in their obsession with the lessons of last week, so I think that in the next 30 years or so, the battle may be to constrain NGDP growth rather than promote it. I would like to see more emphasis on NGDP growth as a disinflationary/deflationary policy, especially for when there is a productivity boom like the 1920s or late 1990s & something like inflation targeting could be very destabilising.

  24. Gravatar of Geoff Geoff
    2. January 2013 at 14:12

    W. Peden:

    My chart of wages and salary accruals relative to GDP, and your chart of total compensation relative to GDP, follow the same declining trend. I have no idea why you are saying the two graphs are “divergent.” I see almost a mirror image.

  25. Gravatar of W. Peden W. Peden
    2. January 2013 at 14:17

    Geoff,

    I like to think that I’d ask them for a reason for the shifting of the goalposts. In this context, it’s because we want wages to track something (i.e. what workers get out of working) but there are factors distorting that tracking. It happens all the time in economics e.g. money supply figures get distorted by financial innovation, household income figures get distorted by divorce rates, employment rates get
    distorted by wars and so on.

    I don’t excuse the falsification at all, but rather claim that the original statement was not the relevant one. It is possible to have very inflationary situations in which wages are stagnant, but total compensation for some reason is accelerating dramatically.

    So I’ll let you answer the question: what is it that you want the wage data to track and why?

  26. Gravatar of CA CA
    2. January 2013 at 14:17

    Yogi, simple question: are nominal wages sticky on the downside?

  27. Gravatar of W. Peden W. Peden
    2. January 2013 at 14:19

    Also, I don’t think that the first graph I posted shows a notable long-term trend one way or the other.

  28. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 14:23

    @ W. Penden

    If you read my latest reply to Don Geddis. you’ll see that the main drawback of NGDPT as opposed to inflation targeting (I dislike both) is that NGDPT makes it easier for central banks to be even more irresposible under the cover of “growth targeting”, something that you also seem to imply in your reply to my post directed to you.

    So, if inflation targeting vs. Austrian thinking is not to be discussed, I’d simply say that NGDPT is worse than inflation targeting because of psychological and marketing (propaganda) reasons. It is more “saleable” to an unsuspecting public, since it is easier to justify not to restrict monetary policy when “things are good”. I do not believe this is a triviality.

  29. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 14:27

    @ CA

    not in my country. Wages have been going down since 2008. But to be fair to the intent of your question, they are somewhat sticky on the downside, in the short run only, yes, but that does notjustify inflation as a compensation mechanism.

  30. Gravatar of Geoff Geoff
    2. January 2013 at 14:43

    W. Peden:

    “One way that you can adapt your criticisms and historical allusions into an argument is this: if NGDP targeting leads us to forget the long-run neutrality of money (by which I mean, in this context, that any given trend rate of increase in the money supply cannot boost real growth) then we might sleepwalk back into the precisely the kind of thinking that produces major inflationary policies.”

    That’s not a very strong argument. A stronger one is this: If we can all agree that money is short term non-neutral, then I submit that when we realize that the market is path dependent, then money is long term non-neutral as well, since we get from A to long term B through a series of non-neutral money short-term path dependent segments.

    Prolonged periods of NGDPLT targeting cannot claimed as only bringing about malinvestment and a boom in the short run, after which everything somehow smooths out in the long run and stability is achieved without recession. Not when each subsequent moment in time is dependent on past recurring money injections that are non-neutral.

    It would be like saying “Alcohol is long-term neutral, because the effects wear off after enough time lapses….so let’s keep drinking!” Well, yeah, you can do that, but your long-term is going to be path dependent on short-term drinking binges, which means alcohol isn’t long run neutral.

    Actually, to be more accurate, even a single dose of alcohol will forever alter the course of history. My weekend drinking binge I had years ago, while the physiological effects have long since worn off, nevertheless affected my life irrevocably. If I didn’t get drunk that one night, then I may have otherwise met a different woman, moved to a different town, and so on. Butterfly effect.

  31. Gravatar of W. Peden W. Peden
    2. January 2013 at 14:52

    TheYogiRock,

    One could do what Hayek did and call NGDP targeting “control of the monetary flows”. Note both our arguments are strictly speakig non-sequiturs, unless a slippery slope is proven, since it involves arguing against NGDP targeting based on what it’s not rather than what it is. One might as well condemn Austrian School economics because it SOUNDS like liquidationism, and indeed some Austrian School economists (e.g. Rothbard) were arguably liquidationists.

    Geoff,

    I agree on path dependency, but I disagree that any particular steady NGDP growth rate (or freeze or contraction rate) is more associated with malinvestment than any other.

  32. Gravatar of Geoff Geoff
    2. January 2013 at 15:22

    W. Peden:

    I agree on path dependency, but I disagree that any particular steady NGDP growth rate (or freeze or contraction rate) is more associated with malinvestment than any other.

    Are you saying that there is no reason to believe a 5% NGDPLT targeting will be more associated with malinvestment than, say, a 3% or 10% or 0% NGDPLT? If so, that isn’t what I am talking about.

    I am only saying that any steady NGDP growth rate, be it 0% or 5% or 10%, does not have long run money neutrality, because of the path dependency concept.

    I am saying that I think it is wrong to believe that adopting a steady 5% NGDPLT will only generate malinvestments, if it does generate them that is, in the short term, after which they will be liquidated, then readjustment, then we’ll eventually be on a “stable” growth path because “then” we’ll be in the long run. I think this is a mistake, because of the path dependency.

    While it is fashionable to analyze monetary policy using a predominantly forward looking approach, most regular people in the economy are backwards looking, and their actions are affectual in the market too.

    The most sophisticated of bond traders and monetary policy specialists cannot control everyone’s actions, and yet many people whose spending significantly affects investor’s behavior, are predominantly backward looking and cannot calculate that their wages will go up X% when the CB inflates at Y%. As such, this notion of viewing the market as people forgetting the past, and adapting to a permanent 5% NGDP growth path in such a forward looking way that temporal errors don’t accumulate, but peter out, I think is wrong.

    What if a constant NGDP targeting seemed to bring stability, but had catastrophic long run consequences as the economy cannot take any more accumulated errors generated by the NGDP constant targeting?

    I mean, suppose a single firm or city or individual state saw a guaranteed 5% increase in revenues each and every year, no matter what investments anyone made, and no matter what decisions are made. I can imagine how coordination based errors would go unnoticed for very long periods of time. After all, a guaranteed 5% increase in revenues means you can buy ANY ASSET WHATEVER, at the firm level if NGDP targeting of the firm, or a share of assets that spans the city, or individual state, for NGDP targeting at city or state levels, and you will be guaranteed to make a return, which will mean you have no reason to buy asset X over asset Y. Can you not see how that may generate problems?

    The monetary system would not prevent errors from being given “tough love” by outright losses, since there is always a rise in revenues. That’s my main beef with purposeful aggregate spending targeting. The implicit “guaranteed win” sends off alarm bells in my mind.

  33. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 15:27

    @ W. Peden

    yes, they are strictly speaking non-sequiturs, but I’d argue that if one takes into account the historical record of the FED, “my” non-sequitur looks less so: there is an inflationary bias in the FED’s record. And please, when you think of inflation think of real inflation, not the distorted (thru geometric mean calculations, hedonic factors and substitution effects) measures published and used to deflect NGDP. As said, visit ShadowStats.

    A slippery slope is not proven, but it is strongly hinted by the FED’s historical record. Can I prove the FED will use NGDPT to push higher inflation? No, I can’t, but I can argue, based on its record and on the nature of NGDPT that it might well do it. Can I prove that I will not live 150 years? No, I can’t, but I can supply a very strong argumentation as to that I won’t. Proof is not the only way to some “truthness”.

    Liquidationism, good or bad, does not have a chance to be implemented. If it was, we could discuss its drawbacks or goodness, but it is not the case.

    In practical terms, chances of implementation, the slippery slopes of inflationism and liquidationism are not of the same quality. One, liquidationism, is very unlikely, the other, inflationism, is strongly hinted by the FED’s history. Not all non-sequiturs are of the same color or size.

  34. Gravatar of ssumner ssumner
    2. January 2013 at 15:28

    Rebeleconomist, Aren’t you still confusing real and nominal GDP? Structural problems don’t impact NGDP.

    Jon, Good points, I was restricted due to a lack of space.

    Tyler, I plan a NGDP futures paper in the spring, but it won’t help the financial industry, as it will be run by the Fed.

    YogiRock, I see it’s bringing the zany commneters. Hyperinflation? That means RGDP would have to fall at more than 30% a month, producing mass starvation within two years. Yikes! Switzerland would be poorer than Zimbabwe after 2 years of 5% NGDP growth. I change my mind.

    Geoff, I assume people would understand that “follows” meant correlated with, not identical too. There is population growth, and also a small trend decline in the share of GDP going to labor. Obviously NGDP growth rates are somewhat higher. But when the CPI spikes and NGDP doesn’t, wages follow NGDP. That was the point.

    Brock, No, slow NGDP growth has caused the government’s finances to sharply deteriorate. Faster NGDP growth would actually help overall, despite modestly higher interest rates (not 5% BTW). Revenues would rise much faster than expenses.

    James, I plan a reply when I have time.

  35. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 15:37

    @ ssummer

    no need to joke with the extremely visual examples…it is bad enough now with foodstamp usage at historical highs.

    My point was not that hyperinflation is a certainly, it is not even under NGDPT, but that NGDPT makes higher and uncontrolled inflation likelier, because it offers the FED a better cover to cheat.

  36. Gravatar of Geoff Geoff
    2. January 2013 at 17:52

    Dr. Sumner:

    “I assume people would understand that “follows” meant correlated with, not identical too. There is population growth, and also a small trend decline in the share of GDP going to labor. Obviously NGDP growth rates are somewhat higher. But when the CPI spikes and NGDP doesn’t, wages follow NGDP. That was the point.”

    I think I am with you when you say “follow” as in “correlated with.” It’s just that I don’t see any positive correlation in the data (for the US at least, not sure about other countries) that confirms the theory “wages tend to follow growth in national income”. I see a distinct negative empirical correlation, and quite a substantial one.

    You say it’s a “small trend decline” in wages. Yet correct me if I am wrong, but when you take the maximum of 53% in 1970, and the current 44% percent now, that’s not exactly small potatoes is it? It’s 9%. Isn’t 9% of US NGDP a significant number?

    Finally, you say that for scenarios of CPI spiking and NGDP not spiking (when does that happen?), wages tend to follow NGDP. OK, but you’re talking about a hypothetical, not US history. And correct me if I am wrong, but if you take the long term NGDP trend and compare it to wage share of national income since the 1940s, we see that the wildly fluctuating NGDP during the 1940s and 1950s saw above 50% wage share of national income, while the more stable NGDP post 1970 saw a continuously declining wage share of national income.

    I guess I just don’t understand the theory being presented. Is it a hypothetical?

  37. Gravatar of Tommy Dorsett Tommy Dorsett
    2. January 2013 at 18:09

    Scott – Congrats. Short and sweet. Unfortnately, the comment section of the FT is filled with an astonishing level of ignorance, arrogance and insolence. If this is the hideous state of mind of the body economic, we still have a lot of work to do.

  38. Gravatar of ChargerCarl ChargerCarl
    2. January 2013 at 18:46

    I feel like everyone in the blogosphere subscribes to FT but me.

    Is it worth it?

  39. Gravatar of The Lucas Critique Revisited « Uneasy Money The Lucas Critique Revisited « Uneasy Money
    2. January 2013 at 19:03

    [...] Congratulations to Scott Sumner on his excellent op-ed on nominal GDP level targeting in today’s Financial Times. Share [...]

  40. Gravatar of The Lucas Critique Revisited « Uneasy Money The Lucas Critique Revisited « Uneasy Money
    2. January 2013 at 19:03

    [...] Congratulations to Scott Sumner on his excellent op-ed on nominal GDP level targeting in today’s Financial Times. Share [...]

  41. Gravatar of Tyler Joyner Tyler Joyner
    2. January 2013 at 19:39

    Scott – If it’s a futures market, that means traders and investors behind them. We make money from that, from the commissions, the spread, and from the float. Cyclical businesses which are especially vulnerable to economic downturns will have an interest in hedging via your proposed futures market.

    Also, the inherent leverage involved in futures means that your market will be a powerful way to invest. If the NGDP futures market is adopted in multiple countries with different currencies… that would really be a revolution in the futures industry. People will make fortunes.

  42. Gravatar of Ben J Ben J
    2. January 2013 at 20:15

    If no one is going to do it, I will. YogiRock, you lose all credibility as a commenter when you start quoting shadowstats as a source for inflation figures. You demonstrate yourself to be rather embarrassingly credulous.

  43. Gravatar of TheYogiRock TheYogiRock
    2. January 2013 at 22:40

    @ Ben J

    would you back your assertions with at least some rationale? Shadowstats publishes the method by which they compute CPI. I’d be interested in knowing what is wrong with it besides the fact that you seem to dislike it

  44. Gravatar of Ben J Ben J
    2. January 2013 at 23:27

    Well YogiRock, let’s think for a while. Imagine Shadowstats is right to take the BLS numbers, and add a constant. And don’t think that they actually ‘recalculate’ inflation, they really do just add a constant.

    Here is what John Williams from Shadowstats told James Hamilton:

    “I’m not going back and recalculating the CPI. All I’m doing is going back to the government’s estimates of what the effect would be and using that as an ad factor to the reported statistics.”

    http://www.econbrowser.com/archives/2008/10/shadowstats_res.html

    But even if we did believe Shadowstats, the implications are absurd. What has inflation been? Close to 10% annually, for years now (and sometimes higher!), according to their annual consumer inflation chart.

    That means investors in the tiny, tiny, inconsequential US Treasury market for short term bonds:

    http://www.bloomberg.com/quote/USGG2YR:IND/chart/

    …must have been losing between 7% and 9% on their bonds annually every year! That’s strange. But I’m sure shadowstats knows better than the US Treasury market.

    But let’s take a longer look at their ‘proprietary inflation data’, going back to what they claim is the misleading index change in 1980 (Excel file warning):

    http://www.jparsons.net/antishadowstats/Anti-Shadow%20Stats.xls

    Now we all know that if inflation is higher than the increase in house prices, then real house prices fall. Somebody kindly plotted US house prices discounted at ShadowStats inflation levels:

    http://blog.jparsons.net/2011/03/shadow-stats-debunked-part-i.html

    Oh, so according to Shadowstats, US home prices declined 60% from 1980 to 2010, and declined *rapidly* from 2005 to 2008. This means the only way you can say Shadowstats is accurate is if you believe there was no bubble in house prices, and in fact that real house prices have been falling for decades. Right…

    But here’s the best part – and forget that every single other measure of inflation matches the BLS figures (MIT Billion prices project, for example), forget that anyone who has taken a macro class (or even read Mankiw) knows that CPI overstates inflation, forget that Scott has written time and time again about how BLS rent-equivalents overstate housing costs dramatically;

    Price of a Shadowstats subscription today? $175.

    Price of a Shadowstats subscription 6 years ago?

    http://gyroscopicinvesting.com/forum/index.php?topic=1425.0

    …. $175.

    So either Shadowstats has been kind enough to reduce the real value of their revenue 10% annually for 6 years, or they don’t drink their own Kool-Aid. Which one do you think?

  45. Gravatar of Ben J Ben J
    2. January 2013 at 23:30

    And Scott – in that last post (waiting for you to moderate) where I said “no bubble in house prices”, I meant “no large increase in house prices”. Sorry, but it’s so easy to slip into the mainstream usage of ‘bubble’, and I know how much you disapprove…

  46. Gravatar of asdasdasd asdasdasd
    3. January 2013 at 00:14

    Scott, there’s a massive list of UK macro-economists expressing their views on the inflation target in the FT, might be of interest:

    http://www.ft.com/cms/s/0/671b15fc-5460-11e2-9d25-00144feab49a.html#axzz2GtgFRSwJ

  47. Gravatar of W. Peden W. Peden
    3. January 2013 at 00:29

    Geoff,

    “Can you not see how that may generate problems?”

    Yes, but it’s not analogous with NGDP targeting, since there is no single agent with a guaranteed level of revenue in NGDP targeting, and the economy as a whole does not behave like a single firm. An NGDP targeting regime is no different from a gold standard, insofar as it’s logically compatible with any individual making either unlimited losses or unlimited profits.

    So, while NATIONAL income grows at a trend of 5% in a 5% NGDP targeting regime, any individual’s income can vary dramatically from that, so the market incentives & disincentives of a profit & loss system are retained.

  48. Gravatar of Saturos Saturos
    3. January 2013 at 00:51

    Where is MF these days anyway? On vacation? But that didn’t stop me from commenting. But then I’m probably hopelessly addicted by now.

    Maybe YogiRock knows where he is? Mars, perhaps? http://theyogirock.com/

  49. Gravatar of asdasdasd asdasdasd
    3. January 2013 at 00:56

    Apologies, you’re probably going to find that really depressing.

    How many of them do you think a) understand NGDP level targeting? and b) have read any of the literature on NGDP targeting, optimal inflation targeting, or the liquidity trap and Japan 1992-present?

    E.g. Mike Wickens (Professor of economics at University of York) asks “If inflation is more than 20% as in the 1974 due largely to import price inflation and there is recession, should the aim be to cut growth further to achieve a nominal income target?”

    Answer yes.

    I don’t see how anyone could even ask that question if they understood what was being proposed.

  50. Gravatar of Ben J Ben J
    3. January 2013 at 01:23

    “E.g. Mike Wickens (Professor of economics at University of York) asks “If inflation is more than 20% as in the 1974 due largely to import price inflation and there is recession, should the aim be to cut growth further to achieve a nominal income target?”

    …does this guy think that Paul Volcker did anything different under an inflation targeting regime?

  51. Gravatar of Geoff Geoff
    3. January 2013 at 01:34

    W. Peden:

    “Yes, but it’s not analogous with NGDP targeting, since there is no single agent with a guaranteed level of revenue in NGDP targeting, and the economy as a whole does not behave like a single firm. An NGDP targeting regime is no different from a gold standard, insofar as it’s logically compatible with any individual making either unlimited losses or unlimited profits.”

    “So, while NATIONAL income grows at a trend of 5% in a 5% NGDP targeting regime, any individual’s income can vary dramatically from that, so the market incentives & disincentives of a profit & loss system are retained.”

    OK, if the individual is not guaranteed a revenues with national NGDP targeting, and this is supposedly sufficient for there to be a profit and loss system, then if NGDP targeting is carried out at the individual state level, then individual people will also not be guaranteed a revenue, and so there will be “some” profit and loss present at the state level as well. Same thing with cities, neighborhood, any level that isn’t the single individual, agreed?

    Given that with NGDP targeting at various geographical levels (why geography?) there will be a profit and loss system at the country level, individual state level, city level, neighborhood level, I am thinking that there is a progressive degradation in the “quality” of profit and loss, the smaller the NGDP targeting territory becomes. At the individual level, there is zero profit and loss, just profit. At the two person level, there is an introduction of profit and loss, but probably mostly profit for both people. At the neighborhood level, the profit and loss degradation is reduced further. At the city level, degraded still further. And so on, until we reach the country level.

    Would you agree then that country level NGDP targeting would have a greater degradation in the profit and loss system, as compared to a world NGDP targeting program? If you can agree with this, then is it not correct to say that a world of countries adopting NGDP targeting would contain a positive level of profit and loss degradation, as compared to a world NGDP targeting program? And, that such a country specific NGDP targeting regime would not be able to prevent country to country coordination problems (of the sort that would prevail with individual city NGDP targeting) that cannot be corrected with losses, because there is zero change in the relative country to country NGDP fluctuations and guaranteed country level gains?

    If every country adopted NGDP targeting, then there would invariably be zero country level losses that are experienced due to country to country discoordination. No matter how discoordinated one country is relative to another, no matter how much one country over or under expands relative to another, there will be no losses that stem from THIS particular discoordination. As a result, such discoordination, if it arises, has no way of self-correcting. It would be like two cities each having a guaranteed city income, no matter how distorted the city to city coordination becomes.

    Thus, we can say that national level NGDP targeting is disruptive to nations that engage in world trade.

    ———————–

    What if one invests in a broad index fund that tracks national NGDP growth for its return? Can there be guaranteed returns for this? Would the return be higher or lower than sovereign debt? My guess is lower, because NGDP targeting is not debt targeting.

  52. Gravatar of W. Peden W. Peden
    3. January 2013 at 02:19

    Geoff,

    (1) “At the individual level, there is zero profit and loss, just profit.”

    No, nominal revenue does not equal real profit at all. The nominal/real and the revenue/cost confusions seem to drive most of the rest of your chain of thought.

    (2) “It would be like two cities each having a guaranteed city income, no matter how distorted the city to city coordination becomes.”

    This analogy does not work either, because different countries either (a) use different currencies that float, in which case competitiveness differences manifest themselves in exchange rate fluctuations, or (b) peg or use the same currency, in which case there are internal economic adjustments just as within a given country.

    (3) “What if one invests in a broad index fund that tracks national NGDP growth for its return? Can there be guaranteed returns for this?”

    Real returns? If it’s an ultra-safe bet, it will be arbitraged down to very low returns, like short-term government bonds. If there is a risk premium, then it follows that returns will not be guaranteed.

    Scott Sumner actually argues that such a market (except as a futures market) could be created as a means of carrying out NGDP targeting. He’s written a few papers/articles/posts on it. I’m fairly sceptical about it, because I’m suspicious of any market that needs a government subsidy to exist.

    (4) “Would the return be higher or lower than sovereign debt? My guess is lower, because NGDP targeting is not debt targeting.”

    If it’s annual NGDP growth, then it would be somewhat more uncertain than (say) 3 month government bonds, I suppose. More importantly, since an NGDP tracker fund would have no limit under par, you could theoretically have an unlimited fall in the nominal value of the asset (e.g. if fell by 30%, you’d suffer a 30% loss, just like a company stock) whereas interest rates on government bonds can’t fall below zero. (Of course, one definitely gets real and/or post-tax losses on government bonds, but this would apply to an NGDP fund as well.)

    I don’t think that an NGDP tracker fund would be technically possible, given how much of the economy doesn’t issue bonds or equity, but I might be wrong. I don’t actually know how stock market tracker funds work either.

  53. Gravatar of Geoff Geoff
    3. January 2013 at 02:55

    W. Peden:

    “No, nominal revenue does not equal real profit at all. The nominal/real and the revenue/cost confusions seem to drive most of the rest of your chain of thought.”

    I didn’t say nominal profit equals real profit. I was talking about nominal profit, not “real” profit. NGDP targeting for the individual will lead to guaranteed profit. I suppose I should be cordial like yourself and say that your initial confusion of what I said (really, how in the world did you infer from my statements that I equated nominal and real profit?), probably “drives most of the rest of your chain of thought.”

    (2) “It would be like two cities each having a guaranteed city income, no matter how distorted the city to city coordination becomes.”

    “This analogy does not work either, because different countries either (a) use different currencies that float, in which case competitiveness differences manifest themselves in exchange rate fluctuations, or (b) peg or use the same currency, in which case there are internal economic adjustments just as within a given country.”

    This isn’t an argument against what I said because you’re not refuting the fact that country level NGDP targeting would have a guaranteed country level revenue the same way that city level NGDP targeting would have a guaranteed city level revenue. City level NGDP targeting does not rule out city specific currencies that float in currency markets. So it is not right to say that country level NGDP targeting is different from city level NGDP targeting because there are country specific currencies that float.

    (3) “What if one invests in a broad index fund that tracks national NGDP growth for its return? Can there be guaranteed returns for this?”

    Real returns? If it’s an ultra-safe bet, it will be arbitraged down to very low returns, like short-term government bonds. If there is a risk premium, then it follows that returns will not be guaranteed.

    I would think that no guaranteed returns can only arise with no guaranteed NGDP growth.

    Scott Sumner actually argues that such a market (except as a futures market) could be created as a means of carrying out NGDP targeting. He’s written a few papers/articles/posts on it. I’m fairly sceptical about it, because I’m suspicious of any market that needs a government subsidy to exist.

    Thanks. I’ll look into them.

    Out of curiosity, since you said you are suspicious of markets that need subsidizing, can I ask you why you are suspicious?

    (4) “Would the return be higher or lower than sovereign debt? My guess is lower, because NGDP targeting is not debt targeting.”

    “If it’s annual NGDP growth, then it would be somewhat more uncertain than (say) 3 month government bonds, I suppose.

    Why do you think that? Are you saying that NGDPLT is less volatile than 3 month treasury returns?

    More importantly, since an NGDP tracker fund would have no limit under par, you could theoretically have an unlimited fall in the nominal value of the asset (e.g. if fell by 30%, you’d suffer a 30% loss, just like a company stock) whereas interest rates on government bonds can’t fall below zero. (Of course, one definitely gets real and/or post-tax losses on government bonds, but this would apply to an NGDP fund as well.)

    Are you sure you’re comparing apples and apples here? Bonds can incur 30% losses as their prices tend toward zero, just like an NGDP tracker could. I don’t think it’s right to compare nominal prices of NGDP tracker assets, with interest rates on bonds. I think it’s better to compare principle with principle, and yield with yield.

    I don’t think that an NGDP tracker fund would be technically possible, given how much of the economy doesn’t issue bonds or equity, but I might be wrong. I don’t actually know how stock market tracker funds work either.

    I am no expert either, but this may help:

    http://www.digitallook.com/funds/howtrackerfundswork

  54. Gravatar of W. Peden W. Peden
    3. January 2013 at 08:08

    Geoff,

    “NGDP targeting for the individual will lead to guaranteed profit.”

    No: that my revenue goes up by x% every year does not imply that my profits go up by x% every year.

    “really, how in the world did you infer from my statements that I equated nominal and real profit?”

    I think you might be equating profits with revenues and nominal changes with real changes. NGDP has no necessary connection to the rate of profit in an economy.

    As for the nominal and real distinction: let’s first take the “individual NGDP target” case. I suppose means someone receives 5% for whatever they produce, and they consume what they produce. (I don’t think it makes a difference to take this person- Robinson Crusoe, let’s call him- as a “closed economy”.)

    First, it’s rather strange to talk in terms of profit here, since profit = revenue – costs and this RC has no monetary revenue in the conventional sense i.e. money received for sales that they can then use to buy things they want. However, we can talk in terms of RC being richer or poorer at the end of the year, either in the sense of accumulating things or having been able to consume more.

    Second, that RC receives a 5% increase in money every year doesn’t mean that he is 5% richer. RC would only be richer, in real terms, if he had produced more real things.

    In the two person example, where (let’s say) Robinson Crusoe trades with Friday, we can talk about profits, but there is no guarantee that there is a net real profit. Their nominal expenditures on final goods (NGDP) must go up, but goodness knows that one’s nominal expenditures have no necessary connection to profit!

    Furthemore, NGDP targeting doesn’t change the probability that either Crusoe or Friday or both make a real profit, as opposed to any other monetary system that provides equivalent stability. (A monetary system where the amount of money went up by a random percentage that changed every year would change the probability of profits, since it would greatly disrupt things like contracts.)

    “This isn’t an argument against what I said because you’re not refuting the fact that country level NGDP targeting would have a guaranteed country level revenue the same way that city level NGDP targeting would have a guaranteed city level revenue.”

    A fair point, but NGDP targeting doesn’t guarantee an increase in REAL revenue one way or another. To get richer, both the city and the country have to produce more.

    “I would think that no guaranteed returns can only arise with no guaranteed NGDP growth.”

    In practice, I don’t think that any central bank could guarantee x% change in NGDP growth within each given time period for all time. If a central bank could guarantee an exact rate of NGDP growth, by definition there would no risk premium involved, so I think that investors would arbitrage any profits out very quickly. There are no profits in betting that the sun will rise in the morning.

    “Out of curiosity, since you said you are suspicious of markets that need subsidizing, can I ask you why you are suspicious?”

    It demonstrates that people aren’t willing to voluntarily pay for what the market supplies, and the existence of the market is dependent on taxpayers being forced to fork out the money. The taxypayers’ money could be better spent elsewhere. Government subsidy for some special purposes but I’m not yet convinced that it’s necessary or optimal for macroeconomic stability that a government subsidy for a futures market.

    “Why do you think that? Are you saying that NGDPLT is less volatile than 3 month treasury returns?”

    No: I think NGDP growth is significantly more unpredictable in the short-run because of the difficulties in collecting data, whereas one can follow minute-by-minute changes in the yield on government bonds. Also, a central bank doing annual NGDP targeting would permit short-run fluctuations in NGDP growth, which would introduce volatility in the market.

    “Are you sure you’re comparing apples and apples here? Bonds can incur 30% losses as their prices tend toward zero, just like an NGDP tracker could. I don’t think it’s right to compare nominal prices of NGDP tracker assets, with interest rates on bonds. I think it’s better to compare principle with principle, and yield with yield.”

    Good point.

    “I am no expert either, but this may help:

    http://www.digitallook.com/funds/howtrackerfundswork

    Thanks, that’s a fascinating link. I had no idea there were even different strategies for running tracker funds.

  55. Gravatar of Geoff Geoff
    3. January 2013 at 09:17

    W. Peden:

    “No: that my revenue goes up by x% every year does not imply that my profits go up by x% every year.”

    With individual NGDP targeting, an individual purchases assets for $X today, and they’re guaranteed to be able to fetch $X x 1.05 = $X*1.05 one year from now, given that this year’s revenues are $X (which can earn a profit on assets purchased for $X/1.05 last year). And so on.

    “really, how in the world did you infer from my statements that I equated nominal and real profit?”

    “I think you might be equating profits with revenues and nominal changes with real changes. NGDP has no necessary connection to the rate of profit in an economy.”

    You still think I am doing that, after I said I am not? After I said that I am only looking at nominal profits for now? Don’t you mean “I thought you might be…” as opposed to “I think you might be…”?

    My thinking is that the only way that NGDP targeting will not generate guaranteed profits is if aggregate costs exceeds aggregate revenues. I grant that this is theoretically possible, but when you have constant, permanent, year after year after year pattern of spending increases, I don’t see how aggregate costs could ever catch up to, let alone pass, aggregate revenues. This is because costs are a function of past spending, and past spending is a function of past money supply, which will tend to be lower, wouldn’t it?

    Maybe you can explain how aggregate costs can exceed aggregate revenues in a scenario where spending each year rises.

    “As for the nominal and real distinction: let’s first take the “individual NGDP target” case. I suppose means someone receives 5% for whatever they produce, and they consume what they produce. (I don’t think it makes a difference to take this person- Robinson Crusoe, let’s call him- as a “closed economy”.)”

    “First, it’s rather strange to talk in terms of profit here, since profit = revenue – costs and this RC has no monetary revenue in the conventional sense i.e. money received for sales that they can then use to buy things they want.”

    I wasn’t assuming the individual is in a “closed economy”. I was assuming there is only individual NGDP targeting. So you get 5% increase in sales every year, I get 5% increase in sales every year, everyone, we all get 5% increase in sales every year.

    “However, we can talk in terms of RC being richer or poorer at the end of the year, either in the sense of accumulating things or having been able to consume more.”

    I am actually just referring to the nominal spending growth that allows each individual to earn 5% more each year, no matter what they produced, thus never going bankrupt in the nominal sense.

    “Second, that RC receives a 5% increase in money every year doesn’t mean that he is 5% richer. RC would only be richer, in real terms, if he had produced more real things.”

    Agreed!

    “In the two person example, where (let’s say) Robinson Crusoe trades with Friday, we can talk about profits, but there is no guarantee that there is a net real profit. Their nominal expenditures on final goods (NGDP) must go up, but goodness knows that one’s nominal expenditures have no necessary connection to profit!”

    If they are GUARANTEED to go up 5% every year, then you can purchase any assets you want for $X right now, and you’re guaranteed to earn $X*1.05 next year, assuming that this year’s revenues are $X/1.05 which was earned on assets purchased for $X/(1.05^2) one year ago. And so on.

    “Furthemore, NGDP targeting doesn’t change the probability that either Crusoe or Friday or both make a real profit, as opposed to any other monetary system that provides equivalent stability. (A monetary system where the amount of money went up by a random percentage that changed every year would change the probability of profits, since it would greatly disrupt things like contracts.)”

    I am sure you will agree that if an individual is guaranteed to earn 5% more each year in nominal terms, he has less incentive to change or improve his production methods, since no matter what he does, he will earn a guaranteed 5% growth in revenue in exchange for whatever it is he produced.

    Whether or not he gets a “real return” is related, but different issue, considering how a given individual calculates by using primarily dollars, not so much guesstimates of real aggregate output.

    This isn’t an argument against what I said because you’re not refuting the fact that country level NGDP targeting would have a guaranteed country level revenue the same way that city level NGDP targeting would have a guaranteed city level revenue.

    “A fair point, but NGDP targeting doesn’t guarantee an increase in REAL revenue one way or another. To get richer, both the city and the country have to produce more.”

    Agreed, but I want to emphasize that most people adjust their behaviors according to spending and prices, not inflation adjusted prices, because it’s much more difficult to do the latter than the former. Unions fight for higher wages, not more consumption. Companies focus on profit and revenue forecasts, and focus less on what their revenues can buy in real terms for their own consumption. Yes, money is made to ultimately consume at the end of the day, but in terms of planning and forecasting, it’s mostly about the Benjamins.

    I would think that no guaranteed returns can only arise with no guaranteed NGDP growth.

    “In practice, I don’t think that any central bank could guarantee x% change in NGDP growth within each given time period for all time. If a central bank could guarantee an exact rate of NGDP growth, by definition there would no risk premium involved, so I think that investors would arbitrage any profits out very quickly. There are no profits in betting that the sun will rise in the morning.

    So when we talk about NGDP targeting that uses daily forecast instruments, daily NGDP estimates, and daily OMOs, we’re not talking about NGDP targeting, but a range of possible NGDPs that fluctuate?

    To what degree can NGDP fluctuate in practise while still being called NGDP targeting? I thought NGDP targeting would have 5% NGDP growth every year, no questions. If there is room for fluctuations, then would 2008-2009 be considered a period of successful NGDP targeting? If not, why not? If not, why is that NGDP targeting a failure whereas the period of say 1980-2001 not a failure? How much fluctuations is too much?

    Out of curiosity, since you said you are suspicious of markets that need subsidizing, can I ask you why you are suspicious?

    “It demonstrates that people aren’t willing to voluntarily pay for what the market supplies, and the existence of the market is dependent on taxpayers being forced to fork out the money. The taxypayers’ money could be better spent elsewhere. Government subsidy for some special purposes but I’m not yet convinced that it’s necessary or optimal for macroeconomic stability that a government subsidy for a futures market.”

    If taxpayers are forced to pay taxes by law, then what you say taxpayer’s money “could be better spent on” would also be forced payment, wouldn’t it? Couldn’t someone respond to you the way you are responding to subsidized futures markets by saying “I am suspicious of what you, W. Peden, want the government to spend taxpayer money on, because if your project needs taxpayer money, then that (I quote you) “demonstrates that people aren’t willing to voluntarily pay for what the market supplies, and the existence of your project is dependent on taxpayers being forced to fork out the money.”

    Perhaps I misunderstood you, but it seems as though your suspiciousness towards taxpayer subsidized projects only applies to other people’s taxpayer financed project ideas, and not your own.

    Why do you think that? Are you saying that NGDPLT is less volatile than 3 month treasury returns?

    No: I think NGDP growth is significantly more unpredictable in the short-run because of the difficulties in collecting data, whereas one can follow minute-by-minute changes in the yield on government bonds. Also, a central bank doing annual NGDP targeting would permit short-run fluctuations in NGDP growth, which would introduce volatility in the market.

    Why would a CB permit fluctuations in NGDP targeting? Is that a part of the theory itself, or are you guessing? If NGDP targeting is adopted, and we have economists and BLS data munchers on the case, wouldn’t there be a huge incentive to improving the collection of NGDP data? I don’t think it is fair to use today’s NGDP collection methods when we don’t live in an NGDP targeting world, and holding them constant forever even if there is an NGDP targeting adoption in the future. Perhaps NGDP collection will become a daily ocurrence, as opposed to the what, quarterly it is now?

    As for the treasury returns, what about bootstrapping? Shouldn’t 3 month treasury bills, rolled over for 10 years say, fetch the same return as a 10 year bill (abstracting away from transactions costs, etc), and since 10 year treasuries would reflect 10 year NGDP forecasts, the data of which is very easily collected, wouldn’t it follow that 3 month treasuries would be stable as well, lest arbitrage is possible? Maybe I am talking out of my derriere on this one.

    http://www.digitallook.com/funds/howtrackerfundswork

    Thanks, that’s a fascinating link. I had no idea there were even different strategies for running tracker funds.

    Modern finance is, IMO, more complicated than quantum mechanics. This is because there is never long run stability in the subject matter. The human element adds a complexity that no vibrating atom can match. I think humans are the undiscovered country, more so than space and the oceans.

  56. Gravatar of W. Peden W. Peden
    3. January 2013 at 10:38

    Geoff,

    “With individual NGDP targeting, an individual purchases assets for $X today, and they’re guaranteed to be able to fetch $X x 1.05 = $X*1.05 one year from now, given that this year’s revenues are $X (which can earn a profit on assets purchased for $X/1.05 last year). And so on.”

    What if some assets can’t be sold or can’t be sold except at a discount?

    “After I said that I am only looking at nominal profits for now?”

    Sorry, I overlooked that priviso.

    “This is because costs are a function of past spending, and past spending is a function of past money supply, which will tend to be lower, wouldn’t it?”

    What about costs incurred during the time period of the NGDP target?

    “I am actually just referring to the nominal spending growth that allows each individual to earn 5% more each year, no matter what they produced, thus never going bankrupt in the nominal sense.”

    I don’t follow the ‘thus’ here. An individual is bankrupt if they can’t service their debts, which is quite different from having a guaranteed nominal income. Unemployment benefits provide minimum incomes, but this does not imply that unemployed individuals never go bankrupt.

    “I am sure you will agree that if an individual is guaranteed to earn 5% more each year in nominal terms, he has less incentive to change or improve his production methods, since no matter what he does, he will earn a guaranteed 5% growth in revenue in exchange for whatever it is he produced.”

    No, I can’t agree with this at all. His incentives are to maximise his real earnings, not his nominal earnings.

    Furthermore, the analogy between this and NGDP targeting at the super-Robinson Crusoe level is misleading, since if there is a competitive economy with two or more people, they will act to maximise their own earnings.

    “Whether or not he gets a “real return” is related, but different issue, considering how a given individual calculates by using primarily dollars, not so much guesstimates of real aggregate output.”

    People only calculate nominally when changes in nominal prices are not worth the opportunity cost of taking price inflation into account. It cannot be separated from the issue of incentives.

    “Agreed, but I want to emphasize that most people adjust their behaviors according to spending and prices, not inflation adjusted prices, because it’s much more difficult to do the latter than the former. Unions fight for higher wages, not more consumption. Companies focus on profit and revenue forecasts, and focus less on what their revenues can buy in real terms for their own consumption. Yes, money is made to ultimately consume at the end of the day, but in terms of planning and forecasting, it’s mostly about the Benjamins.”

    It really depends on economic conditions. If price inflation is at a rate at which taking inflation into account makes a significant difference to people’s real earnings, they will take it into account. Investors do this today over long periods of time in which prices are uncertain. Trade unions most certainly spent a lot of effort taking inflation into account during the 1970s. Indexed contracts are used as well, when people consider it worthwhile doing so.

    People pursue real wealth and only neglect nominal changes in prices insofar as they’re not worth taking into account as part of that pursuit. This becomes more apparent in countries where prices are less stable than they have been in most western countries in recent decades.

    “I thought NGDP targeting would have 5% NGDP growth every year, no questions.”

    Intentions and reality are most definitely two different things!

    “If there is room for fluctuations, then would 2008-2009 be considered a period of successful NGDP targeting?”

    It depends on the NGDP target in question. If it’s a year-on-year 5% NGDP target we’re talking about, then it most definitely a failure, and a bad one.

    If there was NGDP targeting of a band of say 3-7%, then it would also have been a failure.

    If there was NGDP level targeting, then it would only be a failure if the central bank did not restore NGDP growth onto the targeted trend.

    What is most important is the trade-off between the predictability of monetary policy, the level of intervention, and minimising the central bank creating macroeconomic problems.

    “If taxpayers are forced to pay taxes by law, then what you say taxpayer’s money “could be better spent on” would also be forced payment, wouldn’t it? Couldn’t someone respond to you the way you are responding to subsidized futures markets by saying “I am suspicious of what you, W. Peden, want the government to spend taxpayer money on, because if your project needs taxpayer money, then that (I quote you) “demonstrates that people aren’t willing to voluntarily pay for what the market supplies, and the existence of your project is dependent on taxpayers being forced to fork out the money.”

    Perhaps I misunderstood you, but it seems as though your suspiciousness towards taxpayer subsidized projects only applies to other people’s taxpayer financed project ideas, and not your own.”

    Not at all: my suspicion applies to my own ideas as much as any other’s. In either case, I’m open to being convinced, IF the use of force can be justified. Suspicion does not entail rejection, but it does mean a placement of the burden of proof.

    “Why would a CB permit fluctuations in NGDP targeting? Is that a part of the theory itself, or are you guessing?”

    Oh, simply historical precedent. Politics is full of transient things, and one shouldn’t presuppose that any particular NGDP target or NGDP targeting in general would last forever.

    “If NGDP targeting is adopted, and we have economists and BLS data munchers on the case, wouldn’t there be a huge incentive to improving the collection of NGDP data? I don’t think it is fair to use today’s NGDP collection methods when we don’t live in an NGDP targeting world, and holding them constant forever even if there is an NGDP targeting adoption in the future. Perhaps NGDP collection will become a daily ocurrence, as opposed to the what, quarterly it is now?”

    Data collection would presumably improve, but I don’t think that the gains in effectiveness from daily NGDP data collection would be worth the costs in a system of annual NGDP targets.

    “As for the treasury returns, what about bootstrapping? Shouldn’t 3 month treasury bills, rolled over for 10 years say, fetch the same return as a 10 year bill (abstracting away from transactions costs, etc), and since 10 year treasuries would reflect 10 year NGDP forecasts, the data of which is very easily collected, wouldn’t it follow that 3 month treasuries would be stable as well, lest arbitrage is possible? Maybe I am talking out of my derriere on this one.”

    They might be more stable than otherwise, but NGDP over 10 years varies from what’s going on with the government’s finances over 10 years, so stabilising NGDP growth over 10 years still wouldn’t make 10 year treasuries predictable. There’s an analogy here with inflation targeting: if inflation is stable over 10 years, that rules out some possible causes of changes in the value of 10 year treasuries, but it doesn’t rule out all of them, so even in countries where central banks have been very successful at their given inflation targets (at least over 10 year periods) 10 year treasuries still carry risks and therefore opportunities for profit.

    “Modern finance is, IMO, more complicated than quantum mechanics. This is because there is never long run stability in the subject matter. The human element adds a complexity that no vibrating atom can match. I think humans are the undiscovered country, more so than space and the oceans.”

    Absolutely. If this side of economics interests you, and you haven’t already read it, I recommend this book by Ludwig von Mises-

    http://mises.org/Books/humanaction.pdf

    It’s heavy-going at times (especially at the beginning, which has a lot of interesting but controversial things to say about the methodology of economics) and it doesn’t have all the answers, but I’m sure that, with your critically aware mind and ability to grasp the basics of a theory in admirably quick time (you seem to have picked up quite a bit about NGDP targeting in a brief amount of time, since I think that you are new here) you could profit a lot from it.

  57. Gravatar of ssumner ssumner
    3. January 2013 at 11:20

    Tyler, No commissions. The Fed buys and sells unlimited amounts of NGDP futures contracts at the target price.

    No profits for Wall Street.

    Geoff, It sounds like you have wages and not total compensation. The fall in total comp has been milder. Health care. Total comp is certainly much more than 44%. I simply meant that the annual rate of decline in the share of labor was fairly small. I was making a macroeconomic claim, not a welfare claim about income distribution or fairness. I don’t object to people arguing workers are getting a smaller share of GDP.

    In late 2007 and 2008 the CPI shot much higher due to fast rising oil prices. NGDP did not follow, nor did wages.

    ChargerCarl, I don’t either, which means I can’t read my own article. I need to bite the bullet and subscribe.

    Ben, He says inflation in 1974 was 20% and mainly due to import prices? And he’s a professor? How fast were wages rising? (I presume he means the UK.)

  58. Gravatar of Geoff Geoff
    3. January 2013 at 11:58

    W. Peden:

    “What if some assets can’t be sold or can’t be sold except at a discount?”

    Then other assets must then be sold at a surplus, because NGDP can’t fall.

    This is because costs are a function of past spending, and past spending is a function of past money supply, which will tend to be lower, wouldn’t it?

    “What about costs incurred during the time period of the NGDP target?”

    If NGDP targeting is adopted, costs will always be incurred during the time period of the NGDP target (assuming enough time has elapsed whereby costs incurred in the non-NGDP targeting time period peter out).

    “I don’t follow the ‘thus’ here. An individual is bankrupt if they can’t service their debts, which is quite different from having a guaranteed nominal income. Unemployment benefits provide minimum incomes, but this does not imply that unemployed individuals never go bankrupt.”

    Fair point. I guess what I should say is that there is no necessary reason why a person with a guaranteed income has to go bankrupt. As long as they always ensure their costs are less than their guaranteed income, profits are a certainty. They have full control over the money they spend.

    “No, I can’t agree with this at all. His incentives are to maximise his real earnings, not his nominal earnings.”

    These are not mutually exclusive concepts. Most people think of maximizing their nominal earnings, which has the byproduct of maximizing their real earnings, given that there is a particular pricing trend that prevails in the economy.

    To say that people’s incentives is not to earn a nominal income, but a real income, would suggest that nominal income is completely divorced from real income. In my view, seeking one is seeking the other in a market economy.

    “Furthermore, the analogy between this and NGDP targeting at the super-Robinson Crusoe level is misleading, since if there is a competitive economy with two or more people, they will act to maximise their own earnings.”

    I am not making analogies, I am making illustrations to highlight a particular concept that I called “profit and loss degradation.”

    A person with a guaranteed income is living in a degraded profit and loss environment, because no matter what they produced, their output is guaranteed to earn 5% more revenues every year. There is no ability of other people to withhold their money from him, signalling to him to change his ways. No matter what he does, he gets a guaranteed 5% increase in revenues.

    This degradation principle I already mentioned, but it unfortunately was not responded to.

    My point is that the same principle of profit and loss degradation, that exists for the individual in an individual NGDP targeting world, also exists, but to a lesser degree, in two person group NGDP targeting scenarios, which is less than three, which is less than four, and so on. My main point, and I would very much like your thoughts, is understanding the level of profit and loss degradation between a country level NGDP targeting world, and a world NGDP targeting world. At the very least I hope you can understand when I say that I think it is greater than nothing. That the reason a firm level NGDP targeting world would virtually destroy the profit and loss mechanism firm to firm, is the same reason, albeit to a lesser degree, that a country level NGDP targeting world would virtually destroy the profit and loss mechanism country to country.

    What of a world NGDP targeting program then? Is that something you think is warranted? If not, why not? If so, then that would carry the potential for individual countries to experience massive fluctuations in NGDP in a world NGDP targeting world, the same way cities in the US experience massive fluctuations in NGDP in a country level NGDP targeting world.

    “People only calculate nominally when changes in nominal prices are not worth the opportunity cost of taking price inflation into account. It cannot be separated from the issue of incentives.”

    Agreed. By the same logic, nominal prices and returns cannot be separated from incentives either.

    “It really depends on economic conditions. If price inflation is at a rate at which taking inflation into account makes a significant difference to people’s real earnings, they will take it into account. Investors do this today over long periods of time in which prices are uncertain. Trade unions most certainly spent a lot of effort taking inflation into account during the 1970s. Indexed contracts are used as well, when people consider it worthwhile doing so.”

    Right, but would you agree that this is still a scenario of people primarily focusing on what nominal incomes and prices people can fetch? For that is what they are changing to deal with inflation? Asking and bid prices changing? That instead of people wanting a 2% nominal raise, they may want a 5% nominal raise?

    “People pursue real wealth and only neglect nominal changes in prices insofar as they’re not worth taking into account as part of that pursuit. This becomes more apparent in countries where prices are less stable than they have been in most western countries in recent decades.”

    If inflation is not worth taking into account, then this connects back to my point about profit and loss degradation. If someone experiences a rise in nominal income, and they don’t bother to ask whether this was due to inflation, or a rise in the market demand of their goods, then they may believe they are experiencing a rise in income because they are producing a more valuable output relative to other output. In reality it could be just because of money creation.

    This is why I am thinking that NGDP targeting would degrade the profit and loss mechanism that balances country versus country. If one country expands in a bad way relative to other countries, and there is discoordination between countries, then most people in each country will have less ability to know, because each country is going to have a guaranteed 5% increase in aggregate revenues, no matter what each country produces.

    If a country is predominantly an exporter, but then the world wants something else, then if that country is engaging in NGDP targeting, and foreigners stop buying those goods, then that country’s sales are not going to diminish, despite the fact that their capital base and output are not in line with foreigner’s desires.

    I thought NGDP targeting would have 5% NGDP growth every year, no questions.

    “Intentions and reality are most definitely two different things!”

    Definitely. So under what circumstances will NGDP 5% targeting intentions not result in 5% NGDP targeting results, given that it is “law”?

    If there is room for fluctuations, then would 2008-2009 be considered a period of successful NGDP targeting?

    It depends on the NGDP target in question.

    You mean it depends on Fed whims? If the Fed is targeting 5% NGDP with a standard deviation of 3 or 4 sigma (meaning 66% or 99% volatility (I think?)), then as long as this occurs, monetary policy has been a “success”?

    “If it’s a year-on-year 5% NGDP target we’re talking about, then it most definitely a failure, and a bad one.”

    What if the Fed wanted NGDP to fall the way it did? Then monetary policy has been a “success”? In other words, success and failure are completely at the discretion of central bankers?

    “If there was NGDP targeting of a band of say 3-7%, then it would also have been a failure.”

    OK, but what if there was a target of -5% to 5%? Then success?

    I guess what I am trying to wrap my head around is why the foundation for good or bad NGDP performance, in your view, is grounded on the quite subjective central banker desires, rather than some non-subjective, economic principles perspective.

    “If there was NGDP level targeting, then it would only be a failure if the central bank did not restore NGDP growth onto the targeted trend.”

    So if the Fed isn’t targeting NGDP, which was the case 2008-2009, and they allowed NGDP to fluctuate, then because NGDP was not the target, we can’t say the Fed’s policy was a failure? How can you square that with Dr. Sumner’s position that the Fed “failed”?

    “What is most important is the trade-off between the predictability of monetary policy, the level of intervention, and minimising the central bank creating macroeconomic problems.”

    OK, but like you said, intentions are not the same thing as results.

    Why does NGDP have to be predictable? If an individual person, city, county, and state should not have a fixed predictable income no matter what the respective populations produce as output, then why should there be a fixed predictable income for other sized regions that we call countries? Isn’t geographical borders a rather arbitrary distinction for such an important thing? Why is NGDP targeting for the US as a country “good”, but NGDP targeting for a neighborhood in the Bronx “bad”?

    I guess I am just trying to wrap my mind around what I think is a rather glaring arbitrariness to the whole thing.

    Not at all: my suspicion applies to my own ideas as much as any other’s. In either case, I’m open to being convinced, IF the use of force can be justified. Suspicion does not entail rejection, but it does mean a placement of the burden of proof.

    What if someone proposes to you a peaceful alternative? Would you be as suspicious of them as you would be for someone who proposes to you a forced, mandatory alternative? To which person ought we be more suspicious? To which person ought we place the burden of proof?

    “Oh, simply historical precedent. Politics is full of transient things, and one shouldn’t presuppose that any particular NGDP target or NGDP targeting in general would last forever.”

    OK.

    “Data collection would presumably improve, but I don’t think that the gains in effectiveness from daily NGDP data collection would be worth the costs in a system of annual NGDP targets.”

    How are you measuring the gains and costs here such that you conclude the costs would probably outweigh the gains?

    Suppose it costs an additional $10 billion of taxpayer money for daily NGDP data collections. Are these the only costs? What about the lost opportunities? And what are the gains that should be associated with these costs?

    I get profit and loss. Gains and costs are rather straightforward. If a firm spends an additional $10 billion on project X, but incurs a low return, or negative return, then I can know, and the firm’s owners can know, that the costs outweigh the gains.

    But when we’re talking about taxpayer financed activity, in a non-market setting, it becomes very difficult. Since you said the costs would probably outweigh the gains, perhaps you can shed some light on how you are arriving at that conclusion, because I am unable to make sense of it.

    “They might be more stable than otherwise, but NGDP over 10 years varies from what’s going on with the government’s finances over 10 years, so stabilising NGDP growth over 10 years still wouldn’t make 10 year treasuries predictable. There’s an analogy here with inflation targeting: if inflation is stable over 10 years, that rules out some possible causes of changes in the value of 10 year treasuries, but it doesn’t rule out all of them, so even in countries where central banks have been very successful at their given inflation targets (at least over 10 year periods) 10 year treasuries still carry risks and therefore opportunities for profit.”

    Good point.

    “Absolutely. If this side of economics interests you, and you haven’t already read it, I recommend this book by Ludwig von Mises-”

    Thanks. Good lord that is one big book. Maybe when I get finished with the sidebar links on this blog, I’ll check it out. I am lazy though.

    I’m not that quick. I thought asking so many questions would mean I am slow. Thanks for your patience and time. NGDP is pretty much just the ol’ AD idea from the classical/neoclassical/Keynesian schools. I guess that’s why it makes sense to me. I took a little economics in college, and I remember the AD stuff.

  59. Gravatar of Geoff Geoff
    3. January 2013 at 12:30

    Dr. Sumner:

    “Geoff, It sounds like you have wages and not total compensation. The fall in total comp has been milder.”

    Thanks, yes, total compensation is a better metric (duh! I’ll go back under my rock).

    http://research.stlouisfed.org/fredgraph.png?g=edl

    Still, total compensation relative to NGDP went from a high of around 59.8% in 1970, to about 54.2% now. A 5.6% drop, while is no small potatoes either, but, I think, within the realm of reasonable volatility. Yet the downward trend for the last 40 years can be cause for concern.

    What if it keeps going and NGDP targeting isn’t stopping it, but, maybe, perhaps, exacerbating it to at least some degree? I am thinking that because CB policy is focused in investment and banking, rather than wages, that it may explain at least some portion of the declining trend. I have no idea how much, I am just speculating here.

    “I simply meant that the annual rate of decline in the share of labor was fairly small. I was making a macroeconomic claim, not a welfare claim about income distribution or fairness. I don’t object to people arguing workers are getting a smaller share of GDP.”

    OK. I will only say that “small” and “large” are in the eye of the beholder. To you, 5.8% decline is fairly small. But when you put that 5.8% in comparison with NGDP, that’s a lot of money. If workers retained the same 59.8% percentage as in 1970, then today that would equate to 0.598*($15.8 trillion) = $9.5 trillion. Comparing that to the actual share of NGDP of 54.2%, it works out to about a $1 trillion difference.

    The workforce is about 135 million. $1 trillion spread over 135 million people works out to be an additional $7,400 a year to the average worker.

    Imagine if instead of a falling wage share, workers experienced that reduction as an increase in their direct taxes, and that money got transferred as a subsidy to dividend and interest earning individuals. That would have the same result. Who wants a revolt?

    “In late 2007 and 2008 the CPI shot much higher due to fast rising oil prices. NGDP did not follow, nor did wages.”

    Stupid question: If oil prices, instead of falling in 2008, had instead kept rising at, say, 5% annually, which presumably would have kept consumer prices from falling, then would that have had any impact on NGDP?

  60. Gravatar of W. Peden W. Peden
    3. January 2013 at 15:00

    Geoff,

    “Then other assets must then be sold at a surplus, because NGDP can’t fall.”

    The net value of their assets could fall even if NGDP didn’t fall.

    “If NGDP targeting is adopted, costs will always be incurred during the time period of the NGDP target (assuming enough time has elapsed whereby costs incurred in the non-NGDP targeting time period peter out).”

    By ‘time period’, I meant say during that year, in a year-on-year NGDP target.

    “Fair point. I guess what I should say is that there is no necessary reason why a person with a guaranteed income has to go bankrupt. As long as they always ensure their costs are less than their guaranteed income, profits are a certainty. They have full control over the money they spend.”

    That’s true of any business: if cost does not exceed income, one makes a profit. There is no more of a guranteed profit here than there would be a guaranteed loss if one set an NGDP target of -5%.

    “These are not mutually exclusive concepts. Most people think of maximizing their nominal earnings, which has the byproduct of maximizing their real earnings, given that there is a particular pricing trend that prevails in the economy.”

    That’s quite a given! Also, it’s not quite right to say that people maximise their earnings, since the opportunity cost of earnings is always being traded off against alternatives e.g. leisure, job security, work satisfaction.

    A pay rise of 2% in a lousy job may be worth my while if I expect inflation to be around 1%, but not if I expect inflation to be about 3%.

    “To say that people’s incentives is not to earn a nominal income, but a real income, would suggest that nominal income is completely divorced from real income. In my view, seeking one is seeking the other in a market economy.”

    Oh, it’s not entirely divorced. There are definitely money illusions and so on. However, it’s real incomes that are the goal, and it’s real incomes that people have incentives to earn.

    “Right, but would you agree that this is still a scenario of people primarily focusing on what nominal incomes and prices people can fetch? For that is what they are changing to deal with inflation? Asking and bid prices changing? That instead of people wanting a 2% nominal raise, they may want a 5% nominal raise?”

    They may ASK for a 5% nominal raise, but only because they want a real raise.

    “A person with a guaranteed income is living in a degraded profit and loss environment, because no matter what they produced, their output is guaranteed to earn 5% more revenues every year. There is no ability of other people to withhold their money from him, signalling to him to change his ways. No matter what he does, he gets a guaranteed 5% increase in revenues.

    This degradation principle I already mentioned, but it unfortunately was not responded to.”

    I’m afraid it’s just not a good point: let’s say the person only produces mudpies, and their own currency (call it the MP) is printed to the extent that people buy the mudpies such that the nominal expenditure on the person’s mudpies goes up by 5%. That person is no more shielded from profit and loss than any other mudpie salesman and will end up no richer than someone whose mudpies simply pile up; both have just as much an incentive to produce more marketable output.

    “What of a world NGDP targeting program then? Is that something you think is warranted? If not, why not? If so, then that would carry the potential for individual countries to experience massive fluctuations in NGDP in a world NGDP targeting world, the same way cities in the US experience massive fluctuations in NGDP in a country level NGDP targeting world.”

    Such a system wouldn’t produce heaven on earth or even be the best of all possible worlds, but I suppose it could work fairly well. Fluctuations in one country would be balanced out by opposing fluctuations other countries, since everyone’s expenditures are someone else’s income. Some people are into ideas about optimal currency areas and so on, and there is a lot of legitimate problems there (although usually bad answers) but I don’t think a world NGDP target would be that bad. It would have some interesting similarities with the old gold standard system, in terms of adjusting money in response to market demand.

    “Agreed. By the same logic, nominal prices and returns cannot be separated from incentives either.”

    Only in times and places where prices have considerable stability. In an NGDP targeting economy, for example, a production shock could significantly alter people’s pricing habits.

    “This is why I am thinking that NGDP targeting would degrade the profit and loss mechanism that balances country versus country. If one country expands in a bad way relative to other countries, and there is discoordination between countries, then most people in each country will have less ability to know, because each country is going to have a guaranteed 5% increase in aggregate revenues, no matter what each country produces.

    If a country is predominantly an exporter, but then the world wants something else, then if that country is engaging in NGDP targeting, and foreigners stop buying those goods, then that country’s sales are not going to diminish, despite the fact that their capital base and output are not in line with foreigner’s desires.”

    Assuming the two countries are using different currencies (let’s say it’s Mexico and the United States) then this is addressed by exchange rates. So let’s say American exports become less competitive against the peso: the value of the dollar vs. the peso falls, increasing the incentives for Americans to produce more marketable output to acquire more pesos. The better the output, the more pesos they get.

    (Incidentally, a 5% NGDP target wouldn’t guarantee that every component of NGDP increases by 5%.)

    “Definitely. So under what circumstances will NGDP 5% targeting intentions not result in 5% NGDP targeting results, given that it is “law”?”

    Circumstances in which the central bank fails to expand or contract base money in line with the demand to hold base money. That could be due to forecasting error or a technical failure.

    “You mean it depends on Fed whims? If the Fed is targeting 5% NGDP with a standard deviation of 3 or 4 sigma (meaning 66% or 99% volatility (I think?)), then as long as this occurs, monetary policy has been a “success”?”

    It depends how one is defining ‘success’. In the sense that the Fed would have met its target, it would be successful. In the sense that some broad goals for monetary policy would have been achieved, it would have been a success. None of that implies that it would have been the best possible or practicable monetary policy.

    “What if the Fed wanted NGDP to fall the way it did? Then monetary policy has been a “success”? In other words, success and failure are completely at the discretion of central bankers?”

    No: the point of a year-on-year NGDP target would be to restrict the Fed’s discretion about what NGDP would be in a given year. So it wouldn’t be up to the Fed what the NGDP target for that year would have been.

    “OK, but what if there was a target of -5% to 5%? Then success?”

    The target would have been hit. One could object to that target, of course, e.g. such a target leaves a huge amount of uncertainty as to what can be expected from the Fed and the overall economy, not to mention a lot of discretionary power in the hands of the Fed.

    “So if the Fed isn’t targeting NGDP, which was the case 2008-2009, and they allowed NGDP to fluctuate, then because NGDP was not the target, we can’t say the Fed’s policy was a failure? How can you square that with Dr. Sumner’s position that the Fed “failed”?”

    I don’t make a habit of defending things that other people say.

    As far as ‘failure’ goes: one could argue that the Fed failed in its (vague and nebulous) mandates. I’m inclined to take a long view, and argue that those mandates are bad in themselves and could be replaced by better mandates or no mandate at all.

    “Why does NGDP have to be predictable?”

    Monetary policy should be predictable; stabilising NGDP has the advantage of doing that, by setting limits on the discretionary power of monetary policymakers.

    (It also sets both prices & real output on a predictable long-term path, but that’s a different issue from what I
    meant in that quote.)

    I think there are better ways to hamstring monetary policymakers and my ideal systems are quite radically different from NGDP targeting, but NGDP targeting is fairly high up my list of preferred “least bad options” for monetary policy.

    “I guess I am just trying to wrap my mind around what I think is a rather glaring arbitrariness to the whole thing.”

    One significant difference is that the Bronx doesn’t issue its own currency.

    “What if someone proposes to you a peaceful alternative? Would you be as suspicious of them as you would be for someone who proposes to you a forced, mandatory alternative? To which person ought we be more suspicious? To which person ought we place the burden of proof?”

    I wouldn’t be suspicious of either person; I’d be suspicious of their proposals. Quite an important distinction! I trust the motives of plenty of people with bad policy ideas.

    As for their alternative, that it was peaceful would immediately be a big factor in its favour. It wouldn’t be a decisive one: for example, begging invading armies not to attack is a peaceful alternative to having a military, but not a better one.

    “Since you said the costs would probably outweigh the gains, perhaps you can shed some light on how you are arriving at that conclusion, because I am unable to make sense of it.”

    Loosely and subjectively, much as I make most of my decisions in life.

    “Gains and costs are rather straightforward. If a firm spends an additional $10 billion on project X, but incurs a low return, or negative return, then I can know, and the firm’s owners can know, that the costs outweigh the gains.”

    Yes, though even then you don’t necessarily solve issues of opportunity cost, since it is always possible that the money could be better spent elsewhere, given the objectives of the firm in question.

    “I thought asking so many questions would mean I am slow. Thanks for your patience and time.”

    Not at all: one thing I’ve learned in teaching is that asking questions (and presenting some interesting counterarguments) is a sign that someone is paying attention and has done their homework. I once taught (and sometimes learned from) an ex-army officer who had a near excess of very interesting questions, but who was by no means slow.

    “NGDP is pretty much just the ol’ AD idea from the classical/neoclassical/Keynesian schools. I guess that’s why it makes sense to me. I took a little economics in college, and I remember the AD stuff.”

    I’m not an economist, and I find that economists use ‘aggregate demand’ to mean so many different things that I try to avoid ever using it. I also think it’s a bit of a dubious phrase if taken literally: ‘aggregate demands’ would at least have the benefit of reminding one that there are loads of different people and firms in an economy, with different plans, tastes, incomes and expenditures.

    I dislike the phrase ‘economic efficiency’ for much the same reason: economies don’t produce a single output in the real world, so the most obvious sense of ‘efficiency’, i.e. production less cost, doesn’t apply to them.

    ‘Nominal gross domestic product’ is less misleading once one knows what it means.

  61. Gravatar of ssumner ssumner
    4. January 2013 at 12:15

    Geoff, Monetary policy can’t really control long run trends in real variables, such as the labor share, just short run business cycles and long run inflation.

  62. Gravatar of Geoff Geoff
    7. May 2013 at 05:58

    W. Peden:

    I said: “Fair point. I guess what I should say is that there is no necessary reason why a person with a guaranteed income has to go bankrupt. As long as they always ensure their costs are less than their guaranteed income, profits are a certainty. They have full control over the money they spend.”

    You replied: “That’s true of any business: if cost does not exceed income, one makes a profit. There is no more of a guranteed profit here than there would be a guaranteed loss if one set an NGDP target of -5%.”

    No, it isn’t true of any business, because any business is not guaranteed a 5% growth in revenues every year. They would earn an uncertain level of revenues, and that makes it possible for revenues to decrease below costs.

    In our hypothetical example of individual level NGDP targeting on the other hand, all the individual has to do is ensure he doesn’t spend (invest) more than his next year’s guaranteed annual revenues, and he will never incur a nominal loss, ever.

    For consider, if the individual knew his next year’s revenues will be $50000×1.05 = $52500, then all he has to do is ensure that he does not invest more than that this year. He has full control over his expenditures. He can guarantee himself a profit. In fact, there would be less incentive to invest anything at all, because if his revenues are capped at $52500 next year, it means the less he invests this year, the greater his net income will be next year. He could literally produce junk he dug up in his backyard, and sell it for a guaranteed $52500 revenue next year, and then $55125 the year after that.

    The same would be true for every other individual as well. They also would experience a 5% growth in guaranteed revenues. They could avoid losses by spending less than their income. They would have the same incentive to produce and invest less in real terms.

    Of course, price inflation would go through the roof, and would limit the incentive to not invest, but you can see the likely outcome of targeting individual incomes.

    Well, the same degradation in quality and price signalling that exists with individual income targeting, would also exist, but to a slightly lesser degree, with household income targeting. And city level targeting would be slightly less than that. And so on. At the country level, there is still degradation.

    Dr. Sumner:

    “Geoff, Monetary policy can’t really control long run trends in real variables, such as the labor share, just short run business cycles and long run inflation.”

    While those individuals in control of the money cannot consciously control long run trends in real variables, that does not mean their activity does not have long run (unintended or otherwise) effects on real variables.

    “Fixing” short run corrections, preventing liquidation and unemployment via inflation in the short run, has long run real consequences.

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