Those who don’t like QE should root for a higher inflation target

The Wall Street Journal has a good article on the dilemma facing the Swiss National Bank:

Nearly every major central bank is buying nontraditional assets to resurrect domestic economies in the wake of the worst global recession in 75 years. The U.S. Federal Reserve is buying mortgages; the European Central Bank is making unusually long loans to banks; and the Bank of Japan is buying real-estate investment funds.

All risk losing money, but Switzerland’s exposure stands out in character and scale: Its central bank is buying assets from other countries and its holdings of currencies, bonds, stocks and gold—nearly 500 billion Swiss francs, about $541 billion—are nearly the size of the nation’s gross domestic product. In contrast, the Fed’s buying of bonds and mortgages amounts to about 20% of U.S. national output, and the European Central Bank’s holdings stand at 30% of total GDP.

In September 2011, the SNB set a goal of keeping its currency from rising beyond 1.20 francs to the euro, a threshold that SNB Chairman Thomas Jordan has said the bank would fight to maintain “with the utmost determination.”

The strategy, so far, is working. The franc hasn’t crossed the 1.20 threshold in 16 months. The Swiss economy is growing, albeit slowly, while the euro-zone economy is contracting. Inflation is nonexistent, though rising real-estate prices are prompting worry. Exports are up despite the euro-zone recession.

.  .  .

“The SNB is acting very much like a leveraged hedge fund,” Bruce Krasting, a former currency trader, wrote on his blog. “It’s making currency ‘bets’ with the people’s money. It’s taking some very big risks.”

Switzerland’s central banker acknowledged the risks but said there was no alternative. “It’s not excluded that we could suffer a loss, but the risk of doing nothing was greater,” Mr. Jordan, the Swiss central banker, said in an interview. “The franc was so strong that we could have fallen into a deflationary spiral.”

At the zero lower bound central banks face three choices:

1.  Become passive, and fall into a deflationary spiral.

2.  Maintain the inflation target, and buy as much as it takes to insure the target is hit.

3.  Raise the inflation target, allowing the central bank to dramatically shrink its balance sheet (as a share of GDP.)

Most people don’t understand this, they believe moving from step two to step three would require a larger balance sheet.  Australia maintains a slightly higher inflation target than the Fed, ECB, or SNB, has positive interest rates, and has a monetary base of only 4% of GDP.

And deflation really isn’t much of an option.  Eventually politics will force the central bank to act:

The Swiss feared entire swaths of industry would disappear forever. “There is no way within one or two years to recover such an enormous amount of price competitiveness,” said Hans Hess, president of Swissmem, which represents around 1,000 mechanical and engineering companies. “There was a risk that a significant number of Swiss export companies would either have been wiped out or have had to leave Switzerland.”

So it’s print money now or print money later.  If you really, really don’t want to see a lot of money printing, negative IOR might help, but higher trend inflation is the only real alternative.

I’m not sure what the SNB should do.  The same article suggests they are dabbling in securities:

Unlike big private investors, the SNB can’t hedge its foreign-exchange risk. To limit its euro exposure, the SNB has moved to diversify and now holds 12% of its reserve in foreign equities, unusual for a central bank. It has traded euros for U.S. dollars, British pounds, Australian dollars and others.

Last year, it began buying South Korean won and recently said it would station seven people in Singapore to facilitate “round-the-clock operations” in foreign-exchange markets.

As of the end of September, the latest data available, 48% of its holdings were in euros—down from 60% at midyear—28% in U.S. dollars and 24% in other currencies.

“I never thought I would ever see such an anti-inflationary conservative institution as [the SNB] hold our currency as part of their reserves,” said Australian central banker Glenn Stevens. “It’s a remarkable thing.”

Notice how my favorite economies all end up with governments owning lots of foreign equities?  It goes against Switzerland’s conservative ideology.  But as I’ve argued many times, a bit of socialism might be the price you pay for a conservative monetary policy.  The lower the inflation target, the greater the quantity of assets that must be purchased by the central bank (as a share of GDP.)

Even though I am a libertarian, I’d be hard pressed to predict disaster for Switzerland.  Obviously this particular gamble might fail, but in the long run a strategy of borrowing money from Europeans at zero interest rates and investing in Asian equity markets would be expected to yield a positive rate of return, if only due to the Balassa-Samuelson effect.  Countries like Switzerland and Singapore get rewarded for their virtue.   They borrow at low rates and run massive current account surpluses.  Their thrift allows them to keep tax rate slower than their neighbors.  And their relatively low tax rates keep their economies richer than their neighbors.  These two countries have the highest share of millionaires in the world. Singapore decided to create a sovereign wealth fund many years ago. And now the logic of its position is pushing the Swiss in the same direction.

This example also highlights the real issue created by the zero lower bound.  The question is not; “will QE work or not?” There is always some level of QE that will work. The real question is whether central banks prefer a lower inflation target with a large balance sheet, or a modestly higher inflation target with a smaller balance sheet.


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54 Responses to “Those who don’t like QE should root for a higher inflation target”

  1. Gravatar of Bill Woolsey Bill Woolsey
    10. January 2013 at 08:31

    Privatize hand-to-hand currency and negative IOR.

    Small central bank balance sheet and zero inflation.

    Problem solved….

    The problem is 100% the notion that government must provide zero-interest hand-to-hand currency on demand.

  2. Gravatar of Britmouse Britmouse
    10. January 2013 at 09:01

    I think the SNB should do the Svensson plan. If they set out a clear plan to slide the Euro peg & a CPI level target, I can’t imagine they’d have to defend the peg as much. They seem to have a pretty loose mandate for price stability so PLT would work.

  3. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    10. January 2013 at 09:09

    No mention of Buchanan’s passing?

  4. Gravatar of ColdCapital ColdCapital
    10. January 2013 at 09:30

    Dr -

    I know you have previously advocated for an NGDP futures market, but, within the constraints of the existing financial architecture, how would you propose the Fed raise the inflation target (beyond guidance)? Certainly not straight debt monetization?

    Thanks.

  5. Gravatar of marcus nunes marcus nunes
    10. January 2013 at 10:01

    Scott
    “The real question is whether central banks prefer a lower inflation target with a large balance sheet, or a modestly higher inflation target with a smaller balance sheet”.

    There´s always the alternative of scrapping the IT target alltogether and adopt an NGDPL Target

  6. Gravatar of Don Geddis Don Geddis
    10. January 2013 at 10:10

    @ColdCapital: Hey, I’ve been reading this blog! Let me take a stab at an answer.

    Even without public futures markets, the Fed can still announce a target path for future NGDP. This is especially useful if they announce a Level Target instead of just a growth rate target.

    Then, internally, they choose actions so as to bring their internal forecasts in line with their announced targets.

    Are you asking what explicit actions the Fed takes? It buys Treasuries. But if that’s your question, then it sounds like you’re a person of the concrete steppes. You are missing the significance of expectations. Chuck Norris doesn’t get people to leave the room, by forcibly moving them there (aside from the first few, to demonstrate credibility). People leave because of the threat that Norris communicates; the actual movement, from one room to another, the people do on their own, voluntarily.

    So, the answer to your “how” question, is that 99% of it is just the announcement itself (assuming it is credible). If not yet credible, start buying T-bills until the threat does become credible.

  7. Gravatar of Sina Motamedi Sina Motamedi
    10. January 2013 at 10:19

    What the Swiss National Bank has demonstrated is that if a central bank wants to hit a nominal target, it can.

  8. Gravatar of RebelEconomist RebelEconomist
    10. January 2013 at 10:52

    “Raise the inflation target, allowing the central bank to dramatically shrink its balance sheet (as a share of GDP.)

    Most people don’t understand this, they believe moving from step two to step three would require a larger balance sheet.”

    I am not convinced either – which is of course the response you want from someone. What’s your evidence for this view, Scott? And don’t quote me Australia – to paraphrase a recent comment from a colourful English football manager, you’d have to be a dope to fail at monetary policy in Australia.

  9. Gravatar of Geoff Geoff
    10. January 2013 at 12:32

    I can support NGDPLT if the difference X between current NGDP and some arbitrary desired NGDP, is made up for by my nominal income growing by X.

    I don’t see how my life is improved if X is made up for by other people’s nominal incomes increasing. They’ll just outbid me for scarce goods, services, financial securities, and other things with money prices.

    Can someone explain to me why I should support that which puts me in a relatively worse position, just because I lack the power to control the Fed such that I am put in a relatively better position?

  10. Gravatar of Jeff Jeff
    10. January 2013 at 13:16

    Since the SNB can always depreciate its own currency, it doesn’t have a currency risk. Start at 1.2 Swiss Francs to the Euro. SNB spends 1200 francs to buy a thousand Euros and locks them in a vault. If the Franc appreciates to parity with the Euro, and they sell the Euros to buy Francs, SNB is out 200 Francs. But they can avoid this outcome by doing what they’ve been doing: printing up billions of Francs and buying billions of Euros with them. The risk goes only one way, i.e., they may end up depreciating the Franc to, say, 1.4 Francs to the Euro. In that case, when they sell the Euros, they turn a profit.

    Nobody in their right mind bets against a determined central bank in the currency markets.

  11. Gravatar of Justin Irving Justin Irving
    10. January 2013 at 13:51

    Thanks for the update on the SNB Scott. I didn’t realize that their balance sheet was growing again.

    Personally, I don’t see how the SNB’s strategy is really so risky. They are basically buying a ‘world economy’ ETF. If they lose money on that, they will have bigger problems.

  12. Gravatar of Ben J Ben J
    10. January 2013 at 13:59

    “Can someone explain to me why I should support that which puts me in a relatively worse position, just because I lack the power to control the Fed such that I am put in a relatively better position?”

    Yes, you’re right Geoff, I know realise how it’s not in my enlightened self-interest to solve unemployment. Tight money forever!

  13. Gravatar of Ben J Ben J
    10. January 2013 at 14:00

    Sorry, “know” should be “now”

  14. Gravatar of W. Peden W. Peden
    10. January 2013 at 14:32

    The Swiss exchange rate floor has not only worked, it’s got easier for them over time-

    http://www.bbc.co.uk/news/business/market_data/currency/13/11676/twelve_month.stm

    - they’re not even bumping-along-the-bottom of their floor anymore.

    Anyway, this is an excellent post. Of the options, I suppose I prefer a mildly deflationary policy plus a central bank with a lot of assets.

  15. Gravatar of Geoff Geoff
    10. January 2013 at 14:44

    Ben J:

    “Yes, you’re right Geoff, I know realise how it’s not in my enlightened self-interest to solve unemployment. Tight money forever!”

    Well, I wasn’t asking for tight money. I was asking for loose money, as long as that loose money immediately goes towards raising my own income, rather than your income, or someone else’s income.

    If my choice is between raising your income and not my income, versus not raising your income nor my income, I would pick the latter.

    Call that tight money if you want. I will call it non-special privilege money.

  16. Gravatar of Don Geddis Don Geddis
    10. January 2013 at 14:45

    @Geoff: “I don’t see how my life is improved if X is made up for by other people’s nominal incomes increasing. They’ll just outbid me for scarce goods

    If other people are currently unemployed, so their income goes from zero, to the prevailing wages … but then also national output production increases by the same amount … then your relative ability to bid for goods and services hasn’t changed, has it? But yet the government’s finances are in far better shape, as they will get more tax revenue and be forced to spend less on welfare transfer payments.

    You don’t need to have your personal nominal income increase, in order for improved macroeconomic conditions to benefit you personally.

  17. Gravatar of Ben J Ben J
    10. January 2013 at 15:31

    “Well, I wasn’t asking for tight money. I was asking for loose money, as long as that loose money immediately goes towards raising my own income”

    You’re asking for tight money for everyone else, and loose money for yourself, and in doing so trying to demonstrate what you perceive from first principles to be the inherent immorality of manipulating gross nominal income. But why waste time with the Socratic method? Just make your point.

    Nominal GDP targets obscure profit and loss signals in the market, increased inflation will bid up the price of goods, causing scarcity for some and artificial plenty for others, etc. Is that what you’re trying to say?

  18. Gravatar of Geoff Geoff
    10. January 2013 at 17:28

    Don Geddis:

    “If other people are currently unemployed…”

    Then they are of no benefit to me in the material sense. Others benefit me in their productivity, not their spending. Their spending only represents a benefit to me and others if that money was earned via their productivity. If their spending is not based on earnings, but inflation, or welfare, or what have you, then they are benefiting at other people’s expense.

    “so their income goes from zero, to the prevailing wages … but then also national output production increases by the same amount”

    Abracadabra?

    So why not have everyone on welfare then, financed by the Fed? Nobody needs to actually produce anything, because productivity magically arises when people spend money.

    “then your relative ability to bid for goods and services hasn’t changed, has it?”

    If their spending is using money they did not earn, I am not better off, because I am only better off by their production. I don’t care about other people’s money, I care about what others can DO for me and trade to me.

    “But yet the government’s finances are in far better shape, as they will get more tax revenue and be forced to spend less on welfare transfer payments.”

    How can the government having more revenue lead to the government being “forced” to spend less on welfare?

    “You don’t need to have your personal nominal income increase, in order for improved macroeconomic conditions to benefit you personally.”

    I don’t benefit from “the macro economy”. I benefit from a specific group of individual people of whom I happen to trade with in my life.

    I am not better off if others have their money incomes increased, either by welfare or by the Fed.

  19. Gravatar of Geoff Geoff
    10. January 2013 at 17:35

    Ben J:

    “You’re asking for tight money for everyone else, and loose money for yourself, and in doing so trying to demonstrate what you perceive from first principles to be the inherent immorality of manipulating gross nominal income. But why waste time with the Socratic method? Just make your point.”

    I am not asking for tight money for everyone else. If my income is increased by the difference between actual and desired NGDP, then total NGDP will rise as desired, and so there will be no tight money in the economy.

    My spending is associated with total NGDP rising at the desired level.

    Where are you inferring that I want tight money for everyone else? I am not saying I want NGDP to fall. I just want NGDP to rise by way of my income and spending rising. Total NGDP will rise as desired.

    “Nominal GDP targets obscure profit and loss signals in the market, increased inflation will bid up the price of goods, causing scarcity for some and artificial plenty for others, etc. Is that what you’re trying to say?”

    I am saying that I will support NGDPLT if the difference between actual and desired NGDP is made up for my my own nominal income (and spending) rising, and that other people’s nominal incomes can rise by virtue of my spending my money on their output for my benefit.

    I am just saying that I will support NGDPLT if I am the sole “primary dealer” in the marketplace. I would like to have the sole privilege in selling my assets to the Fed. My resulting spending will then spread throughout the economy, raising other people’s nominal incomes, such that NGDP rises at the desired rate.

    This is exactly what NGDPLT is about. The only difference is that I am the only primary dealer.

    I am not such an altruist / demagogue that I will be against NGDPLT period. I would be in favor of it, as long as it is subject to only one single condition.

  20. Gravatar of Scary Scott Sumner Statements Scary Scott Sumner Statements
    10. January 2013 at 17:42

    [...] At this point I think my analysis is superfluous. I just need to quote this guy. If you folks don’t see what I see, I don’t know what my commentary will add. These quotes all come from the same post: [...]

  21. Gravatar of Don Geddis Don Geddis
    10. January 2013 at 18:05

    @Geoff: Ah! So you’re a crazy “Austrian” internet troll. I’m sorry for having encouraged you! My bad.

    Just for the record, you misunderstood my example. I was saying that the people were unemployed now, and thus not producing wealth. But if the macro economy improved, then they might get jobs, and be productive, and the nation/world overall would be wealthier. In other words, it was a counter to your example that, just because they have additional income, while yours may be unchanged, doesn’t mean that you will suffer because “they’ll just outbid” you, as you claimed. Because your example ignored that the wealth of the world is not fixed, and a better macro economy could (should) result in more wealth being created. A win-win! (Also, you misunderstood my “more tax revenue and less welfare”. It was just a conjunction, not a causal link. There would be less welfare, because there would be fewer unemployed, and some government welfare is function of how many people happen to be unemployed.) Also, you benefit from the macro economy, if you have any assets in a bank account or money market fund or the stock market, which earns some kind of overall return. Your direct benefit is the real return to that savings (nominal – inflation), but that depends on the health of the macro economy. Right now, real returns to savings are very low. With a healthier economy, you, personally, would see higher real returns to your own savings.

  22. Gravatar of ssumner ssumner
    10. January 2013 at 18:07

    Bill, If the interest rate is negative, how do banks make a profit on currency?

    Britmouse, I’ve also wondered why they don’t opt for a crawling exchange rate peg.

    Patrick, I was thinking of writing something about Buchanan, but I’m shamefully ignorant of his work–haven’t really read much since grad school. So I thought it best to leave the obits to the George Mason folks. He was certainly a giant in public choice economics, and a defender of small government, so I’m sad to see him pass away.

    Cold Capital. I’d adopt level targeting, and then use things like TIPSs

    Marcus, Yes, I was just sticking to their preferred target.

    Sina, That’s right.

    Rebeleconomist, There are lots of empirical studies that show the demand for base money slopes downward, as a function of the opportunity cost of holding base money.

    Jeff, Yes, they could do this, but there is no guarantee they will make a profit. In any case, the macro effects are far more important than any expected profit or loss to the central bank.

    Justin, I agree.

  23. Gravatar of Geoff Geoff
    10. January 2013 at 18:40

    Don Geddis:

    “@Geoff: Ah! So you’re a crazy “Austrian” internet troll. I’m sorry for having encouraged you! My bad.”

    Huh? I am not “Austrian.” What are you talking about? I consider myself more of a classical liberal. Or maybe I am misunderstanding you?

    “Just for the record, you misunderstood my example. I was saying that the people were unemployed now, and thus not producing wealth. But if the macro economy improved, then they might get jobs, and be productive, and the nation/world overall would be wealthier.”

    Getting jobs IS the macro economy improving. The macro economy doesn’t improve and then people get jobs. People get jobs and that’s how we know the economy is improving.

    “In other words, it was a counter to your example that, just because they have additional income, while yours may be unchanged, doesn’t mean that you will suffer because “they’ll just outbid” you, as you claimed.”

    But it isn’t a counter to my example. You just inserted a deux ex machina and skipped over the “people get money from welfare or the Fed” step, and went straight to “the macro economy improves” step.

    There is a huge gaping hole there.

    My argument, which you have not countered, is that I and every other producer, as a group, are not benefited by virtue of an external group of money spenders. Producers are benefited by virtue of other producers. If an external group of non-productive money spenders enter the picture, it is pure wealth transfer from productive to unproductive, because while the productive are putting wealth into the market for sale, those who are spending money are not putting wealth into the economy themselves.

    It would be like me spending $14 trillion out of thin air, and buying up the entire economy. Everyone would be millionaires, but they would have zero wealth because I would own it all.

    The same principle is present in less than 100% purchasing scenarios. Instead of outright take over of the economy, there is a constant exploitation of those who are producing wealth.

    “Because your example ignored that the wealth of the world is not fixed, and a better macro economy could (should) result in more wealth being created. A win-win!”

    Explain how in the world having people spend without producing value for me, improves my life, please!

    “(Also, you misunderstood my “more tax revenue and less welfare”. It was just a conjunction, not a causal link. There would be less welfare, because there would be fewer unemployed, and some government welfare is function of how many people happen to be unemployed.)”

    There would be fewer employed how? At what cost?

    “Also, you benefit from the macro economy, if you have any assets in a bank account or money market fund or the stock market, which earns some kind of overall return.”

    That is me benefiting from the specific people I trade with. If I hold assets in a particular bank, then I benefit from doing business with that bank. If I hold money market funds, then I benefit from those specific people who earn a return on those funds. I may benefit from a very large number of people in the sense of division of labor, but it’s always a delimited number of people. It isn’t “the macro economy” as if everyone is helping me. There are criminals, unproductive people on welfare, and primary dealers who get to do business with the Fed, all of whom spend money without providing me with any value.

    “Your direct benefit is the real return to that savings (nominal – inflation), but that depends on the health of the macro economy. Right now, real returns to savings are very low. With a healthier economy, you, personally, would see higher real returns to your own savings.”

    You’re still missing steps here. Healthier economies aren’t automatic.

  24. Gravatar of Federico S Federico S
    10. January 2013 at 19:00

    Hey Scott,

    thanks for the post but two issues.

    1. I hope I’m misinterpreting you when you say: “Countries like Switzerland and Singapore get rewarded for their virtue. They borrow at low rates”. I read that as saying that these countries have low long term rates because they’re [insert any Victorian value here]. I think you mean that they’re running low ngdp targets (explicit or implicitly)
    2. I’ve been thinking about the stuff you raised in this post for a while, and the main issue I have with moving from a low NGDP target to a high NGDP target while reducing the size of the base is that CBs may have a credibility problem. I haven’t read Woodford’s paper, but I saw him present at the AEA and he mentioned this. I’m thinking in terms of a model whereby people’s forward expectations are formed by previous economic data. I think this is a pretty accurate model (meaning it works about 75% of the time at least, though the counterfactual is extremely hard to test). If this is true, then it means that you can’t move to a higher NGDP target without massively increasing the base. After some years of running a high NGDP target I agree that the base will shrink, but in the meantime the people who don’t like a large monetary base can’t really use a higher NGDP target to reduce the size of the base. What do you think of this issue (specifically, the issue of a CB credibly committing to a long term policy in a short amount of time)?

  25. Gravatar of Ben J Ben J
    10. January 2013 at 19:22

    Geoff, I know you think trying to demonstrate the distributional consequences of NGDP targeting through a lovely parable is very clever, but the problem is that nobody here agrees with your premise.

    For example

    “…My resulting spending will then spread throughout the economy, raising other people’s nominal incomes, such that NGDP rises at the desired rate.”

    Changes in NGDP caused by movement in what Scott Sumner calls ‘the base’ do not ‘spread’ through the economy from the point of entry. Since the demand for base money (as defined by economists) is mostly endogenous, anyone who has an increase in demand for cash can simply go to an ATM. They don’t have to wait for you, you kind kind Primary Dealer you, to increase your nominal spending.

    So your lovely story, full of false concern about how you are not a demagogue and so are happy to be a Primary Dealer, doesn’t demonstrate anything but your own ignorance for the expectations component of NGDP.

  26. Gravatar of Ben J Ben J
    10. January 2013 at 19:25

    Every comment you’ve made is like this. I would love you to be the Primary Dealer. You’d be perfect. While you ponder what to spend the cash you have just exchanged assets for, you’d be shocked by an increase in NGDP before you even began spending. You know, because ATMs exist.

  27. Gravatar of Richard W Richard W
    10. January 2013 at 20:21

    ” Unlike big private investors, the SNB can’t hedge its foreign-exchange risk. ”

    ” To limit its euro exposure, the SNB has moved to diversify and now holds 12% of its reserve in foreign equities, unusual for a central bank. ”

    Far from can’t hedge its exposure, buying equities where they have bond exposure is a hedge.

    Israel’s central bank has been diversifying into US stocks since March. Eventually they are aiming for 10 percent in equities. The Czech Republic has been doing it since 2006 and are now up to 10 percent. South Korean central bank have been doing it for years. The problem for the SNB is their mark-to-market losses on their equity holdings exceeded their dividend yield. Not a huge problem when equities only amount to 9 percent of their reserves. However, the SNB pays dividends from their net profit to the cantons who use it in public spending. Losses for the SNB means less funds for the cantons.

  28. Gravatar of Don Geddis Don Geddis
    10. January 2013 at 20:23

    @Geoff: “I am not “Austrian.” What are you talking about?”

    Look up “Austrian economics”. I suspect you’ll quickly find a community of people that you have much more in common with — rather than commenting here, where people don’t even agree with your initial assumptions.

    “The macro economy doesn’t improve and then people get jobs.”

    Not quite. Companies today don’t hire and expand today, because they don’t expect to see enough revenue in the future to pay for current expansion. As soon as they start to believe that the future will have more NGDP, then they’ll immediately expand their hiring today. So the thing that needs to change, is their prediction of future cash flows. The whole key (as Ben J says above) is expectations.

    “deux ex machina … and went straight to “the macro economy improves” step.”

    So you don’t understand how nominal changes can have real effects? Before you comment further, it seems like you first ought to read a little, to at least understand the basics of the theory that you are criticizing. Have you read through Sumner’s FAQ, linked at the top right of every page on this blog? Have you read Sumner’s National Affairs paper on the whole idea? How about at least watched his 15min video explaining our current recession?

    You’re right, that I didn’t explain in my comment how printing more money results in more people having jobs. But Sumner has covered that subject numerous times over the course of this blog. You can’t expect people to repeat the details of every complex argument in every blog comment.

  29. Gravatar of Saturos Saturos
    10. January 2013 at 21:17

    Scott, you know that accomodative policy doesn’t necessarily mean increasing the money supply, right? So your talk of money printing is unnecessarily provocative. And you don’t want higher trend inflation to escape a liquidity trap, only temporarily higher, to maintain a constant level path of NGDP growth. Higher trend inflation would only help keep the central bank balance sheet permanently lower, but that wasn’t the issue. I bring this up after reading Bob Murphy’s post: http://consultingbyrpm.com/blog/2013/01/scary-scott-sumner-statements.html . You’ve scared away another potential supporter.

  30. Gravatar of Saturos Saturos
    10. January 2013 at 21:18

    accommodative, darn it.

  31. Gravatar of Prakash Prakash
    11. January 2013 at 02:38

    Hi Scott, Please consider this as a reply to both your previous post and this one.

    Sometime during the cantillon effect debate, I had made a comment that monetary expansion should involve giving every adult citizen a certain loan amount at an equal interest rate to everyone. Those who feel the interest rate is worth it, will take the loan. Others will ignore it. This interest rate becomes the instrument of policy. Monetary contraction would involve sale of present assets and after they are all sold, an increase in the rate.

    NGDP or Nominal wages can continue being the indicator of monetary policy. The central bank tries to target a slowly growing level of NGDP or median nominal wage.

    Almost no one thought this suggestion was even worth considering or commenting on. George (Selgin, I presume) had indicated that this meant I had lost faith in the entire financial system.

    But looking back to that comment and the recent posts, I think that the comment wasn’t an entirely loony one.

    In the last post you indicated the need for a policy that survives the zero bound and in this post you indicated that signalling a rate was not enough for the Swiss Central Bank. It had to make purchases and in fairly large quantities.

    I think that the MMT/MR folks believe that Market Monetarism will also face a “zero bound” of its own, which is the complete exhaustion of government securities to buy, while the target has not been hit. Beyond that, the central bank has to start buying private securities, which is fiscal policy, in your understanding.

    It is here where I think that my monetary/fiscal hybrid suggestion on sending the money via loans made to individual citizens should do better. It will never hit the zero bound until scarcity itself is abolished, and there is always scope of expansion of the amount given at low levels of interest.

    Also, every citizen has the potential to get richer, which is better than just the government getting richer. Your long run relies on the swiss and singaporean govts remaining uncorrupt with such a bounty staring at them. I’m a little skeptical of that in the very long run.

  32. Gravatar of RebelEconomist RebelEconomist
    11. January 2013 at 04:08

    “Rebeleconomist, There are lots of empirical studies that show the demand for base money slopes downward, as a function of the opportunity cost of holding base money.”

    A circular argument. If the market does not believe that the central bank will raise inflation, then they do not factor the higher inflation rate into the opportunity cost of base money.

  33. Gravatar of RebelEconomist RebelEconomist
    11. January 2013 at 04:19

    Switzerland is very different from Singapore. The reserves in Singapore have been built up slowly, and largely “fiscally sterlised” so that they effectively no longer of any (domestic) monetary policy significance.

    By contrast, Swiss reserves have been built up rapidly, and are owned against a pile of base money. That could yet generate an unacceptable rate of domestic inflation, and force the fixed rate policy to be abandoned. Moreover, with a fixed peg, the Swiss are effectively offering a backstop for holders of the euro. Their real test may come if it looks like the euro may break up, in which case the SNB’s balance sheet would explode. I suspect that in that case, the Swiss would rapidly resort to capital controls, rather than their undoubtedly infinite capacity to create base money to hold their peg.

  34. Gravatar of Bill Woolsey Bill Woolsey
    11. January 2013 at 05:03

    Scott:

    Any bank that doesn’t find issuing hand-to-hand currency profitable will stop.

    There are two possible outcomes. One is a payments system with no currency. This lasts until banks find it profitable to issue currency again. It is possible that would be never.

    The other is banks that issue currency to fund higher risk and longer term assets. In other words, while the private currency would be short, it would no longer be safe.

    If I ran a bank, I would just quit issuing currency. But there would be a profit opportunity to set up poorly-capitalized banks that issue currency by purchasing risky assets.

    Currency, of course, would be a very poor store of wealth, but currency is usually a poor store of wealth and its valuable role is for small hand-to-hand transactions, where it isn’t a store of wealth.

    Of course, if no one wants to use risky currency, then we are back to a cashless payments system.

    I can think of two realistic scenarios. One is that sound banks would give up issuing currency, and that weak banks would issue it. Because the weak banks are risky, there would be little demand for their currency as a store of wealth. Still, the currency would be available for use for small face-to-face transactions.

    An alternative scenario is that retailers would issue their own currency. But that is the same thing as a risky bank funding long and risky assets with short term funds. (Though some might be very well capitalized.) If this is a temporary situation, they might make it “redeemable” solely in their own products and give it an expiration date. Sort of like coupons.

    Your approach is to manipulate the rules defining the medium of account–the macroeconomic environment–to make the issue of hand-to-hand currency profitable. I think that is a horrible idea.

    I favor growth in nominal GDP so that prices will stay stable on average. If the issue of currency is not profitable, then there won’t be any currency issued.

    Your approach is more rapid growth in nominal GDP so that nominal interest rates will be high enough that government will find it profitable to issue hand-to-hand currency and, of course, using it will be less attractive and so the total amount of base money will be smalller.

    To cut to the chase–we need higher inflation all the time so that government can make more profit by printing currency.

    Or, of course, the central bank can purchase lots and lots of assets, and bear lots and lots of risk, while creating lots and lots of short and safe assets. (primarily reserve balances.)

    That is the approach I favor if the central bank issues currency. And the large balance sheet, too much central bank risk, “problem” should be solved not by shifting to a high inflation nominal target (particulatly the shifting part) but rather by privatizing the currency and making interest rates on the monetary authority’s negative.

    Let the private sector worry about how to issue hand-to-hand currency. If there is no solution, then there won’t be any.

  35. Gravatar of Bill Woolsey Bill Woolsey
    11. January 2013 at 05:15

    Saturos:

    Sumner is advocating a higher trend growth rate of nominal GDP. This will result in higher nominal interest rates all the time. Most economists would say that it would result in higher inflation on average, which results in higher nominal interest rates on average.

    It is still true that whatever growth rate of nominal GDP we have, the zero nominal bound is less likely to be a problem.

    But the demand for the monetary base on average is going to be higher, lower the trend growth rate of base money.

    With private currency, currency is no longer part of the base, and so there is a much lower base all the time. And if the interest rate paid on reserve balances is cut with other interest rates, “low” interest rates has no particular impact on the demand for base money.

    Government issue of currency means that the entire currency issue is base money and involves higher base money at all times, and it also puts a lower bound on the interest rate on reserve balances, because people can always shift from bank deposits to currency.

    The whole “too much base money” problem is the issue of government currency.

    Of course, with a private set up, currency will only be issued if someone finds it profitable. If they don’t, then we don’t have any hand-to-hand currency.

    It is true, of course, that at higher trend nominal GDP growth rates, the “problem” of private currency issuing being unprofitable would be less likely.

  36. Gravatar of Bill Woolsey Bill Woolsey
    11. January 2013 at 05:19

    Saturos:

    Oops:

    The more rapid the trend growth rate for the NGDPLT, the lower the average demand for base money. (Assuming currency serves as base money.)

  37. Gravatar of ssumner ssumner
    11. January 2013 at 06:06

    Federico, Good point, my virtue comment was ambiguous. Here are some possible interpretations:

    1. Low default risk, unlike Greece.

    2. Smart to stay out of the euro, so (as with Denmark) foreigners want to loan them money at low rates.

    3. Low trend NGDP growth, but of course that only lowers the nominal rate at which you borrow money, not the real.

    I think I had points one and two in mind, but should have been more specific.

    I have two answers to your send point:

    1. Let the market decide the size of the base.
    2. I think expectations would respond quickly. When the German hyperinflation ended in early 1924, the ratio of the base to GDP soared almost immediately.

    Saturos, You said:

    “Scott, you know that accomodative policy doesn’t necessarily mean increasing the money supply, right? So your talk of money printing is unnecessarily provocative.”

    I was making the opposite claim, that a more accommodative monetary policy probably would not involve printing money.

    Regarding your second comment, this post was focused on Switzerland. It’s quite possible that the Swiss could have an optimal monetary policy, and still see their base soar to over 100% of GDP via foreign hoarding of SF. My point was simple; if the Bob Murphy’s of the world don’t want central banks to buy up large swaths of the economy, and if THAT SEEMS TO BE HAPPENING UNDER “OPTIMAL” MONETARY POLICY (policy keeping Swiss prices stable), then raise the inflation/NGDP target.

    Prakash, If there is a zero bound problem in government securities to buy, I’d much rather eliminate it with a higher NGDP target.

    Rebeleconomist, You’ve just switched to an entirely different and unrelated topic. In any case, the public will “believe” in whatever the central bank actually does over time. If they do 7% inflation for 40 years in a row, the public will believe in 7% inflation. Count on it.

    On your second comment: A lot of inflation at a 1.2 exchange rate to the euro? What universe are you living in? They’ll be lucky to avoid deflation.

    Bill, For some reason I can’t follow the argument. Currency is a way for banks to borrow money at zero rates. If there is an alternative mechanism with a negative rate, why pay zero?

    I’m reluctant to move toward a currency system that only works if banks are at a significant risk of failing. What would a country like Canada do?

  38. Gravatar of Scary Scott Sumner Statements – Unofficial Network Scary Scott Sumner Statements - Unofficial Network
    11. January 2013 at 07:36

    [...] Post navigation ← Weaponized Keynesians? Three Blues and a pair of former Blues named to Africa Cup of Nations squads → Scary Scott Sumner Statements Posted on January 11, 2013 by admin At this point I think my analysis is superfluous. I just need to quote this guy. If you folks don’t see what I see, I don’t know what my commentary will add. These quotes all come from the same post: [...]

  39. Gravatar of Those who don’t like QE should root for a higher inflation target « Economics Info Those who don’t like QE should root for a higher inflation target « Economics Info
    11. January 2013 at 09:01

    [...] Source [...]

  40. Gravatar of Bababooey Bababooey
    11. January 2013 at 09:50

    I’m not sure what the SNB should do.

    I just thought that rare admission deserved a special commemoration.

    With affection, M.

  41. Gravatar of Jeff Jeff
    11. January 2013 at 10:06

    @Scott,

    I agree. I was only trying to point out that the idea that a central bank trying to depreciate its currency faces a “currency risk” akin to that of a private trader is nonsense.

  42. Gravatar of Max Max
    11. January 2013 at 19:19

    If currency pays interest, then seignorage is independent of interest rate. And of course no zero bound.

    This requires that currency doesn’t convert to/from electronic money (the unit of account) at 1.0, but at rate that changes daily. Therefore, every currency transaction requires a simple multiplication. Not a problem in the computer age.

    This is Miles Kimball’s idea which Bill discussed on his blog.

  43. Gravatar of ssumner ssumner
    12. January 2013 at 09:42

    bababooey. Thanks. I guess I should do that more often.

    Max, There are millions of sellers who still aren’t in the computer age. It wouldn’t work.

  44. Gravatar of Max Max
    12. January 2013 at 10:44

    When was the last time you bought something, and the seller computed sales tax BY HAND?

  45. Gravatar of Bill Woolsey Bill Woolsey
    12. January 2013 at 11:47

    Scott:

    Why do banks pay negative interest rates? Because their earning assets pay low interest rates.

    If all interest rates are negative, then no one would want to issue currency. (Are you assuming this?)

    If some interest rates are negative but other interest rates are significantly positive, then you can always set up a bank that profits by borrowing by the issue of zero interest currency. You just set up a risky bank.

    Of course, there are alternatives. Currency is all dated, and you pay a premium with you withdraw it. It expires after a month.

    Whatever solution the private sector determines is fine with me.

    But don’t hold the entire macroeconomy hostage to hand-to-hand currency.

    I don’t care if the drug dealers and tax evaders can’t find any currency.

    Max: I don’t agree with Kimball’s approach.

  46. Gravatar of ssumner ssumner
    12. January 2013 at 14:17

    Max, Many times, at collectable shows, garage sales, rare book shows, art shows, flea markets, used car sales to individuals. I do lots of transactions in cash. I know many people who carry $1000s in cash in their pockets and buy stuff with cash. (I don’t.) We are decades away for a cashless economy–but I agree we’ll get there someday. Miles is just too early.

    First they came for our guns, then they came for our money . . . .

    Bill, I just don’t see how you could get a stable currency supply in an economy were currency paid zero rates and risk free rates were negative. I don’t want a system built on moral hazard, where banks are taking my money, givening me zero interest cash and taking big gambles with my money.

    I don’t see the economy being held hostage to zero interest cash. There’s no reason we can’t have a monetary policy where equilibrium interest rates are positive, at least 99.9% of the time.

  47. Gravatar of Max Max
    12. January 2013 at 14:39

    Interest bearing currency is (slightly) inferior as a medium of exchange, but superior as a store of value. But the two roles aren’t completely unrelated – some people would transact more with currency if it were a better store of value.

    So you can’t say for sure that eliminating traditional currency would decrease the use of currency. It might increase it if the CB sets seignorage at a reasonable level.

  48. Gravatar of ssumner ssumner
    13. January 2013 at 08:47

    Max, I agree we could do it in a technical sense. It might even be optimal. But it’s a political nonstarter right now. Paper cash is still widely preferred to smart card cash.

  49. Gravatar of Bill Woolsey Bill Woolsey
    13. January 2013 at 15:02

    Scott:

    I don’t know about 99.9% of the time, but I would agree with 90% of the time–and I mean real interest rates. That is, with a 3% nominal GDP growth path (and 0% trend inflation rate,) 90% of the time, banks would find the issue of currency profitable.

    With privately issued currency, the demand for base money would be very low, and so the central bank’s asset portfolio would be very small.

    What happens in the 10% (or .1%) of the time when equilibrium real interest rates on deposits would be negative? Then banks simply don’t issue currency.

    I think you are assuming that bank deposits are claims to bank currency. That is wrong.

    If you want to hold safe bank deposits, you can. It is just that sometimes you might have to pay. The nominal yields would be negative.

    In those rare times, if you want to hold currency, you might just be frustrated.

    I have explained that even then, there might be risky currency available. But you wouldn’t have to hold it.

    And more importantly, your deposit in your bank would not be claim to risky currency.

    With private issue of currency, currency is not the medium of account or the medium of redemption. It is nothing like a system where currency serves as base money and is the medium of account and medium of redemption for deposits.

  50. Gravatar of Max Max
    13. January 2013 at 17:37

    Who said anything about smart cards? I’m talking about a system where paper money earns interest. The interest is delivered by changing the exchange rate (daily) with the unit of account. Given a price expressed in the unit of account, you multiply by some number with a lot of decimal points, which changes every day, to convert into paper money units. It’s the same math as adding units to an interest-earning bank account, but instead of adding units, the paper units get more valuable in terms of the unit of account.

  51. Gravatar of Geoff Geoff
    13. January 2013 at 17:48

    Max:

    “I’m talking about a system where paper money earns interest. The interest is delivered by changing the exchange rate (daily) with the unit of account.”

    That’s the kind of socialist monetary system I can support, because everyone who holds dollars will be receivers of new money from the Fed. That will be most fair, IMO.

  52. Gravatar of Geoff Geoff
    13. January 2013 at 18:41

    Don Geddis:

    “Look up “Austrian economics”. I suspect you’ll quickly find a community of people that you have much more in common with — rather than commenting here, where people don’t even agree with your initial assumptions.”

    What “initial assumptions” are you talking about?

    OK, I looked up “Austrian economics”, and I am not sure what to look for. I see wikipedia entries and blogs and whatnot, but I feel like I am being sent on a wild goose chase.

    I am not actually interested in finding people who agree with me. That would be boring, IMO.

    “The macro economy doesn’t improve and then people get jobs.”

    “Not quite. Companies today don’t hire and expand today, because they don’t expect to see enough revenue in the future to pay for current expansion. As soon as they start to believe that the future will have more NGDP, then they’ll immediately expand their hiring today.”

    I disagree. I think that those who spend money on labor, and expect to earn profits, take into account TWO demands and TWO prices, not just one demand and one price like you say. The two demands and prices are current goods/labor demand and prices, and final output demand and prices.

    Profits can be made in a context of next year’s prices expected to be higher or lower, if current goods and labor are set at prices taking the expected prices into account.

    I don’t agree that next year’s nominal demands and prices have to increase before current expansion can take place in REAL terms. For current prices are set by taking into account next year’s prices. If next year’s prices are expected to rise by 5% or fall by 5% by today’s price setters, then I don’t understand where you are getting the notion that today’s price setters will just sit on their thumbs, maintain an arbitrary set of prices today, and not care if those prices will lead to profits or losses given their expectations of next year’s prices.

    Why do next year’s prices have to be higher than today, before today’s price setters will set market clearing prices today? Is there something special about one expectation of future prices over another than leads to different price setting activity today?

    If today’s price setters are capable of setting current prices to generate 10% profit with expecting future prices of +5% next year, then why aren’t they capable of setting current prices to generate 10% profit with expecting future prices of -5% next year?

    Just consider the electronics industry. Many electronics goods of similar type decrease in price over time. Next year’s price for a 42 inch HD flatscreen TV, for example, is probably going to be lower than the same type of 42 inch HD flatscreen TV today. Yet investors, sellers, manufacturers, all of today’s price setters for factors of production, are somehow able to price current factors in such a way that they continually expand their business.

    I think you are conflating nominal spending growth with real spending growth. Expansion can and does occur in markets where prices fall over time.

    Why can’t that happen in all markets? Why can’t future expected lower prices be taken into account by today’s price setters, who will set today’s prices accordingly, given those expectations?

    “So the thing that needs to change, is their prediction of future cash flows. The whole key (as Ben J says above) is expectations.”

    Agreed! Yet I still don’t see why those expectations have to necessarily be greater than zero percent growth. If you are serious about the whole issue being expectations, rather than the actual values of those expectations, then the actual values of those expectations should not matter, because whatever those prices are, can be adapted to via a planned set of current prices that take into account those future prices.

    “deux ex machina … and went straight to “the macro economy improves” step.”

    “So you don’t understand how nominal changes can have real effects?”

    If those nominal changes are expected, and there are no surprises, then there should not be any “real effects.” If there are real effects with changes to money, then by definition those real changes cannot be expected, but unexpected.

    For example, if the Fed promised to double the money supply and double future spending next year, and everyone expects it, and everyone is aware of how it will affect their business, then the inflation will have zero effect on real activity, because the only thing that will change, are the numbers on income statements, price tags, and so on. Real behavior would be no different.

    Don’t you think that the large drop in aggregate spending 2008 to 2010 had real effects precisely because it was not expected by everyone, and not taken into account by everyone in their pricing behavior in the years prior?

    The fact that nominal changes can have real effects is true, only if the nominal changes are not able to be predicted and anticipated by everyone. How many plumbers and janitors and street sweepers (no offense to them) do you think correctly expected and understood what would happen in 2008-2010 to spending, and how their own incomes would be effected because of it? Give me a break.

    If you start talking about expectations, and you are talking about correct expectations, then it doesn’t matter what next year’s spending or prices will be. They can be ANYTHING, and everyone in the present will adapt to it by changing current prices to ensure they don’t incur losses.

    Now, what I also think is that unanticipated changes to money on the upside, i.e. unexpected inflation, are just as disruptive as unexpected changes to money on the downside, i.e. unexpected deflation. They are just as disruptive because they incur people who didn’t expect correctly with the same real losses. They just look different because in the former, nobody is incurring nominal losses, while in the latter, they are incurring nominal losses. The real losses are the same.

    “Before you comment further, it seems like you first ought to read a little, to at least understand the basics of the theory that you are criticizing. Have you read through Sumner’s FAQ, linked at the top right of every page on this blog?”

    Yes. Actually I have. It is precisely because I have delved into the FAQs, and links in the sidebar, that I had so many questions regarding the NGDP futures securities model. I have actually informed a few commenters here, of whom you seem to agree with, about how there are some incomplete and inconsistent things in the NGDP futures model, and they had no idea.

    Before you reply again, I think you ought to read a little more economics from other sources first, because I think I am somewhat more well rounded. The fact that you recommended me to not visit this blog, and visit only those blogs whose commenters I agree with, shows me that you are not very wide-read, but narrow read, and prefer to stay that way. That’s unfortunate, because what I have found in my experience is that sometimes I thought I knew something, but I realized I did not, because it took a different way to look at it, a different approach, a different perspective. My “aha” moments have been more frequent when I have surrounded myself with people with different approaches (which is one of the reasons I am posting here).

    If you don’t want to surround yourself with people with varying perspectives and various approaches, then I can only say that you will continue to make errors like believing that only next year’s prices matter, as if current prices cannot change, despite the fact that market prices are set by people in the present!

    “Have you read Sumner’s National Affairs paper on the whole idea?”

    I have.

    “How about at least watched his 15min video explaining our current recession?”

    I have not seen that video, but I imagine that because it’s only 15 minutes, it will be a summary of what I have already read in the sidebar.

    “You’re right, that I didn’t explain in my comment how printing more money results in more people having jobs. But Sumner has covered that subject numerous times over the course of this blog. You can’t expect people to repeat the details of every complex argument in every blog comment.”

    I fully appreciate that, but then I think to myself, you too cannot expect to have the same counter-arguments repeated to you if you don’t make the effort yourself to read those counter-arguments and understand them.

    I think I have a pretty good grasp of the monetarist arguments for how making more pieces of paper can increase employment and real goods, but I am hesitant to accept it, because I see some problems in the theory. I hope you aren’t so narrow minded that you infer from my disagreeing with it is SUFFICIENT grounds that prove I do not understand it. For that would be just pure anti-intellectual demagoguery.

    I respect you have an opinion, I respect that you believe what you believe, and I respect that you want to believe that more pieces of paper can make people wealthier. What I don’t respect is the way you have approached my posts, in this condescending, holier-than-thou manner, that suggests I have insufficient knowledge solely because I am not approaching economics the same way you are.

    I highly recommend that you change your demeanor to be more intellectual, and less “us versus them” that we would find in a schoolyard playground.

  53. Gravatar of ssumner ssumner
    14. January 2013 at 08:26

    Max, Given that most Americans cannot do simple math, that would be a nightmare.

  54. Gravatar of Geoff Geoff
    14. January 2013 at 13:45

    Ben J:

    “Changes in NGDP caused by movement in what Scott Sumner calls ‘the base’ do not ‘spread’ through the economy from the point of entry. Since the demand for base money (as defined by economists) is mostly endogenous, anyone who has an increase in demand for cash can simply go to an ATM. They don’t have to wait for you, you kind kind Primary Dealer you, to increase your nominal spending.”

    I wasn’t just talking about “the base.” The base is only one portion of the overall money supply.

    I am talking about money as such.

    If NGDP targeting is carried out by my total money sum growing by virtue of me selling stuff directly to the Fed, then I will support NGDP targeting.

    If you or someone else are the one who sells stuff to the Fed, then I will not support it.

    If EVERYONE were primary dealers and could sell their stuff directly to the Fed, then I guess I would support it, but it would be a giant waste of time, because it would not bring about the “stimulative” effects that occur on the basis of the Fed buying from only some people

    “So your lovely story, full of false concern about how you are not a demagogue and so are happy to be a Primary Dealer, doesn’t demonstrate anything but your own ignorance for the expectations component of NGDP.

    Your response to me is built on a straw man, Ben J, and I have not said anything that would contradict the “expectations component” of NGDP.

    I fully support you trying to make perfectly correct expectations of how much money the Fed will send to me, and of what you think I will do with the money, and what those people who receive that money from me will do, and so on. I will fully support you to make the best expectations you want, and set your prices accordingly.

    Saying I am ignorant of expectations is clearly only you trying to paint me in a negative light because I refuse to support NGDP targeting if I am not a primary dealer, which is what nice good little obedient boys and girls are supposed to do, now isn’t it?

    If you want ignorance, read your response and then my post you responded to. You will see that what you said doesn’t have anything to do with what I said.

    Cheers.

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