What the blogosphere does best

Think of the blogosphere as a sort of improv jazz band, where one blogger riffs off another.  Or a mind meld, where the collective brain is smarter than any individual brain.  Andy Harless started the ball rolling with his usual insightful metaphors:

Machismo is a type of commitment mechanism.

If you’re a perfectly rational nerd, people will always expect you to do the rational thing. You won’t be able to make credible threats unless it would be rational to carry out the threat. And it seldom will be. After all, how often is it really rational to whoop someone’s ass?

On the other hand, if you’re a tough, macho badass, people will always expect you to do the tough, macho badass thing. You’ll always be able to make credible threats, because carrying out threats is always the tough, macho badass thing to do. And since the threats are credible, you mostly won’t have occasion to carry them out.

This principle has a traditional application to monetary policy. If your central banker is a perfectly rational nerd, he’s going to let the inflation rate get too high, because he won’t be able to make a credible threat to cause a recession. Obviously you want a tough, macho badass. You want the kind of central banker that likes to pick up small animals in his talons so that he can crush them to death and serve them for dinner.

And then Cardiff Garcia takes it one step further:

To use the slightly altered terms of Harless, you can have rational nerdery and macho badassery, but you can’t have both.

Or maybe you can?

Yet an ideal monetary policy framework does include both. The rational nerdiness is there to correctly interpret economic conditions and diagnose the correct policy, while the macho badassery is needed to convince the markets and economic agents generally that the Fed will do what is necessary to carry out this solution, ie to influence expectations.

This is difficult so long as embracing the former means giving up the latter.

All of which has been a long windup to saying that the appeal of the Evans Rule, and if we ever get it, some variation of NGDP level targeting, is this: theyinstitutionalise the macho badassery, which in a dual-mandate framework can only be applied to one of the two mandates.

Not so with an Evans Rule or NGDP level targeting, where it can be applied symmetrically — because in each it is well understood when the “recklessness” towards either unemployment or inflation kicks in, and when it will end. And therefore it ceases to be reckless.

I like that last line.  I’ve always been bothered by Paul Krugman’s “promise to be irresponsible” line.  Not that the comment wasn’t brilliant, in a counterintuitive sort of way.  But rather because it is an obvious turn-off to central bankers—who aren’t typically the Hunter S. Thompson type, if you know what I mean.  Even worse, it’s not even needed.  NGDPLT is the responsible thing to do, and it works.

PS.  Last year I had this to say on the topic:

This provides one more reason why inflation targeting should be abandoned and replaced with NGDPLT.  If inflation targeting can only work at the zero bound if austere conservative central banks promise to behave like drunken teenagers with the keys to their dad’s Porsche, then it can never work.

The post I took that quotation from has interesting quotes from Tim Duy, Matt Yglesias and Daniel Kuehn.

HT:  123


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17 Responses to “What the blogosphere does best”

  1. Gravatar of Christopher Rubicam Christopher Rubicam
    22. February 2013 at 15:24

    I follow the discussion about how NGDPLT works, but I don’t understand it deeply. You often have stated the desirability of 2% inflation with 3% real GDP growth. Why not 1% or 0% inflation, especially as you are generally a self-professed deficit hawk? Are you saying that there is a “natural” level of about 2% inflation or that our human psychology resonates with that relatively low level of inflation? Would it be possible to target NGDPLT without inflation?

  2. Gravatar of Doug M Doug M
    22. February 2013 at 16:22

    Game theory of chiken…you must always project the image of machismo whether or not you actually intend to fight. If you appear to be a chicken you will be challenged.

    If we extend this to central bankers, central bankers must talk tough. The must create at least the illusion that they will do all of the tough and unpopular measures it takes to maintain a stable price level. All Fed members should talk like inflation targeting hawks even if they are not.

  3. Gravatar of Benjamin Cole Benjamin Cole
    22. February 2013 at 16:54

    Inflation taregting?

    Jeez, even at that the Fed is failing miserably

    Seven out of the last nine CPI readings have been flat to down…

    This is an “easy” Fed policy?

    I thought “easy” meant you have some inflation….

    For many, many years I wondered about Japan, why they were stuck…now, I am beginning to understand…..

  4. Gravatar of Philo Philo
    22. February 2013 at 17:59

    A “macho badass” or a “drunken teenager” acts irrationally. A Sumnerized central banker hardly acts at all; he just operates on automatic pilot. But a Sumnerized central banker is what we want (if we’re stuck with a central bank). So Harless is wrong that we want a macho badass. His remarks aren’t clever; they’re just misguided.

  5. Gravatar of TravisV TravisV
    22. February 2013 at 19:07

    Dear Blog Readers,

    Could someone please explain to me exactly why U.S. stocks typically go up when the Japanese central bank surprises markets with easier monetary policy?

    Thank you very much.

  6. Gravatar of marcus nunes marcus nunes
    22. February 2013 at 19:32

    TravisV
    Maybe because the market hopes in the end ‘Yale will overwhelm Princeton’
    http://thefaintofheart.wordpress.com/2013/02/23/behind-the-abe-putsch/

  7. Gravatar of What the blogosphere does best | Fifth Estate What the blogosphere does best | Fifth Estate
    22. February 2013 at 20:07

    [...] See full story on themoneyillusion.com [...]

  8. Gravatar of TravisV TravisV
    22. February 2013 at 20:27

    So that is the one and only reason? The market hypothesizes that FOMC members will see Japanese stocks go up and unemployment go down and suddenly realize “Hey, we should do the same thing here in the U.S.!”

    There isn’t more to it than that?

  9. Gravatar of TallDave TallDave
    22. February 2013 at 20:46

    This provides one more reason why inflation targeting should be abandoned and replaced with NGDPLT. If inflation targeting can only work at the zero bound if austere conservative central banks promise to behave like drunken teenagers with the keys to their dad’s Porsche, then it can never work.

    Ah, I was wondering about this the other day. A lot of people conflate NGDPLT with money-printing, but most market monetarists believe the sort of asset-buying the Fed has been forced into won’t be necessary when targeting NGDP, correct? Like being stuck in first gear, vs being in fourth, you have to rev a lot higher to get the same effect.

    I think I’ve mostly converted to NGDPLT because the more I think about inflation the more ineffable it seems, and the worse a basis for monetary policy.

  10. Gravatar of nickik nickik
    22. February 2013 at 20:50

    @Christopher Rubicam

    Your question has been answered more or less in this blog allready.

    http://www.themoneyillusion.com/?p=592
    http://www.themoneyillusion.com/?p=3059
    http://www.themoneyillusion.com/?p=15240

    These are all post that go more or less into diffrent amounts of NGDP growth and potential deflation.

    I would sum it up with this, from the point of basic theory the NGDP growth rate does not really matter ie. both -10% and +10% would be fine.

    Now there are practical reason why you probebly some people argue for some numbers and others dont. This blog is called the money illusion, one reason for that is that it is easier to give workers wage rises then wage cutes in times of deflation. So its only in the heads of workers. Thtas why you might want a NGDP growth that is begger then RGDP growh.

    There are those who call for 0%, targeting a NGDP that is equal about equal to RGDP or avg. RGDP ofer some timespan. This would in theory reduce menu costs and things like that.

    Again others as you can see in the post above call for a productivity norm, meaning that prices should fall when the economy is growing, imagen if the NGDP growth was 0%, then you would have a negative GDP deflator of about equal to the real growth rate.

    There are many reasons why some call for this and that but in reality most people would be fine with anything from 0% to 7%. The one real issue is trend, you cant have 5% growth for 20 years and then just say, from now on we will have 0% growth. Thats probebly a bad idea. So most market monetarist at the moment call for a 3-5% growth trendline.

  11. Gravatar of Woj Woj
    23. February 2013 at 02:11

    Fed Puts Macho Bada$$ery At Risk
    Inflation expectations and unemployment are moving in the wrong direction since the policy change. The Fed has taken a big risk with its established inflation credibility. I fear the results will be very disappointing.

  12. Gravatar of ssumner ssumner
    23. February 2013 at 07:43

    Christopher, You said;

    “You often have stated the desirability of 2% inflation”

    Actually I’ve never claimed that 2% inflation is desirable, indeed I don’t think inflation matters at all. As for NGDP growth, it had been trending up at about 5% before the crisis, so these expectations were embedded in wage and debt contracts.

    I am not wedded to 5% in the long run, but think it’s a reasonable compromise as higher NGDP growth distorts capital markets and lower NGDP growth distorts labor markets. So there’s a tradeoff.

    Philo, I think Harless supports NGDPLT.

    Travis, The global economy is not a zero sum game. What’s good for Japan is good for America.

    TallDave, That’s right.

  13. Gravatar of dtoh dtoh
    23. February 2013 at 08:11

    Scott,
    Harless, Garcia, and Krugman are all off base. NGDP level targeting has nothing to do with irresponsibility or badassery. It’s responsible, rationale and predictable.

    The problem with NGDP targeting is that it allows central bankers to be replaced with an application running on an iPhone.

  14. Gravatar of Geoff Geoff
    23. February 2013 at 09:13

    Dr. Sumner:

    “As for NGDP growth, it had been trending up at about 5% before the crisis, so these expectations were embedded in wage and debt contracts.”

    The last time I checked, economics profs, bond traders, and unions did not take into account NGDP when dealing with pricing of contracts. Rather, they all focused on price levels.

    NGDP has been growing at 4-5% since 2010, and yet interest rates are still on a downward trend. Why? Because price inflation has not increased abnormally. If price inflation picked up, to say 5% or 10% annualized, then you might see interest rates and wage contracts increase, even if NGDP is not increasing by that same rate.

    I don’t buy this claim that wage earners and bond traders take into account NGDP. It doesn’t seem to hold up.

  15. Gravatar of ssumner ssumner
    23. February 2013 at 09:24

    dtoh, I think Harless and Garcia would agree with you.

    Geoff, You said;

    “The last time I checked, economics profs, bond traders, and unions did not take into account NGDP when dealing with pricing of contracts. Rather, they all focused on price levels.”

    Nope, it’s NGDP they care about. For example, suppose RGDP growth expectations rise sharply but inflation expectations are unchanged (late 1990s–2000) If they cared about inflation, interest rates would not rise. But faster real growth causes interest rates to rise, showing they actually care about NGDP growth.

    Ditto for labor markets, if inflation is high but NGDP is well behaved, wages will stay well behaved.

    You may be right about econ profs, but they don’t matter.

    Interest rates also reflect the level of NGDP, which is why they are currently low. BTW, inflation has not slowed since 2010, so even if you were right the example you provide does not support your argument.

  16. Gravatar of Geoff Geoff
    24. February 2013 at 09:25

    Dr. Sumner:

    “Nope, it’s NGDP they care about. For example, suppose RGDP growth expectations rise sharply but inflation expectations are unchanged (late 1990s–2000) If they cared about inflation, interest rates would not rise. But faster real growth causes interest rates to rise, showing they actually care about NGDP growth.”

    I don’t think you’re showing that econ profs, bond traders and unions care about NGDP with that statement. I think you’re just stating the theory that interest rates rise with higher real growth.

    Except interest rates do not rise with higher real growth. Higher real growth makes prices fall, ceteris paribus. Selling more goods at lower prices does not increase nominal revenues, hence profits, and hence interest rates.

    Perhaps you are taking the typical empirical result that booming economic periods are usually associated with inflation, and concluding that the higher interest rates caused by inflation were caused by higher real growth instead?

    Economic growth can occur on the basis of unchanged nominal spending categories (investment, consumption, wages, interest rates, etc), and output increases by virtue of increasing real productivity due to technological progress and capital accumulation. The same nominal interest rates can be associated with lower, the same, or higher real growth.

    “Ditto for labor markets, if inflation is high but NGDP is well behaved, wages will stay well behaved.”

    I think that this is again an assertion of a theory, rather than an empirical one that is related to “Econ profs, bond traders, and unions care about NGDP”, namely, the theory that wages are associated with NGDP.

    Except wages stay “well behaved” even if NGDP is volatile, as we saw 2008-2010 (sticky wages). Wages also declined relative to NGDP since the early 1970s. So both short term and long term there is a problem with connecting wages to NGDP.

    “You may be right about econ profs, but they don’t matter.”

    You matter! Through your economic activities you are also influencing the various statistics you are looking at.

    “Interest rates also reflect the level of NGDP, which is why they are currently low.”

    This is also a statement of theory. Yet other theories are also consistent with this data.

    NGDP annual growth has been above 4% since 2010, and yet interest rates are continuing in what appears as a long term decline.

    NGDP annual growth was around 5% from the mid-1980s to 2008, and yet interest rates continued to fall:

    http://research.stlouisfed.org/fredgraph.png?g=fS5

    “BTW, inflation has not slowed since 2010, so even if you were right the example you provide does not support your argument.

    One could argue that that’s precisely why wages have not slowed since 2010!

    Most unions take into account cost of living adjustments, not NGDP adjustments.

    Most bond traders take into account price inflation when calculating interest rates, not NGDP.

    I really don’t see how you are getting the notion that people care about NGDP, other than through theoretical assertions that don’t have a monopoly on explaining historical data.

  17. Gravatar of ssumner ssumner
    25. February 2013 at 09:23

    Geoff, You said;

    “I don’t think you’re showing that econ profs, bond traders and unions care about NGDP with that statement. I think you’re just stating the theory that interest rates rise with higher real growth.

    Except interest rates do not rise with higher real growth. Higher real growth makes prices fall, ceteris paribus. Selling more goods at lower prices does not increase nominal revenues, hence profits, and hence interest rates.

    Perhaps you are taking the typical empirical result that booming economic periods are usually associated with inflation, and concluding that the higher interest rates caused by inflation were caused by higher real growth instead?”

    Lots of mistakes here. If faster real GDP growth raises rates, even holding inflation constant, that suggests that NGDP does matter. And no, the empirical evidence that real growth raises rates is overwhelming, and not just due to higher inflation expectations.

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