How does market monetarism differ from new Keynesianism?

Paul Krugman’s reaction to the results of The Great Market Monetarist Test has created some confusion.  Some of his supporters tried to convince me that 2013 wasn’t a good test of MM.  You don’t have to convince me, I already believe that. For years I’ve been preaching that there is “no wait and see.”   It’s Krugman who claimed that 2013 was a test of market monetarism.  He’s the one you have to convince.  BTW, Alex Tabarrok, David Beckworth, Bill Woolsey, and Bob Murphy all have excellent posts on this topic.

Obviously it was a sort of crude test, and it’s better that the ex post results came in as we predicted, than otherwise.  But the real test is how policy initiatives affect expected NGDP growth. And we (should) know that right away.

Now that we’ve “won,” there’s been some discussion about exactly what “market monetarism” is. There are clearly many issues where we overlap with new Keynesians (NKs), indeed even more so now that Romer, Woodford, Frankel, etc., have endorsed NGDPLT.  So why not call it market Keynesianism? After all, we agree that wages and prices are sticky.  We agree that temporary monetary injections are not effective.  We don’t want to target the money supply.  So what distinguishes MM?

I suppose there are a number of possible answers, starting with why the hell is NK not called “new monetarism?”  But I think a good place to start is with monetary policy.  Unfortunately the terminology in this field is vague.  In the NK model is the monetary base the instrument, the fed funds rate the short term target, and inflation the policy goal?  Or is the fed funds rate the instrument?  I’m going to trying to sidestep linguistic disputes by describing the process without referring to “instruments.”

As far as I can tell NK goes something like this:

1.  The Fed sets a policy goal.  Let’s assume 2% inflation for simplicity, although it’s actually inflation plus the output gap.

2.  The Fed targets the fed funds rate at a position where they believe the gap between the fed funds rate and the Wicksellian equilibrium rate is most likely to lead to on-target inflation, based on their structural model of the economy.  The gap between the fed funds rate and the Wicksellian equilibrium rate is a sort of policy indicator; it describes the stance of monetary policy.  The fed funds rate is traditionally adjusted via changes in the base, although changes in the interest rate on reserves can also work, and may be used in the future.

How does market monetarism differ?

Some people might point to the fact that I talk much more about the base than do the NKs.  But I don’t think that’s the key.  Like old style monetarists we don’t see the base as indicating the stance of policy.  Unlike old style monetarists, we don’t think any monetary aggregate is a reliable indicator of the stance of policy, although some MMs think broad aggregates are more useful than I do.  So it’s not the base.  I may define the base as “money,” but fundamentals never hinges on definitions.

I think the key is that MMs see market forecasts of NGDP growth as playing roughly the role that the fed funds rate minus the Wicksellian equilibrium rate plays in the NK model.  It’s the indicator of the stance of policy.  It’s easier to explain this difference using inflation targeting, however, so let’s start there first.

NKs would adjust the base in order to move interest rates to a position where their structural model predicted on-target inflation (using Lars Svensson’s target-the-forecast approach.)

MMs would adjust the base in order to move the TIPS spread to a position where the market predicted on-target inflation.

Thus in an inflation targeting world it’s actually pretty easy to explain the difference between NK and MM.  The NKs use interest rates as an intermediate target, and they rely on structural models. The MMs use TIPS spreads as an intermediate target, and rely on the market, not structural models.

Things get a bit trickier when we shift over to the preferred target of the MMs (and increasingly the NKs), which is NGDPLT.  Now we don’t have a market indicator such as the TIPS spread.  What do we do in that case?  The first answer is that we should obviously create and subsidize trading in a NGDP prediction market.  That’s a big part of my agenda.  In the absence of that market, we try to estimate the market forecast of NGDP by looking at a wide range of asset prices (including TIPS spreads) as well as (perhaps) the consensus of private forecasters.  Unfortunately this is a very imprecise process, and that fact obscures what is really going on. It’s easy for me to explain that a market price such as TIPS spreads is the MM equivalent of the fed funds target.  But the “shadow” market NGDP growth forecast is a much fuzzier concept, which makes MM seem more like NK than it really is. It’s easy for NKs to mistake the shadow NGDP forecast as a sort of Svenssonian policy goal, whereas it’s actually the intermediate target, which can be “measured” (actually merely estimated) in real time, just like the fed funds rate.

Because NKs rely on an interest rate intermediate target, they worry a lot about the zero bound, and this also makes them more optimistic about fiscal stimulus when at the zero bound.  In contrast, there is no zero bound on TIPS spreads, and would not be a zero bound on NGDP futures prices, if such a market were created. But that leads to another problem, which economists haven’t thought through clearly enough.  Does the fact that TIPS spreads have no zero bound really take away the “liquidity trap” problem? Can it really be that simple?

Yes and no.  It takes away the direct problem of not being able to lower interest rates below zero, but not the problem lurking in the background, which is that the central bank might have to buy so much stuff to hit the TIPS target than monetary policy bleeds over into fiscal policy.  I think that problem is grossly exaggerated. The mistake NKs make is that they see central banks buy a lot of stuff, fail to hit their target, and then assume that under MM policy they’d have to buy much more stuff.  Actually they could get by with buying much less, but that’s hard to prove to the satisfaction of NKs.  Thus in desperation they end up discussing extreme policy innovations, such as Miles Kimball’s proposal of negative interest on money. That policy would work, but is unnecessary in my view.

One area where NKs and MMs seem to agree is that there is an inflation target or NGDP target path that is high enough to make the zero bound problem go away.  I think we both agree that in that sort of world the fiscal multiplier is roughly zero and MMT is nonsense.  But it’s hard to be certain because NKs like Larry Summers can be very hard to read.  Joe Stiglitz would certainly not agree.

In my view the now famous Krugman “test” of market monetarism is an indication of the pathetic state of modern macro.  We are still in the Stone Age.  Future generations will look back on us and shake their heads.  What were they thinking? Why didn’t they simply create a NGDP futures market?  They’ll look back on us the way modern chemists look back on alchemists.  It’s almost like people don’t want to know the truth, they don’t want answers to these questions, as then the mystical power of macroeconomists with their structural models would be exposed as a sham. Remember when the Christian church produced bibles and sermons in a language that only the priesthood could understand?  That’s macroeconomics circa 2013.

To summarize this overlong post, the nonexistence of an active NGDP prediction market is why people have so much trouble understanding what MM is.  If that market existed then the concept of MM would be far easier to explain.  Indeed quite simple.

HT:  This post was motivated by a Kevin Donoghue comment and a tweet by Andy Harless.


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49 Responses to “How does market monetarism differ from new Keynesianism?”

  1. Gravatar of dtoh dtoh
    5. January 2014 at 18:16

    Scott,
    I’m not sure the NGDP futures market is so critical. As long as the Fed has a consistent level target, the Wicksellian rate will be steadier and therefore asset prices become a pretty good predictor of NGDP. Also I tend to think the market will auto correct and steer itself if it knows the Fed will make up for any misses.

    Slightly aside, I think a big reason for the lack of consensus on monetary economics is the ideological desire for larger government by some economists, which makes them reluctant to admit fiscal policy is a very blunt and often ineffective tool.

  2. Gravatar of ssumner ssumner
    5. January 2014 at 18:41

    dtoh, I agree it’s not critical for implementation of NGDPLT, but it is critical for getting the rest of the world to understand what we are talking about.

  3. Gravatar of dtoh dtoh
    5. January 2014 at 18:50

    Scott,
    A futures market would certainly make things clearer, but as I said, I think a lot of the resistance is ideological.

    The other thing you keep running into is the ZLB issue…. and as I have said countless times, I believe it would be helpful to present the transmission mechanism as an asset price (or asset exchange for goods and services) model if you want to overcome the ZLB issue.

    It’s relatively easy to understand that economic players will exchange more financial assets for goods and services if asset prices rise and/or expected NGDP (the Wicksellian rate) rises.

  4. Gravatar of LK Beland LK Beland
    5. January 2014 at 20:05

    Why are NGDP futures market preferable to a TNGDPPS (TIPS, where I is replaced by NGDP) market? The latter would not need to be subsidized and would serve both as a monetary policy instrument and as a way for the government to refinance its debt. Is it because of market liquidity concerns?

  5. Gravatar of Dtoh Dtoh
    5. January 2014 at 20:11

    LK
    Yours is actually a better solution. I’ve proposed it many times here under the acronym GAINS (Growth Adjusted Income NoteS). I’ve actually structured and executed billions of dollars in index linked notes and have some knowledge of what I speak…. But you won’t convince Scott. He wants a pure futures instrument.

  6. Gravatar of JP Koning JP Koning
    5. January 2014 at 20:44

    “Does the fact that TIPS spreads have no zero bound really take away the “liquidity trap” problem? Can it really be that simple?”

    I don’t think it takes away the problem. The issue, at least as I see it, is that there may be certain situations in which a central bank has made so many permanent additions to the supply of base money that subsequent issuance of base has no effect on the price level. In this case it doesn’t matter if the intermediate target is the fed funds rate, TIPS spreads, or the shadow NGDP forecast since in all cases base money increases have lost their ability to move prices to target. The instrument, not the intermediate target, has gone AWOL.

    Because most central banks pay interest on reserves, it doesn’t take much of an increase in the base these days to render further issuance toothless.

    The next tool a central banker can turn to is reductions in IOR, but once that hits zero than that tool is broken too… unless you can go negative.

  7. Gravatar of Don Geddis Don Geddis
    5. January 2014 at 22:11

    JP Koning: “subsequent issuance of base has no effect on the price level

    So you imagine that the central bank expands the money supply, and then the situation crosses some magic threshold, and no subsequent expansion has any effect on the price level? So the Fed could just start buying up all assets on planet earth, and prices would never rise? The US government could obtain ownership of the entire planet, in exchange for little pieces of fiat paper?

    What possible model of the economy could you have, where that makes the least bit of sense?

  8. Gravatar of lxdr1f7 lxdr1f7
    6. January 2014 at 03:47

    Is there any consideration of how a change in MB affects expectations and TIPS? The transmision mechanism must play a role.

    It seems vital to take into account whether MB is expanded to entities that wont change expectations by accumulating excess reserves or entities that employ the MB into the economy.

  9. Gravatar of Bill Woolsey Bill Woolsey
    6. January 2014 at 04:34

    I think the key difference between new Keynesians and Market Monetarists is interest rates.

    Market Monetarists favor allowing all interest rates to be set by the market and don’t favor having the central bank make any commitments about future interest rates. In particular, Market Monetarists do not favor quantitative easing as a means of lowering long term interest rates.

    Why “Monetarism?” It is because we consider spending on output to important and understood it to depend on the quantity of money and the demand to hold it, or nearly equivalently, the quantity of money and velocity.

    It is different from “Old Monetarism” on policy grounds because Market Monetarists do not favor targeting any measure of the quantity of money. We believe that the quantity of money should adjust to demand to hold it give a level target for spending on output.

    A theoretical difference is the long and variable lags of the effects of changes in the quantity of money. The Market Monetarist view is that expected future changes in the quantity of money effect the economy now.

  10. Gravatar of Benjamin Cole Benjamin Cole
    6. January 2014 at 05:15

    Excellent blogging.

  11. Gravatar of ssumner ssumner
    6. January 2014 at 05:17

    LK, The problem with TIPS is that the TIPS spread gets distorted during liquidity crises, because the nominal bond is more liquid. That problem doesn’t occur with CPI futures (or NGDP futures.)

    JP Koning. You must have stopped reading when you got to the sentence you quoted. You need to finish reading the post. If you did finish I’d suggest telling me why my analysis is wrong. You did not address that at all. Surely you are not claiming that the Fed could buy the entire planet with zero interest cash, and have no inflation?

    lxdr, Yes, I have dozens of posts that discuss the transmission mechanism.

    Bill, You said;

    “I think the key difference between new Keynesians and Market Monetarists is interest rates.”

    Yes, that was basically my point. The difference is mostly about interest rates.

  12. Gravatar of Dan W. Dan W.
    6. January 2014 at 06:00

    Scott,

    I’ve highlighted below what I feel is the most helpful paragraph you have written on your blog. Its value is the admission that at the foundation of your theory rests a lot of uncertainty. You will need something much stronger than “I think” and “That’s hard to prove” if you are to persuade the unpersuaded. On the other hand, I am all for giving your theory a test but what would be the controls and limits of that test?

    BTW, there seems to be a daily cap on the posts I can make to your blog so if I fail to respond to questions it is not for lack of trying.

    “…the central bank might have to buy so much stuff to hit the TIPS target tha[t] monetary policy bleeds over into fiscal policy. I think that problem is grossly exaggerated. The mistake NKs make is that they see central banks buy a lot of stuff, fail to hit their target, and then assume that under MM policy they’d have to buy much more stuff. Actually they could get by with buying much less, but that’s hard to prove to the satisfaction of NKs.”

  13. Gravatar of lxdr1f7 lxdr1f7
    6. January 2014 at 06:16

    ” I have dozens of posts that discuss the transmission mechanism.”

    Can you refer me to any? I remember you commenting that the transmision mechanism didnt matter.

  14. Gravatar of An igyt An igyt
    6. January 2014 at 06:56

    Meanwhile DeLong weighs in with :

    “Believers in market monetarism thought that fiscal policy was nearly irrelevant, and that the adoption of QE III would substantially affect long-term interest rates and substantially spur the recovery relative to baseline

    Believers in regime change thought that if markets were convinced that the Federal Reserve would pursue QE III until the output gap shrank … expectations of the future price level would rise and those expectations would pull current nominal demand up…”

    where “Regime Change” is treated an alternative to MM, not a complement.

    Is this at all sensible? Seems to me the price expectations are as much of the MM argument as are interest rate; and the question of whether fiscal policy matters is something of a sideshow, that it certainly can have Keynesian effects if the central bank displays the right kind of incompetence. So either Brad DeLong or I have deeply erroneous idea of what you have been arguing. And he is smarter…

  15. Gravatar of Max Max
    6. January 2014 at 07:04

    Is it not also the case that New Keynesians believe *fiscal* government stimulus plays an important role, whereas market monetarists believe monetary policy is the only thing needed?

  16. Gravatar of Roger Sparks Roger Sparks
    6. January 2014 at 07:17

    Scott,

    OK, I understand that NK and MM advocates have different targets. How do each measure the actual stimulus that has been applied over the last 40 years or more?

  17. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. January 2014 at 07:25

    Paul Krugman
    “…Incidentally, these other factors are why I don’t take seriously the claims of market monetarists that the failure of growth to collapse in 2013 somehow showed that fiscal policy doesn’t matter. US austerity, although a really bad thing, wasn’t nearly as intense as what happened in southern Europe; it was small enough that it could be, and I’d argue was, more or less offset by other stuff over the course of a single year…”

    This is a testable claim. I will assume by “southern Europe” he means the GIPS. By “intense” I will assume he means the amount of fiscal austerity in any given year.

    Using one of Krugman’s favorite measures of fiscal austerity, the change in the cyclically adjusted primary balance (CAPB) from the IMF Fiscal Monitor, the CAPB increased by the following amounts in the US, the Euro Area, the GIPS as a whole (weighted by potential GDP using IMF estimates of potential GDP), Greece, Italy, Portugal and Spain in 2010 through 2013:

    Entity—-2010–2011–2012–2013
    US——-(-0.2)–1.0—1.1–2.3
    Euro-Area(-0.2)–1.5—1.1–1.1
    GIPS——-1.1—1.6—2.3–0.9
    Greece—–6.4—4.9—3.3–2.2
    Italy——0.1—0.9—2.1–0.5
    Portugal-(-0.2)–7.1-(-0.9)-1.4
    Spain——1.7—1.0—3.0–1.2

    Note that Greece, Italy and Spain started fiscal austerity in calendar year 2010 and the US, the Euro Area as a whole and Portugal started a year later. Note also that US fiscal policy was only less austere than the Euro Area as a whole in 2011. And finally note that 2013 was the first year that US fiscal policy was more austere than the GIPS, but that the intensity of its austerity in 2013 was as great as the fiscal austerity in the GIPS in 2012 which was the peak year for fiscal austerity for those nations as a group.

    Looking at the individual GIPS nations we see that the level of fiscal austerity in the US in 2013 was less than that in Greece in three out of four years, was greater than the worst year of fiscal austerity in Italy which was 2012, was greatly exceeded by Portugal only once in its one truly horrendous year of fiscal austerity which was 2010, and was slightly exceeded by Spain’s worst year of fiscal austerity which was 2012.

    I am gratified that Krugman seemingly acknowledges that the US fiscal austerity of 2013 was greater than anything that the Euro Area has ever experienced as a whole. However, I think by objective measures, measures Krugman himself uses, the intensity of fiscal austerity that the US experienced in 2013 is also as intense as the worst year of fiscal austerity experienced in southern Europe as a whole.

  18. Gravatar of JP Koning JP Koning
    6. January 2014 at 08:15

    Dan/Scott,

    Yes, as long as the Fed buys assets at their fundamental value, at some point subsequent purchases no longer cause inflation. See here.

  19. Gravatar of dtoh dtoh
    6. January 2014 at 08:44

    IMHO, the difference between NK and MM is as follows:

    TARGET
    NK – An uncertain combination of inflation and employment
    MM – NGDPLT

    TOOL
    NK – Interest rates
    MM – Asset purchases (QE, OMO, or whatever you want to call it)

    TRANSMISSION MECHANISIM
    NK – Price of credit/expectations
    MM – Quantity of money/expectations

  20. Gravatar of Randomize Randomize
    6. January 2014 at 10:18

    Scott,

    No need to subsidize a futures trading market. Just get the treasury to start issuing NGDP-adjusted bonds and then target the spreads. The big “risk” in bonds is missing out on a boom in the economy (i.e. growing NGDP) so investors should be interested. Plus, as an entity that makes its money through taxes, a percentage of that economy, the US government would eliminate a fair amount of it’s own risk by tying its debts to its income.

    Win-win with no messy subsidy program.

  21. Gravatar of Don Geddis Don Geddis
    6. January 2014 at 10:48

    JP Koning: OK, I read your “buying up” blog post, and your “Google parable”. Your own analogies have completely misled you. You imagine that Google shares become the Medium of Account, and then claim “I doubt that Google’s liquidity premia will be very large“. Almost certainly false. If Google shares came to be the MOA, used to pay taxes, to denominate mortgages, etc., then the liquidity premium would surely dominate the value of the shares. Secondly, Google shares do have a fundamental value (a claim on future cash flows). But you seem to think this is relevant to US dollars: “because the Fed now owns less income-generating assets than before, thereby rendering it more difficult to make future interest payments to depositors.” No, the Fed doesn’t use its purchased assets to make future payments (it just prints whatever cash it needs), and US dollar bills offer no claim rights on whatever assets the Fed owns. So your analogy completely breaks down.

    With US dollars, “fundamental value” is zero. All the value is liquidity premium, and so QTM (+ velocity/HPE) completely determine the price level. There is no value floor (as has been demonstrated numerous times in history via hyperinflation).

  22. Gravatar of Max Max
    6. January 2014 at 12:42

    The question I have about “buying everything” as a means of circumventing the zero bound: maybe you can hit your current target, but how do you avoid overshooting future targets?

    The answer can’t be, you sell down the assets, because the MM premise is that you never sell (because otherwise it would be a “temporary” purchase, and have no effect).

    (Actually if the CB is targeting anything at all, then there can never be “permanent” changes to the base, since the base depends on the target).

  23. Gravatar of JP Koning JP Koning
    6. January 2014 at 14:53

    Don, good replies.

    The medium of account needn’t be a very liquid asset. People might denominate prices in clams but do all their trading with oysters… in which case oysters would have a higher liquidity premium than the clam MOA.

    But more relevant to my Google piece is that in a highly competitive economy, asset issuers will compete to issue liquid exchange media, pushing liquidity premia down to their cost of production. That’s why I think Google’s liquidity premium would be small, whereas a monopoly issuer like the Fed might sport a larger premium.

    You’re right that if dollars are pure liquidity premium, then purchases can always push the price level up a little further. However, in the same way that a Google share is a claim on underlying Google assets, ownership of a dollar provides one with a “first and paramount” lien on Fed assets. What’s more, hyperinflation is not proof that there is no “value floor” whatsoever — it could also be indicative of declining fundamental value.

  24. Gravatar of Geoff Geoff
    6. January 2014 at 17:45

    NGDP prediction markets would not convey information about NGDP, for the return implied in futures securities would be based on the discretionary interest rate the Fed would pay on margin accounts.

    No investors can take ownership of “NGDP”. In order for a futures contract to work, the underlying must be a valued object of economic action.

    Commodities futures work, bond futures work, currency futures work, all of these futures work because the underlying (commodity, bond->cash flow, currency, etc) are able to be owned and economized.

  25. Gravatar of Michael Byrnes Michael Byrnes
    6. January 2014 at 18:49

    Geoff,

    Robert Shiller has an answer: allow Treasury to issue “trills” – bonds that pay the bearer one-trillionth of NGDP annually. Like other treasury bonds, they would sell at whatever price investors are willing to pay for them. In this way, investors could “take ownership of NGDP” in the same way that they take ownership of treasury bonds.

  26. Gravatar of Geoff Geoff
    6. January 2014 at 19:31

    Michael Byrnes:

    This is more like it. These are not futures contracts, but NGDP-linked bonds. That could work.

    But there is still a problem. The present value of a trill would be the discounted future cash flows, right? Whatever the market discount rate happens to be, what does the prevailing discount rate suggest about expected NGDP growth? Clearly NGDP itself won’t be the only factor affecting the yield/price of a trill.

    Given that the risk of a trill would be higher than a “regular” treasury bond, an additional premium would be required. How do you separate that premium into its constituent components that the Fed can look at to know whether it should print more or less today? It’s one thing for investors to be told “Don’t worry, we’ll make sure NGDP grows by 5%”, but it’s another thing for the Fed to know how much to print now in order to do that given the trill bond yields.

    For example, suppose the Fed observes the yield on 1 year trills to be 3%. Equivalent “regular” 1 year treasury yields 2%.

    How much should the Fed print now?

  27. Gravatar of Geoff Geoff
    6. January 2014 at 19:37

    Michael:

    Why aren’t investment banks and hedge funds issuing NGDP-linked bonds now? If they provide value to investors, and given investors don’t all agree with each other, isn’t there an opportunity for speculation-based profit with trills now? Those investors who expect NGDP growth to be X% next year could short trill bonds to those who expect NGDP growth to be (X-a)% next year, for example.

  28. Gravatar of Mike Sax Mike Sax
    6. January 2014 at 20:37

    “I suppose there are a number of possible answers, starting with why the hell is NK not called “new monetarism?”

    Aha! An easy one-Stephen Williamson already took that. The great thing is that he seems to believe that monetary policy is not effective here and that we need more public debt-yes more. Who knew I was a New Monetarist…

    Scott I know you wont let the fact that you haven’t won anything stop you from gloating… That’s ok. You can say you’re right 1000 ties and I’m sure you already have-and that’s just today-but this won’t make you right as a matter of fact.

    Unless the performance of 2013 was optimum then we would have been better off without the sequester. No amount of declaring victory can obscure that.

  29. Gravatar of dtoh dtoh
    6. January 2014 at 22:10

    Three comments on the NGDP Futures vs. GAINs (note linked to NGDP) debate.

    1. If the Fed is committed to making sure that the payout on the futures contract is zero (or at least entirely predictable), there will little interest on the part of the market in taking either a short or long position…. thus very little trading volume. If there was any kind of two sided underlying demand for this type of product, it would already exist.

    2. With GAINs, the Fed (or Treasury) would effectively take one side of the futures trade…. so as long as they are willing to pay the price necessary to attract a counter-party you can get the trade done…. and since the note offers an underlying high credit income stream, there is a naturally deep market as long as the issuer (Fed or Tsy) is willing to pay the risk and credit premium.

    3. Even though there is no natural market for NGDP futures, the Fed could also go into the market and be a counter-party to futures trade. This could work, but I suspect there would be more political push back to the Fed/Tsy entering into naked futures contracts than there would be to the issuance of NGDP linked notes.

  30. Gravatar of ssumner ssumner
    7. January 2014 at 06:10

    Dan, There is a mountain of evidence that faster expected NGDP growth leads to a smaller Base/GDP ratio. Look at countries like Australia.

    Don’t know what causes your daily cap, wish it applied to Geoff.

    lxdr, Check out my short course on money in the right column.

    igyt, It’s Brad who is confused, not you.

    Max, Yes, I think I mentioned that in the post.

    Roger, MMs look at NGDP growth. Not sure about NKs.

    Mark, That’s very interesting data.

    JP, That’s just crazy talk.

    Mike Sax, You said:

    ““I suppose there are a number of possible answers, starting with why the hell is NK not called “new monetarism?”

    Aha! An easy one-Stephen Williamson already took that.”

    I’d like to believe you are joking, but given it comes from you . . .

    Randomize, Actually you don’t need to do a subsidy, I just throw that out to reassure people. And a subsidy would not be “messy” it would simply be a slightly higher interest rate on margin accounts.

    Max, You said;

    “The question I have about “buying everything” as a means of circumventing the zero bound: maybe you can hit your current target, but how do you avoid overshooting future targets?”

    That was a reductio ad absurdum. You don’t actually do that. You just buy Treasury debt (under NGDPLT).

    dtoh, The fact that the Fed is trying to prevent NGDP from moving away from target has absolutely no bearing on the trading volume. If you were right, there would be almost no trading volume in any market, because all markets have a market expectation roughly equal to the price.

  31. Gravatar of Max Max
    7. January 2014 at 06:54

    “That was a reductio ad absurdum. You don’t actually do that. You just buy Treasury debt (under NGDPLT).”

    And if the GDP growth rate target turns out to be too low and you hit the zero bound? Would you agree that the only purely monetary solution is to change the target? Or do you say that any GDP path is possible by means of OMOs?

  32. Gravatar of Macro Experiments are not Controlled | askblog Macro Experiments are not Controlled | askblog
    7. January 2014 at 07:14

    […] *To be less uncharitable, let Scott speak for himself. […]

  33. Gravatar of dtoh dtoh
    7. January 2014 at 08:19

    Scott,
    You said; “The fact that the Fed is trying to prevent NGDP from moving away from target has absolutely no bearing on the trading volume. If you were right, there would be almost no trading volume in any market, because all markets have a market expectation roughly equal to the price.”

    I suspect this is quite different than a normal market. In normal markets, expectations can change and no individual market participant has sufficient clout to significantly move the market on anything other than a temporary basis. But to use your analogy, with an NGDP futures market, it would be like having Chuck Norris in the trading pit insisting that the contract should always trade at zero.

  34. Gravatar of lxdr1f7 lxdr1f7
    7. January 2014 at 16:36

    “Dan, There is a mountain of evidence that faster expected NGDP growth leads to a smaller Base/GDP ratio. Look at countries like Australia.”

    Australia has no reserve requirement imposed by the central bank this is why base/gdp ratio is lower.

  35. Gravatar of dtoh dtoh
    7. January 2014 at 17:22

    Scott,
    You said; ” There is a mountain of evidence that faster expected NGDP growth leads to a smaller Base/GDP ratio. Look at countries like Australia.”

    I think you need to need to explain this a little more carefully. If there is some sort of correlation, it ought to hold not just between different countries, but within a single country over time at different points in the economic cycle.

    If you look at US data (either pre-Lehman, or net of ER post-Lehman), I think you will see some (but not mountainous) correlation so I’m not saying you’re wrong, but I think it would be more edifying to explain the relationship in terms of a) changes in V as a result of changes in short term nominal rates, or b) as a Fed policy response to either excessively strong or excessively weak growth.

  36. Gravatar of Erik Trygger Erik Trygger
    8. January 2014 at 00:17

    Scott, if the difference between MM and NK is this:

    “NKs would adjust the base in order to move interest rates to a position where their structural model predicted on-target inflation (using Lars Svensson’s target-the-forecast approach.)

    MMs would adjust the base in order to move the TIPS spread to a position where the market predicted on-target inflation.”

    How should it be interpreted that Krugman chose to use US TIPS and forward exchange rates to analyze Japanese inflation expectations or more generally the effect of Abenomics. Doesn’t this blur the difference between MM and NK?

    http://krugman.blogs.nytimes.com/2013/10/27/ppp-and-japanese-inflation-expectations-extremely-wonkish/

  37. Gravatar of Dustin Dustin
    8. January 2014 at 04:42

    dtoh,
    If I understand you correctly, you have highlighted an issue that I have been hung up on. Regarding the price of an NGDP future:

    If the Fed can control NGDP or NGDP expectations 100%, and the NGDPLT is 5%, then the market fully expects a future NGDP growth of 5%. The futures price would always be 0 (ie, no trades)! The only way this security could have substantive value is if expectations deviated from the NGDPLT, which can only result from1) the Fed does not control NGDP and expectations 100% or 2) the Fed is playing games with investors who would be essentially betting what the Fed is going to do, which is nothing like any other security where the market controls the price and not a single entity.

    Is this off base? Who would go long an NGDP futures contract in excess of 5% knowing that this single trade would drive NGDP expectations above 5% and therefore compel the Fed to act so the NGDP achieved only 5%?

    In other news – I generally enjoy your posts as they are structured simple and are quite easy to follow even when navigating complex topics.

  38. Gravatar of Roger Sparks Roger Sparks
    8. January 2014 at 05:59

    Scott,

    I have a new post entitled Positive Taxation as a Method of Measuring Monetary Stimulus found at http://mechanicalmoney.blogspot.com/2014/01/positive-taxation-as-method-of.html.

    It seems to me that both NK and MM camps could better use measurements taken from past data to better advance their theories. Positive taxation as a stimulus is one method of measurement.

    NGDP is hidden in this method, but NGDP is a goal, not a method. Both NK and MM are really using variation in the money supply as the active tool to tweek economic progress. The NK emphasis on interest rates is a less direct movement of money supply when compared to the brute-force approach of MM direct injections.

    A chart in my post illustrates actual money supply stimulation for the last 40 years as a POSITIVE TAX, calculated in three ways. The chart can be found directly from the Federal Reserve at http://research.stlouisfed.org/fredgraph.png?g=qIf.

  39. Gravatar of ssumner ssumner
    8. January 2014 at 06:14

    Max, There are some NGDPLT target paths that are so low that the demand for base money would be so high that the Fed would have to purchase assets other than T-bonds. But the US doesn’t face that problem if the NGDP target is set at 5%. Probably not if set at 4%.

    dtoh, Of course the contract must trade at zero, but that in no way stops people from trading. In any market people trade because there is a diversity of opinion.

    lxdr. No, by far the most important reason is that they have faster NGDP growth.

    Erik, Yes, but there are still important differences, such as his belief that monetary policy is weak at the zero bound. And this leads to his belief in fiscal stimulus.

    Dustin, See my reply to dtoh. You are confusing the market with individual traders. The market may think that Apple stock should be at $478, but if it is then trades still occur.

    Roger, You said;

    “Both NK and MM are really using variation in the money supply as the active tool to tweek economic progress. The NK emphasis on interest rates is a less direct movement of money supply when compared to the brute-force approach of MM direct injections.”

    I don’t quite follow this. The second sentence seems to contradict the first.

  40. Gravatar of Roger Sparks Roger Sparks
    8. January 2014 at 06:45

    Scott,

    “Both NK and MM are really using variation in the money supply as the active tool to tweek economic progress. The NK emphasis on interest rates is a less direct movement of money supply when compared to the brute-force approach of MM direct injections.”

    We could think of NK emphasis on interest rates as primarily effecting the private sector. Interest rates seriously influence private decision makers contemplating loans that would increase the money supply, thus increasing NGDP.

    Brute force injections of money (MM theory) would flow to a different group of decision makers. At first glance, this group of decision makers would not be active seekers of money. Instead, they would be seekers of investments, which is a far different emphasis from seeking money.

  41. Gravatar of dtoh dtoh
    8. January 2014 at 08:28

    Scott,

    I don’t think there would be no trading volume, it would just be fairly limited. Also, it takes a lot of traders/investors and a lot of volume to keep a futures market viable. You can get an indexed note off the ground with a lot less volume and a lot of the volume can be driven by investors who are simply looking at the yield on the underlying note. In a past incarnation, I actually spent a fair amount of time negotiating with folks like Leo Melamed to try to launch some index futures. It’s really tough because the needed market dynamics and demand usually just aren’t there. Indexed notes are much easier and get you 95% of what you would want.

  42. Gravatar of Max Max
    8. January 2014 at 09:40

    “There are some NGDPLT target paths that are so low that the demand for base money would be so high that the Fed would have to purchase assets other than T-bonds.”

    Either the purchase is “expected to be temporary” and has no effect*, or it’s “expected to be permanent” which implies overshooting future targets (in other words, it implies that the target path has been changed). Since the CB can change the target path without buying anything, the purchases are superfluous except perhaps as a commitment device.

    Where do you disagree?

    ( * to be more accurate, it has an effect, but it’s not a monetary-quantity effect )

  43. Gravatar of Dustin Dustin
    8. January 2014 at 11:27

    Scott,
    Thank you for your response – and sorry for sounding dense here … BUT Market priced securities offer capital gains, interest, or dividends. NGDP future would offer none of them as the values is and always will be $0.

    If the Fed controls NGDP, and the Fed wants 5% growth, why would I ever bet growth will not equal 5%?

    A positive cash flow to the investor is only possible if the growth forecast fluctuates (ie, capital gains opportunity) – which implies that the Fed does not have 100% control over NGDP.

    Ok, so the ‘Fed controls NGDP 100%’ is my real quibble here

  44. Gravatar of dtoh dtoh
    8. January 2014 at 18:08

    Dustin,
    Thanks. A physicist friend once told me that if someone can’t explain something simply, it’s usually because they don’t understand what they’re trying to explain.

  45. Gravatar of Bill Woolsey Bill Woolsey
    9. January 2014 at 05:37

    Max:

    I certainly don’t believe that the monetary base should always be increasing, with each increase “permanent.” I most certainly believe that open market sales should sometimes be used.

    And I am nearly as certain that Sumner agrees with me.

    Suppose nominal GDP is below target. Base money is increased. That part of the increase needed to get nominal GDP to target is permanent. Any part beyond that amount is temporary. And really, if the demand for base money should change, what part was necessary changes, and so any part that is no longer necessary can be reversed.

    Now, suppose nominal GDP is on target. Base money is increased a lot. If it were a permanent increase, then nominal GDP would rise far above target. But that would mean that the target for nominal GDP changed. If it didn’t, then base money will fall again, and the temporary increase in base money will have little effect.

    Suppose nominal GDP is above target. Base money is decreased through open market sales. The portion of the decrease needed to return nominal GDP to target is permanent. Any excess decrease in base money is temporary. If the demand for base money should rise, then how much decrease was necessary changes. And so what was the permanent decrease is no longer permanent but reversed.

    Suppose nominal GDP is on target, but base money decreases. If it were permanent, it would force nominal GDP below target. But then, the target for nominal GDP would have changed. So, if the target does not change, base money must be increased again. The change was temporary. It will have little impact on nominal GDP.

  46. Gravatar of Bill Woolsey Bill Woolsey
    9. January 2014 at 05:53

    Nominal GDP futures have payoffs if nominal GDP deviates from target.

    If the Fed adjusts base money enough so that its position is zero, then the trades would be between those who think that money is still too tight and those who think it is too loose. Krugman is a bear, sells, goes short. Meltzer is a bull, buys, goes long.

    If Krugman is correct, nominal GDP comes in below target, and he collects from Meltzer. If Meltzer is correct, nominal GDP comes in above target, and he collects from Krugman.

    Now, if there is only one speculator, and it is just Krugman. And the Fed always hedges, then if Krugman sells, the Fed expands base money enough to Krugman changes his mind and buys, closing off his position. Krugman makes no money. Why shoud he trade.

    That is the scenario you are focusing on. The market is being treated as a single person and if the Fed always hedges, there is no incentive to trade.

    But we know there are plenty of Meltzers and plenty of Krugmans. There will be trading.

    If the Fed doesn’t always hedge, then the market is betting against the Fed. Given the current set up, Meltzer buys. The Fed doesn’t reduce base money because Yellin thinks Meltzer is wrong. The Fed is short. Krugman also sells, which makes the FEd less short. But, the Fed remains short along with all the other bears.

    Now, the Fed can (and maybe should) take a short position such that it anticipates that it will make no money. Nominal GDP will be on target. Those who have perfect faith in the Fed would take no position. Only those who think Yellin is too tight would still go short. Meltzer, however, would still be going long.

  47. Gravatar of ssumner ssumner
    9. January 2014 at 06:20

    Roger, I don’t follow that comment. MMs don’t use the monetary base any differently from NKs. They both use it to target some other variable.

    dtoh, First of all it doesn’t matter if any trading occurs or not if we are talking about a NGDP futures policy regime. If it’s just a market, the Fed can always subsidize trading. And second, you haven’t responded to my point that people trade because of differences in opinion, in any market. They don’t trade because the market consensus differs from the market price. It doesn’t, in any market.

    Max, I strongly disagree. The whole point of the purchases is not to move market expectations of NGDP, but rather to equate base supply and base demand when NGDP expectations are on target. That’s why the Fed buys or sells bonds.

    Dustin and dtoh, It’s explained quite simply in the paper linked to in the right column. It’s not hard. Also Bill has some comments below.

  48. Gravatar of dtoh dtoh
    9. January 2014 at 07:24

    Scott,
    If the Fed is willing to set up and subsidize the exchange, that’s an entirely different matter. Most of my comments were really directed at the ability to set up an economically viable market on a private exchange. But again, why would they do this if they can do NGDP linked notes at a fraction of the cost. (Of course they could just write a check to the Merc to get create NGDP contracts.)

    But back to the other question. Sure there will be differences of opinion, but when the Fed has a commitment and unlimited resources to make sure that their opinion is correct, you’re going to find a lot less people willing to take the other end of the trade.

    Question back to you – What is a futures contract going to tell you that you couldn’t get out of an indexed note. (Keep in mind that TIPS are really option like rather futures-like and therefore you lose liquidity when they’re out of the money. You would not have to repeat this same mistake with an NGDP linked note.)

  49. Gravatar of Max Max
    9. January 2014 at 07:28

    Suppose that long term GDP (level) expectations are on target, but near term expectations are below target. What should the CB do?

    (a) “Temporarily” increase the base (will this work if interest rates are at the CB’s floor?)

    (b) “Permanently” increase the base (won’t this cause long term expectations to rise above target?)

    (c) Do nothing.

    (d) This situation is impossible.

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