Bernanke on monetary reform

Well this is the post we’ve all been waiting for, isn’t it?  Ben Bernanke has a post discussing options for monetary reform. As you’d expect, it’s a really well thought out post—first rate.  And as you’d expect, I am still able to find a few points where I disagree.  But let’s start with the good stuff:

Of course, no policy framework is without drawbacks, as attested by the difficulties the FOMC has faced in dealing with the zero lower bound on interest rates. If the Committee were to contemplate changing its framework, there are two directions it might consider.

He’s open to alternatives, and recognizes that policy has been less effective since 2008.  The first alternative is a Taylor-like instrument rule, which Bernanke finds useful but a bit too rigid to rely on completely.  Ben shows he’s a natural blogger by providing a long quote explaining why policymakers cannot rely too rigidly on a mechanical rule, before telling us:

As some will have guessed, the quote is from John Taylor’s classic 1993 paper introducing the Taylor rule, “Discretion versus Policy Rules in Practice” (pp. 196-7).

A little bit of teasing from the former Fed chair to (perhaps) the next Fed chair if the GOP retakes the White House. Then the second alternative:

The second possible direction of change for the monetary policy framework would be to keep the targets-based approach that I favor, but to change the target. Suggestions that have been made include raising the inflation target, targeting the price level, or targeting some function of nominal GDP. Some of these approaches have the advantage of helping deal with the zero-lower-bound problem, at least in principle.

That’s good.

My colleagues at the Fed and I spent a good deal of time during the period after the financial crisis considering these and other alternatives, and I think I am familiar with the relevant theoretical arguments.

I’m sure that’s right, and I’m certain there is nothing theoretical that I could have added that would have carried much weight at the Fed.  They’d be better off talking to people like Michael Woodford.  Nonetheless, later I’ll argue that the Fed was not fully aware of the political implications of these alternatives.

Although we did not adopt one of these alternatives, I will say that I don’t see anything magical about targeting two percent inflation. My advocacy of inflation targets as an academic and Fed governor was based much more on the transparency and communication advantages of the approach and not as much on the specific choice of target. Continued research on alternative intermediate targets for monetary policy would certainly be worthwhile.

One of Bernanke’s good qualities is that he’s open-minded.  He obviously sees that given what’s happened since 2008, in retrospect a slightly different approach might have been better.  But of course we can’t rewrite history, and there are credibility issues that constrain policy, as they should.  The italicized phrase may surprise some readers who don’t play close attention.  I’ve always argued that it would have been quite difficult for the Fed to abandon its 2% inflation target right after formally adopting it in 2012.  A central bank that is so cavalier with previous promises would not be trusted any more than the Argentine central bank.

Finally we get to the key three paragraphs:

That said, I want to raise a few practical concerns about the feasibility of changing the FOMC’s target, at least in the near term. First, whatever its strengths and weaknesses, the current policy framework, with its two explicit targets and balanced approach, has the advantage of being closely and transparently connected to the Fed’s mandate from Congress to promote price stability and maximum employment. It may be that having the Fed target other variables could lead to better results, but the linkages are complex and indirect, and there would be times when the pursuit of an alternative intermediate target might appear inconsistent with the mandate. For example, any of the leading alternative approaches could involve the Fed aiming for a relatively high inflation rate at times. Explaining the consistency of that with the statutory objective of price stability would be a communications challenge, and concerns about the public or congressional reaction would reduce the credibility of the FOMC’s commitment to the alternative target.

Second, proponents of alternative targets have to accept the fact that, for better or worse, we are not starting with a blank slate. For several decades now, the Fed and other central banks have worked to anchor inflation expectations in the vicinity of 2 percent and to explain the associated policy approach. A change in target would face the hurdles of re-anchoring expectations and re-establishing long-term credibility, even though the very fact that the target is being changed could sow some doubts. At a minimum, Congress would have to be consulted and broad buy-in would have to be achieved.

Finally, a principal motivation that proponents offer for changing the monetary policy target is to deal more effectively with the zero lower bound on interest rates. But economically, it would be preferable to have more proactive fiscal policies and a more balanced monetary-fiscal mix when interest rates are close to zero. Greater reliance on fiscal policy would probably give better results, and would certainly be easier to explain, than changing the target for monetary policy. I think though that the probability of getting Congress to accept larger automatic stabilizers and the probability of their endorsing an alternative intermediate target for monetary policy are equally low.

There’s much that can be said here, and I’m going to consider the question of Congressional authorization in another post, over at Econlog.  But let me just say here that I think he’s wrong about price level and NGDP targeting, I don’t think they would require Congressional authorization.  A 4% inflation target perhaps would.

Obviously I don’t think fiscal policy would be better than monetary reform, but it’s a moot point as we both agree that Congress is not about to start using fiscal policy to stabilize the economy at the zero bound.  Nor are the Europeans or the Japanese.  Indeed the Japanese sharply tightened fiscal policy in 2014 (and unemployment fell).  So with fiscal policy off the table we need to improve monetary policy to make it more effective.

Reading between the lines, and based on what I’ve read from various insider sources, Bernanke may have the following concerns:

1.  Congress would not like a 4% inflation target.

2.  The Fed establishment hates (price or NGDP) level targeting.  It puts them right in the spotlight, with “ownership” for adverse moves in the nominal economy.  They’d rather be one of many factors making our economy work better.

Here are a few areas where I disagree with Bernanke’s pessimism.  Let’s start with communication.  It’s often claimed that it’s easier to communicate an inflation target than a NGDP target.  “The public understands inflation.”  No they don’t!!! They don’t have a clue as to what inflation means.  Most of my students were far above average, and yet when I would ask them the following question (as economics major seniors), 90% would get it wrong:

If all prices rise 10% and all wages and salaries also rise 10%, has the cost of living actually risen?

Most say no, whereas the correct answer is that the cost of living rose 10%.  Bernanke discovered this in 2010 when core inflation fell to 0.6% and the Fed announced it was going to try to raise the cost of living for Americans, to help the economy.  Talk radio went nuts, and Bernanke ran into a firestorm of criticism.  It sounds “bad.”  The Fed may correctly view 2% as a symmetric target, where misses in either direction are bad, but the public sees it more like the ECB, the lower the inflation the better.  That’s because the public thinks their own nominal income is unrelated to changes in the cost of living, whereas the Fed believes that monetary stimulus will boost RGDP, and this causes the average American’s nominal income to rise even more than inflation rises.  Inflation targeting is a communication nightmare.

Second, Bernanke seems to overlook the fact that even with its current dual mandate there are times where the Fed must pursue an inflation rate higher than 2%.  Indeed if it were not true, if they always focused like a laser on 2% inflation, then they’d have a single mandate, and their policy would be indistinguishable from a central bank with a single mandate.  In fact, when there is a severe adverse supply shock, such as an oil embargo, the Fed does aim for above 2% inflation.  In this respect, NGDP (growth rate) targeting is very similar to current Fed policy.  As far as price level targeting, the Fed could easily argue that aiming for a long run 2%/year rise in the price level is more consistent with their Congressional mandate, as it provides more long price level predictability that inflation targeting (where the price level has a random walk element.)

I’ve already indicated that the “blank slate” argument is a genuine concern.  But I also have argued that there are creative ways of addressing this issue.  A likely compromise would involve the Fed setting intermediate NGDP target paths every 5 years, where the target growth rate was the Fed’s estimate of trend RGDP growth, plus 2% inflation.  That would keep inflation close to 2% in the long run, while gaining some of the advantage of NGDPLT over the business cycle.  For those who worry that inflation would vary somewhat, recall that under current policy inflation reached almost 5% in mid-2008, and then fell into negative territory over the next year.  That doesn’t seem very stable to me.

As far as communication, the Fed should continue to communicate to the public that it has a 2% inflation goal (if that’s indeed what Congress wants) but communicate to the markets that it has an intermediate NGDP target that it thinks is most consistent with its combined inflation/employment goals.

And finally, I think some of the concern that NGDPLT might be inflationary was due to the fact that the issue happened to gain traction at a very unusual point in US history, where trend RGDP growth was falling from 3% (over more than a century) to 2% or even slightly less.  But that’s likely to be a fairly rare occurrence.  God help us if the rate keeps falling to zero.  In that case monetary policy will be the least of our concerns.  We’ll be broke.

HT,  Patrick Sullivan, Ken Duda, Britonomist


Tags:

 
 
 

56 Responses to “Bernanke on monetary reform”

  1. Gravatar of jknarr jknarr
    16. April 2015 at 09:28

    Scott, this is where your “Monetary Policy is not about Banking” piece is so apropos. The Fed is a banking institution. As a banking institution, it is deeply concerned with lending and debt. NGDP targeting forces the Fed to concentrate on monetary policy, to the (mostly) exclusion of banking/debt interests.

    Another way of viewing NGDP targeting is leverage. If the Fed guaranteed (worked toward) a set pace of NGDP expansion, it is also targeting a set pace of deleveraging in the broad economy.

    At present, we have debt booms- and busts- that the Fed cleans up after the fact by stabilizing the banking system. Banks (more specifically, debt) are preserved at the expense of real economy booms and busts.

    NGDP targeting would force the banking system to endure greater debt booms and busts — debtholders would have to suck up defaults/inflation if NGDP were indeed running above target and a real slump hit — the Fed could not bail debtholders out. (More specifically, if inflation picked up the pace and real output dropped (NGDP expanding constant in an already-NGDP overshoot scenario.)

    This scenario would constitute a widespread debt-deleveraging via higher inflation and greater default. Deleveraging is antithetical to banking interests, yet deleveraging can be desirable for the macro economy.

    Under the current regime, debt is stabilized and NGDP is allowed to vary. Stabilize NGDP, and returns on debt begin to vary more widely.

    Volcker’s targeting of the money supply (more akin to NGDP targeting than rate setting regimes), which let rates vary in the marketplace gives a hint about possible NGDP targeting outcomes. Interest rates would vary more widely, as they become true pricing/discount mechanisms. Debtholders would no longer have the price-setting efforts of the Fed work in their favor.

  2. Gravatar of Lawrence D’Anna Lawrence D'Anna
    16. April 2015 at 10:13

    Laser light is typically collimated, which is kind of the opposite of being focused. Maybe you should say “focused like a laser which someone has decided to shine though a converging lens”

    😛

  3. Gravatar of Philo Philo
    16. April 2015 at 11:16

    “[I]t would have been quite difficult for the Fed to abandon its 2% inflation target right after formally adopting it in 2012.” OK. But couldn’t they at least have *hit* it, instead of running consistently lower?

  4. Gravatar of marcus nunes marcus nunes
    16. April 2015 at 12:28

    Scott, you say:
    And finally, I think some of the concern that NGDPLT might be inflationary was due to the fact that the issue happened to gain traction at a very unusual point in US history, where trend RGDP growth was falling from 3% (over more than a century) to 2% or even slightly less.”
    At one point I suggested the fall in trend RGDP will likely come to be called the “Bernanke break”!

    https://thefaintofheart.wordpress.com/2014/01/27/will-bernankes-legacy-be-having-introduced-a-unit-root-in-us-rgdp/

  5. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    16. April 2015 at 13:19

    Superb post,
    I would add that there are various measures of inflation and all of them are faulty to some extent.
    Scott is right on about the claim that people don’t understanding inflation.
    Inflation targeting and dual mandate are inconsistent , perfect insight.
    Marcus and Scott, I really would love that by stabilizing NGDP at 4%, and by eliminating macro instability, RGDP actually rose to 4% and we achieved 0% inflation …

  6. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    16. April 2015 at 13:42

    I’ll just repeat that for Bernanke to first mention NGDP targeting (along with two other options), then say; ‘I will say that I don’t see anything magical about targeting two percent inflation.’, seems disingenuous at best.

    Why didn’t he tell us what he thinks about NGDP as a target?

  7. Gravatar of Morgan Warstler Morgan Warstler
    16. April 2015 at 15:22

    1. Ben doesn’t get to resent Level Targeting. His team is in the sh*thouse. He needs to PROVE is that if we had LT (inflation of NGDP) in 2004-7, it wouldn’t have stopped the Housing stupidity. And I mean prove in a blog, that had they had no discretion, if Friedman’s PC ran monetary policy, it would have been worse.

    2. Once the Fed no longer has discretion, the inflation / real growth mix is 10$ THE JOB of Fiscal policy. Fiscal stimulus that cuts taxes mostly leads to real growth. Pay raises for public employees without productivity gains is inflation. CBO and Fed would be scoring budgets and say “this Dem plan looks like 3.5% inflation and 1.5% RGDP and this GOP plan is the reverse.”

    The point is, by SUPPORTING removing the Fed from the equation, Ben is actually putting the responsibility where it REALLY goes – on elected officials.

  8. Gravatar of Major.Freedom Major.Freedom
    16. April 2015 at 15:45

    “It’s often claimed that it’s easier to communicate an inflation target than a NGDP target. “The public understands inflation.” No they don’t!!! They don’t have a clue as to what inflation means. Most of my students were far above average, and yet when I would ask them the following question (as economics major seniors), 90% would get it wrong:”

    If all prices rise 10% and all wages and salaries also rise 10%, has the cost of living actually risen?

    Answering “no” to that question does not necessarily serve as evicdnce one does not understand inflation. All it would mean is that they just don’t know what the common definition for “cost of living” happens to be.

    The public gets price inflation. They know when prices rise more than their incomes. The only reason why you want to convince your readers that the public doesn’t understand inflation is because you want to foist more of it on the hapless public and devalue the purchasing power of all those whose income rate increases don’t keep up with price rate increases. Attack price inflation because you want more of it right now.

  9. Gravatar of benjamin cole benjamin cole
    16. April 2015 at 16:06

    Excellent blogging.
    But there is another choice between 2 percent ITand a 4 percent IT—a choice that seems to have worked in real life. The Reserve Bank of Australia has a 2% to 3% IT band.

    I prefer the nominal GDP LT approach. But the Reserve Bank of Australia has the second best choice.

  10. Gravatar of AL AL
    16. April 2015 at 16:18

    Of course the public doesn’t understand inflation, because the public thinks money is “real”. If you believe that, how can you see inflation as anything other than a destructive force?

    Probably we should be glad the public doesn’t understand inflation for the same reason we should be glad the public doesn’t understand money–it’s not clear the system could survive a mass enlightenment.

    The much much more significant question is whether or not the power of a collective money delusion is strong enough to offset what appears to be an increasingly inexorable trend toward zero (or lower) growth.

  11. Gravatar of TravisV TravisV
    16. April 2015 at 16:45

    Good post by Patrick Sullivan:

    http://hisstoryisbunk.blogspot.com/2015/04/bernanke-bernanke.html

  12. Gravatar of Sumner on Bernanke’s monetary reform « Economics Info Sumner on Bernanke’s monetary reform « Economics Info
    16. April 2015 at 17:00

    […] Source […]

  13. Gravatar of CMA CMA
    16. April 2015 at 17:22

    What about employing more effective tools? Im not saying ngdplt is innefective. Im saying rate targeting and asset purchases are less effective tools than emoney heli drops (hel-e’s).

    Hel-e’s will effectively stimulate ngdp while maintaining a higher level of interest rates therefore growing the financial sector and speculation less. As a result higher real gdp growth and stability will prevail.

  14. Gravatar of TravisV TravisV
    16. April 2015 at 17:45

    Christopher Mahoney suggests below that lower bond yields would result in higher stock prices. I’m inclined to think the opposite.

    http://seekingalpha.com/article/3061326-the-weak-economic-data-is-bullish-for-stocks

  15. Gravatar of dtoh dtoh
    16. April 2015 at 18:11

    @scott

    Don’t forget there will be a certain personal bias coming from Fed officials. After all, if there were an NGDPLT, then the entire FOMC could be replaced with an app running on my iPhone.

  16. Gravatar of dtoh dtoh
    16. April 2015 at 18:20

    @scott

    Also I don’t see why they are worried about inflation. Is it even possible at a given NGDPLT, to have higher inflation during a recession than you would have during full employment. I think not.

  17. Gravatar of Ben (“Blade Runner”) Bernanke | Historinhas Ben (“Blade Runner”) Bernanke | Historinhas
    16. April 2015 at 18:26

    […] Scott Sumner wrote that […]

  18. Gravatar of Vaidas Urba Vaidas Urba
    16. April 2015 at 22:30

    Scott,

    My question to Bernanke:

    Is Taylor Frontier a good description of monetary optimization problem? Do you agree with market monetarists that reducing the variance of nominal GDP is more important than reaching the best point on Taylor Frontier?

  19. Gravatar of Vaidas Urba Vaidas Urba
    16. April 2015 at 22:31

    Unfortunately his comment thread is already closed.

  20. Gravatar of Prakash Prakash
    16. April 2015 at 22:52

    Wouldn’t a nominal median income target be easier to communicate under the listed circumstances? Almost every adult could understand the nominal median income with a minimum of effort.

  21. Gravatar of Morgan Warstler Morgan Warstler
    17. April 2015 at 00:10

    dtoh, this is my take, I think Scott agrees?:

    1. NGDPLT set at 5% or 4% (or even Woolsey’s 3%) whatever it is, basically puts Fiscal front and center.

    2. Sure there might be shocks here of there, but ultimately, the mix between RDGP and inflation, month to month, is basically a report card on a govt’s economic policy.

    This is where I think I game things out and Scott doesn’t venture down this path:

    3. So imagine the R’s and the D’s looking at a monthly report card of 4% inflation and 1% RGDP (or 6% inflation and -1% RGDP), and think about how news is covered in a NGDPLT future.

    I think the politics here is a sea change. Scott says people don’t understand inflation

    “The public understands inflation.” No they don’t!!! They don’t have a clue as to what inflation means.”

    I think people understand inflation just fine. I think that what people don’t understand is how govt crowds out private sector growth.

    I’ll go further, I think in todays world, people are smart enough to know inflation sucks, bc in a perfect world in their mind, made more obvious by the rapid improvement in tech, they would have no inflation, bc all productivity gains would flow to them as lower prices, not higher wages.

    But even in today’s world, when govt wastes money on EX IM or Solar subsidies or public sector unions etc – people don’t get that this DRIVES inflation.

    I’m pretty sure, and here I bet Scott disagrees, that if we get NGDPLT, overnight the mix between inflation and RGDP will become a fight between Dems and Repubs.

    Dems will denounce productivity gains in govt. Repubs will remind people that if govt doesn’t get a raise, that home loans will be cheaper longer.

    And I think this ruth, which is ALREADY true now but hidden from the masses, will become something that unites the poor, middle class and rich (in the private sector) against the middle class and rich in the public sector.

    FInally,and this is way edge hypo, I spend alot of time dealing with new measurements in govt productivity being brought about by technology, and I suspect that when these technologie are in the hands of the public, the public clamor for RDGP in the public sector, will make getting the Fed to switch to NGDPLT easier.

  22. Gravatar of Jim B Jim B
    17. April 2015 at 03:41

    My conspiracy theory for the day:
    We are getting closer and closer to revealing the real money illusion, a post where Scott B. Sumner reveals…he is actually Ben S. Bernanke in disguise! He’s been using the Sumner alias to drive the frontier of monetary policy thinking while making the small steps needed to introduce and NGDPLT rule. Or perhaps Bernanke is the disguise…

  23. Gravatar of ssumner ssumner
    17. April 2015 at 06:31

    jknarr, Interesting, but you may give the current regime too much credit when you assume they stabilize debt.

    Lawrence, Yeah, that’s what I meant. 🙂

    Philo, Good point.

    Marcus, Maybe, but my hunch is that it would have happened even with good monetary policy, just much more gradually.

    Patrick, I wonder if a former Fed chair is completely free to speak his mind.

    Morgan, Yep, NGDPLT makes the world safe for classical economics. There are opportunity costs of government spending.

    Ben, Yes, Australia is second best.

    CMA, The financial sector does not grow faster with low rates.

    Travis, Either is possible (reasoning from a price change.)

    dtoh, You asked:

    “Is it even possible at a given NGDPLT, to have higher inflation during a recession than you would have during full employment. I think not.”

    Not only is it possible, it is certain under NGDPLT.

    Vaidas, Very good question.

    Prakash, Interesting proposal. It would probably work.

    Jim, Shhhhh!

  24. Gravatar of Anthony McNease Anthony McNease
    17. April 2015 at 07:48

    Scott and Prakash,

    Similar to Prakash’s idea I was wondering if a target of total wages and compensation might work and also be able to be more easily be understood. The Fed would target a growth path of total compensation basically. This, and Prakash’s would also have the benefit of enabling people to easily understand that if there is a spike (or trough) in inflation the source would be a shift in AS instead of the Fed’s monetary policy.

  25. Gravatar of Anthony McNease Anthony McNease
    17. April 2015 at 07:52

    CMA, low rates depress bank returns. Net interest margins are more compressed. The people wishing for rate hikes the most today are Big Bankers and bond fund managers.

  26. Gravatar of TravisV TravisV
    17. April 2015 at 08:34

    Prof. Sumner, you wrote:

    Travis, Either is possible (reasoning from a price change.)

    With all due respect, that’s not quite satisfying. Due to your insights, I have a ton of confidence that (1) if the 10-year treasury yield quickly falls to 0.5%, real stock prices will be significantly lower and (2) if the 10-year treasury yield quickly increases to 4%, real stock prices will be much much higher than they are today.

  27. Gravatar of Donald Pretari Donald Pretari
    17. April 2015 at 09:29

    “I think though that the probability of getting Congress to accept larger automatic stabilizers and the probability of their endorsing an alternative intermediate target for monetary policy are equally low.”

    I’m pretty sure that this is advocating what I call QE plus a Reinforcing Stimulus as presented in the Chicago Plan of 1933 and Milton Friedman’s “A Monetary and. Fiscal Framework for Economic Stability”. (Friedman 1948) No worry, though. As Bernanke says, this plan is not on the menu.

  28. Gravatar of dtoh dtoh
    17. April 2015 at 09:55

    @Scott
    I asked, “Is it even possible at a given NGDPLT, to have higher inflation during a recession than you would have during full employment.”

    You said, “Not only is it possible, it is certain under NGDPLT.”

    Assume 5% NGDPLT and 3% full employment RGDP growth rate. Excluding external impacts like oil prices: Under what set of circumstances could you get from 3% RGDP and 2% inflation to 0% RGDP and 5% inflation or even 1% and 4%?

  29. Gravatar of TallDave TallDave
    17. April 2015 at 11:28

    dtoh,

    Wow, it’s like this is your first day here. Central banks can always inflate. There is no set of circumstances in which they cannot increase inflation to 5%.

    And the whole point of NGDPLT is to increase inflation when growth is low, and reduce inflation when growth is high, such that NGDP is smoothed.

    See http://www.nationalaffairs.com/publications/detail/re-targeting-the-fed

  30. Gravatar of CMA CMA
    17. April 2015 at 14:17

    “CMA, low rates depress bank returns. Net interest margins are more compressed. The people wishing for rate hikes the most today are Big Bankers and bond fund managers.”

    Ceteris paribus, if the central bank lowers rate it lowers funding costs for banks and increases asset prices. Increasing bank returns and the BS.

  31. Gravatar of dtoh dtoh
    17. April 2015 at 16:09

    @tall dave
    You’re missing the point. A central bank can always inflate. That’s obvious and not disputed. The question is can a CB inflate while at the same time holding the RGDP growth rate at level substantially below the full employment growth rate (i.e maintaining a constant NGDP growth rate.)

    I think (absent external circumstances such as higher oil prices or the imposition of higher consumption taxes) that the answer is no.

  32. Gravatar of Don Geddis Don Geddis
    17. April 2015 at 16:26

    @dtoh: You’re asking a weird question. The central bank only controls nominal variables, like NGDP. It doesn’t have any power to do anything to RGDP — aside from forcing a nominal shock that has real effects. But you’re asking in an NGDPLT scenario, where there is no nominal shock. In that case, the ONLY thing affecting RGDP, is supply-side factors. Aka, the “higher oil prices, or taxes”.

    But you then try to exclude supply-side factors in your question. Well, the simple answer is, if there is no supply-side shock, and no demand-side shock, then there is no recession. You get whatever real growth you get, and the economy is at “full” employment.

    The scenario you’ve outlined is self-contradictory. A central bank cannot “hold RGDP … substantially below” while at the same time “maintaining a constant NGDP growth rate”. The central bank has no tool to accomplish your hypothetical.

  33. Gravatar of Andrew_M_Garland Andrew_M_Garland
    17. April 2015 at 16:48

    Sumner: “The Fed believes that monetary stimulus will boost RGDP, and this causes the average American’s nominal income to rise even more than inflation rises.”

    (1) Do you believe inflation boosts income more than prices? What is the mechanism and the evidence for both the mechanism and the result?

    (2) What is the definition of inflation here?

    (3) “(The average income rises)” Does this increase income inequality? That is, do some groups win and some lose? If so, what justifies harming some to help others, and which are the groups?

    (4) Are lenders and people who save money punished, and are debtors such as the US Treasury and home owners benefitted? If yes, what is the justification for intentionally doing so?

  34. Gravatar of Jim Glass Jim Glass
    17. April 2015 at 18:04

    Sumner: “The Fed believes that monetary stimulus will boost RGDP” … Do you believe inflation boosts income more than prices?

    Inflation is prices. What else?

    “(The average income rises)” Does this increase income inequality? That is, do some groups win and some lose? If so, what justifies harming some to help others, and which are the groups?

    In a growing economy average income rises. Most people consider this a better state of affairs than in a stagnant or shrinking economy, in which average income stagnates or falls. You are suggesting a contrary view? Because in that case some gain while others lose?

    “What justifies” the car makers profiting at the cost of the buggy makers in a growing economy? Or the makers of tractors and farm machinery profiting at cost of the small, by-hand family farmers who were so driven out of business by the machinery makers that they fell from the solid majority of the population to less than 2% today? One would have to think about that…

    Of course, in stagnant and declining economies some groups gain and others lose as well. Look at the Great Depression. Can you name any real-world stagnant or declining economy in which it wasn’t true that some groups gained and others lost?

    Let’s say you could. Would a reduction in inequality justify intentionally reducing national income, intentionally making everyone in total poorer? For instance, if so, as a thought experiment, a second Great Depression would by justified by reducing the Gini Coefficient by how much?

    Are lenders and people who save money punished, and are debtors such as the US Treasury and home owners benefitted? If yes, what is the justification for intentionally doing so?

    By increasing Real GDP, that is by increasing employment and real wages? How would that work? Please specify. Moreover, if true, would that justify preserving higher unemployment and lower wages? By how much?

  35. Gravatar of Rajat Rajat
    17. April 2015 at 19:13

    “Bernanke may have the following concerns:…
    2. The Fed establishment hates (price or NGDP) level targeting. It puts them right in the spotlight, with “ownership” for adverse moves in the nominal economy. They’d rather be one of many factors making our economy work better.”

    Yes, we knew that. So what if the Fed establishment hates level targeting? All Bernanke’s post says is that we’ve thought of the alternatives and we’ve decided the status quo is best. At the least, he should have made some attempt to reconcile his pre-Fed views on the ZLB with his current comments. What is the value of Bernanke’s blog if indeed he disagrees with the status quo but doesn’t say what he really thinks? When does he get to say what he really thinks – on his deathbed? On this effort, we’re not going to get much insight from his book either.

  36. Gravatar of ThomasH ThomasH
    17. April 2015 at 19:20

    “Congress is not about to start using fiscal policy to stabilize the economy at the zero bound.”

    Nor should they. They should however legislate a regime in which, as the number of projects with present costs and future benefits with positive NPVs at the government’s borrowing rate rises with the fall in interest rates toward the ZLB, government investment in those project also rises.

  37. Gravatar of TallDave TallDave
    17. April 2015 at 20:16

    dtoh — OK, that makes more sense, but I agree with that Don said — under NDGPLT, from the Fed’s POV, RGDP is (essentially) an independent variable, while NDGP depends on the Fed.

    If you’re saying that a 0/5 full-year scenario seems unlikely outside of shocks, I would tend to agree. In fact, the mere fact the Fed had a policy of NGDPLT would cause markets to look at spiky RGDP data and expect compensatory Fed action, which would tend to ameliorate recessions and booms (with or without shocks).

  38. Gravatar of dtoh dtoh
    18. April 2015 at 00:48

    @Don Geddis
    “A central bank cannot “hold RGDP … substantially below” while at the same time “maintaining a constant NGDP growth rate”. The central bank has no tool to accomplish your hypothetical.”

    That is exactly the point I’m making. It’s a given that Fed action under NGDPLT, would be primarily in response to supply shocks. What I’m suggesting (and I apologize for not being sufficiently clear) is that it’s hard to conceive of any stimulative Fed response to a shock using an NGDP target and current policy tools that would result in a return to target that was primarily nominal (inflation) rather than real growth…. absent some further unexpected shock.

    Thus the concern raised in Bernanke’s blog that “….any of the leading alternative approaches could involve the Fed aiming for a relatively high inflation rate at times” seems misplaced to me. Using an NGDPLT, not only would the Fed NOT being aiming for high inflation, it simply would not happen (absent some further external shock).

  39. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    18. April 2015 at 07:08

    ‘Patrick, I wonder if a former Fed chair is completely free to speak his mind.’

    Well, he started a blog.

  40. Gravatar of Don Geddis Don Geddis
    18. April 2015 at 07:56

    @dtoh: But your the one who added the “absent some further external shock”. Surely Bernanke meant exactly that situation: there’s a supply shock (oil, etc.), RGDP drops, and then because of NGDPLT, the Fed aims “for a relatively high inflation rate”.

    Sumner argues that the economic damage that people think is caused by high inflation, is actually caused by NGDP shocks. But there’s no question that many people think high inflation by itself is bad. And there’s no question that, at times, NGDPLT would lead to higher inflation than pure inflation targeting. (That’s kind of the point, actually.)

    I don’t know why you’re trying to find a scenario of high NGDPLT inflation without supply shocks. The supply shock scenario is the scenario that is of concern to Bernanke (and other fans of inflation targeting).

  41. Gravatar of ssumner ssumner
    18. April 2015 at 10:14

    Anthony, Yes, that would be a good policy.

    Travis, Perhaps, but that’s a different claim. In the past few years we’ve seen that changes in interest rates don’t correlate well with changes in growth.

    dtoh, An adverse supply shock. Obviously if we are targeting NGDP we’ve ruled out adverse demand shocks, so supply shocks (like a smaller labor force) are all that’s left.

    Andrew, You said:

    “Do you believe inflation boosts income more than prices?”

    No. Never reason from a price change.

    And this makes your other questions moot points.

    Rajat, He should do a post explaining how and why his views changed since 2003.

  42. Gravatar of Anthony McNease Anthony McNease
    18. April 2015 at 10:57

    CMA,

    “Ceteris paribus, if the central bank lowers rate it lowers funding costs for banks and increases asset prices. Increasing bank returns and the BS.”

    Lower rates do lower the discount rates used to calculate the NPVs for equities, and lower rates to lower the costs of funding banks, i.e. deposit rates. However lower rates also depress the rates banks charge for loans, and this reduction is greater than the lower funding costs. Therefore loan margins are lower, and there profits, when rates are lower. Lower rates also dressed the rates earned on bonds for the same reason. And despite the increased returns on equities with low rates banks make very little money on equities. Profits are earned from loan margins and investment banking/trading fees.

    Bank profits and profit margins will increase when rates increase. When a rate hike is inevitable or announced the stock market will go down, but bank stocks will rise. And you should not confuse the stock market with the “financial sector.” You need to look up the relative sizes of the markets for equities, bonds, commodities and currencies.

  43. Gravatar of dtoh dtoh
    18. April 2015 at 13:47

    @Scott,
    You said, ‘An adverse supply shock. Obviously if we are targeting NGDP we’ve ruled out adverse demand shocks, so supply shocks (like a smaller labor force) are all that’s left.”

    Would a credible NGDPLT policy completely eliminate demand shocks? I am asking. Policy execution might not be perfect.

  44. Gravatar of Andrew_M_Garland Andrew_M_Garland
    18. April 2015 at 20:36

    Mr. Sumner,

    Thanks for your reply:

    AMG: “Do you believe inflation boosts income more than prices?”
    Sumner: “No. Never reason from a price change.”

    That surprises me. I saw your post as supporting an inflation target of 2% and maybe 4%. Your answer indicates that you don’t support inflation as a way of raising income (production). So, you don’t agree with Bernanke’s policy?

    It seems to me that NGDPLT (Nominal GDP Level Targeting) would involve causing or fighting inflation to get the right level of NGDP. If inflation doesn’t raise real incomes, then why increase or decrease inflation?

  45. Gravatar of ssumner ssumner
    19. April 2015 at 06:55

    dtoh, Sure, but we were assuming it does work (for the sake of argument.)

    Andrew, No, I don’t favor inflation targeting, I favor NGDP targeting. The effect of inflation on output is ambiguous (never reason from a price level change.) It depends whether the inflation is supply or demand side.

    I do think a 4% inflation target would keep us above the zero bound, and thus prefer it to our current policy. But it’s still a bad policy, just less bad than current policy.

    My point was that monetary policy that raises inflation will also raise real income, if the economy is depressed. But inflation in general has no direct effect on real income. Higher inflation from an expansion of NGDP is a side effect of stimulus, it doesn’t CAUSE output to rise.

  46. Gravatar of dtoh dtoh
    19. April 2015 at 08:34

    Scott,
    I think we agree, but not sure. Do you agree that Bernanke’s concern that “any of the leading alternative approaches could involve the Fed aiming for a relatively high inflation rate at times” is misplaced?

  47. Gravatar of Quotes & Links #60 | Seeing Beyond the Absurd Quotes & Links #60 | Seeing Beyond the Absurd
    20. April 2015 at 03:29

    […] ivory tower. Really good speech and if you don’t believe me you can read Scott Sumner’s assessment of it. […]

  48. Gravatar of Morgan Warstler Morgan Warstler
    20. April 2015 at 05:18

    dtoh,

    “Thus the concern raised in Bernanke’s blog that “….any of the leading alternative approaches could involve the Fed aiming for a relatively high inflation rate at times” seems misplaced to me. Using an NGDPLT, not only would the Fed NOT being aiming for high inflation, it simply would not happen (absent some further external shock).”

    ——

    I broke these out from you bc I’ve tried to make similar arguments.

    When I game out NGDPLT the Fed is still buying and selling assets – sadly T-Bills, and I’m a big believer, regardless of Scott’s HPE, that the Fed should follow Farmer’s wishes and stop buying T-Bills and just buy and sell a random basket of stocks.

    This points to an issue I think matters, namely Cantillon effects – I’d LOVE, and and I mean LOVE to have Scott and Farmer publicly do a skype debate on if it matters what the Fed buys.

    Having a Keynesian argue we need to increase animal spirits by buying private industry stocks vs. govt bonds VS. the MM godfather arguing – it doesn’t matter at all…

    would weird me out.

    Scott are you listening?!?

    —–

    Anyway, dtoh, when I game it out, I tend to think about two modes:

    1. Game start – from today until… everybody has tested and retested the Fed’s political willingness to LET GO OF DISCRETION, bc Fed bankers are political animals full of self-agency.

    2. Game play once game start is over – now we’d been cruising along at the NGDPLT – the formula for hitting the LT month after month has been established – and market participants have been suitably smacked down.

    Once we get to 2, I think your point is correct:

    “Using an NGDPLT, not only would the Fed NOT being aiming for high inflation, it simply would not happen”

    Bc if you think about GETTING OVER my #1 is a VERY BIG HURDLE.

    I don’t think this is given much focus by Scott, and I try to say as much like a conservative GOP asshole as possible to force the issue… Much of HOW govt does what it does, not WHAT, just HOW, is so inefficient that a NGDPLT is incredibly good for a GOP.

    Think about it. Suddenly, the GOP gets to be in favor of all current funding levels for $ transfers, but whittle the size of govt down in terms of public employees.

    And almost every major change the GOP makes, they will be rewarded with an AWESOME economy…. cheap borrowing as far as the eye can see.

    I think this is going to immediately be clear to the Dems, and I think they will do everything possible to topple NGDPLT and to get the Fed to use it’s discretion.

  49. Gravatar of ssumner ssumner
    20. April 2015 at 05:48

    dtoh, I certainly agree for NGDPLT and PLT, as I indicated.

  50. Gravatar of dtoh dtoh
    20. April 2015 at 07:28

    @Morgan Warstler

    1. I tend to think financial assets are mostly fungible for the purpose of monetary policy…. doesn’t really matter what the Fed buys, but I haven’t spent that much time thinking it through.

    2. I’m not really sure that NGDP changes the political debate. Getting rid of business cyclicality clears some things up, but I suspect if gov’t crowds out the private sector and pushes RGDP down it will get blamed on other things and the NGDP target will just get quietly ratcheted down from 5 to 4 to 3.

  51. Gravatar of Blogger Bernanke’s abundance of caution | Drawnlines Politics Blogger Bernanke’s abundance of caution | Drawnlines Politics
    20. April 2015 at 10:02

    […] economist Scott Sumner points out that a nominal-spending target is compatible with the mandate, because the Fed would target a […]

  52. Gravatar of Morgan Warstler Morgan Warstler
    21. April 2015 at 00:33

    Scott, you should answer on this:

    “I’m not really sure that NGDP changes the political debate. Getting rid of business cyclicality clears some things up, but I suspect if gov’t crowds out the private sector and pushes RGDP down it will get blamed on other things and the NGDP target will just get quietly ratcheted down from 5 to 4 to 3.”

    This is a really important point, dtoh raises.

    Do you think a sh*tty Fiscal )say 1% RGDP and 4% Inflation) for say 2 years – rather than the Congress / Govt taking the blame, instead the Fed decies, no the NGDPLT should be lowered to 3%?

  53. Gravatar of ssumner ssumner
    21. April 2015 at 05:57

    Morgan, I don’t see why the NGDP target would be lowered.

  54. Gravatar of Morgan Warstler Morgan Warstler
    21. April 2015 at 08:58

    dtoh, I honestly think we have to discuss NGDPLT in either state 1 of 2…

    Meaning can we expect the Fed to stick to it

    vs.

    What happens after its been running thru periods where Fed stuck to it.

  55. Gravatar of TallDave TallDave
    22. April 2015 at 06:13

    Higher inflation from an expansion of NGDP is a side effect of stimulus, it doesn’t CAUSE output to rise.

    This seems to be an under-appreciated point, probably because the mechanisms are a bit fuzzy (higher wages? liquidity effects?).

  56. Gravatar of chris mahoney chris mahoney
    3. May 2015 at 14:29

    Of course the FOMC should consider PLT or NGDPLT. But for now, I’d settle for inflation and expected inflation that meet the existing 2% target. Over time, inflation should average 2%, not 1%.

Leave a Reply