Two targets, two tools

An important idea in macroeconomics is that you need at least as many tools as targets.  Over at Econlog, I have a long post discussing Roger Farmer’s views on monetary policy.  Here I’ll do a short post, giving you the Cliff’s Notes version.

In a better world, economists wouldn’t focus on interest rates.  But they do.  So how do we make sure that a change in interest rates has the desired effect?  After, all, higher rates could represent tight money (liquidity effect) or easier money (income and Fisher effects.)  How do we pin it down?

With two tools.  If you want interest rates to rise, you can raise the IOR.  If you want to make sure that this increase reflects the income/Fisher effects, you need to also use one of the following tools:

1.  A huge increase in the quantity of money (old monetarist)

2.  Target a higher commodity price index (1980s supply-side econ)

3.  Target a higher price of foreign exchange–i.e. depreciate your currency.  (Mundellian economics)

4.  Target higher stock prices.  (Roger Farmer)

5.  Target a higher NGDP futures price (market monetarist)

In each case, you use a “whatever it takes” approach to open market operations, to get your second policy tool moving in an unambiguously expansionary direction.

Recently, the Swiss did this in reverse.  In January 2015 they lowered interest rates and simultaneously appreciated the Swiss franc.  This assured that the lower interest rates were contractionary (income/Fisher effect.)  Singapore also uses exchange rates as a policy tool.  The BOJ has dabbled in Farmer’s approach, buying ETFs.  But not enough to make it effective.

PS.  Nick Rowe has a related post on Roger Farmer’s proposal.

Off topic:  In January 2014, I argued that “IndoAsia” would be the next big growth story.  This article says it’s beginning to happen.  And remember that 60 Minutes story about the ghost cities in China?  The ghost neighborhood in Zhengzhou that they highlighted seems to be doing fine:

Home prices in at least one district in Zhengzhou, which became a symbol of China’s property excesses because of rows of empty housing developments, have risen two-thirds this year to 25,000 yuan ($3,747.56) per square metre on average, a sales manager told Reuters on a recent visit to the city.

The average new home price in 70 major cities climbed an annual 9.2 percent in August, up from 7.9 percent in July, according to data from China’s National Bureau of Statistics.

After a period of modestly slower growth, the China boom is picking up speed again.  Looks like the naysayers will have to wait a few more years for the most widely predicted crash in history.

It’s hard not to be super optimistic about the world right now.  Asia is booming, and most people are Asians.


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22 Responses to “Two targets, two tools”

  1. Gravatar of H_WASSHOI (Maekawa Miku-nyan lover) H_WASSHOI (Maekawa Miku-nyan lover)
    2. October 2016 at 08:52

    rough math & argument

    Maybe it is enough to push up Nikkei225 1000yen with 3 trllion yen ETF buying.Now BOJ is buying 6 trillion yen per year.

    (NGDP growth rate) – (longterm interest rate) = risk premium

    If risk premium is about 5-6%,
    They need around PER 25 stock prices, above 25000 yen.

  2. Gravatar of H_WASSHOI (Maekawa Miku-nyan lover) H_WASSHOI (Maekawa Miku-nyan lover)
    2. October 2016 at 08:55

    oops, I mean

    p=E/P+g-i

  3. Gravatar of CA CA
    2. October 2016 at 09:10

    For those interested, Scott was on Larry Kudlow’s radio show talking about Trump’s monetary policy. It’s the 10/1/16 show, and can be downloaded as a podcast on most podcast apps.

  4. Gravatar of Major.Freedom Major.Freedom
    2. October 2016 at 10:17

    Sumner wrote:

    “An important idea in macroeconomics is that you need at least as many tools as targets.”

    Excuse me, but who is this “you” being referred to? It is certainly not me, or any other of the billions of other everyday citizens around the world.

    No, this “you” is not just any person, in which case this statement might in some way be related to ECONOMICS, it is rather a very particular group of people, and oh surprise, they are statesmen and state created and protected socialist, oligopolistic counterfeiters of money.

    This is politics. Backed by coercion not consent.

    This is what is being called “macroeconomics”.

    Why do you use such vague, weasal words as if you were talking directly to your readers about something they can act upon themselves in their daily lives?

    With actual economics on the other hand, the statements you make would apply to individual humans as such. For example how the law of marginal utility can be used to understand how money, production and prices are related.

    You should read Mises’ “Theory of Money and Credit”, a work that demolishes the fallacious divorcing of economics into “micro” and “macro” spheres each with their own alleged economic laws. Nobody has actually shown or proved why the laws that apply to a specific person or two people or three people, are separate and distinct from the laws that apply to millions of people. There has always been just a claim for one set and a claim for another set. Nowhere is there any explanation or proof for how exactly the laws change when an additional person is added to the group. Macro is in this way similar to how religious doctrines arise. There is the empirical day to day lives of mortal human individuals, and then there is the holistic realm, cut off from the Earth, with its own realities and laws.

    This blog post is worthless to the economist.

  5. Gravatar of Ray Lopez Ray Lopez
    2. October 2016 at 11:48

    One target (NGDPLT), one tool (Scott Sumner). I like this slogan, like Taiwan / PRC (‘one nation, two states’).

  6. Gravatar of Ray Lopez Ray Lopez
    2. October 2016 at 14:36

    OT – sorry for the long post, but does Sumner even read the literature on NGDPLT and how lousy it is? This is from a 2004 textbook. I think Mishkin was also on the Fed Reserve Board during the 2008 Crisis (he bailed just before the fan gots hit). –RL

    Mishkin textbook “Economics of Money” (2004) On NGDPLT:
    The concern that a sole focus on inflation may lead to larger output fluctuations has led some economists to propose a variation on inflation targeting in which central banks would target the growth rate of nominal GDP (real GDP times the price level) rather than inflation. Relative to inflation, nominal GDP growth has the advantage that it does put some weight on output as well as prices in the policymaking process. With a nominal GDP target, a decline in projected real output growth would automatically imply an increase in the central bank’s inflation target. This increase would tend to be stabilizing, because it would automatically lead to an easier monetary policy.
    Nominal GDP targeting is close in spirit to inflation targeting, and although it has the advantages mentioned in the previous paragraph, it has disadvantages as well.

    First, a nominal GDP target forces the central bank or the government to announce a number for potential (long-term) GDP growth. Such an announcement is highly problematic, because estimates of potential GDP growth are far from precise and change over time. Announcing a specific number for potential GDP growth may thus imply a certainty that policymakers do not have and may also cause the public to mistakenly believe that this estimate is actually a fixed target for potential GDP growth. … In addition, if the estimate for potential GDP growth is higher than the true potential for long-term growth and becomes embedded in the public mind as a target, it can lead to a positive inflation bias.

    Second, information on prices is more timely and more frequently reported than data on nominal GDP (and could be made even more so)—a practical consideration that offsets some of the theoretical appeal of nominal GDP as a target. Although collecting data on nominal GDP could be improved, measuring nominal GDP requires data on current quantities and current prices, and the need to collect two pieces of information is perhaps intrinsically more difficult to accomplish in a timely manner.

    Third, the concept of inflation in consumer prices is much better understood by the public than the concept of nominal GDP, which can easily be confused with real GDP. …

    Thus it is doubtful that, in practice, nominal GDP targeting would be more effective than inflation targeting in achieving short-run stabilization.

  7. Gravatar of Joe B Joe B
    2. October 2016 at 16:25

    It is interesting that the People’s Bank of China is essentially doing helicopter drops.

    Why do orthodox Western economists resist the choppers?

  8. Gravatar of ssumner ssumner
    2. October 2016 at 16:33

    Ray, You said:

    “First, a nominal GDP target forces the central bank or the government to announce a number for potential (long-term) GDP growth.”

    Wrong. Nope, potential GDP has no bearing on it.

    You said:

    “Although collecting data on nominal GDP could be improved, measuring nominal GDP requires data on current quantities and current prices, and the need to collect two pieces of information is perhaps intrinsically more difficult to accomplish in a timely manner.”

    Wrong. NGDP does not require collecting prices and RGDP, just nominal spending.

    You said:

    “Third, the concept of inflation in consumer prices is much better understood by the public than the concept of nominal GDP”

    Wrong. Not one person in 100 knows why economists want to raise inflation when it is below 2%.

    But you know all that because you are a frequent reader of my blog. Oh wait, Ray doesn’t understand anything he reads.

    That’s all you got?

    Joe, Because it was tried in Japan, and failed. And because even if it worked there are much better options—like NGDPLT.

  9. Gravatar of Gary Anderson Gary Anderson
    2. October 2016 at 18:54

    “Joe, Because it was tried in Japan, and failed. And because even if it worked there are much better options—like NGDPLT.”

    Better for Sumner’s cronies. It was not tried in Japan. It is against the law in Japan. It is dirty money in Japan.

    Lonergan is confident it can be administered carefully and productively. If Sumner does not believe Friedman on this, he is not a true monetarist.

    The gap between rich and poor is something Sumner will only tackle with tax fairness, not with monetary stimulus.

  10. Gravatar of Jill Jill
    2. October 2016 at 19:21

    Major Freedom, I have read that Austrian economists like Mises reject empiricism. So even if someone did prove that the laws that apply to a specific person or two people or three people, are separate and distinct from the laws that apply to millions of people, it wouldn’t matter to them, would it?

    And it seems intuitively obvious to me that nations of millions of people have significant differences from families of a few people. It doesn’t seem so to you? Just for starters, have you ever met a family that could print its own currency and have it be accepted by everyone else in the world?

  11. Gravatar of Will Will
    2. October 2016 at 22:59

    Prof. Sumner,

    You said,

    In each case, you use a “whatever it takes” approach to open market operations, to get your second policy tool moving in an unambiguously expansionary direction.

    Basically, if the Fed raises the funds rate by raising IOR, but also increases OMOs to target something, then everything is fine?

    Isn’t this equivalent to the Fed raising the funds rate (less OMOs or higher IOR) but also using helicopter drops to meet a target?

  12. Gravatar of William William
    2. October 2016 at 23:03

    Prof. Sumner,

    You said,

    In each case, you use a “whatever it takes” approach to open market operations, to get your second policy tool moving in an unambiguously expansionary direction.

    Basically, if the Fed raises the funds rate by raising IOR, but also increases OMOs to target something, then everything is fine?

    Isn’t this equivalent to the Fed raising the funds rate (less OMOs or higher IOR) but also using helicopter drops to meet a target?

  13. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. October 2016 at 04:12

    ‘If you want interest rates to rise, you can raise the IOR.’

    Or, simply cut interest on excess reserves to zero, along with a pronouncement that ‘interest rates are not the price[s] of money.’

    Then you wouldn’t need a second tool.

  14. Gravatar of Ray Lopez Ray Lopez
    3. October 2016 at 05:28

    @ssumner – Scott, those quotes were not mine but from Mishkin’s textbook, as I said: “Mishkin textbook “Economics of Money” (2004)”. You have a problem with him? Take it up with him. Keep in mind he’s been on the Fed board, and makes more money than you, and has a textbook in his name. And you? That said, he came across as a bumbling, absent minded fool on “Inside Job” (2010), but then again most of your colleagues did.

  15. Gravatar of Gary Anderson Gary Anderson
    3. October 2016 at 07:56

    So, Scott Sumner you should get out more. Apparently the TBTF banks do asset purchases for the Fed, or should I say in place of the Fed:

    http://www.rollingstone.com/politics/news/the-vampire-squid-strikes-again-the-mega-banks-most-devious-scam-yet-20140212

    This is why big finance is so much bigger and why people despise banks. If assets ever fall, guess who will bail these banks out Scott? The taxpayer.

    So, that is just a massive scam.

  16. Gravatar of Gary Anderson Gary Anderson
    3. October 2016 at 07:57

    And if banks can rig LIBOR, how much do you think they can rig prices for everything we buy?

  17. Gravatar of Gary Anderson Gary Anderson
    3. October 2016 at 08:15

    And Scott, you said I couldn’t learn economics. But I have learned from you, in going back to those emails that:

    I see that banks are afraid to lend at low rates. You were correct, really low rates are not easy money, at least to main street. Low rates are easy money to big purchasers of real estate, but not for main street.

    But your views on asset buying make me wonder. I emailed you when oil was to 100 dollars. You said in an email to me that you were ok with 120 oil.

    But, Scott, hoarding controls supply, and makes for artificial pricing. Hoarding is not real economics. It is a false economics that acts often times as a tax on everyone.

    This is the only issue I agree with the libertarians on, that hoarding does not make for free markets.

    Hoarding only gives the opportunity for the wealthy to buy what most of main street cannot afford. Like hoarding houses. And hoarding oil is a tax which the wealthy can more easily afford.

    That is why asset purchases are not getting money into the hands of main street. Trickle down is fairly limited. The divide between rich and everyone else is getting larger.

    Hoarding by a central bank is only done in emergency deflationary situations, but the big banks are hoarding continually, even when times are improving.

    What do you say about that?

  18. Gravatar of Gary Anderson Gary Anderson
    3. October 2016 at 08:20

    So, think about it Scott. You have traders making trades. You know how they can be certain to win the trades? Their banks buy the assets in massive quantities, and the traders win!

    That is decay, and smart people will just stop trading with these banksters. And yes, in this the term bankster applies.

  19. Gravatar of ssumner ssumner
    3. October 2016 at 09:21

    Will, Everything’s fine if they target the right thing (NGDP futures prices). If not, then it could go very badly.

    No, it’s not equivalent to a helicopter drop—a silly idea not worth considering.

    Patrick, Yeah, you could do that, but it would be a tight money policy. I’m trying to get rates to rise via an easy money policy.

    Ray, You said:

    “Keep in mind he’s been on the Fed board, and makes more money than you,”

    Yes I know he does. For instance, he made over $100,000 on a 2006 report on the Icelandic financial system–the one that said things were fine.

    And yes, I know it was Mishkin, I’n not stupid.

  20. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. October 2016 at 10:22

    ‘Patrick, Yeah, you could do that, but it would be a tight money policy. I’m trying to get rates to rise via an easy money policy.’

    It would be expansionary–less incentive for banks to keep money out of circulation (as excess reserves). Ceteris paribus, it should raise interest rates in the markets from their abnormally low current rates.

    It’s the opposite of what The Fed did last December when doubling the IOR rate led to lower 10 year rates.

  21. Gravatar of Joe B Joe B
    3. October 2016 at 15:47

    Scott: I thought the Bank of Japan has done QE but not helicopter drops. That seems to be consensus.

    Why do you say the BoJ has tried and failed with chopper drops?

    Also, you say if QE is thought to be permanent it leads to hyperinflation. David Beckworth says QE must be thought of as permanent to be effective.

    Clarification?

    If Japan did chopper drops, where is the inflation? If no inflation, then why not permanently fund a portion of government through chopper drops?

  22. Gravatar of ssumner ssumner
    4. October 2016 at 09:21

    Patrick, It has both expansionary and contractionary elements.

    Joe, David and I agree on this, it’s a subtle distinction you are missing. We both think QE needs to be permanent to be effective. We both think that the current level of QE would be hyperinflationary if permanent.

    Helicopter drop is a metaphor for combined fiscal/monetary expansion. I.e. for big deficits where the central bank buys up the debt. That’s what the BOJ has been doing.

    It doesn’t mean a literal drop of money from a helicopter. I agree that that policy would work.

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