For younger readers, or non-economists, I should point out that James Tobin was a famous Keynesian economist and Nobel laureate. Indeed he was a sort of Keynesian’s Keynesian, one of the most respected Keynesian economists of the 1960s-70s. Kevin Donoghue recently sent me a 1983 paper by Tobin that contradicted my argument that liberal economists don’t tend to support NGDP targeting. In 1983 James Tobin did:
For two years ahead, the intermediate target should be nominal GNP growth, or as Robert Gordon has suggested, nominal final sales. [So I'm Tobin and Bill is Gordon.] This would indicate how the policymakers would allow price and productivity shocks to affect output and employment, while allowing complete freedom to offset velocity-of-money surprises with money supplies. Indeed the Fed might advertise this target as a velocity-adjusted monetary aggregate, a concept toward which it has been groping in these last turbulent years . . .
A nominal GNP or final sales target implies for the duration of its tenure a one-for-one trade-off between price and quantity. An upward supply price shock would mean commensurately smaller real GNP growth. These terms of trade may not accord with national priorities. Separate ranges for price and quantity would allow an extra degree of freedom. But a nominal GNP target range is easier to explain and understand.
. . .
I know that central bankers will object because explicit policymaking on these lines makes their responsibilities for important economic outcomes transparent. They prefer to hide behind less meaningful descriptions of what they are doing. But there is no reason for the rest of us to respect that preference. (Italics added.)
Of course some people have argued that the Fed was not to blame for the recent fall in NGDP, after all interest rates weren’t raised in mid-2008, rather they were kept stable. Here is what Tobin says in 1983:
However, as I have argued above, “doing nothing” is not well defined. Mariners would not define a fixed rudder angle rather than a fixed compass heading as conservatively “doing nothing.” [Suddenly I feel like a plagiarist.] Monetary rules themselves require the authorities to adjust instruments to achieve intermediate targets. How fast they should try to return to track when events beyond their control, like wind, waves, and currents, throw them off is a consequential problem. Achieving intermediate targets, to whatever degree of precision, does not in any case achieve desired paths of macroeconomic variables that really matter. Your conclusion as to what is the minimum-risk strategy, or an optimal strategy, will depend on your model of the financial and economic system and on your objectives and priorities. It is unlikely to coincide with holding constant any of the instruments or variables directly under central bank control or any intermediate policy targets.
I wish Tobin had lived long enough to have something to say about the role of money in the current financial crisis. As you know I am one of the few people who think tight money, defined as a policy of suddenly driving NGDP growth 8% below trend, was the most important factor in the financial crisis, which became most destructive in late 2008. Tobin wrote this paper as we were just emerging from an almost equally severe recession in 1981-82, when unemployment reached 10.7%. I had forgotten that there was also an international debt crisis in 1982. But now I remember, and I recall the crisis was blamed on banks making a lot of foolish loans to third world countries. But Tobin has an interesting observation:
Last summer Chairman Volcker and his Federal Reserve colleagues suspended their monetarist targets, to almost universal relief. The severity of the recession, the international debt crisis, and the pace of change in financial structure were all good reasons. (Italics added.)
I don’t entirely share Tobin’s anti-monetarist sentiments, which are overdone at various points in the paper. Indeed at one point he blames monetarists for the bad condition of the economy between 1973-79; a bizarre argument. But the debt comment is interesting, so I decided to go back and look at the NGDP numbers. Between 1971:3 and 1981:3, NGDP grew at about 10% to 11% a year, although the rate was volatile. Then between 1981:3 and 1982:3, nominal growth dropped to a mere 3%. Hmmm, NGDP growth suddenly dropped about 7.5% below trend–does that sound familiar? And the drop led to an international debt crisis (many of the debts were dollar-denominated.) There was also an S&L crisis.
Under normal times, there would be nothing wrong with 3% NGDP growth, indeed it might be optimal. But because wage contracts reflected expectations of more than 10% NGDP growth, as did loan contracts, employers ended up laying off lots of workers, and debtors ended up defaulting on lots of debts. It’s like musical chairs; when the music stopped there weren’t enough dollars of NGDP out there to pay the debts and salaries that had been contracted under much different expectations. And of course the same thing happened in 2008.
So to summarize, Tobin believes:
1. We should target NGDP.
2. Sneaky central bankers will try to dodge their responsibility for stabilizing NGDP growth, by refusing to be tied down by any specific policy goal. But we shouldn’t let them.
3. Some other trade-offs between prices and output are possible (an anticipation of the Taylor Rule?) but NGDP is easier to explain and understand.
4. Economists currently lack a good definition for a neutral monetary policy stance.
5. Holding interest rates steady at 2% does not mean that the Fed is maintaining a policy of monetary ease. Policy changes when the compass changes, not the rudder. (The compass is expected NGDP, the rudder is the fed funds rate or the monetary base.)
6. A financial crisis can result from excessively tight money.
And here is the weirdest thing of all; I have always thought I had nothing in common with James Tobin, who I always saw as an outdated Keynesian. And yet there they are; all the important ideas from my blog, published in a Tobin paper in 1983. Economics is not like the hard sciences, there is much to be gained from reading old texts.