The Fed “blithely declares” we should consider targeting NGDP
Why does stuff like this have to happen when I have no time to blog? I promise commenters that I will eventually get to comments from recent posts. Perhaps tomorrow night. And then there is the backlog of posts I need to do. But this one can’t wait. I saw the following comment from someone whose byline is an apparent reference to Keynesian economics (“Obsolete Dogma“):
If it makes you feel any better, the latest FOMC minutes (http://read.bi/8Xejge) show the board considered implementing either a NGDP or price level target instead of targeting the rate of inflation.
The FOMC brings to mind Churchill’s quip about Americans: they always do the right thing “” after they have exhausted all other possibilities.
He or she is referring to this comment in the Fed minutes:
Participants noted a number of possible strategies for affecting short-term inflation expectations, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP.
Like the hardy band of hobbits who brought the ring to Mordor, our little group of bloggers from schools like Texas State, Bentley, The Citadel, Wayne State University have finally succeeded in bringing NGDP targeting (level targeting no less!) into the formerly impregnable Federal Reserve System. Kudos to Matt Yglesias as well. And of course level targeting-advocate Michael Woodford, who in all seriousness does have influence at the Fed.
Here’s Yahoo’s explanation of why stocks turned around after Yellen’s scary statement depressed prices this morning:
WASHINGTON (AP) — The Federal Reserve is leaning toward taking two steps to boost the economy: Buying more Treasury bonds to drive down loan rates, and signaling an openness to higher prices later to encourage more spending now.
And another Yahoo story explained the market reaction:
NEW YORK (AP) — Traders pushed shares higher Tuesday after minutes from the latest Federal Reserve meeting kept hope alive that the central bank would take more action to stimulate the economy.
The Fed had said after its Sept. 21 meeting that it was concerned that inflation was too low, and suggested it could step up its purchases of government bonds and take other action to encourage lending.
Minutes from the September meeting, released Tuesday afternoon, indicated that Fed Chairman Ben Bernanke and his colleagues were nearing a consensus on what steps to take. Traders are hoping for more concrete news from the Fed following its next meeting in early November. (Emphasis added.)
Yes, I understand that the details will probably be underwhelming, and I shouldn’t get my hopes up. But the fact that they are thinking along these lines may pay off in the next business cycle. Imagine if these policies had been adopted in September/October 2008. Remember, NGDP fell in 2009 at the fastest rate since 1938—level targeting would have made a huuuuuge difference in October 2008.
PS: The post title is a reference to this Paul Krugman post. In fairness to Krugman, any price level or NGDP target announced by the Fed is probably going to be too low to make a dramatic difference. But I think he might underestimate the advantages of level targeting over “memory-less” growth rate targeting. At least I don’t recall him discussing the topic.
Tags:
12. October 2010 at 15:23
The FT’s Money Supply blog says that Bernanke is making a speech on Friday about “revisiting monetary policy in a low inflation environment”.
http://blogs.ft.com/money-supply/2010/10/12/the-fomc-debates-talking-up-inflation/
Though the sentence following the one Scott quotes says that “The minutes of FOMC meetings were seen as an important channel for communicating participants’ views about monetary policy” so perhaps he won’t announce anything on Friday.
Also at that link, Alan Ruskin of Deutsche Bank says: “The market smells a contradiction between the Fed targeting higher inflation and buying treasuries to lower nominal yields”. But surely the Fed’s actual goal is to reduce real yields, not nominal?
12. October 2010 at 16:31
Encouraging, but you know what’s not encouraging.
The backlash is in full force now in the media. For awhile no one was talking about the Fed even when it began to gear up for QE2 in September. I was hoping that the Fed would continue to just be ignored. That would be the best outcome.
But now, everyone is talking about the Fed and the usual suspects are spitting out the usual lines (you can’t print your way to prosperity, hyper-inflation coming!, pushing on a string, look at GOLD! etc., etc.)
I hope that this doesn’t derail what seems to be very encouraging developments.
12. October 2010 at 16:52
Certainly the most promising sign to come out of the Fed yet. Now if they’d begin considering the ER problem, QE would actually be worth it.
And I’m afraid you misunderstood my byline; it seems you projected a bit there. I’m an Yglesias-style liberal converted to the cause of monetary stimulus, who doesn’t find that much distance between yourself and Krugman on the issues of the day (fiscal policy excluded, obviously). The byline is a reference to a line from an RFK speech.
And agree or disagree: until/if the ER problem is solved, it would be better – in a clearly hypothetical world – for state governments to be allowed to issue legally redeemable, depreciating Worgl-style scrips to fill in budget shortfalls than for another round of QE.
12. October 2010 at 17:07
“Like the hardy band of hobbits who brought the ring to Mordor”–I guess we shared the same American teenage years.
Ben Bernanke strikes me as the very picture of sobriety, circumspection and caution. So, we may see something along the lines of $40 billion a month of QE, and a few other measures, and talk of higher inflation targets.
BTW, no one is talking about the fact the way we measure inflation probably overstates the reality (Boskin). I don’t know if the Fed uses a GDP deflator or what to measure inflation. In any event, we are close to zero real inflation now.
Congrats to Scott Sumner, and the other hobbits. You have the ring in place.
Now is the time to pour it on.
12. October 2010 at 17:14
One concern is the Fed’s “dual mandate”.
Suppose the Fed starts NGDP level targeting and unemployment falls some but remains quite high. For Sumnerites, the Fed has done all it can. Any remaining unemployment is likely structural — Arnold Kling’s time to shine! In other words, the Fed has established optimal macroeconomic conditions for microeconomic coordination (as Woolsey likes to say). But the Fed is still going to be confronted with high unemployment, and it will be under pressure to do more — especially if QE2 has some initial success. The Fed may be tempted to drop NGDP targeting and continue quantitative easing. The result would probably be stagflation.
Okay, I am getting slightly ahead of myself.
12. October 2010 at 17:18
Who is Gollum in this story? I want to say Krugman or DeLong, but that would probably be a tad unfair.
12. October 2010 at 17:51
“Congrats to Scott Sumner, and the other hobbits. You have the ring in place.”
I ditto that. Here’s to the battle of ideas.
I have to think that Lars Svensson and other central bankers communicate thoughts to the Fed via various channels. It’s nice that those ideas are apparently being tabled.
12. October 2010 at 17:54
The Fed better deliver at the next meeting or the market is not going to take it well. Frankly, I think market expectations have become a bit too enthusiastic considering the previous conservatism of the Fed.
Bernanke doesn’t look much like Mordor but he does look quite a bit like the Travelocity gnome.
12. October 2010 at 17:59
“Like the hardy band of hobbits who brought the ring to Mordor, our little group of bloggers from schools like Texas State, Bentley, The Citadel, Wayne State University have finally succeeded in bringing NGDP targeting (level targeting no less!) into the formerly impregnable Federal Reserve System.”
Sounds like a great set-up for a documentary.
12. October 2010 at 20:00
[…] His semi ‘celebration’ here. likebot_bgcolor = ''; likebot_url = 'http://www.tvhe.co.nz/?p=5460'; likebot_type = […]
12. October 2010 at 20:34
Leigh,
But surely the Fed’s actual goal is to reduce real yields, not nominal?
Yes!
12. October 2010 at 20:55
hooray
12. October 2010 at 21:26
[…] Sumner — a lonely crusader for NGDP targeting for two decades — is also celebrating. A number of those supporting NGDP targeting have a background in Hayekian macroeconomics, and as […]
12. October 2010 at 22:18
Gollum would have to be one of the tight money guys. Since Gollum transformed from a hobbit named Smeagol, maybe Anna Schwartz?
13. October 2010 at 03:41
It took me several months to figure out that the Fed’s doubling of the monetary base was meaningless.
At first I was shocked and awed by it like most everybody who paid any attention. Doubling the money supply overnight was far more awesome than anything in the history of the Fed — and way more than was necessary, according to historical precedent.
Several years in a row of double-digit growth in the money supply would be enough to eventually pull us out of this credit supercycle bust — no need for an overnight triple-digit explosion. Many econ bloggers openly worried about hyperinflation resulting from the unprecedented burst of new cash. Some still do!
But it was all fake, because the Fed “sterilized” the growth by paying above-market interest rates on banks’ excess cash, sucking it right back out of the economy.
Now financial reporters and investment bankers and hedge fund traders are watching the Fed engage in an internal debate about whether to grow the monetary base by another $500 billion or more. And it is just a waste of time and effort, because however much the Fed grows the monetary base, they will continue to sterilize this growth by paying above-market interest rates on the excess.
Why do they even bother? Don’t the members of the Fed realize what they are (not) doing?
—–
There are two components to the power of money: (1) amount, and (2) velocity. Total spending is the product of the amount of money times how often money is spent.
When the Fed doubled the money supply, this had the potential of doubling the apparent size of the economy overnight, which would’ve caused quick increases in sales and production, and probably a lot of inflation. But only if the velocity of money remained constant.
As the Fed doubled the money supply, they also added a new policy in which they paid interest on banks’ excess cash. The amount the Fed currently pays, 0.25%, is greater than the rate on short-term Treasury bills, and also greater than the amount banks pay each other for short-term loans. Therefore, when a bank has more cash than it needs, it is likely to park it with the Fed for 0.25% rather than circulate it through the financial system and the wider economy.
Prior to October 2008, the Fed had never paid interest on excess reserves. This new policy reduced the velocity of money, even a bit more than the amount of money increased. So the decreased velocity more than offset the increased amount — probably adding to the depth of this nasty recession by reducing overall spending.
—–
It doesn’t matter whether the Fed decides to add another $500 billion or more to the money supply. It won’t make any difference to the economy until the Fed stops paying above-market rates on excess reserves. The market rate is currently somewhere between 0.14% and 0.19%, so if the Fed really wants to boost the economy it needs to cut its rate on excess reserves to 0.13% or less.
Paradoxically, the more the Fed increases the money supply, the less likely they will be to stop paying above-market rates on the excess — because they are rightly afraid that such a move could cause hyperinflation.
So, the Fed has boxed itself inside a worthless policy that will not help the economy and from which they are afraid to escape. Meanwhile, the economy stagnates.
13. October 2010 at 04:05
[…] other kinds of assets, most seem to agree to this) and interestingly GDP targeting. That is an idea suggested many times by Scott […]
13. October 2010 at 04:14
Liberal Roman,
The problem is two-fold. On the one hand, there are Keynesians, who at best claim that monetary stimulus will be ineffective and at worst say it will be damaging.
On the other, there are the Austrian Schoolboys and other assorted deflationists. They’ve been predicting hyperinflation “in the near future” for at least two years now (three or more in some cases) with narrow-money growth as their best evidence. Monetary stimulus makes their claims seem more plausible.
Of the two, I think that the deflationists are the most dangerous. Apart from Stiglitz, at least no Keynesian is actively opposing monetary stimulus. “Pushing on a string” and such is annoying, but I doubt it will damage things too much and will (if wrong) at least go some way to discredit Keynesianism.
Deflationists, on the other hand, have psychology on their side. It’s well documented that most people (including economics students) have horrifically inaccurate estimates of inflation and always overestimate it. People can be convinced that the US is already suffering from too much inflation. This wouldn’t be a problem normally, but when a mass-movement like the Tea Party is giving the general public so much influence in America, people’s lack of basic economic information is dangerous.
Still, if the Fed gets to work at all, this in itself is good news for much of the world. Many countries have handled this crisis masterfully, but have nonetheless suffered due to the gross incompetance of the US government and Fed.
13. October 2010 at 04:25
Doug Bates,
I can’t help but notice you move from talking about the “monetary base” to the “money supply”. But the money supply can be measured in wider ways than the monetary base (which is sometimes called “narrow money”) which have been growly slowly or falling since 2008. I think that M3 is the widest measure of the money supply in the US, and it’s been appalingly deflationary since 2008. In fact, I think that even with Fed action the US is in for a period of stagnation or even a double-dip, because M3 has been falling during much of 2010.
13. October 2010 at 06:07
What does it mean that they are considering QE? Are they going to buy a $1B per month in used car loans or are they going to buy $100B per month in T-bonds? And for how long?
If they are dropping the fed funds rate for QE they need some kind of target to tell us the scope and duration of what they are planning to do. So why not target price level or NGDP? Targeting commodity prices would be unappealing to them.
13. October 2010 at 06:19
@W. Peden,
The QE2 backlash continues. This time Nial Ferguson offers his infinite wisdom. (His view on QE is in the middle of the article)
http://www.cnbc.com/id/39646116
He claims that QE2 will do nothing but boost commodity prices. Can someone be more wrong? The sad fact is that commodity prices rising reflects real supply problems for our major commodities. These problems become very evident when full growth returns.
Of course, IMO, there is nothing really wrong with a $150/barrel oil. It does the job of cap & trade without Congress having to pass anything.
13. October 2010 at 06:37
Worth repeating a Hayek quote from his response to questions from Gottfried Haberler:
“The moment there is any sign that the total income stream may
actually shrink, I should certainly not only try everything in my power to prevent it from dwindling, but I should announce
beforehand that I would do so in the event the problem arose.”
(as quoted by Lawrence White–<a href="http://economics.sbs.ohio-state.edu/jmcb/jmcb/07056/07056.pdf"PDF here).
13. October 2010 at 06:59
Bloomberg says Eggertsson has attended the last FOMC meeting:
http://noir.bloomberg.com/apps/news?pid=20601087&sid=acZudC6SsBGU&pos=7
13. October 2010 at 08:10
Wooo!
Yay! NGDP targeting > inflation rate targeting.
13. October 2010 at 10:07
Congratulations.
The Bloomberg article 123 links to makes it clear Eggertsson and Woodford are making serious contributions, I wonder if Bernanke didn’t bring them in to bolster his case. (And why Obama didn’t nominate one of them to the Fed).
As a slight aside, I’ve noticed that a number of the opponents of more monetary stimulus, like Rajan or Stiglitz, for example, are primarily concerned with the effect of ‘excess liquidity’ in emerging markets. Is this from a different theoretical view of the neautrality of money? Or a difference using open macro models? Or something else?
13. October 2010 at 10:51
Liberal Roman,
That (what Ferguson says) doesn’t make any sense, of course.
I agree re: oil prices. I have no problem with rising oil prices (I don’t have a car, which probably affects my sentiments) because it’s a sign of the market encouraging environmentally beneficial action. Since I DO breathe air (I haven’t managed to reduce that particular form of consumption) I find myself somewhat of a green capitalist.
13. October 2010 at 12:12
The message is getting out, sort of, and meeting resistance.
On my car radio today I heard a female Bloomberg radio host interviewing the “chief economist” of some Wall Street securities house. (Nomura?)
Her: “The Fed has signaled its intention to undertake Qualitative Easing (sic)…”
Chief economist: “I am very strongly against that. This is an attempt to target a future price level by increasing inflation. But the one lesson I thought we’d learned is that when the Fed loosens the public’s inflation expectations bad things happen, inflation very easily gets out of hand. There is nothing wrong with today’s inflation situation. We must not forget the inflation experience of the 1970s…”
13. October 2010 at 12:15
I am beginning to wonder if the real deal is that many conservatives fear QE2 will work, therefore meaning Obama’s health care and liberal agenda is not what is stifling economic growth.
Too far fetched? Well, take for example John Taylor’s review of Allen Meltzer’s Fed history.
Taylor manages to discuss the Great Inflation beginning in 1965, and why the Fed was accommodative, without mentioning the Vietnam War.
Taylor then moves on to the Volcker years, and the pressure Volcker was under to ease up–but only from Carter people. The Reaganites never pressured Volcker, in Taylor’s review. Yet we know from public record that Reagan’s Treasury Secy Don Regan publicly criticized Volcker, and that ultimately Volcker was edged out in favor of Greenspan.
Obviously, some economists bring their political biases with them, and that is okay, this is America. I think those same biases are at work now, in all the honking about QE being bad.
If we had a Repubclian President, we might be hearing a different story. If we started up a war, we for sure would be hearing a different story.
BTW, I am no Obama fan. I am very pro-business. I believe in limiting federal outlays to 16 percent of GDP.
I am just wondering about this strange attachment to stringing a monetary noose around our economic necks. It has gotten peculiar–we are at zero inflation, nearly. 10 percent unemployment.
13. October 2010 at 12:29
Heavens to Murgatroy!
A headline on the cover of the WSJ today is “Fef Chief to Apply Lessons of Japan.”
The Japan Wing Orcs are being driven back by a fiesty little band of hobbits…
13. October 2010 at 14:11
@Benji… you are beginning to wonder???
Jesus man, I’ve been telling you this since I arrived.
I’m glad you want to keep spending to 16%, that’s very nice. I want to GUT Public Employees before the economy improves.
Since we have the crisis before us, and the election is but weeks away… we can work together. First, I’ll get what I want, and then you can get what you want.
Small note: it isn’t about QE2 working wonders, it is about not changing the narrative until we get the policy changes we want.
And it is become clear to me that Cochrane’s approach is FAR superior to Scott’s – because if focuses CLEARLY on guaranteeing savers no more than 2% level tax as trade for believing in the dollar… regardless what happens to unemployment.
Scott should change his mind.
13. October 2010 at 14:11
@Benji… you are beginning to wonder???
Jesus man, I’ve been telling you this since I arrived.
I’m glad you want to keep spending to 16%, that’s very nice. I want to GUT Public Employees before the economy improves.
Since we have the crisis before us, and the election is but weeks away… we can work together. First, I’ll get what I want, and then you can get what you want.
Small note: it isn’t about QE2 working wonders, it is about not changing the narrative until we get the policy changes we want.
And it is become clear to me that Cochrane’s approach is FAR superior to Scott’s – because if focuses CLEARLY on guaranteeing savers no more than 2% level tax as trade for believing in the dollar… regardless what happens to unemployment.
Scott should change his mind.
13. October 2010 at 22:42
Under most circumstances, do both NGDP targeting and price inflation targeting require an increase in what I consider to be the yet undefined M?
13. October 2010 at 23:45
@Fed Up:
“Under most circumstances, do both NGDP targeting and price inflation targeting require an increase in what I consider to be the yet undefined M?”
No, it depends on what the target is. If the target is per capita NGDP growth less than minus the rate of increase in productivity then per capita M would necessarily decrease (assuming constant velocity).
If the target is above minus the rate of increase in productivity then per capita M would have to increase.
14. October 2010 at 06:36
[…] Sumner writes: Like the hardy band of hobbits who brought the ring to Mordor, our little group of bloggers from […]
14. October 2010 at 14:04
Doc Merlin said: “No, it depends on what the target is. If the target is per capita NGDP growth less than minus the rate of increase in productivity then per capita M would necessarily decrease (assuming constant velocity).
If the target is above minus the rate of increase in productivity then per capita M would have to increase.”
Can you rephrase that? I sort of get it and sort of don’t. Thanks!
14. October 2010 at 17:24
Leigh, I also noticed that Ruskin quote, and put it in a later post.
Liberal Roman, Yes, the critics don’t know if it’s pushing on a string or hyperinflation, they just know it’s bad.
Obsolete Dogma, I just threw that in as a joke, I had no idea as to your views.
I am afraid I don’t know much about state level script. My hunch is that it won’t do much, but I’ll reserve judgment. I have no objection to giving it a try.
Thanks Benjamin.
Lee Kelly, I won’t worry about the Fed swinging from too little inflation to too much, their swings tend to take about 20-30 years.
JTapp, It can now be revealed, Lars Swensson does this back channel communications to the Fed through my blog. About one in ten posts are his.
Joe Calhoun, I have that same worry. Isn’t Nov. 3 also the day after the election? Could be interesting.
Charlie, Good idea.
TGGP, I’m not going there.
Doug Bates, Good point. I’ve been critical of the IOR from the very beginning.
Charles William, Yes, the QE needs to be combined with some sort of target to be effective.
Liberal Roman, Yes, as I recall when we last had $150 oil we had 6% unemployment. As soon as oil prices collapsed, so did jobs.
JTapp, That’s a good Hayek quotation.
123, That’s interesting about Eggertsson.
Doc Merlin, I agree.
OGT, I know of no model where monetary stimulus doesn’t boost US AD, but does hurt emerging markets. If such a model exists, I’d love to see it.
Jim Glass, Yes, just another reason why the Fed should never talk about inflation—stick to NGDP.
Benjamin, Yes there is a lot of politics involved.
Fed up, Maybe 60% or 70% of the time M has to increase.
14. October 2010 at 17:53
How does positive productivity growth and cheap labor figure into NGDP targeting?
15. October 2010 at 16:01
Fed up, Not at all.
15. October 2010 at 16:20
ssumner said: “Fed up, Not at all.”
I need an explanation for that one, please.
17. October 2010 at 05:49
Fed Up, I can’t think of any reason they would affect NGDP. Why would they affect M*V?
17. October 2010 at 14:08
Scott, could it affect M*V by affecting V? as V would be sped up by decreased transaction costs (and thus search costs).
17. October 2010 at 14:32
@W. Peden
“It’s well documented that most people (including economics students) have horrifically inaccurate estimates of inflation and always overestimate it. ”
This is because the things that most people have common interaction with tend to have very high inflation rates during periods of inflation. Things like food and energy can have extremely high rates of inflation, which is why they are often ignored by policymakers. There really isn’t a single price level, there is only a distribution of prices. PY=MV is only a first order approximation that ignores the effect of expectations on relative prices of durable goods.
22. October 2010 at 22:36
“How does positive productivity growth and cheap labor figure into NGDP targeting?”
“Fed Up, I can’t think of any reason they would affect NGDP. Why would they affect M*V?”
It seems to me that positive productivity growth and cheap labor produce lower price inflation or even price deflation. At low price inflation, zero price inflation, or price deflation, the medium of exchange can become a saving(s) “vehicle”. That lowers the velocity of the medium of exchange.
23. October 2010 at 06:05
Doc Merlin, The Fed offsets any V change sdue to technology.
Fed up. No, lower inflation doesn’t cause money hoarding if NGDP is still growing just as fast. It is NGDP growth that determines money demand.
27. October 2010 at 23:16
“Fed up. No, lower inflation doesn’t cause money hoarding if NGDP is still growing just as fast. It is NGDP growth that determines money demand.”
Sorry, I’m not getting that. If someone wants to save risk free and price deflation is 3%, then why not save risk free in the medium of exchange and earn a positive 3% real return? As long as the person saves, isn’t velocity of the medium of exchange zero?
27. October 2010 at 23:21
“Doc Merlin, The Fed offsets any V change sdue to technology.”
By increasing M? If not, how?
4. November 2010 at 17:25
Fed up, If NGDP is growing fast, they can get better than a 3% rate of return elsewhere.
12. February 2016 at 08:02
[…] Scott Sumner – who has been advocating nominal GDP targeting for months – argues the policy would have made a huuuuuge difference had it been adopted in October 2008. Remember, NGDP fell in 2009 at the fastest rate since 1938. In another post, Sumner notes that Roosevelt’s “gold-buying program” of October-December 1933 was the last time (and perhaps only other time) that the US government explicitly tried to raise the price level. The Fed better fasten its seat-belt, as the previous price level raising policy was a bit controversial. Several FDR advisers resigned in protest. If the Fed can convince markets that they can raise the price level without changing their 2% inflation target, it is likely that all markets will react positively. If they are seen as raising inflation in a semi-permanent way, stocks may still rise (albeit by a smaller amount), but bonds will sell off. […]