Reply to DeLong on NGDP futures targeting

I tried to leave a comment at Brad DeLong’s blog, but I just can’t figure out these newfangled comment sections.  So I’ll post it here.  (I did leave a similar comment at Tyler Cowen’s post)

I’m kind of amused to see Brad DeLong suggest I finally ”plump” for NGDP futures targeting.  I’ve devoted my entire career to the idea.  Indeed I presented this idea at the AEA meetings in 1987, and have 6 publications on the futures targeting idea. 

My 1995 JMCB piece is an inferior version of the plan, which I have pretty much abandoned.  I’m sticking by my 1989 version, as well as my 1997 version.  But my two most recent publications are probably best.  I have an Economic Inquiry article with Aaron Jackson, and a B-E Contributions to Macroeconomics article, both from 2006.  The latter is closest to what I have just described. Many others have published similar ideas (Thompson, Hall, Woolsey, Glasner, Dowd, Hetzel, etc.)  Milton Friedman once endorsed Hetzel’s proposal, which is actually inferior to the others.  Hall’s was in the JME.  Dowd’s was in the Economic Journal.  At least one of my publications was refereed (I’m almost sure) by one of the smartest macroeconomists in the universe.   I also mentioned the idea to John Cochrane last year, and a few months later he seemed to endorse a similar idea.  None of this makes it right, but there has certainly been a long literature on the subject.  Yet DeLong treats it like some wacky idea I dreamed up for the National Review. 

Bernanke and Woodford wrote an article criticizing the concept in 1997.  (The critique doesn’t apply to the version discussed below.)  So did Garrison and White.  I’m embarrassed to admit that I forgot that Tyler Cowen had also done so.  I need to reread his article and think about it, but I won’t have time for quite a while, as I am travelling tomorrow. 

Of course the National Review paragraph had to grossly simplify, and cut lots of corners.  The 3% interest Brad DeLong mentions is wrong, it doesn’t factor in at all.  But I can’t blame him, as I didn’t provide enough information.  There are three completely different ways of setting this up, but I prefer to think about the following thought experiment:

1.  Set a policy goal, say 2% inflation over the next year.

2.  Have each FOMC member vote on the monetary base setting most likely to achieve that goal.

3.  Set the actual instrument at the median vote.

4.  One year later have the doves (i.e. those voting for a more expansionary setting) pay the hawks a $1000 salary bonus if the CPI is above 2%, and vice versa.  This encourages accurate voting.

5.  Now expand the FOMC from 12 members to all 7 billion humans (excluding North Koreans, who might vote as a bloc).  Make voting voluntary.

6.  Switch from one-man-one-vote to one-dollar-one-vote.

7.  Make the reward/punishment proportional to amount by which the actual CPI misses the target.

8.  Require every voter (speculator) to have a margin account.  Pay interest on the margin accounts at a rate high enough to create a sufficiently liquid market. 

9.  Now you have CPI futures targeting.

10.  Switch to a 5% NGDP target and you have NGDP futures targeting.

Here’s my challenge.  I started with something close to real world monetary policy (you could even use the fed funds instrument, unless up against the zero rate bound.)  I moved one step at a time to my preferred policy.  At which step did I make a mistake?

Of course there are lots of issues like the risk of someone moving the entire economy to make money on a side bet elsewhere, which can be dealt with using pragmatic fixes, like having the central bank take a position against a large and highly suspicious bet from a single individual or firm.  

BTW,  I mentioned the idea to John Cochrane last year, and a few months later he seemed to endorse a similar idea.

Contrary to DeLong’s claim, there’d be no huge swings in the monetary base, as the real demand for base money is fairly stable when expected NGDP growth is on target.  But if there was a surge in the liquidity needs of the economy, so be it.

Regarding helicopter drops on bankers; banks need play no role in my plan.  The Fed could swap briefcases of $100 bills with private individuals who own bonds.

The point of this policy is not to provide a painless way out of this hole (there might be price risk on the assets bought by the central bank) but rather to prevent us from getting in the hole in the first place.

PS.   Ignore DeLong commenters like Waldmann, he completely misunderstood the proposal.  There are no arbitrage opportunities because the Fed only pegs the price of 12 or 24 month forward NGDP contracts.  Trading begins on a new contract long before the previous one matures.

PPS.  I have a cold, will be travelling, and have lots of grading to do.  Don’t expect comments to be answered anytime soon.

PPPS:  Here’s a blog post that discusses the idea in a bit more depth.


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62 Responses to “Reply to DeLong on NGDP futures targeting”

  1. Gravatar of Andy Andy
    14. December 2010 at 20:29

    You should feel honored that DeLong did not pronounce you the stupidest man alive. Then again, you might have been in good company.

  2. Gravatar of Mark A. Sadowski Mark A. Sadowski
    14. December 2010 at 20:29

    Scott it’s versus him. And I mean this in the nicest way. I like you both.

    But I want YOU to win.

    Battle of the giants.

  3. Gravatar of Mark A. Sadowski Mark A. Sadowski
    14. December 2010 at 20:30

    Go Champ!

  4. Gravatar of Brad DeLong Brad DeLong
    14. December 2010 at 20:34

    Where does the “finally” come from?

  5. Gravatar of Mark A. Sadowski Mark A. Sadowski
    14. December 2010 at 20:51

    It’s time for the rub down. You can do it!

  6. Gravatar of Bill Woolsey Bill Woolsey
    14. December 2010 at 21:24

    Scott:

    You need to watch this loose talk about trading futures contracts directly impacting the quantity of money. It doesn’t.

    It would be possible to sell oil today to be delivered in a year. You get the money now and come up with the oil a year from now. Similarly, you could buy oil now for delivery in a year. You pay money today, and a year from now, you get the oil.

    If you imagine settling these with cash rather than oil, then you could sell oil today and get the money now. Then, when you are supposed to deliver the oil, you just give the money needed to buy the oil.

    You could purchase oil today, paying the money now, and then, when you are supposed to receive the oil in a year, you would just get the money that you would need to buy the oil.

    These contracts would be loans but with the interest rate depending on the difference between the price of oil for future delivery and the spot price of oil when the contract is settled.

    Generally, the price of these contracts be less than the expected price of the oil by the interest rate. Presumably, there would be a risk premium.

    Future contracts instead are promises to pay money for oil next year, but at a price agreed now. And, of course, to sell oil for money in a year, but at a price agreed now.

    There is no borrowing or lending to it. Both parties must put up collateral, which is like posting a bond. Those selling the futures contract don’t get money now. They pay money (or put up collateral.)

    With index futures convertibility, if there is going to be a change in the quantity of money, the Fed needs to use open market operations with securities of some sort.

    P.S. With a Minsky recession, leaving aside suspending cash payments and negative interest rates on deposits, the Fed must simply purchase securities with yields greater than zero.

  7. Gravatar of justanothereconomist justanothereconomist
    14. December 2010 at 22:04

    Scott- I think your proposal is interesting I have some questions/comments:

    1) Why do you need the 500/100 OMO commitment? Why couldn’t the Fed just commit to buy and sell NGDP futures at the target price. (Which you already have in your plan).

    Then if expectations of NGDP are below target, investors will sell their futures, as the fraction of the target is worth more than what the future NGDP will be. This will increase the money base. When will this stop? Once enough investors have sold futures such that money base is sufficient to get to the NGDP target. Same thing for expectations of NGDP above target- investors will sell their NGDP futures to the Fed, reducing money base until NGDP is back on target.

    I think you are seeing the FED as just another investor who, when they gain or lose cash, they will shift other parts of their portfolio, which means that this cash will just go somewhere else, thus keep the money base the same. This is not the case with the Fed, which can create or destroy money base without limit.

    So basically, you already have a money base rule, no need for 500/100. It’s as if the Fed was fixing the dollar to NGDP futures, though the dollar would still float against all other currencies. It’s a “domestic peg,” which creates a monetary policy rule.

    If I’m right about this, then you wouldn’t need any interest rate target. The interest rate would always be at the Wicksellian rate.

    I don’t know that I totally understand Woolsey’s comment, but I think I disagree. Wouldn’t your theory imply that the Fed engaging in any swap (bond, foreign currency, etc.) would have no effect? That seems false.

    2)Why the margin accounts? You don’t need to artificially introduce these government accounts to have sufficient liquidity in any other financial or trading market. Given that economic/financial theory just imposes arbitrage conditions, the required size of the market is indeterminate. (Size measured in any way, in dollars or in people trading). But given that most markets have plenty of liquidity from the financial/rich people that dominate these markets, there’s no need to artificially introduce margin accounts. If someone wants to get in the market, and he doesn’t have enough money to do so, who cares? It’s not an issue in any other market.

    2b) Even if someone couldn’t afford to sell their NGDP futures, it seems likely that it would be possible to short these futures as this is the case in markets like intrade. Naturally some collateral might be required, but again, I think the market could take care of this. (It’s rare that I have an opinion that is more pro-market than you :) )

    3) I don’t get Brad’s comment that the money base would be volatile. Who cares, if you get 5% nominal NGDP growth? Let’s put it this way: what level of money base volatility would be too high, if I offered in exchange that the economy had never deviated from a 5% NGDP path. Money base stability is a means, not an end.

  8. Gravatar of axiom axiom
    14. December 2010 at 22:42

    Posted at Cowen’s; hope this is right —

    Bill Woolsey’s comment is very useful.

    The Fed creates a trading position for itself by participating in NGDP futures market transactions.

    The Fed’s implicit/explicit objective should be to keep its own futures market position flat – i.e. neither net long nor net short.

    A flat position reflects the market’s net view that NGDP expectations are on target.

    The Fed gets flat by conducting regular open market operations in such a way as to steer market expectations for NGDP back on target.

    E.g. if the futures market has a net short position with the Fed, and the Fed has a corresponding net long position, the Fed should supply reserves to the market through standard OMO. This easing should move NGDP expectations back to target, and thereby create bids for the Fed’s long position such that it can get back to flat on its futures exposure.

    Thus, the Fed must use standard cash money markets and OMO to influence NGDP futures market prices and NGDP expectations.

    The integrated Fed operation has virtually nothing to do with the cash flow that’s associated with futures markets transactions per se.

    It has everything to do with the price signal and the corresponding trading position that’s delivered by the futures market to the Fed.

    And it has everything to do with the cash flow that’s associated with the resulting normal OMO strategies adopted by the Fed, in response to the futures market signals and trading position delivered to it.

    I wonder if DeLong understands this.

  9. Gravatar of rob rob
    14. December 2010 at 22:56

    “there is a general rule: when Scott Sumner says you are wrong, you are wrong” – TC

    Damn. Of all the blogs in all the world I’ve been called wrong on, I think my comments have been called wrong the most times on this one. Please correct me if I am wrong.

  10. Gravatar of Left Outside Left Outside
    15. December 2010 at 02:57

    “Switch from one-man-one-vote to one-dollar-one-vote.”

    You should almost immediately stop referring to your policy in this way.

    I’m talking from a political economy point of view. Rich people have more dollars or pounds etc. than poor people, were anything to go wrong, and it appeared that the rich had more democratic voting power over proceedings than the poor your system could well be rejected in toto.

    Voting rights based on property are particularly unpopular, not just 19th C democracies, but in the way voting in the IMF is organised, there’s a lot of past and present animosity towards the idea.

    I assume you were using short hand, but don’t its an open goal for anti-Sumnerians.

  11. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    15. December 2010 at 04:06

    It is definitely possible to peg the dollar to NGDP futures. Today the dollar is pegged to the fed funds rate target. The problem is when the peg collapses or loses credibility. The fed funds rate peg collapsed after Lehman:
    http://themoneydemand.blogspot.com/2010/11/collapse-of-fed-funds-rate-peg-and.html

    It is easier to restore the fed funds rate peg than it is to restore the NGPD futures peg. On the other hand, when the NGDP futures peg is restored, we will almost by definition get a very speedy recovery.

    One could say that the NGDP futures peg might have survived the Lehman crisis, but then we just have to wait for a bigger crisis.

    The bottom line is that the NGDP futures peg is more desirable than the fed funds rate peg.

  12. Gravatar of Bill Woolsey Bill Woolsey
    15. December 2010 at 04:55

    Just an economist:

    Futures contracts don’t work that way.

    An index future on NGDP for fourth quarter 2011 at a price of $1,000 would require sellers to pay buyers $10 for every percentage point NGDP was above target. It would buyers to pay sellers for every percentage point NGDP is below target. If NGDP is on target, no one pays anyone.

    The Fed “creates” money when the futures contract money expires to the degree it loses money. That is, if the Fed has a position on the contract (is long or short) and loses money because NGDP was below or above target, then it creates money when it pays off the shorts or longs who made money. The Fed destroys money when the contract expires to the degree it makes money. It collects money for those who lost. If the Fed has no position on the contract, that is, the longs and shorts, bulls and bears, in the private sector match, then the Fed doesn’t create or destroy money.

    The reason for the margin accounts is to make sure that those buying or selling the contracts pay off if the lose money when the contract matures–sometime in early 2012 and the NGDP figures are in.

    In some since, the margin accounts have some monetary consequence, but it is always contractionary and both longs and shorts put up funds for margin. That is, people who think that the ecnoomy will contract, have to tie up some kind of funds in a margin account in order to sell the futures contracts.

    It is possible to invent a new kind of contract that involves the Fed borrowing and lending and paying an interest rate that depends on the deviation of NGDP from target. The Fed buys these, which means that it lends money to the private sector and collects the an interst rate that is adjusted in proportion to the deviation of NGDP from target. If NGDP is too 2% too high, then the borrowers must pay the Fed an interest rate on the loan that is 2% higher. If NGDP is 3 % too low, then the interest rate on the loan is 3% lower.

    The Fed could sell these contracts, which would be accepting a kind of deposit from the public. The interest rate would rise if NGDP is above target. And it would be lower if NGDP was below target.

    If this is the Fed’s only asset, then it would need to be buying them (lending) all the time. If NGDP was expected to be above target, then the interest rate will be higher and people will borrow less. But people could also buy from the Fed, and reduce the quantity of money that way, which they would do becaues they could earn a higher interest rate.

    A much more reasonable scheme is for the Fed to do ordinary open market operations and trade these special securities too. If the Fed creates too little base money, people can buy these secutities, borrowing from the Fed. The do this because they will get a lower interest rate when NGDP is below target. Those who instead expect NGDP to be above target will buy from the Fed, getting deposits in the Fed, and do so because they expect higher interet.

    Personally, I think a more sensible approach is to have the Fed do ordinary open market operations and trade ordinary interest futures contracts. The Fed’s instruction should be to keep its net position on the contract at zero.

  13. Gravatar of Charles R. Williams Charles R. Williams
    15. December 2010 at 05:02

    The proposal you outlined is predicated on some stable, predictable relationship between the monetary base (or fed funds) and a future level of NGDP. Imagine a car traveling at top speed on a mountain road. The driver decides to send text messages but he will make sure he does a course correction every 5 seconds. Now you may think that the collapse of Fall 2008 was a result of erratic monetary policy over the prior year and a half but suppose it was not. Suppose policy was stuck on October 1, 2008 on some predetermined interest rate or level of base money. The results could be catastrophic.

    By the way, Cochrane may support something that is superficially like what you propose but his reasons are very different. He thinks monetary policy in the pure sense is impotent at the moment. So he contemplates having the government do something “fiscal” with monetary policy – specifically allowing people to buy insurance from the government against deflation. Of course, when deflation cannot be stopped by pure monetary policy the government will pay claims, thereby stimulating the economy out of a deflationary trap. This is a slick version of the helicopter drop concept.

  14. Gravatar of Bill Woolsey Bill Woolsey
    15. December 2010 at 05:11

    Wow. Lots of typos..

    I think the Fed should do ordinary open market operations and trade ordinary index futures contracts. (I wrote interest future contracts, yikes!)

  15. Gravatar of Bill Woolsey Bill Woolsey
    15. December 2010 at 05:17

    Just another economist:

    I agree about base money fluctuating. So?

    I think the political challenge would be fluctuations in short term interest rates. My answer to that is, so?

  16. Gravatar of Bill Woolsey Bill Woolsey
    15. December 2010 at 07:05

    Charles Williams:

    Why would monetary policy be stuck at some predetermined level on October 1, 2008?

    Oh, maybe you are assuming Sumner’s version of voting, and imagine that we vote this quarter for next quarter’s level of base money.

    I think Sumner would argue that to a remarkable degree, we can fix the problems in October 2008 by having a system that will expand base money in January 2009.

    But I think Sumner actually has in mind that we do this “voting” every day. If the events of October 8 suggest that the current level of base money will result in reduced NGDP a year from now, then more will be created now.

    If NGDP will be on target a year from now, then what kind of catastrophe can occur? NGDP will 4 percent over the next 6 months and then rise again and then someover the next six months? How realistic is that?

  17. Gravatar of Bill Woolsey Bill Woolsey
    15. December 2010 at 07:44

    Scott:

    Jesus!

    I just looked at your past post. Can you get over this growth rate mentality? Targeting the growth path doesn’t mean changing the growth rate based on past deviations. You have a growth path and each and every quarter you have a level of NGDP. YOu know, like $17,245,322,250. If you are on target right now, then it is true that the target for a year from now is 5% above what it is now. (with a 5% growth rate.) But, the target is a dollar amount. Every quarter has a target that is a dollar amount and it isn’t some complicated growth rate based upon some complicated story of past deviations. Yes, you can tell such a story, but why?

  18. Gravatar of Contemplationist Contemplationist
    15. December 2010 at 07:58

    I nominate Bill Woolsey and Scott Sumner to the open Fed seats.

    kthxbye

  19. Gravatar of Jeff Jeff
    15. December 2010 at 08:46

    OK, new rule: If Bill Woolsey says you’re wrong, you’re wrong. Even if your initials are SS.

  20. Gravatar of justanothereconomist justanothereconomist
    15. December 2010 at 09:33

    Bill Woolsey-

    Thank you for clearing this up- I wasn’t clear on how the system worked.

  21. Gravatar of K K
    15. December 2010 at 10:01

    Scott: “The Fed could swap briefcases of $100 bills with private individuals who own bonds.”

    So why don’t we just create all money this way?  The banks issue stock, bonds, whatever (but not money) and investors repo them at the FED for dollars.  Saves us from deposit insurance.

  22. Gravatar of Luis Enrique Luis Enrique
    15. December 2010 at 10:16

    I’d like to see you respond to Raj Sethi. How can this go wrong if market participants start deviating from the behaviour your assume?

    (I think Left Outside makes a good point about marketing this idea outside of the econ academy)

  23. Gravatar of “Finally” "Finally"
    15. December 2010 at 10:44

    I was pretty confused about the “finally” myself. I guess you can argue that when something plumps, it must have changed from an un-plump state? It’s a work of exegesis, I think.

  24. Gravatar of Silas Barta Silas Barta
    15. December 2010 at 12:00

    @scott_sumner: I moved one step at a time to my preferred policy. At which step did I make a mistake?

    The part where you made such a huge fraction of the economy depend on the calculated value of NGDP (where it has not before — creating a Goodhart problem) and let the government be the one to calculate it.

  25. Gravatar of cato cato
    15. December 2010 at 19:00

    scott will love this, from the RBA (australia) website on open market operations:

    “Over 2008/09, ES balances averaged almost $4 billion, compared with $2.5 billion in 2007/08 and around $750 million in the five years prior to the onset of the financial crisis.”

    this is the electronic equivalent to stuffing money into your mattress…the banks panicked and took all their money out of the economy and stuffed it in their ES mattress at the RBA!

    the RBA should have immediately started helicopter dropping the excess ES funds into the community, small business owners and consumers surely wouldn’t have panicked as much as the banks…they would have spent and employed and created an economy =)

  26. Gravatar of Doc Merlin Doc Merlin
    16. December 2010 at 05:54

    @Silas:

    I’ve made that argument here too. This is why free banking is a better alternative to an NGDP targeting fed.

  27. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. December 2010 at 13:37

    Graph of the day, perhaps of the week:

    http://economistsview.typepad.com/economistsview/2010/12/index-of-hours-worked.html

    Just to get back to the 1947-2007 trendline we’d have to have an increase in hours worked (nonfarm business) by about 12% as of 2010 Q3.

    Gap in NGDP? What gap in NGDP? We’re all just displaying a sudden preference for leisure.

  28. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. December 2010 at 14:15

    Perhaps I was too conservative. If one establishes the trendline from 1947-2000 (before the “jobloss” recovery) one gets an average annual rate of hours worked of 1.56%. That means we have to have an increase of about 28% just to get back to trend. (Sounds kind of like GD II doesn’t it?)

  29. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. December 2010 at 15:51

    I just received a Christmas letter from my Aunt (my father’s sister) commending me for my “polished manners and inapproachable character”. I just had to laugh.

  30. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. December 2010 at 16:12

    I guess she’s only been exposed to Dr. Sadowski. She’s never witnessed Mr. Hyde.

  31. Gravatar of Doc Merlin Doc Merlin
    17. December 2010 at 05:51

    @Mark
    “Gap in NGDP? What gap in NGDP? We’re all just displaying a sudden preference for leisure.”

    I think a lot of the problem in unemployment at this point not macro but rather micro in nature. The wedge between salaries and payroll costs keeps getting bigger, and the recent changes in health care law, worsen this trend.

  32. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. December 2010 at 16:43

    Doc Merlin,
    Sounds reasonable, until you consult the data. Unit labor costs (which include benefits) have fallen nearly 5% since peak two years ago.

    The wedge between what we produce and what we earn has widened at an alarming pace. I think the most reasonable explanation is a surplus of highly skilled labor.

  33. Gravatar of scott sumner scott sumner
    17. December 2010 at 17:22

    Andy, Yes, I’ve avoided that. He has called me crazy, however.

    Mark, Thanks.

    Brad, Normally a post headline is “news”. I’m guessing someone wouldn’t post “Milton Friedman plumps for money supply targeting.” But then I’m not quite as famous as Milton Friedman was, so maybe people didn’t know that I’m known as the guy obsessed with NGDP targeting.

    I suppose I could respond “where does all that Biblical stuff come from?”

    Bill, Yes, but I don’t have time to explain the whole plan in short posts. But my academic articles do use that procedure.

    justanothereconomist, I don’t recall the 100/500 plan, can you remind me?

    You are right that the Fed no longer needs an interest rate target.

    2. People need margin accounts or else there is default risk. You don’t want people speculating in NGDP futures, and then refusing to pay up if their bet goes bad.

    3. I agree that base volatility wouldn’t be a concern if NGDP was on target, and I would add that the base would actually be less volatile than under current policy.

    axiom, That sounds right, and indeed is the system I lay out in my longer academic papers.

    rob, You said;

    “Damn. Of all the blogs in all the world I’ve been called wrong on, I think my comments have been called wrong the most times on this one. Please correct me if I am wrong.”

    Wrong again! But remember, all bloggers are liars.

    Left Outside, But that’s equally true of Bretton Woods (most foreign exchange is bought by rich people), or interest rate targeting (most government debt is bought by rich people.) So what’s the difference?

    123, Your example with fed funds is irrelevant, because I am talking about a system where the Fed is the market maker. It cannot collapse, because I can personally go to the Fed to buy or sell unlimited NGDP futures at the target price. Hence no other equilibrium price would be possible. Banks could not borrow and lend to the Fed at the ffr target in 2008, so the analogy is wrong.

    Charles, No the plan does not assume any sort of stable relationship between the monetary base and NGDP.

    I don’t agree about Cochrane, I am pretty sure he sees CPI futures targeting as a quasi-gold standard, with the dollar pegged to a basket of commodities. Cochrane does not believe monetary policy is ineffective at the zero bound under a commodity regime, because you can devalue. CPI targeting relies on the same idea. I’m not sure, but I think that is Cochrane’s assumption.

    Bill#2, Yes Bill, I do envision a new setting every day.

    Bil#3, I definitely believe in level targeting, although I may sometimes use growth for simplicity. Of course futures targeting can be applied to either regime.

    Thanks Contemplationist.

    Jeff, When Bill says I’m wrong, he’s generally right. But not always.

    K, I’m afraid deposit insurance would not go away, although it wouldn’t be needed with NGDP targeting.

    Luis, Where is Raj Sethi’s comment?

    Finally, I don’t know if you know this, but in the econ blogosphere I’m pretty much known as the man who is obsessed with NGDP targeting. That’s my reputation. So it’s kind of weird to read that headline, which really only makes sense if people didn’t know that. On the other hand, they probably didn’t. But then DeLong should have said “some obscure Bentley prof plumps for NGDP targeting.

    Silas, There is no Goodhart problem because there is no intermediate target. Stable NGDP expectations are my goal.

    cato, What are ES balances?

    Mark, Yes, there is a big gap (but nowhere near 28%)

    Doc Merlin, There was no sudden increase in the tax wedge between 2008 and 2009.

    The tax and regulation wedge rose significantly between 1965 and 1969, and yet unemployment fell to 3.5% in 1969. How does your theory explain that?

  34. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. December 2010 at 18:01

    Scott wrote:
    “Mark, Yes, there is a big gap (but nowhere near 28%)”

    That depends on many factors. But do you really think there was a labor bubble in the late 1990s? If so, why was inflation so moderate?

    I suspect we could increase aggregate hours by 28% right now without stimulating hyperinflation just based on trend growth.

    P.S. Do the math. 1.56% annual growth in demand geometrically over a decade plus a 10% decline in actual hours.

  35. Gravatar of Doc Merlin Doc Merlin
    17. December 2010 at 19:17

    @Mark

    Good point on the first part. I don’t agree on the second, however because if that is true, then you would also expect this to be happening in engineering and that high end sector. We don’t; PhD’s still have very, very low unemployment rates as do engineers. Almost all the unemployment has been in the low end, which suggests it isn’t /just/ a surplus of skilled labor, although it could still be contributing through substitution.

    @Scott

    ‘Doc Merlin, There was no sudden increase in the tax wedge between 2008 and 2009.’

    I wasn’t talking about then, I was talking about why the recovery in unemployment will be very slow, instead of bouncing back once the recovery started. Also, most of the expected increases in the tax wedges were announced in 2009.

    I accept your thesis that the crash was in part caused by NGDP drop off. (I also think there was an ABC event as well, and an effective supply shock.)

  36. Gravatar of Doc Merlin Doc Merlin
    17. December 2010 at 19:23

    @Mark:
    “That depends on many factors. But do you really think there was a labor bubble in the late 1990s? If so, why was inflation so moderate?

    I suspect we could increase aggregate hours by 28% right now without stimulating hyperinflation just based on trend growth.”

    1. I don’t accept that inflation has anything to do with labor supply, much of labor nowadays isn’t really involved directly in production but is involved mostly in increasing productive capacity. This means that even at full employment, you can still have the demand side causing price disinflation.

    2. If /average/ (not marginal) productivity grows faster than the labor demand you will still get very low price inflation even if labor demand is high, and average productivity grew immensely in the 90′s. Also trade liberalization had a very similar effect to massively increasing US average productivity, because we could get more stuff per unit effort.

  37. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. December 2010 at 19:41

    Doc Merlin,
    “Good point on the first part. I don’t agree on the second, however because if that is true, then you would also expect this to be happening in engineering and that high end sector. We don’t; PhD’s still have very, very low unemployment rates as do engineers. Almost all the unemployment has been in the low end, which suggests it isn’t /just/ a surplus of skilled labor, although it could still be contributing through substitution.”

    Except that I disagree. The unemployment rate for the high school educated has increased from 3.2% from November 1999 through 10.0% currently. The unemploymwnt rate for those with some college has increased from 2.4% in October 2000 through 8.7% currently, and the unemployment rate among those with Bachelors degress or higher has gone from 1.5% in April 2000 through 5.1% now.

    All have seen their unemployment rates more than triple.

    I could include the ratios for even higher education groups (such as myself) but I don’t think that that is necessary. A better measure might be lost income and I think I could convince you that, this massive loss in labor income is mostly the result of more well educated employees seeing their wages and benefits reduced relative to output.

  38. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. December 2010 at 19:58

    Doc Merlin wrote:
    “If /average/ (not marginal) productivity grows faster than the labor demand you will still get very low price inflation even if labor demand is high, and average productivity grew immensely in the 90’s.”

    Exactly. And how has productivity growth fared recently? Very well? Well,(in the words of Reagan), then let NGDP growth match it.

  39. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. December 2010 at 20:40

    Doc Merlin,
    If you don’t want to argue that the labor market is the cause of inflation than what use are you?

  40. Gravatar of anon/portly anon/portly
    18. December 2010 at 00:48

    “…but in the econ blogosphere I’m pretty much known as the man who is obsessed with NGDP targeting. That’s my reputation.”

    Really? I would have thought you’d still be known more for revving up the debate, and still being the least skeptical, over a more active Fed policy. You’ve worked all along to show us how the NGDP targeting idea is far from all your own.

    “I suppose I could respond ‘where does all that Biblical stuff come from?’”

    Your NR article is strikingly well-argued (as Delong himself says) and soberly-argued, but at the same time not completely lacking in ambition, or audacity. When Delong says that you’re “anticipating that implementation of [your] proposal would bring the New Jerusalem,” I take it be simply making a joke (more of a meta-joke, not mockery) about the whole thing. The extensive quoting from the Bible after that is just his trademark rhetorical underkill.

    I actually thought this was the best part of his comment. I mean, what if NGDP targeting works as advertised?

    Anyway, if it turns out to be true that “liberals would no longer be able to mock those who invoke Say’s Law,” I for one hope that there’s a lengthy enough transition period so that Delong doesn’t have to figure out what to do with all that new free time all at once.

  41. Gravatar of Morgan Warstler Morgan Warstler
    18. December 2010 at 04:54

    “By the way, Cochrane may support something that is superficially like what you propose but his reasons are very different. He thinks monetary policy in the pure sense is impotent at the moment. So he contemplates having the government do something “fiscal” with monetary policy – specifically allowing people to buy insurance from the government against deflation. Of course, when deflation cannot be stopped by pure monetary policy the government will pay claims, thereby stimulating the economy out of a deflationary trap. This is a slick version of the helicopter drop concept.”

    I think Bill gets this too – the true value of it is:

    1. the printed money goes to anyone first, not just bankers.
    2. government spending (debt) as fiscal stimulus goes away.

  42. Gravatar of Doc Merlin Doc Merlin
    18. December 2010 at 05:00

    ““If /average/ (not marginal) productivity grows faster than the labor demand you will still get very low price inflation even if labor demand is high, and average productivity grew immensely in the 90’s.”

    Exactly. And how has productivity growth fared recently? Very well? Well,(in the words of Reagan), then let NGDP growth match it.”

    Average productivity has grown very fast. No argument here, I am not against forward, market-based NGDP targeting. I am against QE if the fed pays IOR at the same time.

    “If you don’t want to argue that the labor market is the cause of inflation than what use are you?”

    Me? No use, I am afraid. Regardless, there is no single price inflation. Price levels come from many, many different sources, and you can have price inflation (or disinflation) with even a completely broken (or functioning great) labour market. Look at the seventies (or mid to late nineties) for an example.

    WRT education, I don’t disagree that we have too many college educated people. I disagree that we have too many skilled employees. For most majors, college doesn’t actually form human capital so much as is a very expensive form of credentialism. This is why I used the example of engineers and Ph.Ds to counter your “excess skilled workers” argument. The problem isn’t that we have too many skilled workers, its that we have too many educated and credentialed workers who really don’t have very useful skills. It has increased the matching problem in the labour market.

  43. Gravatar of Morgan Warstler Morgan Warstler
    18. December 2010 at 05:16

    “If nominal GDP were expected to fall, the Federal Reserve would be shoveling money out the door at negative expected nominal interest rates. If his scheme were applied today it would be quantitative easing on a pan-galactic scale, as everybody would run to the Fed with bonds to use as collateral for their promises to pay the expected futures contract in a year in exchange for the cash now.

    The Federal Reserve would then become truly the lender of not just last but first resort. Why would anybody borrow on the private market even at 0% per year when they could borrow from the Fed at -3%/year? Savers would simply hold cash rather than try to match the terms that the Fed was offering borrowers. Borrowing firms would borrow from the Fed exclusively. The Fed would thus create a wedge between the minimum nominal interest rate that savers would accept (zero, determined by the alternative of stuffing cash in your mattress) and the nominal interest rate open to borrowers.”

    Reading Cochrane, I thought that everyone was coming in and putting money down like at a Vegas Sports book…

    And then either getting back huge windfalls, or losing their bet.

    Why does DeKrugman make this mistake?

    Is there any negative effect from lots of people tying their money up in betting rather than loaning?

  44. Gravatar of scott sumner scott sumner
    18. December 2010 at 06:04

    Mark, You said;

    “That depends on many factors. But do you really think there was a labor bubble in the late 1990s? If so, why was inflation so moderate?”

    I don’t believe in bubbles, but there was a big increase in AS around 2000, which produced above trend employment. Again, the 28% figure isn’t even close to being credible. Simply drawing trend lines is not a good way of determining output gaps, especially long term trend lines. But I agree that there is a big output gap.

    If we closed the 10% NGDP gap, it would be impossible to close a 28% output gap without massive deflation. And how often do you see a boom during massive deflation?

    Doc Merlin, There is no way you can accept my view that the big drop in NGDP caused more unemployment, without also accepting that more NGDP would reduce unemployment.

    anon/portly;

    “You’ve worked all along to show us how the NGDP targeting idea is far from all your own.”

    Exactly, I have to work hard at this because other bloggers often make fun of my obsession with nominal GDP.

    Yes, I understood the religious stuff was a joke, my point was that my “finally” comment was also intended to be a joke.

    Morgan, I don’t know why people can’t understand that it makes no difference whether the new money goes to bankers. The Fed isn’t giving it away, they are selling it to whomever wants to buy it at market prices.

    Cochrane’s theory that QE doesn’t work has already been definitely disproved by the massive market response to QE2 rumors. Cochrane’s theory suggests that that response should not happen at all. He predicts that markets should be completely indifferent to rumors of QE2.

    Morgan, I couldn’t make heads or tails from DeLong’s comment. All I know is that he is not attacking my proposal, but rather some other proposal.

  45. Gravatar of W. Peden W. Peden
    18. December 2010 at 06:06

    anon/portly,

    As long as Krugman has something new to say, DeLong has something new to say.

    Prof. Sumner,

    Would people just forget about interest rates if NGDP targeting was introduced? I tend to think that, if a hypothetical central bank pursued a money supply target for long enough and unambigiously enough, people would eventually stop talking about interest rates or at least not in the way that they do now.

  46. Gravatar of ssumner ssumner
    18. December 2010 at 06:10

    W. Peden, I tend to think people will always be obsessed with interest rates. BTW, just to be clear, I am not proposing a money supply target either.

  47. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    18. December 2010 at 07:33

    Scott, You said:
    “123, Your example with fed funds is irrelevant, because I am talking about a system where the Fed is the market maker. It cannot collapse, because I can personally go to the Fed to buy or sell unlimited NGDP futures at the target price. Hence no other equilibrium price would be possible. Banks could not borrow and lend to the Fed at the ffr target in 2008, so the analogy is wrong.”

    The ability to buy or sell unlimited amount of futures is restricted by collateral requirements from one side, and it is restricted by the solvency of the Fed on the other side. So the peg is vulnerable. By analogy with the ffr peg crash, where the transmission was in the high price of the insurance against the loss of credibility by the fed, the most probable NGDP peg breakdown scenarios will likely involve the breakdown of the arbitrage between the NGDP future that is pegged and the next years NGDP future.

    In the DeLong’s comment thread and in the Cowen’s comment thread there was an interesting discussion about the interaction between the NGDP peg and the Minsky cycle, and about Rajiv Sethi’s idea that “Allow for fat tails, volatility clustering and momentum effects and his proposal would be an disaster.”. I replied to Woolsey in one thread and to Sethi in another thread. In general I have been disappointed by the discussion of the NGDP targeting idea. The commenters mostly ignored two things:

    1. All real world examples of monetary policy involve some kind of peg, the Fed is operating the crawling interest rate peg, some countries are operating exchange rate pegs, we know commodity pegs from history. Many commenters support the status quo, so instead of attacking the idea of the peg, they should have debated relative merits of different kinds of pegs.
    2. Those commenters who think that the monetary policy is prone to collapse in the face of the Minsky cycle, they forgot that the monetary policy collapsed after Lehman. The most important issue after the power of the monetary policy is restored is the speed of the recovery. If the NGDP peg is restored after the monetary collapse, we will almost by definition have a vigorous recovery.

  48. Gravatar of david david
    18. December 2010 at 09:57

    Rajiv Sethi’s comment is here; he comments twice, one briefly and one as elaboration. Brief summary: he questions your reliance on the EMH; the fed may reach its NGDP target most of the time but not all of the time, and the failures may be too hard to bear.

    I daresay the EMH would indeed be heavily tested if something as potentially destructive and profitable as monetary policy is driven by a futures target – might it be possible to occasionally overcome losses in futures markets by betting for/against inflation elsewhere? – but I have not enough knowledge of this field to comment usefully.

  49. Gravatar of scott sumner scott sumner
    18. December 2010 at 11:03

    123, You said;

    “The ability to buy or sell unlimited amount of futures is restricted by collateral requirements from one side, and it is restricted by the solvency of the Fed on the other side.”

    I don’t agree, a price is a price, whether people have enough collateral to buy the asset or not. No other price could emerge in the market, as one side of the market would always prefer to deal with the Fed.

    I don’t see the solvency of the Fed having anything to do with futures targeting. Obviously the problem is equally applicable to any regime, and highly unlikely to be a problem.

    Regarding your other comments, I was also disappointed by the discussion. I mentioned the Bretton Woods peg. No one was raising those issues against that sort of regime.

    David; Thanks, I just left a comment over there in response to Rajiv.

    You said;

    “I daresay the EMH would indeed be heavily tested if something as potentially destructive and profitable as monetary policy is driven by a futures target – might it be possible to occasionally overcome losses in futures markets by betting for/against inflation elsewhere? – but I have not enough knowledge of this field to comment usefully.”

    In practice this would not be a problem, and even if it was, I’ve offered a number of suggestions as to how the Fed could neutralize market manipulators.

  50. Gravatar of Mark A. Sadowski Mark A. Sadowski
    18. December 2010 at 22:43

    Doc Merlin wrote:
    “Me? No use, I am afraid. Regardless, there is no single price inflation. Price levels come from many, many different sources, and you can have price inflation (or disinflation) with even a completely broken (or functioning great) labour market. Look at the seventies (or mid to late nineties) for an example.”

    I was being facetious (as usual). Forgive me.

  51. Gravatar of JKH JKH
    19. December 2010 at 03:01

    Previous posts (Sumner and Rowe) and their related comments note that the Sumner proposal is intended to resolve the “circularity problem”. I’m unclear on the nature of the problem and the reasoning behind the market structure that is needed to resolve it. I gather the solution in the context of NGDP futures market design has to do with the fact that a directional trade in futures carries with it an automatic direct operational instruction for monetary base adjustment. This takes discretion away from the Fed for monetary policy in terms of base setting, at least when operating in normal mode. Apparently there would be a problem if the Fed simply interpreted a stand-alone futures market without such an explicit operational connection, and instead adjusted the monetary base according to its own judgement and discretion.

    I don’t understand the need for this qualification in the structure of the futures market.

    In the context of the Sumner proposal, it seems that each market trade is essentially a bet (or a hedge) against the effectiveness of monetary policy in achieving its NGDP target. In addition, at the same time, each trade influences monetary policy at the operational level of the monetary base setting, and influences it in a direction that actually reduces the probability of the trade’s ultimate success.

    Each NGDP futures trade is a bet that actual NGDP will deviate from the NGDP level prescribed as the policy target. And it’s also a bet that the reason for the deviation is that the Fed won’t be able to set the instrument at the right level in order to achieve that target. In this case, the instrument is assumed to be the monetary base, but as discussed in the comments to other posts, the instrument could be velocity or the interest rate, or something else, I suppose. Finally, the instrument setting is determined by the futures market action itself, as a given net futures position delivered by the market to the Fed carries with it a corresponding instruction to change the instrument setting. So each participant’s bet is a bet that the market as a whole won’t be able to provide the right signal to the Fed. In this sense, each individual is betting against the market, rather than against the Fed directly.

    If I have all that right, the last part is what is required to circumvent the circularity problem, and that’s what I don’t get.

    The crux of the bet is that the Fed will not be able to achieve the policy target based on the management of the policy instrument. But why should it matter whether the erroneous instrument setting is the result of Fed discretion or market discretion? How is the judgment of millions of market participants fundamentally different from that of the FOMC, if the result in either case is subject to non-zero risk in achieving the policy target in terms of an NGDP objective? I can see how someone might argue that the market’s continuous judgement is more credible than the Fed’s. Is that that what is meant by circularity? I didn’t think so.

    Comparing the market to the FOMC in a similar function, each forum has its own average “bet” and its own distribution of bets around that average. It’s just that the “average” vote of the Fed is typically in effect the result of a concentration of (binary) bets where each vote is equal to the average (or majority). But how is a dissenting vote at the FOMC fundamentally different than the “dissenting” vote of a futures market participant who believes the market won’t be able to provide the appropriate average signal that ends up constituting the instrument setting on which target achievement depends?

    In the context of the Sumner proposal, it seems to me that a particular participant is not going to trade in NGDP futures (whether for hedging or speculation purposes) unless he/she perceives risk in the outcome of NGDP relative to the policy target. He/she must believe there is a non-zero probability that the Fed may miss its target. Moreover, he/she must believe there is a non-zero probability of missing the target, notwithstanding the potential for other bets in the marketplace to move the instrument setting one way or another on the basis of the average such bet. In other words, there must be a non-zero probability that an individual participant’s bet will end up “in the money”, whatever instrument setting results from the average of all bets.

    Why should it matter whether or not the instrument setting results from Fed discretion or market provided autopilot? What is it about the judgement of the FOMC group and its discretionary reaction to a futures market signal that would disqualify a disconnected futures market structure from providing an equally useful signal for the appropriate instrument setting? What is it about autopilot market guidance provided by the Sumner structure that ensures a “pure” result? Why isn’t a bet or a hedge against the discretionary ability of the FOMC just as “pure” as a bet against the autopilot guidance provided by the market?

    All that said and questioned, I gather there is a literature on this subject. But the basic intuition of the requirement for the market to actually set the policy (for the instrument setting) is not clear to me, since it seems the policy is at risk in either case.

    So what is the meaning of the “circularity problem” and its solution?

    My sense is that the most important idea behind NGDP futures as a market concept is that it provides a signal to the Fed about NGDP expectations as an indicator. I think Scott has made the point many times that NGDP futures could have been instrumental (literally) in preventing the financial crisis. I think the concept of a market signal may be more important than the engineering of explicit policy instructions coming out of that market signal. But I suppose this depends on the recognition of and response to the “circularity problem”, and assurance that the futures market is functional as intended.

    Any help with this would be appreciated.

  52. Gravatar of 123 123
    19. December 2010 at 05:03

    Scott, You said:
    “I don’t agree, a price is a price, whether people have enough collateral to buy the asset or not. No other price could emerge in the market, as one side of the market would always prefer to deal with the Fed.”
    The problem is that the people with different collateral positions might have different NGDP expectations. For example, inflation expectations in the TIPS market and in the inflation swaps market are different. If they diverge significantly, we could get a demand-side recession.

    You said:
    “I don’t see the solvency of the Fed having anything to do with futures targeting. Obviously the problem is equally applicable to any regime, and highly unlikely to be a problem.”
    Current regime reduces the risk of Fed’s insolvency at the cost of higher macro volatility. Your scheme would do the opposite. The solution is to increase the capital base.

  53. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    19. December 2010 at 07:22

    Scott, real-world monetary policymakers are very concerned about solvency. Last week the ECB has doubled its equity capital.

  54. Gravatar of ssumner ssumner
    19. December 2010 at 12:15

    JKH, Thanks for the thoughtful comment. There’s a lot there, and I’ll try my best. First the easier part:

    1. It’s a little misleading to say the MB is the policy instrument in my proposal. At times I’ve argued there is no instrument. At times I’ve argued that OMOs are the instrument, and at times I’ve argued that NGDP futures prices are the instrument. I’ll try to explain the confusion:

    We often think of fed funds rates as being an instrument, but in a sense they are the target. The Fed actually does OMOs, and uses them to target the fed funds rate. The fed funds rate could also be called an indicator of policy, as could the monetary base. If we are going to call the fed funds rate an instrument, then the price of NGDP futures is the equivalent instrument in my proposal. If we are going to call OMOs the instrument in fed funds targeting, then they are also the instrument in my proposal.

    Regarding policy indicators, I’ve argued there are any number of indicators under my proposal. Traders who think interest rates are informative will use those to decide whether to buy or sell NGDP futures. Monetarist traders might choose to look at the monetary base, or M2, when deciding whther to buy or sell NGDP futures. My paper on the topic was called “Let a Thousand Models Bloom” as the system would allow each trader to use his preferred indicator. Since indicators are often wrongly called instruments, in that sense there is no one instrument.

    I don’t have good intuition about the seriousness of the circulariy problem, hence you may be right in expressing skepticism. All I can tell you is what Bernanke and Woodford said in their 1997 paper. They claimed that if the Fed attempted to target a free standing (external) CPI future prices, there would be a problem if the policy was completely credible. In that case, the CPI would never vary from target, and the Fed would be provided with no information about when to adjust the money supply. The problem is that investors would expect the money supply to be adjusted in response to any slight change in the CPI futures prices, bringing it back on target. Hence the price would never budge.

    They described this as follows; they said as the policy crediblity went toward 100%, the signal to noise ratio would go toward zero. That is, tiny movements in the CPI futures price would become less and less informative or money demand or velocity shocks. I don’t know if that would be a serious problem or not. I tend to doubt it. But it’s a moot point as even they admitted that this problem doesn’t apply if the future market predicts not the future goal variable, but rather the instrument setting required to hit the future goal variable. And this is what my plan does.

    As far as what is necessary for traders to want to participate, it is really no different from any other commodity futures market, it just seems different because the price is fixed. Suppose there is a bell-shaped distribution of forecasts for gold prices in 2013. Say it’s centered around $1500/oz. Then all traders on the left side of the distribution expect lower than $1500 future gold prices, and they will go short. Vice versa for those on the right side of the bell-shaped distribution.

    With NGDP futures, there will also be a bell-shaped distribution of forecasts, centered around 5%. The only difference is that rather than the price itself adjusting to balance the market, the monetary base and fed funds rate adjust until one half of taders expect above 5% NGDP growth and 1/2 expect less than 5% growth.

    I am guessing I haven’t fully answered you questions, but maybe I’ve narrowed it down enough for another go around. Keep in mind that new trades would start each new day. By observing previous days instrument settings, traders would have a rough idea about where the instrument setting would be that day. The contracts would actually be the weighted average of two future quarterly NGDP numbers, centered around the date 12 months in the future (or 24 months if they choose a 2 year window.) That’s what allows for new contracts to be traded each day.

    123, The risk of a demand side recession is 100 times higher under the current regime than under what I propose, even if all traders weren’t identical. The Fed is currently making massive errors, much bigger than what one would get in any plausible futures market. Indeed the Fed admits as much, in their economic forecasts.

    I strongly disagree with your assertion that the risks to the Fed would be much higher under my plan. Just the opposite. The Fed currently has significant price risk precisely becase they have engineerred a huge drop in NGDP growth, forcing them to buy up dodgy assets, and also forcing them to engage in huge QE. Under stable NGDP expectations the demand for base money is also relatively stable, as nominal rates don’t fall to zero (where base hoarding becomes a major factor.)

    If solvency councerns are holding back the ECB, it is a sad commentary on their compentence. In the 1930s solvency concerns caused central banks to hoard gold, which led to the Great Depression and WWII. Solvency concerns are so trivial compared to the cost of recession it’s ridiculous. Remember, any losses to the Fed are more than offset by gains to the Treasury, which is a net borrower. And the Fed isn’t going bankrupt, so they shouldn’t even be seriously thinking in those terms. They are buying relatively short term T-notes, with very modest price risk. They can lose many $100s of billions before even thinking seriously about price risk.

  55. Gravatar of malavel malavel
    20. December 2010 at 05:31

    “I’m not sure how old he is, but I heard him use the word ‘newfangled’ one time. So he’s gotta be pretty far gone.”

  56. Gravatar of JKH JKH
    20. December 2010 at 06:16

    Scott,

    Thanks for the response.

    I understand and agree with the designation of OMO (rather than the monetary base) as the instrument. That was a bit of short hand transference on my part. As I understand your comment, there can be several variations as to what constitutes a target and what constitutes an indicator. (The vocabulary question seems to surface frequently. I seem to recall a framework from somewhere way back that included the tripartite language of policy, instrument, and indicator.)

    “With NGDP futures, there will also be a bell-shaped distribution of forecasts, centered on 5%. The only difference is that rather than the price itself adjusting to balance the market, the monetary base and fed funds rate adjust until one half of traders expect above 5% NGDP growth and 1/2 expect less than 5% growth.”

    That makes sense as the concept.

    Visualizing the granularity of daily operations is a little more uncertain for me. I’m not sure how you would view the portfolio balancing associated with each day’s trading cycle. I can think offhand of at least two ways of viewing it:

    E.g. # 1 – Each day’s trading cycle ends up with the monetary base change that is automatically generated as a result of the net contract position produced by that day’s total trading. Trading recommences the next day, on the basis of that changed monetary base, which tends to prod net positioning in the other direction, which in turn has the effect of smoothing out the contract imbalance for the total of the two days; etc.

    E.g. # 2 – Each day’s trading cycle records the monetary base change associated with that trading in real time, which tends to produce a result that is closer to an intra-day balance in the net positioning of longs and shorts. Any residual base change is still incorporated in the starting position for the next day’s trading.

    I don’t know if either of these examples is close to what you intend, or whether the distinction between them is relevant or not. But I do think picturing the intra-day and/or inter-day mechanics makes understanding the concept easier.

    I thought Bill Woolsey’s post on DeLong’s post was very good, and made a couple of comments there on similar operational matters, one of which relates to quarterly periodicity of current contract operations.

  57. Gravatar of scott sumner scott sumner
    20. December 2010 at 18:39

    malavel, Me?

    JKH, For some reason I don’t quite follow the two examples, but in a sense it doesn’t matter that much as I don’t have strong views. I’ve thought of four possibilities:

    1. Start the new day at the MB setting you ended the previous day.

    2. Start the new day at the previous balance, plus or minus any predictable adjustments due to seasonal and day of the week movements in the base.

    3. Start the next day at the Fed’s predicted final equilibrium, “all things considered.” Give the Fed officials the job of setting the opening base each day as close to their estimate of the closing MB as possible, to reduce the Fed’s risk.

    4. Do offsets for risk accumulated during the previous day. If the Fed took a $40 million net long position the previous day, try to end up with a net $40 million short position today. NGDP changes very gradually from one day to the next, so losses one day would be roughly offset by gains the next.

    I think my one is your number one. Not sure about your number 2. Do any of these seem reasonable?

  58. Gravatar of malavel malavel
    21. December 2010 at 01:32

    Scott, sorry, just a boring joke. Or did you recognize the quote? It’s from an episode of Buffy the vampire slayer called The Real Me. You did use the word newfangled though: “I just can’t figure out these newfangled comment sections”.

  59. Gravatar of JKH JKH
    21. December 2010 at 04:57

    Scott,

    Your versions 1 and 2 seem to be reasonable alternatives as starting points for the trading day, and 4 if I understand it seems reasonable as a plan or strategy for the upcoming day. My version 1 is somewhere in there with your 1 and 2. I’m not sure I quite understand your version 3.

    The point I wondered about in my version 2 was whether the information on the Fed’s net NGDP futures position change and therefore the corresponding required net base change might be made available on a real time intra-day trading basis (in a fully automated system of course). Maybe this is pushing the envelope too far – but it seems to me it’s not that much of a stretch from knowing where fed funds (or a stock price) are trading at a particular moment in time, to knowing what explicit, automatic monetary base signal the futures market is transmitting to Fed strategy at a particular moment in time – even if that projected, evolving monetary base change has not yet been implemented through standard OMO. It just gives traders up to the minute information on the pro forma monetary base result that they’re both producing by their trading and trading in response to, as opposed to waiting for published “batch” information on the monetary base effect of a day’s trading. Given that the system is set up as a dynamic interaction between the NGDP futures market and the monetary base setting, this seems to make sense to me as a trading technology objective. Haven’t thought it through, and it could be there’s some sort of logical contradiction somewhere in that approach, but that’s roughly what I was thinking.

  60. Gravatar of scott sumner scott sumner
    21. December 2010 at 19:26

    malavel, I don’t watch any TV (since the 1990s) so I miss all the pop culture references. Seinfeld was the last show I saw.

    JKH, Yes, I’ve always envisioned it as being a transparent and open process. At the same time I’m not an expert on market construction, so I always felt it would be better if experts designed the market. But your comment seems perfectly sensible to me.

  61. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    22. December 2010 at 03:53

    Scott, You said:
    “The risk of a demand side recession is 100 times higher under the current regime than under what I propose, even if all traders weren’t identical. The Fed is currently making massive errors, much bigger than what one would get in any plausible futures market. Indeed the Fed admits as much, in their economic forecasts.”
    I agree.

    “I strongly disagree with your assertion that the risks to the Fed would be much higher under my plan. Just the opposite. The Fed currently has significant price risk precisely becase they have engineerred a huge drop in NGDP growth, forcing them to buy up dodgy assets, and also forcing them to engage in huge QE. Under stable NGDP expectations the demand for base money is also relatively stable, as nominal rates don’t fall to zero (where base hoarding becomes a major factor.)”
    There are a couple of things here that work in the opposite directions:

    1. Level targeting regimes have less solvency risk than the current regime
    2. Tighter NGDP level targeting regimes create more solvency risk than the more flexible NGDP level targeting regimes. For example, NGDP corridor with 0.5 percentage point limits from the central path would create less solvency risk than your scheme.
    Rajiv Sethi has replied to you here, and as an example he is talking about the collapse of the GBP peg in 1992:
    http://www.marginalrevolution.com/marginalrevolution/2010/12/brain-teasers.html

    “If solvency councerns are holding back the ECB, it is a sad commentary on their compentence. In the 1930s solvency concerns caused central banks to hoard gold, which led to the Great Depression and WWII. Solvency concerns are so trivial compared to the cost of recession it’s ridiculous. Remember, any losses to the Fed are more than offset by gains to the Treasury, which is a net borrower. And the Fed isn’t going bankrupt, so they shouldn’t even be seriously thinking in those terms. They are buying relatively short term T-notes, with very modest price risk. They can lose many $100s of billions before even thinking seriously about price risk.”

    Solvency costs are much smaller than the cost of recession, but so far all the main central banks are very concerned about solvency. Larger equity capital would create a better alignment between the social costs and costs to central bank.

  62. Gravatar of ssumner ssumner
    22. December 2010 at 19:43

    123, The 1992 analogy is not a good one because they abandoned the peg precisely so that they could keep NGDP growing at around 5%. If 5% NGDP growth is not the goal, set another goal. But why would a central bank abandon a policy that is its goal. Why abondon a 5% NGDP growth target? Sure it’s possible, but that’s true of any policy. But it’s not likely. In contrast, currency pegs aren’t an “end” of policy, they are a means to an end. People in Britain care a lot about mass unemployment, they don’t much care about the pound/DM exchange rate. Currency crises are inevitable.
    I’m not convinced you are right that solvency concerns are holding back the Fed. But if so it wouldn’t change anything I said, I’d just insist even more fervently that the Fed is woefully misguided.

    I have no problem with giving the Fed more capital, if you think it would help.

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