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.