Kling and I vs. the interventionists
Here’s a perspective from Arnold Kling that I share:
When you think of the economy, think of a rain forest that you live in and study, not a machine that you fix.
Suppose we have 6% NGDP growth and 14% unemployment. The interventionists will be running around like chickens with their heads cut off, looking for “stimulus” to “create jobs.” Fiscal, monetary, whatever. In contrast, I would point out that NGDP growth was excessive (assuming it was normal in the year before the 6% growth), and call on the Fed to tighten, to slow down NGDP growth. What about the unemployment? I’d look to see if there were other things the government was doing that were messing up the labor markets. And then stop doing them. I don’t believe the government should try to steer the economy like a ship.
This may seem to conflict with my support for a stable NGDP growth rule. If you think so, you are confusing real and nominal variables. It is quite clear that Kling’s metaphors refer to the real economy; machines and rain forests are real things. The real economy is people, buildings, output, ideas, etc. NGDP is actually just another way of thinking about the value of the medium of account (like the price level.)
To see why the nominal economy is totally different, assume the dollar price of apples doubles overnight. I think we can all agree that this won’t have dramatic effects on the overall economy. Yet NGDP measured in apple terms (i.e. using apples as the “numeraire”) will instantly fall in half. From this example it’s obvious that changes in NGDP are very different from changes in real GDP. So why do I think NGDP is so important?
Of all the numeraires, currency is unique. It is the numeraire in which other goods (and labor) are actually priced. Even that would be no more consequential than the apple numeraire, if all wages and prices were flexible. Unfortunately they are often sticky, or slow to adjust. That’s why monetary policy matters, indeed it’s almost the only reason it matters (seignorage is fairly small.)
Currency has two rather special attributes; it is produced at near zero cost, and the government has a monopoly. There is an interesting debate about whether it’s a good idea to handle things that way, but I’d like to focus on a different issue. Given the government is currently running the currency system, how should it do so?
My answer is that it should do so in a way that causes the least harm. Like someone walking through the rainforest trying to avoid stepping on flowers and bugs. It can do that by maintaining a monetary policy that keeps nominal wages and prices closest to their Walrasian equilibrium value, the value if wages and prices were reset each minute by a Walrasian auctioneer. Like Friedrich Hayek, I think a NGDP rule is the best way to do this. Others favor a price level rule.
Many see this as steering the economy, like a machine. Nothing could be further from the truth. It is merely controlling one tiny corner of the economy, currency, in a way that does the least harm. Currency is already controlled by the state, so let’s minimize the harm. By analogy, the state already guarantees bank deposits, so we should minimize the harm from this foolish regulation by not allowing insured deposits to be lent out in risky subprime loans. Keep the government footprint as small as possible. I see the state as like King Kong, rampaging through the forest trying to save his precious Fay Wray, all the while trampling dark-skinned villagers that no one notices.
Remember, currency would be just like apples except for sticky wages and prices. It’s just a numeraire. So if you think monetary policy can do lots of harm, you must believe in sticky wages and prices. But if you do, then shouldn’t we control the value of this dangerous government asset in such a way as to minimize the harm we do?
I would never propose using monetary policy to “fix” any problems in the economy. If there is a recession, or a banking crisis, or a real estate crash, tough luck. I can be just as cold-hearted as the right-winger next door. As long as NGDP is chugging along at the target growth rate, we should not be trying to solve all sorts of macroeconomic problems with stimulus.
That doesn’t mean I believe in laissez-faire, but most of the government regulations I do favor are merely intended to offset the fact that we don’t really have a pure market economy. Lots of air and water is communally owned, our financial system is riddled with government-created moral hazard, we are too kind-hearted to let people starve after they chose not to save for retirement. In almost every case, the government intervention I favor is one that I see doing less harm to “the rain forest” than the status quo.
I wonder if Arnold Kling, or for that matter my commenters, will be surprised that I share Kling’s opposition to a government that is always out trying to fix problems.
Almost titled this “The Kling and I.”
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24. January 2011 at 15:06
I imagine you didn’t lose many debates in school. 🙂
24. January 2011 at 15:41
Currency is also the numeraire in which debts are written – and, as Interfluidity once wrote, nominal debt is the “stickiest price”. If you don’t put it in the contract, unexpected changes in inflation will have no legal impact whatsoever on your ability to enforce other’s liabilities to you – which can always be satisfied in currency, no matter what has happened to the value of that currency in the inter-rim.
It just so happens that most debt-instruments in our society are issued as nominal currency debts – with both sides taking certain risks if inflation diverges from expectations. This doesn’t have to be true – people could start writing contracts in terms of the TIPS or based on the CPI.
In fact, that’s one of the problems that governments are running into. Some of their promises – bonds – are of fixed nominal value. If real growth unexpectedly declines below trend – then an NGDP-targeting regime would give the state some relief by balancing out the effects of lower real growth with higher inflation. Unfortunately, the other promises, pensions and benefits, were written to be real, not nominal, by savvy unions and special interest groups.
If real growth is lower than what was expected (and required) to pay out the pensions, there’s no escape or relief in inflation. And promises to deliver services like health care is a real, not nominal, promise, also immune to relief from inflation.
These types of defined-and-real-benefit promises “lock-in” a certain real rate of growth. If real growth falls below trend for any length of time without returning to trend later – it just means these transfers take up a larger fraction of the economy than anyone originally expected.
In an NGDP-regime, government debt and promises should be required to be nominal – that’s the only way to insure against over-promising, relying too heavily on optimistic projections and being in an un-fixable jam when trouble comes, as it inevitably will.
24. January 2011 at 15:41
“Remember, currency would be just like apples except for sticky wages and prices. It’s just a numeraire. So if you think monetary policy can do lots of harm, you must believe in sticky wages and prices.”
I hereby bestow upon you the Silas Barta Award for Excellence in Sneaking in Non-Sequiturs.
Monetary policy does a lot more than just dupe people about the value of the currency units they’re getting (and given rational adaptations, it’s doubtful it even does that). Believe it or not, monetary policy does not work by having The Ben Bernank go up to every potential transaction and insert extra currency units in it to make sure the trade goes through.
Rather, the central bank buys a bunch of assets it likes, rewarding the subset of the economy holding that asset, who in turn reward the producers of whatever they like, and so on. This props up production structures that would otherwise have to quickly reallocate to producing something people actually want.
Remember, there’s a huge difference between a consumer buying apples because they like apples, vs. a consumer buying apples because they’re afraid their money will wither away in value. The former represents a good economy, the latter a bad.
24. January 2011 at 16:17
Silas
Lets cut the bullshit and get down to the basics.
1- Do you believe in the concept of monetary disequilibrium?
2- Do you believe that nominal shocks can have real effects?
3- If yes to 2), what do you think should be done (or not done) to aid adjustment from a nominal shock with real effects?
The time structure of production along with capital heterogeneity is a fine model of real production. And perhaps Scott can tell you why it doesn’t matter. But even if it does matter, ignore it for now, and answer how you would deal with nominal shocks that have real effects.
Thats all.
24. January 2011 at 16:25
One danger of level targeting: it seems likely that the further away our target, the more we are likely to miss in an absolute sense. E.g, if our target one year is 8% NGDP growth (to make up for a previous shortfall), isn’t there a reasonable risk we will overshoot and get 11% NGDP growth?
Imagine a golfer who is a horrible putter. He’s 30 feet from the hole. Should he try to sink the next shot or should he merely try to get closer to the hole? If he tries to sink the putt he might succeed, but if he misses he is more likely to end up 20 feet away from the hole on the next shot than if he just tried to get closer to the hole. If he tries to merely get closer, he has little chance of sinking the shot, yet the odds are greater he will finish the hole with fewer strokes.
I am curious what an NGDP futures market would behave like, though. Looking at the lousy record of NGDP forecasters I wonder if it is simply one of those things that can’t be forecast. If so, such a market may be akin to a futures market which tries to predict the low temperature in Chicago on December 2, 2012. Such a market wouldn’t tell you anything, yet it would converge around the average historical low for that day. By the same token, an NGDP futures market may converge exactly on trend for a long period, yet may not be sending an informed signal that we are actually on trend. Particularly if the market is subsidized, the problem may be that “good signal” looks exactly like “no signal”.
Of course, I realize you are not suggesting there not be a trial run; just some thoughts.
Keep up the great blogging!
24. January 2011 at 16:30
I was wrong, THIS is the best post you have ever written. Please PASTE this in the right side gutter above your blogroll, and if not in you ABOUT:
“Suppose we have 6% NGDP growth and 14% unemployment. The interventionists will be running around like chickens with their heads cut off, looking for “stimulus” to “create jobs.” Fiscal, monetary, whatever. In contrast, I would point out that NGDP growth was excessive (assuming it was normal in the year before the 6% growth), and call on the Fed to tighten, to slow down NGDP growth. What about the unemployment? I’d look to see if there were other things the government was doing that were messing up the labor markets. And then stop doing them. I don’t believe the government should try to steer the economy like a ship.”
God, it’s just SO NICE. If this post were a woman I would take her home to meet my mother.
There’s ONLY one more thing you need to say….
IF the other commenters here and their ilk WILL NOT STFU when unemployment is 14% and NGDP is 6% – and let us tighten up money (and give up on fiscal), THEN… we can’t do this model.
We have to EXPECT that in the future, we’ll take away the punchbowl and blame other shit, like government interventionist policies, on our problems.
That’s why we have to have a futures market, a Fed as computer, anything that commits the liberal folk here to eat it.
24. January 2011 at 16:34
I had a feeling this post was going to arouse Morgan.
24. January 2011 at 16:36
Great post Scott.
The idea that we must convey to people is that you can’t NOT have a monetary policy. Someone, somewhere in the government has to decide in one way or another how much money to print.
So, when people complain that the Fed is “just printing too much money”, the best retort is “OK, how much money should they print then?”
Most people get stopped in their tracks right there because they forget to realize that someone does have to decide how much money to print.
Anyway, brilliant post. Keep it up Scott.
24. January 2011 at 17:26
Heh, yah, I also had a feeling that Morgan was going to be happy about this.
“There is an interesting debate about whether it’s a good idea to handle things that way, but I’d like to focus on a different issue. Given the government is currently running the currency system, how should it do so?”
Find a way to make market targets of NGDP on a very liquid market! Clearly!
This is something most of us here agree on. 🙂
Another important question is “Given the government is currently running the currency system, what will it do as a collection of rational agents.”
This second question is why some of us (Selgin, Hayek, Larry White, Bill, and little old me) don’t want the government running a currency monopoly.
24. January 2011 at 17:28
@Liberal Roman
“The idea that we must convey to people is that you can’t NOT have a monetary policy. Someone, somewhere in the government has to decide in one way or another how much money to print.”
No, the government doesn’t have to make that decision. 🙂
24. January 2011 at 19:56
Scott, I have a question. From a practical standpoint, do you think the target NGDP growth rate needs to be greater than the average long run real growth rate?
The reason I ask is what happens if you have an NGDP level target with a built in 5% growth rate, but a huge productivity improvement shifts real long run growth to 8%?
I’m trying to figure out how much discretion there should be in setting the built in NGDP growth rate.
24. January 2011 at 20:16
If wages and prices were flexible, there might still be a problem: nominal debt amounts and other fixed price contracts. That might be something that needs to be added by economists to the caveat, ‘except for x,y,z, money doesn’t matter.’
24. January 2011 at 20:24
I think a nice a nice way to combine the rain forest metaphor with your NGDP targeting would be to imagine the money supply as the water supply of Kling’s rain forest – essential to all of its parts. This might make the point clear to many people that the rain forest administrator (government) should refrain from engineering sudden droughts or floods as the life forms in the rain forest could not adjust to such supply changes in the short run, leading to a partial destruction of the complex ecology of the system, based on man different mechanisms of water exchange and use. However, in the long run, the rain forest life could evolve to deal with any level of water supply. Nonetheless, a slow and steady growth in the available water resources would certainly be optimal for the flourishing of the rain forest, while trying to stunt the growth of certain species in favor of more water-saving ones during a previously engineered drought would certainly seem like the height of silliness, just like desperate attempts to use fiscal policy to remedy a contractionary monetary policy.
24. January 2011 at 21:17
So what if the cause of the high unemployment turned out to be not something your government was doing to the economy, but rather a different government was doing? Would attempting to counter balance that effect be justified?
24. January 2011 at 21:24
Engines and rain forests are very similar in that they could both be seen as thermodynamic systems designed to maximize entropy production.
One evolved to do what it does, the other was improved by applied thermodynamics. I believe the latter process is generally faster (though it may not be).
One interesting question is: which of our policies are applied economics? Which are the product of economic evolution?
A second question is: are economic theories are good enough to apply? I think your view boils down to answering that none are, so we should have limited intervention. But maybe your view boils down to answering that none could ever be?
Not sure where I was going with this. Except to say that the argument may just reduce to the capabilities of economic theory versus evolution via market forces.
24. January 2011 at 21:34
Scott, I’m hoping the Mitt Romney campaign is aware of you and has your number-or any of the likely Republican candidates for that matter.
24. January 2011 at 21:53
“Even that would be no more consequential than the apple numeraire, if all wages and prices were flexible.”
Debts would also have to be flexible in nominal terms. Otherwise you would still get debt deflation.
24. January 2011 at 21:56
“My answer is that it should do so in a way that causes the least harm.”
As you have probably guessed, I disagree. I think that it should do so in a way that does the most good. “The greatest good for the greatest number” has one too many gradest in it but is still on the right track.
24. January 2011 at 22:00
“It is merely controlling one tiny corner of the economy,”
Since the effect of money on economic activity is pervasive, to control money is to impose contol on the entire economy. It is the equivalent of controlling a person’s heartbeat.
24. January 2011 at 22:09
“Suppose we have 6% NGDP growth and 14% unemployment. The interventionists will be running around like chickens with their heads cut off, looking for “stimulus” to “create jobs.” Fiscal, monetary, whatever.”
That is me to a T. I am serious about being a full employment hawk.
“It can do that by maintaining a monetary policy that keeps nominal wages and prices closest to their Walrasian equilibrium value, the value if wages and prices were reset each minute by a Walrasian auctioneer. Agreed. When you have 14% unemployment nominal wages and prices are WAY away from these values and strong, decisive action is needed to move them toward those values.
“I think a NGDP rule is the best way to do this”
Also agreed. But after a very serious shock from the financial system that leaves the financial system damaged, the Fed is not likely to be willing to do this, and it MAY not be able to. I agree with Christina Romer’s view that under such extraordinary situations ONLY, expansionary fiscal policy is needed as an additional stimulus.
24. January 2011 at 22:24
“I would point out that NGDP growth was excessive (assuming it was normal in the year before the 6% growth), and call on the Fed to tighten”
That will not move the wages and prices to their Walrasian equilibrium values, but, rather, move them away.
24. January 2011 at 23:46
CA,
I’m lukewarm on most if not all the presidential candidates right now (Gary Johnson excepted), but if someone was forward thinking enough to want Scott on their team, I’d think very hard about supporting them the way half the internet was cheering on Ron Paul or Dennis Kucinich last election. (I initially wanted to qualify that statement on the condition that they seriously intend to listen to Scott’s advice, but given how heterodox he still seems to be, them approaching Scott for advice would in of itself be a very positive signal that they want to take him seriously.)
24. January 2011 at 23:55
Looks like Hilsenrath has got the scoop. Bernanke wants inflation targetting; the FOMC doesn’t want to give it to him. This is the battle for 2011. http://online.wsj.com/article/SB10001424052748703921504576094460047100354.html
25. January 2011 at 00:22
Wow, you even got me to agree with you. Nice post!
Just one question:
“Currency is already controlled by the state, so let’s minimize the harm.”
Are you saying that the currency monopoly is harming the economy? Is there any system that would be superior in your opinion, or do you think the monopoly is the best among many bad options?
25. January 2011 at 00:30
Just another short question:
Do you think something the government does could push down NGDP? So let’s say you have NGPD targeted at 5% and the government decides to raise everybodies taxes to 80%. Do you think that would cause NGPD to fall? And if yes, could such an intervention be offset by monetary means or would you have to repeal the tax hike to get NGPD growth back to 5%.
25. January 2011 at 02:16
@Markus:
Any supply side intervention that slows velocity (money being held constant) will necessarily lower NGDP. However, this is /always/ bad, and trying to offset this with monetary increases will result in price level increasing (and increased price dispersion.) It is best if per capita NGDP is steady and predictable, but at the same time it is a /really/ bad idea to use fiscal and or regulatory effects to lower NGDP.
25. January 2011 at 02:47
Good post, magnific, woww, King Kon looking for its love, the forest,people massacred by insoucience of the Big KK, nice analogy, excellent. I only can say how much i´d lik to have wrote some thing like that. You have created a new Mith, sustituing KK for Leviatan, great, very.
Beside that, I suscribe the two question of Marcus, there are quite interesting and I can´t imagine the answer.
25. January 2011 at 04:38
I think you are leaving out a section of the rainforest analogy. What if there are inhabitants of the rainforest area that are actively cutting down and burning the rainforest. If your goal is to protect and maintain the functionality of the rainforest, wouldn’t you have to intervene.
It’s also interesting that you brought up a case significantly different than today, but similar to a situation of yesterday. Many of those who are complaining the most about possible inflation are also saying that we should not intervene to reduce unemployment. So it’s ok to fix what I want fixed, but don’t solve the problems I don’t see as problems.
The person responsible for solving the inflation problem used to have some say in the White House, but it seemed no one wanted to listen. If you’re going to bring up that situation, you have to at least give a nod to Volcker.
Does the state really have a monopoly on the money supply? How about the move to change the leverage ratio of the biggest i-banks? How much of that created money flowed right to the worst places – poorly underwritten loans, bundled in the least responsible fashion.
Is deposit insurance really just ‘government created moral hazard’? How about stop lights creating the moral hazard of people not looking before they pass through an intersection. By your logic, any action the government takes to promote safety and soundness, is actually promoting moral hazard. If anything, the gov is not using the stick part of deposit insurance enough. Using deposit insurance gives the gov an opening to tighter regulations, something they are not really doing.
25. January 2011 at 04:54
I favor a 3% growth path for money expenditures.
If taxes and regulation reduces the growth path of real output, then the result will be a shift to a higher price level, and inflation until that is reached.
If continually rising taxes and regulations causes the growth rate of output to shift to a lower level, then the result will persistent inflation. For example, 3% spending growth and 2% real output growth gives 1% inflation. If this persists, I would favor shifting to a slower growth rate of money expenditures, but the decision should be made and then implemented in say, 5 years. Of course, stopping the bad supply side policies would be better.
25. January 2011 at 06:40
Jim,
“How about stop lights creating the moral hazard of people not looking before they pass through an intersection.”
If anything it would be green lights not stop lights that cause people to be less careful. But traffic lights are entirely different from deposit insurance. A moral hazard is a situation where a risk is shifted. The person deciding gets to enjoy the potential benefit of the risk he takes but doesn’t have to bear the downside loss if things go wrong. Deposit insurances shifts that downside loss risk from the persons who actually benefits from an investment to the taxpayer.
Traffic lights don’t do that. If you just rely on the green light and get hit by a bus because of that, it’s you who dies not your neighbor. The risk stays where it belongs. No moral hazard problem here at all.
“By your logic, any action the government takes to promote safety and soundness, is actually promoting moral hazard.”
No. Only if it shifts a risk (i.e. insures something). There are tons of things the government can and should do to increase safety and soundness (including traffic lights) without creating moral hazards. As for deposit insurance, it creates the opposite. The money of the taxpayers who have to pay other peoples losses is less safe than without the insurance and soundness is obsolete anyway if you are insured.
I am sure that there are resonable arguments that could be brought up in favor of deposit insurance and against the moral hazard argument. Comparing it to traffic lights, however, only shows that you hadn’t understood the problem.
25. January 2011 at 07:23
Deposit insurance does shift risk, but it is in place to prevent bank runs by the depositors themselves. The traffic light isn’t a good example. However, it is not completely the taxpayers who are providing the insurance (in theory they would not be providing the insurance at all).
One of the problems with the FDIC specifically and in most gov’t insurance programs generally is that they undercharge for the actual risk being shouldered. That the FDIC was not collecting premiums from 1996 to 2006 is unconscionable.
Autos aren’t the worst place to talk about moral hazard: “Insurance companies worried that protecting their clients from risks (like fire, or car accidents) might encourage those clients to behave in riskier ways (like smoking in bed, or not wearing seat belts).”
25. January 2011 at 07:24
The question is never how one can MAKE the economy grow. It is always how one can LET the economy grow.
FEH,
It’s great to be in favour of higher employment. The question is whether or not macroeconomic policy- with all the lags, imperfect information, human factors and so on- is the way to get it. I would say “no” and argue that the way to “full employment” (assuming we are referring, unlike Keynes, to a high level of employment, because Keynes’s ‘full employment’ could well be 14%) would go along the lines of-
(1) Place the worker’s power clearly and definitely above trade union power in the law.
(2) Introduce a minimum-income welfare system (e.g. a negative income tax) that makes every job pays.
(3) Eliminate all payroll taxes.
(4) Eliminate, wherever possible, any law or regulation that makes hiring workers difficult.
In other words, let’s return to Keynes: full employment is a macroeconomic problem, but the level that constitutes ‘full employment’ is decided by real factors. That’s why the Great Moderation occured when monetary policy makers worked out that their objective should be to control what they can control (inflation) not what they can’t control (unemployment or inflation + the exchange rate).
25. January 2011 at 07:30
The most significant moral hazard in banking is not from deposit insurance, but the existence of too-big-to-fail institutions. It was not the protection of insured depositors that led to the bailout of AIG, or TARP. We protected the shareholders of those institutions (Citi/BoA…) and also their bondholders. None of which had an explicit insurance policy, but yet enjoyed the implicit insurance and the upside to the risks up to the crisis point.
25. January 2011 at 07:34
Bogdan, Not in my own mind. 🙂
Indy, If the government had sound finances (think Singapore) that wouldn’t be a problem. Unfortunately . . .
Silas, Actually, the amount of assets the government buys are normally utterly trivial, far too small to affect anything. Only since 2008 has the government bought significant amounts of assets in OMOs. This post was focusing on normal times.
Plus, they don’t even necessarily benefit bond holders, as bond prices often fall when bonds are bought (income and expected inflation effect.)
Dirk, The golf analogy is not good because golf balls can’t think. Markets can think. If they are overshooting NGDP, they know the Fed will tighten. This is effectively equal to tightening right now, and tends to reduce NGDP. Speculation is stabilizing, just as with a credible currency peg.
Morgan, Just to give you a cold shower, I did add that 6% was excessive if we were on target the previous year.
Dustin, Me too.
Liberal Roman, yes, that also drives me nuts, people talking as if you can “use” monetary policy, or not use it.
Doc Merlin, Yes, I think NGDP futures can offer something for both sides.
Kevin, Surprisingly, it doesn’t matter. I have lots of other posts arguing that price inflation really doesn’t matter, wage inflation does. If you have 8% real growth and 5% NGDP targeting, you get negative 3% inflation. With 1% pop. growth, nominal wages will rise 4% a year, and real wages will rise 7%. That’s fine.
TravisA, Depends what you mean by “matter.” Those are sunk costs, and hence have no impact on output. But they do redistribute income. If bad enough, it could cause a banking collapse, and real GDP falls. But with 5% NGDP growth a banking collapse is very unlikely.
Gregor, I was trying to think of a good analogy, and was thinking in terms of global warming. The water example is good, and I like the long run angle (evolution) which I hadn’t thought of.
Doug, Even people like Krugman who worry about Chinese imports, say it’s not a problem is we have good AD policies (which I take to be 5% NGDP growth.)
If it’s a real policy overseas, like war or protectionism, there’s not much monetary policy can do about it. Diplomacy or military action are required.
Jason, Yes, in a sense everything is endogenous, or “evolved.” You said;
“I think your view boils down to answering that none are, so we should have limited intervention. But maybe your view boils down to answering that none could ever be?”
Not quite, if you take certain aspects of society as a given (communally-owned air), for instance, then I think government regs. can help. I also think a modest amount of income redistribution may be good. (Education vouchers, etc.)
CA, Unfortunately I’m too much a non-team player.
Full Employment Hawk, Regarding debt deflation, see my answer to TravisA.
You said:
“As you have probably guessed, I disagree. I think that it should do so in a way that does the most good. “The greatest good for the greatest number” has one too many gradest in it but is still on the right track.”
That’s actually the same, if you assume the Walrasian eq. outcome is optimal. (Which was my assumption.) Even if it wasn’t, I would despair at the thought of the Fed trying to improve on that.
You said;
“Since the effect of money on economic activity is pervasive, to control money is to impose control on the entire economy. It is the equivalent of controlling a person’s heartbeat.”
We are debating the meaning of terms like “control.” The effect is powerful, so I’m trying to minimize the effect, influence the natural heartbeat as little as possible. Do you disagree?
You said:
“That is me to a T. I am serious about being a full employment hawk.”
If NGDP growth is adequate and we still have high unemployment, it’s a huge mistake to go for more stimulus. (As the Europeans discovered a few decades back.) Labor market reform (dereg.) is the only option.
You said:
“But after a very serious shock from the financial system that leaves the financial system damaged, the Fed is not likely to be willing to do this, and it MAY not be able to.”
Not likely? Obviously, but that’s what you and I are trying to change. In 1930 they weren’t like to stop M1 from falling 30%. Now they have been convinced to not do that.
As far as not able, FDR disproved that when the banking system was flat on its back in the spring of 1933, and he engineered rapid NGDP growth.
You said;
“That will not move the wages and prices to their Walrasian equilibrium values, but, rather, move them away.”
No, it will move them toward equilibrium, the problem is that an array of government regs will have caused “equilibrium” to be severely non-optimal. A regulatory fix is needed.
Johnleemk, Johnson is my favorite, the only candidate I’d work for.
manny, Thanks, I’ll take a look.
Markus, I’ll probably disappoint you, but I think it’s too risky to immediately move to laissez-faire, we don’t know what the price level would look like. Money is arguably a natural monopoly because of network externalities. Just to be clear, I mean the medium of account is a natural monopoly, I’m fine with private banks issuing currency.
Maybe this will work. Have a system of NGDP futures targeting, where the dollar is redeemable into NGDP futures contracts at the target price. let private banks issue currency, with the proviso that it must be redeemable into these NGDP futures contracts. The Fed just handles the mechanics of the futures market, and passively adjusts bank reserves to keep the NGDP futures price stable. Is that laissez-faire enough?
Real shocks like bad tax policy cause RGDP to fall, but NGDP doesn’t fall if you are targeting it. Instead you get inflation.
Luis, Thanks, I was hoping people would like that metaphor. I think people who have recently seen the film will recall that the audience is supposed to root for Fay Wray, and not care about all the dark-skinned natives being trampled (this was 1933) I tried to use it as a metaphor for the “invisible victims” of the nasty side effects of bad government policies. Fay Wray is the beautiful progressive goal. Doing PC judo on progressives.
Jim, You said;
“I think you are leaving out a section of the rainforest analogy. What if there are inhabitants of the rainforest area that are actively cutting down and burning the rainforest. If your goal is to protect and maintain the functionality of the rainforest, wouldn’t you have to intervene.”
Look closely, I didn’t leave it out. That’s what I alluded to at the end, the need for environmental regs if there is communally-owned property. Tree cutting is less of a concern on private property.
Yes, Volcker did a good job.
The government has a monopoly on one type of money–I said “currency.” There are private money substitutes (close but not perfect.)
Be careful about moral hazard, you need to separate two issues. Yes, both FDIC and traffic light clearly create moral hazard. Traffic lights have benefits that outweigh the costs, FDIC doesn’t.
Bill, Inflation doesn’t matter, NGDP growth matters. Inflation’s just a number the BLS pulls out of the air with quality adjustment hocus pocus. It’s not how much more we pay for stuff like cars and TVs. Pick a NGDP growth rate and stick with it. 3% is fine.
25. January 2011 at 07:37
Jim, I don’t agree, more money was spent bailing out the small banks than the large banks. The problem with FDIC isn’t the fees (which are paid by taxpayers in the long run), it’s that they allowed banks to take excessive risk with insured deposits
W. Peden. I agree.
25. January 2011 at 07:45
Do you have any evidence that shows that more net money went to small banks versus TBTF institutions? You have to add as a credit what small banks have/had paid in premiums.
25. January 2011 at 07:51
How you look at or measure things also makes a difference. If one factored in the cost of homes, and not just an owner-equivalent rent, then you see a much different inflation rate in 2005-2007, which would have prompted different actions by the Fed. Likewise, looking at static costs only of the bailout underestimates its true cost: http://www.bis.org/review/r100406d.pdf .
25. January 2011 at 08:30
@scott_sumner: Please review the Fed’s purchases in 2008 and examine for compatibility with your claim that Fed purchases are utterly trivial.
@Contemplationist:
1) Depends on what assumptions you’re trying to smuggle in with the concept. Please rephrase in terms of testable predictions.
2) I believe that what you’re *calling* nominal shocks can have real effects, thought I don’t regard that referent as a nominal shock. (To avoid weasel accusations: I agree that true nominal shocks — e.g., cash exploding, bank records being hacked — can have real effects.)
3) In regard to what you are *calling* nominal shocks, I believe that producers should shift toward production structures that involve making what people want (rather than what they are currently refusing to buy) and which make best use of current resources (job skill sets, physical capital, inventories). I believe individuals should re-value goods according to what now would be valuable in light of the information revealed by the events labeled as a nominal shock.
25. January 2011 at 09:06
Scott,
I couldn’t agree more. I just finished a column on nolanchart that I believe you can use as a “case in point” on the microeconomic scale. In a nutshell, it illustrates that where the Urban Enterprise Zone (UEZ) had failed to produce an economic recovery in New Jersey’s cities, individual entreprenours succeeded.
http://www.nolanchart.com/article8300.html
25. January 2011 at 09:17
Scott, I find your general approach to NGDP targeting interesting. As with other policy prescriptions during the crisis & after, I wonder how it would have worked during the housing bubble run-up. Using NGDP data (from macroadvisers) from 1992-, and a simple logest, NGDP was above trend, using a 6 month average of (NGDP – trend) starting in July 2003. By that measure, I assume you would have been in favor of Fed tightening during that period, which in hindsight, most people agree with.
Both monetary and fiscal policies are much less useful when only used in one direction (tax cuts can stimulate the economy, but their utility and practicality diminish when you’ve got massive deficits). If the fed only looks at lowering rates as a useful policy tool, you will get negative effects, but you’ll also have less arrows in your quiver (it’s easier to lower rates than to run zirp’s).
With any policy recommendations, it is absolutely necessary to see how they would have operated pre-crisis and whether it would have made problems worse or better.
25. January 2011 at 09:33
“let’s minimize the harm”
Following up on Dirk’s comment, what if a large policy change leads to higher volatility? Perhaps the policy setting that gets us to 5% expected NGDP growth produces a range of 2-8, while a more conservative policy would be expected to fail but produce a tighter range, perhaps 3-5. Arguably the latter would be less harmful.
I agree that in equilibrium with the policy in place this sort of situation is implausible (i.e. the policy setting expected to hit the target should not change vol expectations so much as to be relevant). However, in the current situation, perhaps the Fed is worried about uncertain terrain and so is trading off an increased expectation of moderate undershooting to reduce the chance of signficant overshooting.
25. January 2011 at 11:13
Reading the comments here and in the previous couple of blog entries I had the following insight.
I don’t especially mean to pick on “vulgar” Austrians (and more generally, believers in the Recalculation Story), but this debate has exemplified to me a strange thing about them. “Vulgar” Austrians claim to believe that market economies are wonderful things, able to adapt to just about anything. Anything, that is, except bad government policy.
I generally view the free market as an incredibly resilient thing, that given a steady growth in NGDP, all the “bubbles” in the world induced by bad government policy can’t do it much harm. And yet for advocating NGDP level targeting I’m occasionally accused of being central planner with absolutely no respect for the free market. Hmmm.
25. January 2011 at 12:11
Mark
I think the problem is that the Austrians have been so isolated for so long from the mainstream that they have not faced serious arguments from within the broader econ community. That is not really their fault – the mainstream loves to define “reasonable” range of opinion and strenuously keep out dissent. But its time they grow up and handle the argument now that the limelight is sorta back on them.
25. January 2011 at 14:49
@Mark:
Compared to the average austrian, you are… You forget just how anarchistic they tend to be.
25. January 2011 at 18:54
Scott,
I have a couple of really basic questions. (Apologies in advance to everyone who understands this stuff better than I do.)
What is the point of NDGP targeting. Is it to serve as a counterweight to cyclical swings in the economy by creating relative increases/decreases in money supply and thus impacting economic activity through the cost of credit… or does it impact economic activity through market expectations.
Doesn’t the supply/demand for credit change over time (e.g. in reaction to a really bad shock or an over-exuberant market) and therefore isn’t it possible that NDGP targeting just results in a change in velocity which blunts the impact on cost of credit and/or economic activity.
How do you set the NDGP target.
How do you keep the NDGP targeting from being politicized. There are winners and losers depending on the N to R spread.
What is the impact over time if NDGP targeting is not internationally harmonized?
Was Bernanke ill-informed, unwise or just timid?
Do you believe that a) the government can allow major financial institutions to fail or b) that the government needs to regulate them…. or c) neither.
25. January 2011 at 20:04
Kevin Dick worries about what happens “if you have an NGDP level target with a built in 5% growth rate, but a huge productivity improvement shifts real long run growth to 8%?
What happens is that goods cost less to make and this fact actually gets reflected in a falling price level. To imagine that the target needs modification in this case is to overlook the basic point that NGDP is the very thing that needs to be stabilized, not P itself. You want to stabilize NGDP not as a means for stabilizing P but because stabilizing NGDP beats stabilizing P!
25. January 2011 at 20:51
George,
What I think is more interesting is that those who scream for a NGDP target – they have to do their best to encourage these aggressive productivity gains.
You can’t say, “wages are sticky” and then champion policy that causes sticky wages. So anyone who supports say Minimum Wage, cannot claim to want to target NGDP…. they have just want to tax savers.
The single part of our economy most ready to bear giant productivity gains are public employees and government operations – we can easily demand and and find 5% gains annually for the next 5 years.
And joy of joys every cut in PE compensation is another chance to print some money!
26. January 2011 at 06:49
Morgan_Warstler, I think I speak for everyone here when I insist you not post while high.
26. January 2011 at 07:53
if you couldn’t bring yourself to title it The Kling and I, in the very least, this post should have ended with “et cetera, et cetera, et cetera”
26. January 2011 at 15:53
Silas, I eat logic for breakfast.
If you want level price targeting, if you support it, you are saying you that promising to make up the overruns and far misses in the aggregate – it is guaranteed – otherwise, you don’t get the expectations win.
So SINCE you have to be so adamant we can always make it up, and will make it up, the best way to test the motives of those who argue it now – when we are running under 5% growth…
Is to make them take it in the fanny on wages for their favorite interest group – Public Employees.
Since they are getting a system that allows us to print to hit the target, then there is no negative effect from firing lots of public employees – even now when the economy is so bad. Indeed, there are massive productivity gains to be wrung from GOV2.0.
I realize, support, and commend your rather straight forward (bland) Austrian approach – I’m simply concerned with extracting a pound of flesh from the opposition – just in case they are only pretending to like Scott because they can’t get any more Fiscal Stimulus.
Someday, we may indeed get a Austrian system, until such time, I support the long term Ronald Reagan strategy of bankrupting Democrat administrations as a pre-emptive strike. It’s the least ugly of many ugly options.
Cheers!
27. January 2011 at 06:08
Jim, Premiums paid by small banks are essentially taxes, that means the cost is passed on to consumers. FDIC is estimated to have lost over $100 billion, mostly to small banks. TARP is estimated to lose zero to large banks.
You said;
“How you look at or measure things also makes a difference. If one factored in the cost of homes, and not just an owner-equivalent rent, then you see a much different inflation rate in 2005-2007, which would have prompted different actions by the Fed. Likewise, looking at static costs only of the bailout underestimates its true cost: http://www.bis.org/review/r100406d.pdf .”
That’s why I think the Fed should pay no attention to inflation, and focus on NGDP growth.
Silas, You said;
“@scott_sumner: Please review the Fed’s purchases in 2008 and examine for compatibility with your claim that Fed purchases are utterly trivial.”
Who said their purchases in 2008 were trivial, and what does this discussion have to do with this post–which is about conventional monetary policy?
Bill Gee, Yes, that’s a good analogy.
Jim, My general view is that monetary policy was pretty good from 1983 to 2007. Not perfect, but not far off course. It was still slightly too procyclical, but I don’t see monetary policy as playing a significant role in the housing bubble. The low interest rates were caused by weak business investment after the tech bubble burst, and high Asian savings rates.
fmb, The key to macro stability isn’t so much stabilizing actual NGDP, but expected NGDP. And we can certainly keep expected NGDP growing at a stable 5% rate. If we do that, wage gains will be stable, and asset prices will be much more stable than currently. Those factors will help make NGDP itself more stable. Stabilizing NGDP expectations is the best way to stabilize actual NGDP. As an analogy, if the government stabilized 12 month forward gold prices, spot prices would also be more stable.
Mark, Yes, and they also seem to believe monetary policy can have a massive impact on the economy, except when trying to help things, then it has no impact.
dtoh, I don’t have time for complete answers, but briefly here are a few (many other posts provide more complete answers)
1. The problems allegedly caused by inflation are actually due to NGDP fluctuations.
2. Stable NGDP will reduce the business cycle (and bubbles) by more than stable inflation.)
3. Target NGDP expectations, because modern macro suggests (correctly) that unstable NGDP expectations cause unstable actual NGDP.
4. The government needs a rule. Some governments have already adopted inflation rules, so I don’t think it’s political impossible to get there some day. NGDP targeting is an easier sell politically, as it involves both of the Fed’s mandate’s not just inflation.
Also check out my answer to fmb.
George, I agree.
Colin, Is that how Kling ends his posts?
27. January 2011 at 06:34
Scott,
FDIC works part and parcel with the Fed to protect the banksters. It is better if you admit it. They assume the best thing for America is whatever keeps the banks, ALL banks, stable.
This is a moral hazard.
The FDIC refuses to admit new online banks with innovative business plans to pay the higher riskier insurance and go compete with banks.
This is a moral hazard.
Every Friday night, when the FDIC shuts down the failing banks under “loss sharing” arrangements, the new acquiring bank claiming to be excited to grow into new markets, is really just getting at the cheap assets BEFORE regular folks can get at them.
The rule should be simple: IF you are an FDIC insured bank, you do not get to sell loans you write…. I prefer ever, but 5 years would be plenty.
And when a bank is put on waivers, its entire book should be exposed online, and all investors should be able to come in an bid on every loan, every asset.
This will force banks back into a far more conservative position, and force real cost / price based competition on them, because even in failing there will not be a fat place at the table for the next bankster.
FDIC is free bank marketing paid for by the bank customers to sell banks to us.
In light of above you cannot say there is no effect to us, or even what it costs. The market distortions are large.
And since we are not gong to get rid of FDIC, you should support policies such as these.
27. January 2011 at 14:48
Morgan,
I think the better solution is to eliminate the FDIC. Get rid of implicit government guarantees on financial institutions, replace it with an explicit guarantee program, make the program mandatory on large institutions, voluntary for small ones, and impose an equity reserve requirement on all participating institutions where the reserve ratio would depend on type and maturity of the assets. This would be administratively simple and solve nearly all the problems that have occurred in the financial industry.
29. January 2011 at 10:27
dtoh, I would try to get rid of FDIC and raise capital requirements much higher. If our banks couldn’t compete, let foreign banks serve our market.
If we can’t do that, (and I assume we can’t) then ban sub-prime mortgage, and raise capital requirements.
8. June 2011 at 21:24
-“Currency is already controlled by the state, so let’s minimize the harm.”
-Wrong. A utilitarianist approach to a fundamental problem (monopolistic currency) is not ideal. If we read Hayek’s “The Intellectuals And Socialism” we will see him write:
“What we lack is a liberal Utopia… we need intellectual leaders who are… willing to work for an ideal… The practical compromises they must leave to the politicians..”
-Currency is not “one tiny corner of the economy”. It is the foundation of a complex economy that is essential to facilitate trade across borders, languages and between strangers, even Federal Reserves acknowledge the neccesity of stable prices (though they never achieve this in practice).
Your whole article is filled with doublespeak Mr Sumners, the fourth and third last examples show this the best, when you firmly reject government role in “fixing” the economy and then claim you do not favour laissez-faire I can picture you in 1984 ordering a state of continually patchy regulation being called “non interventionist”, or perhaps you as simply handicapped by a lack of “courage to indulge in utopian thought” (Hayek’s words) which of course is as he says “neither intellectually respectable nor likely to inspire any enthusiasm”.