A NGDP targeting counterfactual

A commenter asked me to do a post on what would have happened if NGDP targeting had been put into effect in mid-2008.

The immediate effect would have been a boom in asset prices, and most likely Lehman would not have failed. The big financial crisis of October 2008 would not have happened. In other words, macroeconomic conditions in 2009 would have played out much like the consensus of economists expected in mid-2008—nothing special.

But let’s say I’m wrong, what then?

1.  A sharp drop in demand for credit due to the real estate crash. Note that “demand” is a misleading term, as some of the drop comes from tighter lending standards. This drop in demand for credit would sharply reduce real interest rates in the US, which would reduce the value of the dollar in forex markets.

2.  The lower real interest rate would tend to boost consumption, business investment (including infrastructure), and the lower dollar would boost exports. However another factor (what Tyler Cowen calls “we’re not as rich as we thought we were”) would reduce consumption. The wealth loss comes from the housing crash and an adverse move in the terms of trade (higher oil prices.) Net effect: business investment and exports rise, residential investment falls, and consumption is ambiguous.

3.  There are also cross currents in the labor market. The loss of wealth would increase labor supply, boosting employment. But the re-allocation out of housing construction lowers employment.  Net effect is ambiguous.

4.  The rising oil prices and weak productivity would reduce real wage growth. The RGDP/P split from 5% NGDP growth would be modestly less favorable than normal. Maybe a couple years of 1.5% RGDP growth and 3.5% inflation. If Europe had a severe recession despite sound US policy, then that would make the RGDP/P split even more unfavorable.

PS.  Tyler Cowen has a recent post discussing how capital controls might be able to prevent an overheated economy.  In my view NGDP targeting is the best way to prevent “overheating.”  Real overheating is not much of a problem.  As long as nominal national income continues to grow on trend, the labor market will stay close to equilibrium.

Always focus on the labor market.  Keep that in equilibrium and the free market can handle the rest.

PPS.  Lars Christensen has an excellent new post pointing that that devaluations caused by monetary stimulus tend to boost output by stimulating domestic demand, not net exports.  If I had more time I’d do a post.  BTW, I’ll be busy for the next week, and will have very little time to answer comments.  I will get to them eventually.


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70 Responses to “A NGDP targeting counterfactual”

  1. Gravatar of Peter N Peter N
    11. May 2013 at 05:06

    This graph is a bit complicated, but I found it an interesting way to look at 2008. It’s all data for households and nonprofits from flow of funds

    Lines scaled on the Left are all from flow of funds for households and nonprofits expressed as percent of GDP

    (MFSABSHNO + CEABSHNO)/GDP = (Mutual Funds + Equities)

    The components of the dotcom boom

    REABSHNO/GDP = Real Estate Assets

    The real estate boom

    (REABSHNO + MFSABSHNO + CEABSHNO)/GDP = Real Estate + Mutual Funds + Equities

    The 2 booms added together. Note that they entirely account for the increase in total assets

    (TFAABSHNO + TTABSHNO)/GDP = (Financial Assets + Tangible Assets)

    And thus the increase in net worth which is less extreme due to the increse in liabilities

    TNWBSHNO/GDP = Net Worth

    Scaled on the right is
    TlBSHNO/TNWBSHNO = Liabilities as a percent of Net worth

    Which is a measure of financial leverage

    You can see that until the mid 1980s the ratio of new worth to GDP was fairly stable around 3.5 and liabilities as a percent of new worth after a run up after WWII fro, 7% to 14% around 1965 stabilized there. I interpret this as healthy borrowing, since it had no effect on the ratio of net worth to GDP – that is it caused net worth and GDP to increase at an equal rate.
    What happens next is the great dotcom stock market boom. This produces some asset inflation, but it’s mostly just the irrational exuberance of people investing their own money. You see that the increase in (net worth/GDP) is pretty much entirely due to an increase in financial assets.
    After the dotcom bust, however, the Fed loosens, arguably for too long, and another asset inflation up leg follows without the preceeding inflation having been completely wrung out.
    Unlike the previous boom, this one is fueled by debt leverage taking liabilities as a percent of net worth from 16% to 26%. Regardless of whether you believe this was rational, it clearly wasn’t sustainable, and a naive reading of the chart would indicate that we’ve only retreated 3/4 of the way to historically normal levels (which, I supect is a lot more than the Europeans have managed).
    There are 2 possibilities. Either:
    1) the 4.8 ratio of net worth to GDP was sustainable, and it should have been supported by fiscal or monetary policy depending on your persuasion in that area.
    2) The ration wasn’t sustainable, and it should have been allowed fall with the fall being cushioned by some combination of fiscal or monetary policy again depending on your persuasion.

    It seems to me, however that the choice of policy depends to a large extent on whether you believe 1 or 2 above.

  2. Gravatar of Peter N Peter N
    11. May 2013 at 05:11

    Well, I clearly can’t embed an image as I can with Typepad, so here it is the ugly way

    http://research.stlouisfed.org/fredgraph.png?g=ikL

    I’ll be interested in reactions, since I’ve never seen this data presented quite this way.

  3. Gravatar of chris mahoney chris mahoney
    11. May 2013 at 07:27

    Off-point but I had to post this. CATO’s “analysis” of current Fed monetary policy, which has between one and two errors per paragraph:
    http://www.cato.org/policy-report/mayjune-2013/federal-reserves-unsound-policies

  4. Gravatar of Tommy Dorsett Tommy Dorsett
    11. May 2013 at 09:08

    Scott, via Lars Christensen – We can get a rough proxy for what would have happened by subtracting the CBO’s estimate of the US$ value of potential NGDP from 5% growth path. This exercise suggests that the annual change in the GDP deflator, instead of crashing, would have levitated to 3.6% or so before slowly receding. So there’s your ~1.5% RGDP growth trend. Of course this makes perfect sense: if the Fed had successfully stablized AD/the growth trajectory of NGDP, the hosing bust would have simply been a run-of-the-mill supply shock. And the base would be a much smaller share of NGDP.

    http://research.stlouisfed.org/fredgraph.png?g=il7

  5. Gravatar of Tommy Dorsett Tommy Dorsett
    11. May 2013 at 09:16

    Correction, I meant real potential not nominal.

  6. Gravatar of Peter N Peter N
    11. May 2013 at 10:06

    Well I never believed I was the first person to be thinking along these lines:

    Wealth and Volatility
    Johnathan heathcote
    Minneapolis Fed

    Fabrizio Perri
    Minneapolis Fed

    EIEF July 2011

    http://www.indiana.edu/~caepr/visitors/2011/downloads/HeathcotePerri.pdf

  7. Gravatar of Peter N Peter N
    11. May 2013 at 10:24

    Financial position of the United States

    http://en.wikipedia.org/wiki/Financial_position_of_the_United_States

    Filled with useful information and some wonderful charts. It looks like good teaching material.

  8. Gravatar of TallDave TallDave
    11. May 2013 at 12:09

    Thanks Scott, very interesting counterfactual.

  9. Gravatar of James in London James in London
    11. May 2013 at 13:23

    Peter N
    Sounds like you are new to this blog. Go to FAQs and then starts reading from February 2009.

  10. Gravatar of Peter N Peter N
    11. May 2013 at 14:55

    James,

    I’ve been here before. I’m trying not to be too long winded, since this isn’t my blog.

    I’m going with the counter-factual, since I believe that

    “The immediate effect would have been a boom in asset prices”

    would have been a good result

    “though braking the slide so that most likely Lehman would not have failed.”

    would have been a good thing, and not required a “boom”. The reason is that while I’m not an Austrian, I do believe that the natural tendency of government intervention in busts following credit booms is to start a new up leg from a higher base. The real estate boom starting in 2001 started at a higher level than the dotcom boom of 1992-1999 and ended at a higher level as well.

    Another up leg to something like a net worth to GDP ratio of 5.3 and a liability to asset ratio of 35% wouldn’t have been an improvement.

    One key point is that while the net worth of the financial sector was negative from 2002-2006, it owned 31% of all assets and had all time high earnings as a percent of total earnings – more than the previous peak in 1932 and was double the size it was in 2000. That’s a financial sector bubble. It’s improvement in net worth from 2006-2008 was clearly at the expense of the real economy, from which it was withdrawing credit.

    The credit tightening of Scott’s point 1 started in 2006.

    The paper I cited addresses Scott’s point 2 at some length.

    While I agree “the re-allocation out of housing construction lowers employment.”, I don’t agree “The loss of wealth would increase labor supply, boosting employment.” I believe the negative effect on investment and wage stickiness would reduce employment, though better Fed policy would have made the fall much less severe.

    In particular, the weakness in Europe would have been a drag on the economy, and the loss of collateral quantity and velocity would have also been a problem. If a continuation of the US boom had prolonged the booms in the GIPSICS, their crash would have been even uglier, unless you want to assume the Fed took over the ECB and the Bundesbank.

  11. Gravatar of Peter N Peter N
    11. May 2013 at 14:58

    Should be

    “‘The immediate effect would have been a boom in asset prices’

    would NOT have been a good result”

  12. Gravatar of TravisV TravisV
    11. May 2013 at 17:34

    Kuroda seems to really get it!

    “Bank of Japan chief expects no spike in long-term Japan interest rates”

    http://finance.yahoo.com/news/boj-chief-expects-no-spike-132123965.html

    “Japanese long-term interest rates should not shoot higher as a result of money flowing out of government bonds, Bank of Japan Governor Haruhiko Kuroda said on Saturday.

    Kuroda added, however, that it would be natural for long-term rates to rise over time if Japan meets its goal of pushing inflation up towards two percent.”

  13. Gravatar of Geoff Geoff
    11. May 2013 at 17:55

    “Always focus on the labor market. Keep that in equilibrium and the free market can handle the rest.”

    What is it with this eschatological fetish for “equilibrium”?

    If the state should focus on the labor market, if it’s labor equilibrium that is the end of history, then the state can just print whatever quantity of money is necessary to hire every last laborer in the economy.

    This of course would mean that only the state would be utilizing capital in productive processes, i.e. socialism.

    This would finally put the labor market in the kind of “equilibrium” sought after. Changes to the employment rate would finally come to an end and the labor market would finally be in the ideal “equilibrium”.

    According to Dr. Sumner’s logic, since the labor market is in perfect “equilibrium”, and since the focus is not on employment directed to sovereign consumer preferences, but rather employment for employment’s sake, we don’t have to worry about production or output. As long as every worker is doing “something”, the non-existent free market, i.e. hampered market activity, will take care of the rest.

    It’s Orwellian to see the term “free market” being tossed around on a blog about the best way to impose a state monopoly on money production, along with a host of other interventionist policies.

  14. Gravatar of Geoff Geoff
    11. May 2013 at 17:57

    This blog should have been titled

    MonetarySocialism.com

  15. Gravatar of Geoff Geoff
    11. May 2013 at 18:05

    “Lars Christensen has an excellent new post pointing that that devaluations caused by monetary stimulus tend to boost output by stimulating domestic demand”

    BREAKING NEWS:

    Misleading investors by non-market money production, can result in consumption of capital which shows up statistically as an increase in “output”, which has the unseen, and thus ignored, consequence of a lower than otherwise productive capacity and lower standards of living going forward.

    Lars Christensen isn’t an economist. He’s a statistician, historian, and political strategist.

  16. Gravatar of Geoff Geoff
    11. May 2013 at 18:10

    Output is only boosted by additional saving and investment.

    Output is only sustainably boosted by investment backed by voluntary real savings.

    Investment that is boosted by inflation, rather than real saving, results in capital consumption.

    Demand for output is not what grows economies. Nominal demand for output and nominal demand for input are actually in competition with each other. More of one does not mean more of the other.

  17. Gravatar of Benjamin Cole Benjamin Cole
    11. May 2013 at 19:44

    Re Tyler Cowan and many others:

    Ever, there is this timidity that a bullish pro-growth monetary policy will somehow lead to an “overheated” economy, or some other analogy to an engine running over the red line, or horse that has run too hard for too long.

    So what–we are supposed to throttle down permanently? Keep the horse at a slow walk?

    It is pathetic.

    Can we have a real long boom, and even Fat City first, before we worry about an “overheated” economy? How about some huge profits and job-hopping again? Would a huge dollop of prosperity be so bad?

    The other strange analogy is by Feldstein, who recently opined that the Fed was “saddled” with an enormous balance sheet. You know, the Fed is going to collapse, under the weight of owning $3 trillion in interest bearing assets, that are throwing off lots of interest. It is like putting 1000 pounds of gold bricks on top of a donkey.

    You know, the economy and the especially the financial system are not living things, they are not machines. The Fed could buy a few more trillion in assets, and I wish it would. The Fed HQ will not collapse.

    The economy will not “overheat.’ If–and again I wish it would happen—we ever get to the point where there is so much demand for labor that we get a wage-price spiral going, then we can cut the engines a little. Take some gold bricks off of the donkey.

    But can we get there first?

  18. Gravatar of Joemac Joemac
    11. May 2013 at 19:45

    Scott,

    I still think you haven’t quite “proven” that Lehman brothers and the financial crash were caused by tight money. You argument seems to be, “GDP and NGDP expectations were falling for three months before lehman brothers. THEREFORE, the crash was caused by tight money,”

    But I don’t think that’s enough to convince most people who don’t already agree with your theory of business cycles being mostly driven by NGDP expectations. Most people Need something more to take the “plunge” with you and to believe that the crash was a symptom and not the cause.

    My recommendation to you and the Market Monetarists is that if you want to convince others then you need to look for some statistical “smoking gun” of empirical evidence that definitely shows lehmans and the crash MUST have been caused by tight money. A good empirical analogy would be your effective and powerful use of FDR’s gold devaluation as proof of the power of monetary policy.

    Best regards.

  19. Gravatar of ssumner ssumner
    11. May 2013 at 20:10

    Joe Mac, I was not trying to prove tight money caused Lehman to fail. That wasn’t the point of the post.

    Sorry, no more time today. I did read all the comments.

  20. Gravatar of Edward Lambert Edward Lambert
    12. May 2013 at 00:16

    Scott, I wrote a post in response to your article here…

    http://effectivedemand.typepad.com/ed/2013/05/monetary-policy-based-on-labor-share-during-2008.html

    and I wrote an article on what labor share targeting might look like for monetary policy.

    http://effectivedemand.typepad.com/ed/2013/05/monetary-policy-for-targeting-labor-share-of-income.html

  21. Gravatar of Bill Woolsey Bill Woolsey
    12. May 2013 at 05:52

    Geoff:

    The primary cause of economic growth in the U.S. has been growth in the labor force due to growth in population.

    An important secondary cause of growth has been improvements in technology–new products and new production methods.

    Increases saving and investment is another source of growth. Given the most useful framing, it has not been the most important source of growth.

    With a growing population, it is usual to think of capital on a per worker (or labor hour) basis.

    Even with no net capital accumulation, depreciated capital goods can be replaced by different capital goods that produce more of existing products or different and better products.

    Admittedly, it is not easy to separate out all the effects, but I think you are excessively emphasizing saving and investment in growth.

    My own view is that people should save the amount they want. If they don’t want to save, then that is their business. If that were to occur, then the economy could and probably would still grow, but not as much.

    If you do a thought experiment where population is constant and technology fixed, and institutions unchanged, and then consider an increase in saving, investment, and capital, the result is higher future output and income. Perhaps a useful exercise to understand the impact of saving and investment.

    But don’t confuse the constant population fixed technology scenario with the real world.

    In my view, it is creative destruction that is the key to growth, not increases in the capital stock or the round-aboutness of production.

  22. Gravatar of Geoff Geoff
    12. May 2013 at 08:00

    Bill Woolsey:

    “The primary cause of economic growth in the U.S. has been growth in the labor force due to growth in population.”

    You have it backwards. The primary cause for the growth in population is due to economic growth. If the same aggregate output is produced, and population grows, then eventually population growth will come to an end. But if the same population exists, then aggregate output can continue to grow indefinitely with sufficient technological and capital accumulation,which increases in output per labor hour.

    If you want to understand the primary cause of economic growth, then as a positivist, you could ask why countries with greater populations than the US have historically lagged the US in terms of output, aggregate and/or per worker. That will give you clues as to the actual causes of economic growth.

    Population growth is an effect of economic growth, and at the same time, serves as an available means of production for further growth. But that doesn’t mean the additional population will necessarily be able to continually produce more than it consumes, such that capital accumulation takes place. The requirement for growth here are the primary causes for growth. They are: first and foremost a widespread philosophical cultural rationality, and thus an understanding of respect for individual private property rights, which unlocks the division of labor and allows for capital accumulation and higher output per worker ad infinitum.

    “An important secondary cause of growth has been improvements in technology-new products and new production methods.”

    Agreed, but I would call it secondary to population growth. I would say it is more fundamental than population growth. For if we held technology constant, then at some point capital accumulation would come to an end as lower and lower grades of land are exploited, and as the law of diminishing returns universally sets in. Then, the marginal output gains from additional workers will decline to zero, and prevent any further increases in population without corresponding deaths elsewhere. So population from then on could not grow. Additional workers here would not, contrary to what you said, enable more output. Additional workers would require redirecting already unredirectable subsistence resources. More economic growth would be needed to increase the population. This is another way to understand that population growth depends on additional capital, which itself depends on additional technology (and it cannot be ignored that additional technology depends on additional capital as well. They are interdependent).

    This may be somewhat uncomfortable for you to handle, but it is very likely, indeed it is almost certain, that the only reason you are alive right now, is because economic growth prior to your life has allowed for your parents and their parents and their parents (and so on) to afford children and afford sustaining children into an age where they can have children of their own.

    If it weren’t for the capital accumulation prior to your life, your life could not have been “afforded”, so to speak.

    The “working class”, contrary to being oppressed or exploited by capital, was brought into being by (owned and utilized) capital. If it weren’t for capital accumulation, growths in population would put every individual on a path towards greater and greater impoverishment, until every individual is so poor they cannot even afford to feed anyone else, including potential children.

    “Increases saving and investment is another source of growth. Given the most useful framing, it has not been the most important source of growth.”

    As usual, you have it exactly backwards. Saving and investment are a crucial and fundamental activity that enables growth. If there is no saving and investment, then the only consumption that could occur would be direct hand to mouth consumption. Consuming whatever nature has happened to provide directly for human needs. Apples on trees, fresh waters in streams. Population could grow in this context, but the growth would be limited to the fixed amount of consumer ready resources in nature. Once every last natural consumer ready resource is controlled, any population growth subsequent to that would again drive the individual towards impoverishment, and population growth would then come to an end, and forever more after that, every individual human would live a life in abject (material) impoverishment.

    Luckily though, individuals have reason, and a sense of the future and a sense of being able to change it via saving and investment now. Contrary to being less important than population growth, it is in fact required to enable a growth in population beyond what is possible with hand to mouth lifestyles.

    “Even with no net capital accumulation, depreciated capital goods can be replaced by different capital goods that produce more of existing products or different and better products.”

    Excuse me, but replacing worn out and used up capital goods with new capital goods, require acts of saving and investment. Without continual acts of saving and investment, any capital goods previously produced on the basis of saving and investment, would eventually be used up and worn out with nothing to replace them with.

    “Admittedly, it is not easy to separate out all the effects, but I think you are excessively emphasizing saving and investment in growth.”

    I think you are excessively, mistakenly, catastrophically, under-emphasizing saving and investment in growth. You literally just overlooked the saving and investment in your little thought experiment there of “replacing” old capital with new capital! Without saving and investment, replacement of old capital becomes impossible. For ALL activity would be consumer activity. No capital goods can be produced, because 100% consumer activity means only consumer goods are consumed directly from nature! Not even fishing nets, or plows, or spears can be produced without saving and investment. Producing ANYTHING that isn’t a consumer good, but a means to producing consumer goods, is a saving and investment in the production of consumer goods.

    “My own view is that people should save the amount they want. If they don’t want to save, then that is their business. If that were to occur, then the economy could and probably would still grow, but not as much.”

    Growth would come to an end. Remember, no saving and investment means no tools, no equipment, no material things of any kind that would assist in the production or requisition of future consumer goods.

    How much economic growth do you think is possible on the basis of ZERO TOOLS? Not even clubs or spears or fishing nets or knives or hammers would be produced, since those are acts of saving and investment. Just stop and think about that for a minute or two. It’s clear you haven’t thought about it enough. If savings came to an end tomorrow, I would wager something like 95% of the world’s population would soon perish. For there won’t be any replacement of any materials that go into the production of goods.

    I think you are seriously underestimating saving. Maybe it is so natural and so old that it seems like an automatic law to you, that will somehow manifest itself as a natural gift even if humans did not save. Like nature will take over the production of clubs and spears and fishing nets. It’s so tragic how easily saving and investment can be taken for granted.

    “If you do a thought experiment where population is constant and technology fixed, and institutions unchanged, and then consider an increase in saving, investment, and capital, the result is higher future output and income. Perhaps a useful exercise to understand the impact of saving and investment.”

    Perhaps?

    “But don’t confuse the constant population fixed technology scenario with the real world.”

    Wow.

    “In my view, it is creative destruction that is the key to growth, not increases in the capital stock or the round-aboutness of production.”

    Again, reality is the exact opposite. Factories for example are a core component out of which better and larger factories are made. Machines are a core component out of which better and larger machines are made. The factories that produce iPods were not built in factories that were created from scratch. They were built using resources produced in previously produced factories! Oil refineries didn’t get built out of the rubble of candlestick factories. They were built from the resources saved out of previous factory output.

    Creative destruction is secondary to capital accumulation.

    I am actually quite astonished at how wrong people can be regarding capital, technology, and economic growth. Is it because you have lived a life of consuming most of his earnings, and so has developed the notion that saving and investment, because they aren’t that important in your particular lifestyle, that they aren’t that important for the economy as a whole? Is it because of your anti-rationalist philosophy that results in you putting the most weight on strong backs for economic growth? That strong backs are more fundamental than reason?

    Why can’t animals much strong than us, accumulate capital to any significant degree? Why aren’t apes and gorillas building factories and cities? Why do they live hand to mouth lifestyles, where the only tools they can produce are branches broken off from trees?

    Thay have incredibly strong backs, the strength of 5 to 10 humans, and yet we as relatively weaker beings have produced far more than twig tools.

  23. Gravatar of Geoff Geoff
    12. May 2013 at 08:06

    I should have been more accurate:

    Worn out and used up capital, it were only replaced with equal amounts of capital, would prevent human society from advancing beyond hunter-gatherer. If starting tomorrow, the only capital produced is capital that replaces worn out capital, with no net addition to capital, economic growth would come to an end. If population grew, then each individual alive would become more and more impoverished as new people were born, until every individual was at the minimum subsistence level, after which population growth would come to an end.

  24. Gravatar of Edward Lambert Edward Lambert
    12. May 2013 at 08:25

    Here is a thought provoking article about what causes lower labor shares in the world… the answer is mainly “Financialization”. The result is low labor liquidity, and high capital liquidity.

    http://rwer.wordpress.com/2013/05/01/what-causes-the-share-of-labor-to-decrease-3-graphs/

  25. Gravatar of TravisV TravisV
    12. May 2013 at 08:56

    Prof. Sumner,

    Check this out!!!!

    “Strong money growth “causes” low inflation.”

    http://www.businessinsider.com/global-inflation-surprising-low-2013-5

    “Harris ran twenty years worth of numbers and showed that a growing monetary base, which is happening thanks to quantitative easing, does not correlate well with inflation.

    “For example, Table 1 shows the correlation between the growth in the US monetary aggregates and CPI inflation at various lag lengths,” he wrote. “The correlation is always small and half of the time has the wrong sign – strong money growth “causes” low inflation.”

  26. Gravatar of W. Peden W. Peden
    12. May 2013 at 13:28

    Travis V,

    It’s as if the demand to hold currency is affected by inflation rates and interest rates!

  27. Gravatar of The Great Recession: NGDP fueled or Balance Sheet fueled? | Historinhas The Great Recession: NGDP fueled or Balance Sheet fueled? | Historinhas
    12. May 2013 at 14:36

    […] the comment section of Scott´s “A NGDP counterfactual” Peter N shows this – as he says ugly – […]

  28. Gravatar of marcus nunes marcus nunes
    12. May 2013 at 14:40

    @Peter N
    I gave your story a twist:
    http://thefaintofheart.wordpress.com/2013/05/12/the-great-recession-ngdp-fueled-or-balance-sheet-fueled/

  29. Gravatar of Ben J Ben J
    12. May 2013 at 17:02

    Geoff, can I clarify something,

    “If starting tomorrow, the only capital produced is capital that replaces worn out capital, with no net addition to capital, economic growth would come to an end,”

    Do you mean efficiency unit of capital per capita? Am I reading you fairly when I think you were saying that if capital was replaced at the level of population growth and that technological growth came to an end, there would no longer be growth?

    I can understand if you consider technology as a form of capital, although I’m not sure it makes sense to say ideas can depreciate. But even if they did, capital per capita would need to be stable for growth to be zero, right?

  30. Gravatar of TallDave TallDave
    12. May 2013 at 18:13

    Sorry to be O/T, but just wanted to say I really appreciate the FAQ, very helpful resource. BTW a couple minor punctuation issues in #11 (sorry, my wife is an editor, can’t help it).

    Also thanks for the book recommendation, now to get Fisher on my Kindle :)

  31. Gravatar of Peter N Peter N
    12. May 2013 at 22:06

    A much simpler and prettier chart for net worth liabilities and GDP

    http://research.stlouisfed.org/fredgraph.png?g=in0

  32. Gravatar of Asco Asco
    13. May 2013 at 00:21

    W. Peden

    You mean people hold more money when the cost of holding money is low?

    Say it ain’t so!

  33. Gravatar of W. Peden W. Peden
    13. May 2013 at 04:51

    Asco,

    I was as surprised as you are, though I don’t use the expression “ain’t” in that context.

  34. Gravatar of Saturos Saturos
    13. May 2013 at 05:46

    Scott, any comments on this?
    http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hpp_LEFTTopStories

  35. Gravatar of Geoff Geoff
    13. May 2013 at 07:38

    Ben J:

    “Do you mean efficiency unit of capital per capita? Am I reading you fairly when I think you were saying that if capital was replaced at the level of population growth and that technological growth came to an end, there would no longer be growth?”

    I mean replacing the quantity today’s aggregate capital with an equal quantity of capital, regardless of what happens to the population.

    “I can understand if you consider technology as a form of capital, although I’m not sure it makes sense to say ideas can depreciate. But even if they did, capital per capita would need to be stable for growth to be zero, right?”

    I am inclined to agree with the argument you are making here. It makes sense. If technological progress were included, then it wouldn’t make much sense to say that net capital output will remain at zero, in the face of technological progress. More technology allows us to produce more (capital) with the same capital, so it would be hard to imagine aggregate capital remaining the same in this context.

    So the thought experiment would be modified slightly, and the assumption that aggregate capital is only ever replaced, with no net addition of capital, would be explained by technology progressing at a rate insufficient to overcome the law of diminishing returns, or some other reason. The point of the argument is a ceteris paribus one. Given that capital accumulation comes to an end, where aggregate capital production is only as large as the capital used up, it is true to say that economic growth would end.

    Bill Woolsey argued that economic growth occurs primarly because of population growth. Yet I hope you can see that if capital accumulation ends, then should the population grow, capital per capita would decline and decline until each worker has only enough capital to produce minimum subsistence, after which any further population growth would result in outright deaths due to insufficient resources to even sustain all human lives.

    I think it’s rather clear that Woolsey made the tacit assumption that as population grows, so does capital, and so resources per person doesn’t have to decrease over time towards subsistence in his scenario. So he inferred that it is population growth that is the primary driver of economic growth. Now I would grant that this assumption is not unreasonable, because it makes sense that if population grew, so will capital output in most conditions. But I think if we want to really nail down the causes of growth, we have to make our assumption much more clear, and I don’t think Woolsey has done that.

  36. Gravatar of Peter N Peter N
    13. May 2013 at 08:12

    W. Peden,

    For “say it ain’t so”, look up Shoeless Joe Jackson.

  37. Gravatar of W. Peden W. Peden
    13. May 2013 at 08:29

    Peter N,

    I’m familiar with the idiom, though I’m not at all familiar with baseball, which is very much outwith mainstream Scottish culture.

  38. Gravatar of Who Said It? Who Said It?
    13. May 2013 at 09:07

    […] you choose, go here for the […]

  39. Gravatar of Bill Ellis Bill Ellis
    13. May 2013 at 14:16

    Increasing the labor supply, boosts employment…but not in the real world.

    Sticky wages. So net effect is Not ambiguous.

  40. Gravatar of Joemac Joemac
    13. May 2013 at 15:38

    Scott, it is true about what was the purpose of your post. But you still said…

    “most likely Lehman would not have failed. The big financial crisis of October 2008 would not have happened.”

  41. Gravatar of Peter N Peter N
    13. May 2013 at 17:50

    W. Peden,

    How can you ignore the accomplishments of the great Bobby Thomson, greatest of the (8) Scottish major league baseball players (in 150 years of record keeping).

  42. Gravatar of Peter N Peter N
    13. May 2013 at 18:07

    W. Peden,

    Shoeless Joe Jackson was one of the greatest baseball players of all times. He was (probably falsely) accused of taking part in a plot by gamblers to fix the 1919 World Series between the (favored) Chicago White Sox and the Cincinnati Reds. He was banned from baseball for life.

    The alleged principal among the gamblers was Arnold Rothstein, a major figure in N.Y. organized crime at the time, who appears, thinly disguised, as a minor character in The Great Gatsby.

  43. Gravatar of “A NGDP targeting counterfactual” | Rättvist och balanserat “A NGDP targeting counterfactual” | Rättvist och balanserat
    13. May 2013 at 22:54

    […] Scott Sumner om hur krisen kunde sett ut med nominell BNP mÃ¥lstyrning. […]

  44. Gravatar of Daniel Daniel
    13. May 2013 at 23:19

    To be honest I wish the fed would just fix this macro problem so we can go back to talking about more important stuff. I remember you saying that you focused on neoliberal governments before this mess began. I wondered about basic income after reading this article and how it could relate neoliberalism. Do you think removing a minimum wage and just replacing it with basic income would be better than our current hodge podge? This from Mike Konczal,

    http://www.washingtonpost.com/blogs/wonkblog/wp/2013/05/11/thinking-utopian-how-about-a-universal-basic-income/?wprss=rss_ezra-klein

  45. Gravatar of Ben J Ben J
    14. May 2013 at 02:59

    Geoff,

    I think we’re essentially agreeing that, ceteris paribus, capital per capita falling implies a fall in growth. I don’t think this is controversial (at least not for anyone I’m familiar with!).

  46. Gravatar of Geoff Geoff
    14. May 2013 at 03:59

    Ben J:

    Yes, we do agree with that particular point, but that’s exactly not the argument I am making.

    My argument is that ceteris paribus, a stoppage in capital accumulation results in a stoppage of economic growth. Your point is, I think, subsidiary to this, where if we relax that ceteris paribus, and assume a growing population, then living standards will fall. There would still not be economic growth.

    For imagine if total capital remained constant, but the population decreased over time for a while. While that would result in an increase in capital per capita, economic growth would still be zero.

  47. Gravatar of TravisV TravisV
    14. May 2013 at 06:15

    Marcus Nunes writes that Christina Romer “shows an understanding Bernanke lacks.”

    http://thefaintofheart.wordpress.com/2013/05/14/christy-romer-for-fed-chairwoman

    But how do you know that Bernanke lacks sophisticated understanding?

    It could be that Bernanke sees things exactly the same way market monetarists see things. But the problem is that he has to persuade the FOMC to take tiny baby steps in the market monetarist direction.

    So when he talks to the media and they ask why he isn’t being more aggressive, he has to pretend that the consensus FOMC decision has got it “just right.” Even if he doesn’t believe it.

  48. Gravatar of Chuck E Chuck E
    14. May 2013 at 08:44

    I have served in the public arena on a much smaller scale (School Board President) and while the chairman/president is normally the spokesperson for the Board; he usually can only say what the consensus of his group is. A divided body gives the chairman very little “wiggle” room to talk about the issues. He can preface his remarks by saying “speaking for myself,” but in most official communiques, he is handcuffed by consensus or lack thereof.

  49. Gravatar of John John
    14. May 2013 at 10:07

    Scott,

    Sorry for an unrelated question. Maybe some of the commenters would be good enough to answer in your stead.

    Any thoughts about momentum and dependence regarding the EMH?

    Obviously there shouldn’t be momentum if all the information about a company is priced in accurately and quickly. What I think happens in the real world is that some people act on data more quickly than others so stocks that get hot tend to attract additional investment over time in a way that is not necessarily related to their fundamentals.

    With accurate pricing of info, price movements should be independent. However, periods of volatility tend to cluster together. With accurate information, investors should be able to price in the events of the next few days and smooth out wide swings. Big positive swings and big negative swings the same week or so do point to a big of a herd mentality.

    That said, from my own investment perspective, the EMH has been a very useful tool as it has convinced me to invest in low cost index funds instead of poring tons of effort into foolishly trying to outsmart the market. This has saved a lot of time and effort. Also, it’s useful to watch market reactions to events to get a sense over whether new news is “good” or “bad.” My objection to EMH is trying to use it as a tool to mitigate risk in Modern Portfolio Theory since I think it actually leads to excessive risk taking due to it’s reliance on a bell curve.

  50. Gravatar of TravisV TravisV
    14. May 2013 at 10:46

    I stirred up a hornet’s nest discussing Dr. Sumner on Bob Murphy’s blog!

    http://consultingbyrpm.com/blog/2013/05/who-said-it-5.html#comments

  51. Gravatar of TravisV TravisV
    14. May 2013 at 10:50

    Dear Commenters,

    Yglesias linked to this fascinating article promoting neoliberal anti-rentier policy:

    http://ashokarao.com/2013/05/08/radical-centrism-and-the-return-of-ricardo

    What do y’all think? Here are the major proposals:

    – Nationalize Oil & Gas Companies

    – Carbon Taxes

    – Site Value Taxes

    – Progressive Consumption Taxes

  52. Gravatar of W. Peden W. Peden
    14. May 2013 at 12:22

    TravisV,

    3/4 is not bad for Yglesias.

  53. Gravatar of W. Peden W. Peden
    14. May 2013 at 12:25

    Or maybe just 2/4. I rather skimmed the bit on what a “site value tax” is.

    Property taxes make sense if they’re not easily contestable like LVTs are easily contestable.

  54. Gravatar of JimP JimP
    14. May 2013 at 13:24

    I guess I have not been keeping up.

    This is from the latest Economist. They officially favor NGDP targeting. I did not realize that – and I think it is just great.

    Begin quote – from the article “Horror Story”

    Given this bleak outlook, Mr King has no easy solutions. Free labour movement is one part of the answer, along with fiscal union in the euro zone, so that workers and resources can move where they are needed; countries should also commit to reduce their budget deficits over the medium term, but with the ability to opt out of this commitment when their economies tip into recession; central banks should target the level of economic output (nominal GDP) rather than inflation. This latter approach, one favoured by The Economist, might help to restore confidence, he thinks, “even if the increase resulted more from higher inflation than from a higher volume of activity.”
    end quote

    That is very cool.
    If only Bernanke would do so.

  55. Gravatar of TravisV TravisV
    14. May 2013 at 13:52

    W. Peden, glad you skimmed it!

    JimP, I didn’t realize that about The Economist, great find!!!

  56. Gravatar of JimP JimP
    14. May 2013 at 15:19

    TravisV

    Yes – its nice. The anonymous voice of the Economist just dropped it in there -as if any thinking person would have to agree. Which is true.

  57. Gravatar of TallDave TallDave
    14. May 2013 at 18:32

    That’s nice. I’ve always wanted to agree with The Economist on something.

  58. Gravatar of Colin Docherty Colin Docherty
    14. May 2013 at 18:35

    “PS. Tyler Cowen has a recent post discussing how capital controls might be able to prevent an overheated economy. In my view NGDP targeting is the best way to prevent “overheating.” Real overheating is not much of a problem. As long as nominal national income continues to grow on trend, the labor market will stay close to equilibrium.”

    But aren’t countries in danger of this not developed enough to use NGDP targeting? I can’t imagine Argentina using this to prevent asset pricing problems.

  59. Gravatar of Daniel J Daniel J
    14. May 2013 at 20:03

    Also, there’s a link from Ryan Avent on Christina Romer talking about regime shifts and expectations. She uses comparisons from FDR’s gold buying program to Abe’s reflation program. What I found curious though was a citation to a certain Gauti Eggerston. Have a look, I remember you had a theory on this one.

    “A more controversial element of Roosevelt’s regime shift was the National Industrial
    Recovery Act, passed in June 1933. The NIRA encouraged industries to pass codes of
    conduct that limited price competition and established minimum wages. Gauti
    Eggertsson suggests that the NIRA may have been another factor raising expected
    inflation in 1933 and 1934 (see Gauti B. Eggertsson, 2012, “Was the New Deal
    Contractionary?” American Economic Review 102 (February): 524-555).”

  60. Gravatar of Saturos Saturos
    15. May 2013 at 04:33

    Ah, Daniel, you beat me to it. Greg Mankiw linked to it as well. Here it is: http://emlab.berkeley.edu/~cromer/It%20Takes%20a%20Regime%20Shift%20Written.pdf

    Christina Romer presented this to the NBER. She sounds very market monetarist.

  61. Gravatar of W. Peden W. Peden
    15. May 2013 at 05:18

    Saturos,

    That paper could have had Scott Sumner’s name on it and I’d have believed it.

  62. Gravatar of John John
    15. May 2013 at 05:23

    Geoff,

    I think both you and Bill and missing the most important element of growth which is having rules of the games that allow individuals to plan for the future. Think about what the assumptions are behind a simple Net Present Value calculation. You can’t do this calculation if you cannot be certain that your property will be safe and that there won’t be rapid or unpredictable changes in the value of money. Without institutions protecting property and the value of money, it becomes difficult to plan and prepare for the future regardless of your time preference.

    I think it’s also worth noting that in many ways stable money and private property are the same thing. When the government inflates it is stealing purchasing power and by extension taking your property without permission. This is the virtue of the gold standard. It protects your property from well-intentioned economists and politicians and allows better planning for the future than a fiat money system where you have no idea what the value of your money will be in 20 years. That’s why Mises said that the gold standard was a civil right like the right to free speech.

    You cannot assume institutions of stable money and private property in economics even though you see it all the time. This is a mistake. Every textbook diagram in Micro does it.

    I agree that savings are very important to growth (more so than population or technology) because savings allow for the implementation of new ideas and the increasing productivity of more roundabout methods of productions enables the greater production of goods, especially food, that sustains and provides increasing rather than decreasing living standards for the growing population.

  63. Gravatar of Ashok Rao Ashok Rao
    15. May 2013 at 05:56

    TravisA, thanks for the link!

    W Peden, you said “Property taxes make sense if they’re not easily contestable like LVTs are easily contestable.”

    I don’t want property taxes. They disincentivize good use of land. Here’s Bill Vickrey on the subject,

    “The property tax is, economically speaking, a combination of one of the worst taxes””the part that is assessed on real estate improvements. . . and one of the best taxes””the tax on land or site value.”

    Of course, as you mention, there are problems in distinguishing between land value, and improvements. The tax code can sufficiently allow owners to deduct improvements (more like capital) and deprecation.

  64. Gravatar of W. Peden W. Peden
    15. May 2013 at 07:03

    Ashok Rao,

    I remember someone on here (Jim Glass?) noting that the sheer number of objections that a landowner can make to a LVT (“Is the increase in the value due to this particular improvement? How about this one? How about this one? How about this one?”) makes it an administrative nightmare.

    “I don’t want property taxes. They disincentivize good use of land.”

    That’s not fundamentally different from a progressive consumption tax, which is a tax on improvements of one’s human capital i.e. the more you train yourself, the more you get in wages, and consequently the more tax you pay. So if that’s an objection to property taxes, it’s also an objection to progressive consumption taxes.

    Fake Edit: some words of wisdom from Jim Glass on the LVT-

    “Land value tax is one of those idealistic economic reforms with grievous practical defects in application of the sort that idealists never consider, which make it disastrous in practice.

    People with idealistic “new” tax schemes should always ask themselves this basic question before becoming too enamored of them:

    Politicians tax *everything*, and I mean **everything** they can, often far too far to self-defeating excess. So if this tax is so hugely beneficial, easy to implement, and provides such big benefits that would give the community and its politicians a real competitive edge, then… why isn’t this tax already being used anywhere (or everywhere!) today?

    The answer always is that the purported great “new” tax really is an old tax that was tried and abandoned for good reason.

    The fact that Yglesias while endorsing land value tax is oblivious to both its long real world operational history and its fundamental defects that are obvious to any working tax professional … well, yet one more example of superficial idealism ignoring the lessons of experience and the laws of unintended consequences.

    “Taxing A is bad, thus we should tax B” is highly illogical “” it assumes that B can be effectively taxed.

    It is effectively the same logical error as saying “Here is a market failure (A), thus we need government intervention (B)”. It **assumes** that B will make things better instead of even worse.”

    – and, from Econlog-

    “Land, being fixed in amount, is of course very volatile in price (no supply response to mitigate price movements), and appraisal-based taxes of all sorts are by far the most difficult and costly to administer and vastly the most litigated. (See appraised-property gift tax, estate tax, regular property tax, etc.) They are also the most prone to corruption, for obvious reasons. When the new Pittsburgh land tax system was adopted it was immediately hit with a tsunami of appraisal protests, appeals and litigation, collapsed and was abandoned.

    The first requirement for a “good tax” (or “least bad” one) is that it be easy to administer efficiently and equitably. When a tax like this one comes *nowhere near* meeting even the most minimum practical requirement in that regard, there is little reason to spend a lot of time parsing the theory of it. Except for the academic fun of theory parsing.”

  65. Gravatar of TravisV TravisV
    15. May 2013 at 14:06

    Via Marcus Nunes, here is Krugman’s latest advocacy for fiscal stimulus in the New York Review of Books:

    http://www.nybooks.com/articles/archives/2013/jun/06/how-case-austerity-has-crumbled/?pagination=false

    Pretty disappointing. Indeed, when he criticizes Reinhart and Rogoff, he’s actually arguing with a straw-man, because they’ve always been saying that inflation is a helpful thing that aids economic recovery.

    I wish R&R would be more vocal about the need for inflation, though. And they should be clear that what the globe really needs is for central banks to provide more aggregate demand. Inflation is just a result of more AD and resource utilization.

  66. Gravatar of Suvy Suvy
    15. May 2013 at 15:20

    “Lehman would not have failed”

    Lehman crashed because the fixed income markets came crashing down. That decline had nothing to do with the Fed and everything to do with the level of leverage in the banking system. Lehman, Bear Sterns, etc had leverage ratios at around 40:1 and even 50:1. This is equivalent to trading on 2-3% margin.

    Imagine if you took all the money you had ever saved up and started to trade on 2% margin. A 2% move in the valuation of your assets blows up your portfolio. It’s really that simple. That’s why Lehman went bust, that’s why the entire financial system went completely bust. Then we had to come in to bail these guys out for being morons.

  67. Gravatar of Suvy Suvy
    15. May 2013 at 15:21

    Prof. Sumner,

    Would you ever trade on 2% margin? If so, do you ever think you’d have a chance of being solvent if you did that for 5 years.

    I don’t think you’d do that with your money. I’d certainly never do that with mine because even if I’m slightly wrong, I go completely bust. This is just common sense.

  68. Gravatar of TravisV TravisV
    15. May 2013 at 17:19

    Market Monetarists,

    Karl Smith has a fascinating post entitled “The CBO Is Likely Still Overestimating Future Deficits”

    http://www.forbes.com/sites/modeledbehavior/2013/05/15/the-cbo-is-likely-still-overestimating-future-deficits

    Karl says the following about U.S. gov’t. Interest Expense:

    “a cursory look at the issuance decisions of the Treasury and the buying decisions of the Federal Reserve make it appear as if they are attempting to expand this spread. They are not moving all out to maximize it, as they clearly have the power to “corner markets” to use an old phrase. However, the Treasury is ever so slightly shifting its issuance towards longer term debt which is currently cheap, while the Federal Reserve is buying up high-coupon debt issued in the ’80s and ’90s. Together, this implies that the cost of rolling over U.S. debt is being nudged down and the tail-risk that a huge shift in the bond markets could leave the U.S. government with large bond payments is being eliminated.”

    So many people argue “There is no plausible exit strategy for the Fed! Right now, we have a low-interest rate bubble. When the bubble bursts, annual U.S. gov’t interest obligations will explode and there will be a run on the dollar!!!”

    I’d love to know what the Market Monetarist take on this is. First, Karl seems to be suggesting that the Fed is artificially holding long-term interest rates down. Y’all disagree with that, right?

    Second, more generally, if the economy recovers to “normal” growth and interest rates, how painful will those higher annual interest obligations feel?

    Do y’all have a position on whether a Reinhart/Rogoff-style Expected Debt/GDP “point of no return” level does in fact theoretically exist for the United States? Do y’all envision a future scenario where we hit that point and the political will will finally arrive to combine aggressive gov’t. spending cuts with expansionary monetary policy?

  69. Gravatar of Fed Up Fed Up
    15. May 2013 at 22:49

    “The rising oil prices and weak productivity would reduce real wage growth.”

    What if the real wage growth being too low (including negative) caused the recession?

    “As long as nominal national income continues to grow on trend, the labor market will stay close to equilibrium.”

    If productivity growth is above real GDP, I doubt it. Also, you don’t consider the retirement market.

  70. Gravatar of flow5 flow5
    18. May 2013 at 08:28

    “immediate effect would have been a boom in asset prices”

    Bernanke didn’t need to “validate” real-estate at ever higher price levels, but prices should not have been allowed to just collapse. As those assets which served as loan collateral fell, mark-to-market evaluations resulted in negative equity. Illiquidity then beset the money & capital markets (via higher haircuts & default risks, etc). Risk was thus compounded & contagion quickly became widespread

    Bernanke should never have drained “unweighted” required reserves (the 24 month proxy for inflation) at a contractionary pace (less than zero), for 29 consecutive months. I.e., legal reserves at “e-bound” banks are calculated to be a fraction of the bank’s transaction based accounts 30 days prior (& 93-96% of all demand drafts clear thru these deposit classifications).

    The lags for money flows (our means-of-payment money times its transaction rate-of-turnover) MVt have been mathematical constants for 100 years. So it’s no coincidence that the rate-of-change in MVt peaked with the Case-Shiller’s National Housing Index in the 2nd qtr of 2006 @ 189.93.

    Bernanke (as Fed Chairman) is responsible for controlling both the money stock & its rate of utilization (or AD). However Bernanke imposed subpar nominal-gDp growth & a downward economic spiral.

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