Bentley rulz

The Fed Challenge is a monetary policy debate held each year for teams of undergraduate college students.  Our team usually does pretty well, but yesterday’s performance was especially noteworthy.  They competed in the Northeast semifinals against some obscure colleges such as:

Harvard, Brown, Dartmouth, MIT, Yale, Tufts, Framingham, Salem, Middlebury, Bryant, BC, BU, Bridgewater, Clark, Northeastern, WNEC, Quinnipiac, UNH

And won.  Which means it’s on to the national contest in DC.

Congratulations to our team:

Christina J. Harstad

Satyajeet Jadhavrao

Pranay Kumar Jain

Peter Jurik

David Norrish

Maximillian Barco

Shohana Jannat

Victoria Lee Tran

 Advisors:

David Gulley

Aaron L. Jackson

My colleagues David Gulley and Aaron Jackson have done all the work setting up our team and advising them, but I did get to meet them a couple times and saw their practice session.  One of the team members (David Norrish) offered a fairly persuasive argument against NGDP targeting.  He said something to the effect; “Is it really wise to have the largest economy in the world experiment with a policy that has never once been tried anywhere else?”

Because I am a pragmatist, I found this critique pretty impressive.  After all, inflation targeting was first pioneered in small economies like New Zealand.   And it got me thinking about NGDP targeting in small countries.  Suppose there was a huge rise in the world price of copper, and as a result the Chilean copper industry went from 10% of NGDP to 15% almost overnight.  Under strict NGDP targeting, this would require the non-copper parts of the Chilean economy to shrink by 5% of GDP.  I suppose you could argue that workers should be reallocated to the copper mining industry.  But that industry may be capital intensive, and/or the supply may be rather inelastic in the short run.  Some ideas:

1.  This thought experiment suggests NGDP targeting might work better in very large and diversified economies where no single industry is dominant.

2.  This example suggests Bill Woolsey might be right about nominal domestic final sales being superior to NGDP, after all, most Chilean copper is exported.

3.  Recall that I once argued nominal wage targeting was theoretically superior, but NGDP was a pragmatic compromise.  This example shows where NGDP is no longer a good proxy for nominal wages.

4.  It might be better to set the NGDP target a bit further out in the future—say a policy of targeting 2-year forward NGDP (as some of my commenters suggested.)

The bottom line is that I don’t expect NGDP targeting to be adopted by a small country.  Nominal domestic final sales is still a possibility, however.

PS.  It’s especially gratifying beating the school portrayed in The Social Network.  Let’s see if Greg Mankiw does a post on this.  :)

Update:  In the comment section Bill Woolsey mentioned that he favored targeting nominal final sales, and my example was actually referring to nominal final purchases.  Also in the comment section George Selgin observed that this post raises the question of optimal currency zones.  Or perhaps I should say optimal monetary policy zones.  I think he is right, but I also think the dollar zone is smaller than generally perceived.  For instance, many would include China, despite the fact that the yuan is up about 3% in recent months, and over 20% since 2005.  It’s clear China has raised the yuan precisely because they wanted to avoid the high inflation that would result from a dollar peg.  The three or four countries that actually use the dollar would definitely qualify, but they are quite small.  Those with rigidly fixed rates are also part of the dollar zone, although I believe most of them are also fairly small.  Are there any large countries that have rigidly pegged their currencies to the dollar for a long period?


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19 Responses to “Bentley rulz”

  1. Gravatar of George Selgin George Selgin
    16. November 2010 at 07:40

    While pondering thre merits of NGDP targeting for small countries, here’s a related question: what’s the appropriate economic “area” for which such a target ought to apply?

    The question arises in cases like that of the U.S. dollar, which serves as the chief currency beyond the confines of a single nation-state. No one argues for targeting Alaska’s NGDP, or Hawaii’s, or that of any single U.S. state or subset of states. It’s understood that monetary policy isn’t supposed to try and influence relative income growth shares among these;that a sound policy must allow relatively slow NGDP growth in some regions, offset by relatively fast growth in others.

    But the dollar zone is much broader than the U.S., and especially so if one includes all countries whose distinct currencies are fixed or pegged to the dollar. So ought the Fed ideally to be tracking and targeting the overll NGDP growth rate over a wider dollar zone? Wouldn’t targeting U.S. NGDP pose the danger of introducing unwanted fluctuations in overall dollar zone NDGP growth?

    Of course political economy considerations make make the idea of full dollar-zone NGDP targeting a non-starter; and that exchange controls and such mean that even a dollar-zone NGDP growth rule won’t really be ideal. But I wonder whether the general question here is one you’ve addressed somewhere. (And sorry if you’ve addressed it umpteen times and I missed all of them!) The question raised seems especially pertinent in light of debates concerning the international implications of QEII: perhaps looking at dollar-zone NGDP growth would suggest a different answer to the question whether monetary policy without QEII would be too tight.

    Trade theorists (good ones, anyway) learn thate taking national boundaries too seriously leads to some huge fallacies of misplaced concreteness in their field, and I wonder whether the same risks confronts monetary economists in certain contexts.

  2. Gravatar of JTapp JTapp
    16. November 2010 at 08:28

    To George Selgin re: dollar zone, I recall a Treasury Secretary once saying “It’s our currency, it’s your problem.”

    But ramifications of U.S. pursuing NGDP target does bother me b/c of its effects on developing countries. Pegged countries import our monetary policy. Scott has previously said they should abandon pegs and pursue NGDP growth, but now it seems he’s thinking that may not be a good idea.

    Scott, I follow your logic about disregarding interest rates but I teach capital flows heavily using the UIP condition. A Fed ignoring interest rates to focus on NGDP doesn’t make the interest rates go away. I’m not sure the proper way to think about this internationally, any insights?

  3. Gravatar of Bill Woolsey Bill Woolsey
    16. November 2010 at 08:30

    Final sales of domestic product would have exactly the problem you describe. The only difference between GDP (NGD) and final sales is inventories.

    What you meant was domestic purchases would be better than
    NGDP or Final Sales in this situation. I oppose using domestic purchases, but maybe it would be less bad in this situation.

  4. Gravatar of Bill Woolsey Bill Woolsey
    16. November 2010 at 08:34

    George:

    I think the relevant area for the money expenditure rule needs open borders for labor and investment, as well as goods and services. If someone with immigration restrictions or local-only investment rules wants to tie their currency–fine. But they get to adjust their nominal income based on the real exchange rate. Resources need to be able to follow the money expenditures.

  5. Gravatar of Philo Philo
    16. November 2010 at 09:18

    “4. It might be better to set the NGDP target a bit further out in the future””say a policy of targeting 2-year forward NGDP (as some of my commenters suggested).” Let’s express your recommended policy as “targeting n-month forward NGDP”; how, in theory (i.e., putting aside trial and error), would the proper value of ‘n’ be determined?

  6. Gravatar of OneEyedMan OneEyedMan
    16. November 2010 at 09:55

    “Suppose there was a huge rise in the world price of copper, and as a result the Chilean copper industry went from 10% of NGDP to 15% almost overnight.”

    Shouldn’t a rise in the world copper price strengthen the Chilean peso? That should reduce the price of imports. In a small, open economy like Chile, I’m not sure how much shrinking would be necessary. If the currency rallies enough you could get all the deflation you need from that.

    In your example copper grows 50% but the rest of the economy shrinks 5%. That happens all the time in open export driven countries. People often complain about how commodity exports kill other exports in all sorts of countries. Is this worse?

  7. Gravatar of George Selgin George Selgin
    16. November 2010 at 10:47

    Bill Woolsey is right about open borders–in my defense I meant something like that in referring to “exchange controls and such.” But as for “its our currency, its your problem,” well, that will do for a U.S. government official; but as for me, even setting aside my post-enlightenment refusal to rate the well-being of Amerkens above that of ferners, I worry that targeting the wrong measure of overall NGDP (or DFD) growth means that policy still ends up fostering unhealthy bubbles or deflationary crises. It really boils down to worrying about sampling error.

    Here’s a thought experiment: the Southern states decide to secede again, only this time the North lets them go. Thenceforth there are two sets of NGDP growth states whereas before there was only one; and whereas the rate for the U.S. had been 5% (a Sumner rule having been in effect), now its 2% North and 7% South. Nothing else changes, except that North and South now each have their own central banks. Should each CB now aim for 5%?

  8. Gravatar of Doc Merlin Doc Merlin
    16. November 2010 at 11:27

    @ George Selgin:

    Again, the problem of optimum currency areas comes up. I really think the only way to handle it is to de-nationalize currencies.

  9. Gravatar of Benjamin Cole Benjamin Cole
    16. November 2010 at 11:29

    Congrats to the Bentley team!
    Like most saps, I always root for underdogs.
    Bentley? Who knew?

  10. Gravatar of Morgan Warstler Morgan Warstler
    16. November 2010 at 11:31

    It would be helpful, if you spent some time talking about pissing on booms in general…. how when NGDP hits 5.1% you want to see people fired, even if unemployment is 8%.

    I’d find this very helpful, as it would force your “supporters” to see when you turn around and punch hippies.

  11. Gravatar of George Selgin George Selgin
    16. November 2010 at 11:31

    Doc M.: “Again, the problem of optimum currency areas comes up. I really think the only way to handle it is to de-nationalize currencies.”

    No argument!

  12. Gravatar of Scott Sumner Scott Sumner
    16. November 2010 at 14:21

    George, I added an update at the end to reflect your comment. My sense is that monetary policy is too tight whether we define the dollar zone as just the US, or include those countries with fixed rates to the dollar. As I mentioned above, the yuan is not fixed to the dollar, contrary to widespread impressions. Most currencies fixed to the dollar are small countries.

    JTapp, I think countries that peg to the dollar understand that they must weigh the costs and benefits, and that we’ll focus on our own needs. (Although I agree with George that we should take an international approach.) I have no objection to including the other dollar pegs, as I don’t think it would change things very much–they are mostly small. I don’t see what we gain by looking at interest rates. I think most countries are better off floating, but small ones may benefit from adopting the dollar.

    Bill, Thanks, I added an update.

    Philo, As with everything in economics, there is a tradeoff. Going farther out allows you to adjust more gradually to shocks that throw you off, at the cost of allowing longer periods of above or below target NGDP.

    OneEyedman, Yes, it does happen, but is it optimal? And I believe in most such cases the central bank allows total NGDP to rise somewhat.

    george#2, Well this is no longer a hypothetical, as the eurozone is facing exactly this problem. I think we are learning that the optimal eurozone may be a bit smaller than first envisioned. I should add, however, that it’s not clear how much of the problem is the lack of one size fits all monetary policy, and how much is because the ECB policy is just plain too tight (as in the US.) Or at least was too tight in 2008-09, if you don’t agree about today.

    Benjamin, Thanks.

    Morgan, I don’t favor punching hippies–I think the US needs more hippies (at least during referenda on legalizing pot.) And I have no problem with 6% NGDP growth for a year or two, as we’ve recently run well below target (since 2007.) Eventually I’ll become a hawk, if I live long enough.

  13. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    16. November 2010 at 14:27

    You got by Harvard, but there’s still a powerhouse awaiting you in DC:

    http://www.dailynorthwestern.com/fed-challenge-team-wins-region-qualifies-for-nationals-1.2393639

  14. Gravatar of Wm Tanksley Wm Tanksley
    16. November 2010 at 16:33

    1. Some people have suggested targeting tax revenues rather than NGDP, which has the advantage that the futures contracts would be selling something that the government actually will have ownership over. How does that interact with this?

    2. California already has its own tax currency, called “IOUs”. Since it’s already started, why not have California set up targeting for its state IOUs, including currency markets and futures markets (bought on auction, paid as a fixed percentage of tax revenues), and then see if your ideas work…

    -Wm

  15. Gravatar of Doc Merlin Doc Merlin
    16. November 2010 at 17:00

    @Wm Tanksley

    “2. California already has its own tax currency, called “IOUs”. Since it’s already started, why not have California set up targeting for its state IOUs, including currency markets and futures markets (bought on auction, paid as a fixed percentage of tax revenues), and then see if your ideas work…”

    Because the constitution expressly forbids that. If a state wants to make a currency (for example if they began accepting IOU’s for tax payments and made them legal tender) they would have to make them gold or silver.

  16. Gravatar of Wm Tanksley Wm Tanksley
    16. November 2010 at 21:12

    Doc, you’re right. More specifically, the constitution forbids states from issuing “bills of credit”, which have been ruled to include things that look exactly like CA’s IOUs.

  17. Gravatar of ssumner ssumner
    17. November 2010 at 18:46

    Patrick, Thanks for the info–I shared it with our group. They used the same theatrical technique.

    Wm Tanksley, I think NGDP is better than revenue, but I imagine both would work OK. I can’t really find any strong objection to revenue–it just seems less closely linked to the goals of macro stabilization.

  18. Gravatar of TheMoneyIllusion » Bentley triumphant TheMoneyIllusion » Bentley triumphant
    1. December 2010 at 19:36

    […] few weeks back I reported that our debate team had triumphed in the regional Fed Challenge, topping lesser known schools […]

  19. Gravatar of TheMoneyIllusion » Worthwhile Canadian Initiative TheMoneyIllusion » Worthwhile Canadian Initiative
    6. December 2010 at 08:24

    […] A few weeks back a Bentley student named David Norrish pointed to a flaw in my NGDP targeting idea.  Why [he asked] should we expect the largest economy in the world to experiment with a risky monetary regime that had never been tried out anywhere else?  I seem to recall that ideas like inflation targeting were pioneered by smaller economies such as New Zealand.  So I’m glad to see that the Canadians are considering serving as guinea pigs for price level targeting, before the policy is deployed in the much more important American economy. […]

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