Archive for the Category NGDP targeting


Was the zero bound holding back the Fed during 2009-15?

Most people thought the answers was yes.  I thought it was no.  Here’s a question for the zero bound worriers.  If the zero bound was holding back the Fed during 2009-15, then what’s been holding back the Fed over the past 20 months? Inflation is still below target.

Ignacio Morales set me an interesting graph from JP Morgan, which shows the correlation between global NGDP growth and growth in global profits:
Notice that the correlation seems particularly strong since 2009.

Ben Southwood sent me a ECB study by Luca Gambetti and Alberto Musso, which shows that the ECB’s asset purchase program worked via many different channels. Here’s the abstract:

This paper provides empirical evidence on the macroeconomic impact of the expanded asset purchase programme (APP) announced by the European Central Bank (ECB) in January 2015. The shock associated to the APP is identified with a combination of sign, timing and magnitude restrictions in the context of an estimated time-varying parameter VAR model with stochastic volatility. The evidence suggests that the APP had a significant upward effect on both real GDP and HICP inflation in the euro area during the first two years. The effect on real GDP appears to be stronger in the short term, while that on HICP inflation seems more marked in the medium term. Moreover, several channels of transmission appear to have been activated, including the portfolio rebalancing channel, the exchange rate channel, the inflation re-anchoring channel and the credit channel.

Ben Klutsey pointed me to a Larry Summers piece in the FT:

Historically, the Fed has responded to recession by cutting rates substantially, with the benchmark funds rate falling by 400 basis points or more in the context of downturns over the past two generations. However, it is very unlikely that there will be room for this kind of rate cutting when the next recession comes given market forecasts. So the central bank will have to improvise with a combination of rhetoric and direct market intervention to influence longer-term rates. That will be tricky given that 10-year Treasuries currently yield below 2.20 per cent and this would decline precipitously with a recession and any move to cut Fed funds.

As a result, the economy is probably quite brittle within the current inflation targeting framework. This is under-appreciated. Responsible new leadership at the Fed will have to give serious thought to shifting the monetary policy framework, perhaps by putting more emphasis on nominal gross domestic product growth, focusing on the price level rather than inflation (so periods of low inflation are followed by periods of high inflation) or raising the inflation target. None of these steps would be easy in current circumstances, but once recession has come effectiveness will diminish.


Why Australia hasn’t had a recession in 26 years

In previous posts I pointed out that Australia had avoided recession for 26 years by keeping NGDP growing at a decent clip.  Some commenters suggested that it wasn’t monetary policy; rather Australia was a “lucky country” benefiting from a mining boom.  That theory made no sense, because if your economy depends on highly volatile commodity exports then you should have a more unstable business cycle than countries with large and highly diversified economies.  In any case, recent data completely blows that theory out of the water:

Stephen Kirchner directed me to a very interesting article discussing the views of Warwick McKibbin, who used to be a governor at the Reserve Bank of Australia:

Former Reserve Bank of Australia board member Warwick McKibbin says the world’s central banks should switch to a system of using official interest rates to target nominal income growth to ensure huge household and government debt burdens are unwound safely. . . .

“Inflation has been a good intermediate step because it tied down price expectations and gave people confidence that central banks wouldn’t deflate away their assets,” he will tell a major economics conference in Sydney on Wednesday.

“That’s important when you have high inflation,” as was the case in the 1970s, 1980s and early 1990s.

“But you can still have the same credibility if you do have a very explicit income target, which is really growth plus inflation,” he says.

In Australia, he suggests, that would mean the Reserve Bank would attempt to keep nominal gross domestic product growth – which is essentially a measure of how much the economy is paid for the goods and services it produces – at about 6 per cent.

Australia has a population growth rate of 1.4%, and so there is no question that Australia’s NGDP growth rate should be higher than in the US rate (pop. growth = 0.7%), and much higher than in Japan (falling population).  Nonetheless, I think 6% is a bit high, I’d recommend something closer to 5% for Australia.  On the other hand even 6% would be far better than the sort of policy enacted by the Fed, ECB and BOJ since 2008.

Professor McKibbin, from the Australian National University’s Crawford School, acknowledges that in practice the Reserve Bank already pursues an “ambiguous nominal” income growth target because the formal 2-3 per cent inflation target is only applied “over the cycle”

This supports the claim of various market monetarists, who have suggested that Australia was a covert NGDP level targeter during the Great recession.

I’ve argued that the greatest advantage of NGDP targeting for countries like Japan is that it can reduce the burden of the public debt.  McKibbin makes a similar argument:

“What will matter over coming decades will be nominal income growth because the sustainability of high public and private debt-to-income ratios will need higher nominal income growth than in the past.

Interestingly, even a 6% target would seem to call for monetary tightening right now:

According to his proposed income targeting scheme today’s Reserve Bank cash rate of 1.5 per cent is probably too low given nominal GDP rose in the first quarter by 2.3 per cent from the previous three months, and by 7.7 per cent from a year earlier. “Right now the central bank has probably got loose monetary policy by nominal income standards and you’d expect they’d be tightening policy according to this rule because nominal income growth is rising quite quickly.”

Wait, that can’t be right.  My critics say Australia was just a lucky country benefiting from a mining boom.  It can’t possibly be doing well now that mining investment is collapsing.  Or am I missing something?

The Economist describes how smart countries handle re-allocation out of declining sectors:

As the mining boom petered out, the Reserve Bank cut its benchmark “cash” rate from 4.75% in 2011 to 1.5%. The Australian dollar fell steeply (it is now worth $0.76, compared with a peak of $1.10 six years ago). The cheaper currency and lower interest rates have allowed the older and more populous states of New South Wales and Victoria to keep the economy bustling. Property developers are building more houses, farmers are exporting more food, and foreigners (both students and tourists) are paying more visits: Australia welcomed 1.2m Chinese last year, a record.

Re-allocation doesn’t cause recessions, tight money does.

In the past, I’ve argued that Australia might want to target total compensation of employees, rather than NGDP.  That’s because changes in the price of mineral exports can cause big swings in NGDP, without having much impact on the labor market.  Over the past 12 months, employee compensation in Australia rose by only 1.4%, far below the 7.7% rise in NGDP.  You don’t see those sorts of discrepancies in the US.  So maybe Australia doesn’t need tighter money.

PS.  David Beckworth has a new policy paper on NGDP and the knowledge problem facing policymakers.  As usual, David includes some nice graphics.


David Beckworth interviews Paul Krugman

Love him or hate him, there’s no denying that Krugman is a brilliant economist. David Beckworth’s interview with Krugman is probably my favorite so far in the series, even though on the policy issues I tend to agree more with earlier interviewees such as Bullard.  (Interestingly, these two agreed on a number of issues, despite being far apart on the political spectrum.)

There’s no transcript, so I’ll rely on memory, and then leave a few observations after each point:

1.  When discussing his famous 1998 paper, Krugman said the hard part was determining the implication of an “expectations trap” for policymakers.

This is a very good point, and most people underestimate this problem.  Krugman himself has changed his views as to the paper’s implication, in the years since it was published.

2.  He indicated that when trying to exit a liquidity trap, you don’t need to just convince the central bankers, you also need to convince the public.

I have a “build it and they will come” attitude here.  If the central bank adopts an effective policy response, I think the public will believe it.  The real problem has been the failure of central banks to be willing to adopt “do whatever it takes” policies.

3.  He suggested that price level targeting might not be enough—you might need a higher inflation target if the equilibrium real interest rate fell to very low levels, and stayed there.

Here my view is different.  A liquidity trap should not be viewed as zero nominal interest rates, but rather the zero bound on eligible assets that the central bank has not yet purchased.  Imagine a policy of targeting the price level with CPI futures. That policy will work regardless of how low the equilibrium interest rate falls, as low as the central bank has the ability to adjust its balance sheet to base money demand.  Ditto for exchange rate targeting (i.e. Singapore). Liquidity traps are not times when fiscal policy is needed, they are times when bigger central bank balance sheets are needed.

Krugman cites Japan’s falling population.  On the one hand that might reduce Japan’s equilibrium real interest rate.  But it also reduces aggregate supply, which is inflationary.

4.  Krugman noted that elite policymakers don’t think that an inflation target of higher than 2% is responsible.

My immediate reaction was “Hmmm, where did they get that idea.”  To his credit, Krugman later joked “I may have set back policy by decades with that credibly promise to be irresponsible remark.”

5.  The first QE in the US and Europe helped to restore confidence to economies that had been destabilized by private sector financial turmoil.

My reaction is that that financial turmoil was at least partly caused by bad monetary policy, which was causing NGDP growth expectations to plummet.

6.  Krugman points out that Congress would have objected to a higher inflation target.

I think that’s right, but other options like PL targeting and NGDP targeting we at least possibilities.  More importantly, the Fed could have kept the inflation target at 2% and done far more in the realm of “concrete steppes”.

7.  Krugman’s ideal policy back in 2009 would have been enough fiscal stimulus to get inflation up to 4%, followed by standard monetary policy to stabilize the economy after that (presumably something like policy during the Great Moderation, except with a high enough inflation target to prevent hitting the zero bound.)

That might work, but if you raised the inflation target to 4%, then I doubt you’d even need fiscal stimulus.

8.  On whether 2% was a target or a ceiling, Krugman actually seemed less cynical than David (which might surprise people given their personalities).

I tend to agree with Krugman on this point, but I also believe that David has the better argument, and this is one place where Krugman struggled a bit to refute it. He talked about central bankers wanting to go back to the old days of Volcker, when they fought a heroic battle against inflation, and he also talked about the Fed as an institution having a bias toward fighting inflation.  Of course you could view those observations as supporting David’s claim about 2% being a ceiling, and I sensed that Krugman saw that as well.

9.  Krugman suggested that he had mixed feelings about NGDP targeting, worrying that it might allow too much inflation volatility.

Here again, he struggled a bit in his reply.  At one point he tried to suggest a scary counterfactual of 1% RGDP growth and 4% inflation, and then immediately seemed to realize that a few minutes earlier he had advocated 4% inflation.  In my view Krugman missed the point here.  A period of 1% RGDP trend growth is precisely when you are likely to see the sort of low equilibrium real interest rate that Krugman himself thinks calls for 4% inflation target.  Admittedly I am relying a bit on a sort of “divine coincidence” of RGDP trend growth and equilibrium real interest rates moving together, but I also think there are strong labor market reasons to prefer NGDP targeting. Krugman said something about menu costs of inflation, but surely he cares more about unemployment than menu costs, and labor market stability is almost certainly more closely correlated with NGDP than inflation. Indeed an awareness of that fact (in my view) largely explains why central banks have “flexible” inflation targets.

Like most other mainstream economists, Krugman doesn’t seem aware of all the arguments for NGDP targeting made by market monetarists, and even earlier by George Selgin.  We still have work to do.

Overall a great interview.  Krugman said, “I don’t really know” more often than one might expect from reading his NYT columns, which is to his credit.

I used to think his bashing of the GOP was exaggerated, but now it seems on target.  I say he’s finally got it right, whereas Krugman would presumably say that Trump proves that he was right all along.


Three podcasts

I recently listened to three podcasts, involving James Bullard, Miles Kimball and Tyler Cowen.  In all three cases, I found myself agreeing with most of the ideas. Here I’ll mention a few areas of slight disagreement.

1.  David Beckworth interviewed James Bullard on monetary policy.  Most of what he said made a lot of sense, including his comment that the Fed might be more sympathetic to the NGDP targeting idea if it were starting from scratch, rather than already having invested a lot of credibility capital into inflation targeting (my words, not his.)  My only major area of disagreement was when Bullard worried that the NGDP target would have to be adjusted when the trend rate of RGDP growth changed.  In my view that’s not necessary, except perhaps for the part of RGDP growth changes that reflect changes in labor force growth.

2. Miles Kimball talks about the need for faster RGDP growth, and discusses some ideas for getting there.  He points out that we can’t get significantly faster growth from sectors that have shrunk to a small share of GDP, such as agricultural, and to some extent even manufacturing.  He suggests the big problem area is housing, which absorbs a big (and increasing) share of the consumer budget, but which is seeing virtually no productivity growth.  He focuses most of the talk on making the service sector more efficient.

It’s interesting listening to the Kimball and Cowen podcasts back to back.  In both cases you see Mormon cultural ideas lurking in the background (indeed both speakers alluded to this religion.)  Both are very idealistic, like top 2%.  Kimball suggests imposing a tax surcharge that can be avoided entirely if you donate the equivalent amount to an approved charity.  He argues that donating money makes people less cynical and more altruistic, as compared to being forced to pay taxes to a government bureaucracy that doesn’t seem interested in where you or I think the money should go.  Perhaps people would not work as hard to evade this sort of “tax.”

3.  Cowen notes that people who donate to charity tend to be happier.  He also believes that economic growth is the best way to boost living standards, even for the poor.  (Both Kimball and Cowen emphasize that “growth” should include factors like the environment.)  I’m agnostic on the happiness studies—I wonder if perhaps we’ve got causation wrong; maybe happiness causes altruism and high incomes, not vice versa.  But given that we don’t know, we should probably err on the side of assuming that at least some correlation runs from charity and growth to happiness. (Tyler has a very interesting discussion of what we should do when we don’t know for sure which theory is true.)

Cardiff Garcia did a great job in his interview of Tyler.  Much of it focused on Tyler’s new (unpublished) book, which discusses the philosophical ideas that underlie his other writings. They ended with a discussion of the NBA.  In my view, this is a golden age of basketball.  Never have there been so many great players (AD, Paul George, Chris Paul, Jimmy Butler, Isaiah Thomas, Giannis, John Wall, etc.) who are not even in the top 6 NBA players.  Some of these guys would have been borderline MVPs in previous generations.  But I do have one complaint. The NBA really needs to change one of its rules, as defense gradually evolves to make any sport less entertaining.  Here goes:

New rule:  Officials should ignore minor intentional fouls on fast breaks, where a call would clearly favor the defense.  If the intentional foul is so extreme as to physical stop the fast-breaking offensive player (such as tackling or wrapping up) the official should award (one or two) free throws plus the ball.

In other words:  Discretion, not rules!

I miss the old “showtime era” of the 1980s, when fast breaks were more common. There is something wrong with a rule where:

1.  Calling the foul helps the team that commits the foul.

2.  Calling the foul makes the game more boring.

In economic terms, calling a foul has a “cost”, as they make the game more boring. Fouls can only be justified if they have an even greater benefit to fans.  Often they do—preventing excess physicality—but not minor intentional fouls on fast breaks.

PS.  Westbrook should be the MVP.  He won 47 games with the rest of his team being worthless.  He outplayed Harden when both were on the floor in the playoffs, despite Harden’s supporting cast being far, far better.  He only lost because the Thunder were complete garbage in the 5 minutes he wasn’t on the floor each game. Obviously LeBron is the best player in the NBA, but he’s not the MVP this year.  His team is talented, and should have won more games.


Is the public opposed to NGDP targeting?

I just listened to a very interesting Macro Musings podcast—with David Beckworth interviewing Tyler Cowen.  Tyler sees the Fed passivity during the last decade as part of a broader increase in risk aversion across American society, part of what he calls the rise in complacency.  I like that hypothesis, and look forward to reading his new book on my vacation next week.

I’m less convinced by his argument that this also explains the public’s obsession with low inflation, and refusal to contemplate NGDP targeting.  I would argue that the public is not opposed to NGDP targeting, indeed they’ve never even heard of the idea.  So let’s try to disentangle what Tyler had in mind in his comments on this subject:

1.  The public might prefer the specific policy of inflation targeting to the specific policy of NGDP targeting.

2.  The public might prefer the outcome (in terms of economic performance) of inflation targeting over the outcome produced by NGDP targeting.

The first interpretation is a complete nonstarter.  If you asked the average American to discuss strict inflation targeting, flexible inflation targeting, symmetric inflation targeting, asymmetric targeting, growth rate targeting, level targeting, etc., you’d produce a glazed look on their faces.  And even that understates the problem.  Most people only understand the concept of supply side inflation; they have absolutely no understanding of demand side inflation.  Hence they think inflation is bad because it lowers their real income, but that’s only true of supply side inflation.  Even worse, the Fed only controls demand side inflation, so Fed policy has no impact on the only kind of inflation the public understands.  I used to ask my class whether the cost of living had actually increased if both wages and prices rose by exactly 10%.  And over 95% always got it wrong, claiming that the cost of living had not actually increased.  (Actually, it rose by 10%.)

And even that understates the problem, because very few Americans even understand that the Fed can choose between 2% and 4% trend inflation like someone choosing between massaman curry and pad thai for their entree.  They don’t know that that is what the Fed does.  How many Americans know that the Fed’s tight money caused the Great Recession?

So I’m going to assume that what Tyler meant was that Americans would be happier with the outcome of inflation targeting as compared to the outcome of NGDP targeting.  I doubt that.  People might say they prefer 0% inflation to 2% inflation, but I doubt that they’d say they prefer America’s 2009 economy to its 2007 economy.  But the 2009 economy is what you get when you reduce inflation to 0%.  Actually, we were much closer to NGDP targeting in the period before 2007 than in the years immediately after 2007.  And yet Americans seemed much more unhappy with the post-2007 economy.  Now of course it’s entirely possible that if the Fed had kept NGDP growing at 5% after 2007, the public would have been even angrier than they were with the actual policy (a fall of 3% in NGDP between mid 2008 and mid-2009.)  But I doubt it.  I think they would have been a bit disgruntled by the stagflation, but nothing more.

Both David and Tyler believe that the Fed now views 2% inflation as a ceiling, not a symmetrical target.  I’m still not convinced; let’s look at this again in 10 years.  If it’s still a ceiling, I’ll throw in the towel.  It was clearly a symmetrical target before 2007—why would the Fed have suddenly changed?

PS.  David and Tyler also discussed the declining rate of innovation in the arts.  Here’s a quote from a different Tyler Cowen interview:

If you think about Renaissance Florence, at its peak, its population, arguably, was between 60,000 and 80,000 people. And there were surrounding areas; you could debate the number. But they had some really quite remarkable achievements that have stood the test of time and lasted, and today have very high market value. Now, in very naive theories of economics, that shouldn’t be possible. People in Renaissance Florence, they didn’t produce a refrigerator that we’re still using or a tech company that we still consult.

But there’s something different about, say, the visual arts, where that was possible, and it was done with small numbers. So there’s something about the inputs to some kinds of production we don’t understand. I would suggest if we’re trying to figure out, like what makes Silicon Valley work, actually, by studying how they did what they did in the Florentine Renaissance is highly important. You learn what are the missing inputs that make for other kinds of miracles.

That’s an interesting point–future generations will be more interested in our art than our technology.

Here’s another question to consider. In the arts, there are periods of rapid innovation (the Renaissance), followed by periods of stasis. In David’s interview, Tyler cites the rapid innovation in pop music during the 1960s, relative to the slower innovation today. Is that different from the observation that explorers no longer discover as many new lands as they did in the heyday of Portuguese and Spanish exploration?  Are we less talented at exploration, or are there simply fewer as yet undiscovered lands? Perhaps the analogy is silly, but let’s take it a step further.  The discovery of new planets, and the technology that allows us to get there, would presumably lead to another Golden Age of discovery.  Doesn’t the invention of new art forms (the novel, film, electronic music, etc.) open up vast new fields for artistic discovery? Isn’t Robert Gordon’s argument that innovation in existing fields has diminishing returns, and that we need to develop entirely new fields to supercharge innovation?  Thus we understand the physics of the non-microscopic world so well that it’s getting really hard to radically improve our houses, cars, airplanes, ships and washing machines.  The only area of rapid innovation is at the microscopic level (biotech, computer chips, etc.), which opened up only in the past 50 years or so.  Gordon doesn’t expect more such fields to open up, and thus predicts diminishing rates of innovation in the fields that we already have.  (I’m agnostic on that claim.)