Clive Crook on NGDP targeting
I often criticize press coverage of macro. Very few reporters seem to understand that fiscal and monetary stimulus move the AD curve, and the breakdown between prices and output is determined by the slope of the SRAS curve. Clive Crook is an exception:
A simpler mandate would cut through some of these problems. I’m keen on an old idea that has recently attracted new support. Tell the Fed to target not inflation and full employment but growth in the money value of gross domestic product. A target for growth in nominal GDP is no panacea. It wouldn’t make central banking easy, and you could implement it in different ways — a further source of contention. But the basic approach has big advantages.
In effect, it merges the two halves of the existing mandate, allowing the Fed to be agnostic, as it should be, about the underlying components. Suppose the target was medium-term growth in nominal GDP of 5 percent a year. That might be inflation of 2 percent and growth in output of 3 percent, or stable prices with 5 percent growth, or zero growth with 5 percent inflation. Obviously those outcomes aren’t equally desirable — but the point is that the Fed can’t steer the components, only the aggregate.
A Nominal Solution
Monetary stimulus adds to demand. How that demand breaks down between inflation and output is beyond the Fed’s control. The Fed shouldn’t be held accountable for outcomes it cannot direct. And the presentational advantage really matters. At the moment, nominal GDP is less than 4 percent. The Fed would say: According to the mandate, it needs to be increased; in QE, we have the means to increase it. End of discussion.
The argument between inflation hawks and doves isn’t settled, but it’s suspended, which is fine. If the recession has permanently undermined the economy’s capacity to grow, a 5 percent nominal GDP target might yield over time growth of, say, 2 percent a year with inflation of 3 percent, rather than vice versa, as we’d like. Once that becomes clear, we can talk about reducing the nominal GDP target to 4 percent. Meanwhile the 5 percent target keeps inflation within clear bounds without choking off the possibility of faster growth.
With a simpler goal — one it could actually achieve — the Fed would have less to argue about and less to explain. It would be more accountable. And transparency would provide clarity, which is stabilizing, rather than the current muddle, which isn’t.
Great stuff. BTW, Crook is no Johnny-come-lately to NGDP targeting, he’s long favored the idea.
HT: D. Gibson and an anonymous reader.
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12. April 2012 at 05:41
Yeah, but.
Basically, that was what I thought when I first came across your blog – NGDP targeting is implicit in the fact that we have a ‘trend’ growth estimated 3% and ‘hoped for’ inflation of 2%.
We could make it explicit.
So what? Is it going to solve the big issues of the day? Is it even saying anything that would calm down the gold bugs and the partisans of the “every episode of hyperinflation is preceded by an episode of deflation that the Central Bank/the authorities wanted to combat”?
Basically, much as I can agree with explicit NGDP targeting, the thing I want to know is – how does it matter?
12. April 2012 at 06:07
Scott,
Mr Crook describes the NDGP targeting case very well (but where is the at least equally important LEVEL targeting?). But his commenters are a bit weird. How come yours are so well behaved?
12. April 2012 at 06:12
Clive Crook also writes:
“If the recession has permanently undermined the economy’s capacity to grow, a 5 percent nominal GDP target might yield over time growth of, say, 2 percent a year with inflation of 3 percent, rather than vice versa, as we’d like. Once that becomes clear, we can talk about reducing the nominal GDP target to 4 percent.”
I’ve not yet understood why it is important whether the central bank chooses 3, 4 or 5% as its target for nominal trend growth. Does it matter as long as the CB actually sticks to whatever target it chooses? The important thing is to keep expectations stable right? And if the CB succeeds in this by implementing NGDP targeting then it will not matter for real prices whether inflation is 2 or 3%?
12. April 2012 at 06:37
Frederic, Read my blog to find out.
Rien, Mass media always has awful comments.
12. April 2012 at 06:44
Mads, I completely agree. Just pick a target and stick with it. Inflation doesn’t matter, what matters in NGDP growth.
12. April 2012 at 08:42
Clive Cook’s column was excellent. I encourage MM’ers to leave a comment on it, and send a note to his editor (on bottom of column).
12. April 2012 at 08:49
“the point is that the Fed can’t steer the components, only the aggregate”
“the breakdown between prices and output is determined by the slope of the SRAS curve”
Go fish.
12. April 2012 at 09:22
ssumner:
Just pick a target and stick with it. Inflation doesn’t matter, what matters in NGDP growth.
Why does NGDP growth matter? Does NGDP growth matter because NGDP growth matters? Or does NGDP growth matter because you believe it will minimize unemployment and/or maximize productivity, or achieve some other “higher, nobler” end? If the latter, how you do explain your publicly professed lack of caring about employment and output, as long as the NGDP target is met?
You don’t see a contradiction there? I do. I see NGDP targeting being presented as both a means to an end, and an end in itself. When it is presented as a means to an end, the argument is “NGDP targeting is the optimal monetary policy to maximize employment and output.” When it is an end in itself, the argument is “The Fed should not be in the business of managing the economy; they should ignore employment and output and just target 5% NGDP and never waver from it.”
If inflation doesn’t matter, then why not a -5% NGDP target? The answer is….5% NGDP is a better means to achieve a desired end.
If employment and output doesn’t matter, then why not a -5% NGDP target? Then the answer is…5% NGDP is an end in itself and the Fed should ignore everything else no matter what happens.
Inevitable response to this post: “Major_Freedom, I’ve gone over this, you’re wrong, blah blah blah” in 3, 2, 1…
12. April 2012 at 09:58
Sumner endorses Woolsey’s 3% NGDLT. Morgan seconds the notion.
Agreed.
12. April 2012 at 10:05
Sumner endorses Woolsey’s 3% NGDLT. Morgan seconds the notion.
Agreed.
This reminds me of FDR using his brilliant powers of discerning reality to come up with a “lucky” number for the dollar price of gold.
Maybe we should look at the stars, or watch how the tea leaves fall, or where the rat bones land, and then democratically, purely, honorably, divinely, and devoutly decide on a totally arbitrary number, as long as there is a number, because the number is sacred.
12. April 2012 at 10:06
MF, If you read my blog you’ll find out why NGDP matters. If you don’t agree with the reasons I give, then tell me why. Wouldn’t that be more productive than pretending to be ignorant in every one of your comments?
12. April 2012 at 10:45
Sumner seconds my second.
12. April 2012 at 14:37
In effect, it merges the two halves of the existing mandate, allowing the Fed to be agnostic, as it should be, about the underlying components.
It’s pretty hard to believe that the Fed would be agnostic about the two components. Both the Fed’s own data sets and the public discourse would be awash in statistics about consumer prices and real GDP growth. While there might be some disagreements, everybody would have a pretty clear idea about what proportion of NGDP growth was due to inflation and what percentage was due to RGDP growth.
If we had 5% steady NGDP growth, right on target, but the inflation-based component was steadily around 4% and the RGDP component was steadily 1%, everyone would scream at the Fed to do something different. And if economists then told us that there was no way to boost the real growth component without causing even higher inflation and busting through the target, someone like Matt Yglesias would be the first in line to say, “You know, this NGDP target sucks now. We need a different target.”
And nobody would buy the suggestion that we tolerate 7% NGDP growth “for now”, and then drop it down way below 5% later to hit the level target, because no one will think recession levels of real growth are ever acceptable.
12. April 2012 at 15:50
ssumner:
MF, If you read my blog you’ll find out why NGDP matters. If you don’t agree with the reasons I give, then tell me why. Wouldn’t that be more productive than pretending to be ignorant in every one of your comments?
If you say NGDP matters, then that means it matters…for some desired end, which would make it a means.
If it is a means, then you can’t say you insist on the Fed doing it regardless of the consequences, and yet that is exactly what you did when you said you don’t care if unemployment or output go up or down to any degree, that the Fed should target NGDP come hell or high water.
I’m just trying to make sense of whether NGDP targeting is a means, or an end. If it a means, then you can’t ignore the ends. If it is an end, then you can’t pretend that NGDP “matters.”
12. April 2012 at 19:05
Clive Crook on NGDP targeting
http://www.themoneyillusion.com/
“the point is that the Fed can’t steer the components, only the aggregate”
NO, the composition of the 2 components (output & prices), in nominal gDp, is largely determined by the FED selecting the appropriate (fixed), monetary lag to target.
“the breakdown between prices and output is “DETERMINED” by the slope of the SRAS curve”
The word [determined] should be replaced by “REPRESENTED”.
SRAS has no predictive power.
During a business “cycle” (changes in real-gDp), prices & output (nominal-gDp), always eventually “revert-to-mean” (economic equilibrium — where the quantity demanded & the quantity supplied are nearly equal), via each component’s distinct monetary lag (MVt), & its corresponding r-o-c (the slope over the interval).
An output gap (if it exists), is where the roc in inflation is less than 2-3 percent above the roc in real-gDp (or where the roc in inflation is less than the FED’s inflation target).
I.e., monetary policy should be formulated in terms of desired roc’s in monetary flows (MVt) relative to roc’s in real-gDp.
What the market-monetarists call the output gap, or an aggregate demand shortfall (due supposedly to an excessively tight money policy), is really a countercyclical monetary policy [sic] that caps the roc in real-gDp.
13. April 2012 at 00:07
Just a small addition to the ongoing debate: this piece of empirical evidence suggests contraction, not expansion, of the central bank’s balance sheet (relative to total credit) is correlated with increases in real GDP.
http://docentes.fe.unl.pt/~amateus/eco_desenvolvimento/The%20Quest%20for%20Growth.htm “… an increase of one percentage point in growth… (goes with) a reduction of 28 percentage points in the share of central bank credit in total credit”
13. April 2012 at 00:36
I fail to see what the benefit of an NGDP target over an inflation target would be if you have labor market rigidities keeping people unemployed and production down. At 2% real growth during a recovery no one is happy and no amount money production is going to drive greater real growth in the long run. By yielding to the temptation of trying to boost real growth with greater inflation the Fed will paint themselves into a corner if they haven’t already.
13. April 2012 at 00:44
I do see the benefits of NGDP over inflation targeting in the area of stabilization. If an economy starts making big productivity gains, this tends to drive down prices causing the Fed to inject extra liquidity into an already healthy economy, creating great potential for a bubble and a crash down the road. However, I don’t see the benefits of NGDP targeting for encouraging better growth out of this recession without serious supply-side reforms: deregulation, slashing benefits for not working, and decreasing the burden of the government on the economy by lowering spending. I would typically say lower or eliminate taxes but the government needs to demonstrate it’s ability to cut spending and bring spending in line with revenues before giving out tax cuts.
13. April 2012 at 01:04
John,
I think that NGDP targeting encourages governments to maximise the amount of RGDP growth as a proportion of NGDP growth through the measures you suggest, because if supply-side weakness means that (say) 4% of the 5% NGDP growth is made up of inflation, NGDP targeting restricts the central bank from increasing NGDP growth so that RGDP is at 3-4%.
Inflation targeting does the same thing, of course, but it gold-plates the diamond through reducing NGDP right down in the above scenario assuming that the supply-side weakness becomes a trend.
Greater money creation won’t stimulate growth in the long-run (assuming there’s not a problem of downward rigidides, which there isn’t in the US right now since there’s no deflation) but the experience of Japan suggests that the long-run adjustment to a slower rate of money supply and NGDP growth is a long time i.e. about 10-15 years. In that time, the US would find it increasingly hard to sustain its influence on the world stage and there would be ample opportunities for dubious political movements on both the left & right to exploit the chronic malaise.
13. April 2012 at 01:07
Scott,
Oh, I am. And I thank you for some of the most “summary” posts you’ve done, one after I had described myself as confused. So thanks.
But, here, I exceptionally agree with both Major Freedom: Is NGDP targeting an end or a mean? IMHO, like every macro-economic tool, from fiscal policy to monetary tools, it HAS to be a mean. What really matters is (un)employment, real output and the resulting wealth/income distribution. Everything else is a side-show to manage/optimise these, as best we can.
Also, what about Dan Kervin’s point? As I noted before (and I am not sure you answered clearly), the stagflation of the 80s probably saw an NGDP of 5%. Except it was achieved with 0% RGDP (or below) and 5% and more of inflation. No one was happy about that split.
Whether the CB can or can’t do anything about it is, of course, a different matter.
13. April 2012 at 01:22
flow5,
You said: “An output gap (if it exists), is where the roc in inflation is less than 2-3 percent above the roc in real-gDp (or where the roc in inflation is less than the FED’s inflation target).”
Nice try using fancy terms to pass off nonsense. There are no rigid relationships like this in economics. Maybe in mathematics or physics but not this field. It is completely possible for the roc in inflation to be significantly less than roc in real GDP at full employment. Productivity based deflationary periods are an example of that. Conversely, you can have increases in inflation much larger than increases in GDP accompanied by an output gap. This is called stagflation.
You may object that these situations are unusual. That’s only true for U.S. history over the past 100 years. On the classical gold standard of the 18th century, prices stayed flat for nearly 100 years as gold mining capacity grew alongside goods production. Today stagflation is common in economically mismanaged countries like Iran or Venezuela.
Economics is about finding out the basic laws governing market activity and the rigid relationships of math or the models of physics are not adequate for the task. You can’t run experiments as there are too many possible variables, you can never replicate conditions, and performing the experiment changes the result. As a result, the truly important discoveries in economics such as comparative advantage and the quantity theory of money resulted from reasoning. These principles are profound while the mathematical and model based economists have produced crap.
13. April 2012 at 01:33
W. Peden,
I don’t think there is anyway for them to boost real GDP to 3-4% by boosting nominal GDP under current conditions. Of course, they could manipulate statistics to make it happen but that’s another story. It’s also worth keeping in mind that with inflation targeting at any given rate the Fed can only achieve a stimulative effect by delivering higher than expected inflation. Delivering lower inflation than the markets have priced in will produce all the same effects as deflation. This is why inflation tends to spiral out of control; no policy maker wants to experience the effects of deflation (at least since Volker in 1983).
As I stated before, inflation targeting gets weaker when the economy gets stronger. Higher growth, other things equal, tends to drive down prices leading the Fed to perpetually over heat the economy.
The Japanese situation is not about tight money. It’s about bailouts, crony capitalism, and pro-interest group economic policy. Much like Europe, the Japanese government is way over involved in business. Second, it’s worth pointing out that over the past 20 years, France and Japan have had similar growth in per capita GDP at PPP. It’s not as obvious that living standards are rising in the official statistics because the yen has gotten stronger as well. The increase in Japanese living standards only shows up in PPP measures. By those standards they do just fine for an over regulated corpratist system.
13. April 2012 at 01:40
MF,
I think Sumner’s case is that NGDP matters because it provides a constant stream of money expenditures. Hayek recommended that all prices needed to adapt to the flow of money expenditures rather than using money to do things like lower real wages. With the stream of money expenditures set for the future it is unlikely to get a major depression or inflation since most depressions or inflations have historically had either very low or very high NGDPs. It is rare to find a terrible economy with a nominal GDP in the 3-7% range. Not impossible, but rare.
13. April 2012 at 02:04
John,
I agree that TODAY the Japanese situation is almost entirely due to the factors you mention. However, I think there was a long period of adjustment to the 0% inflation policy. Money is neutral in the long-run, but not in the short run particularly in imperfect markets.
I’m curious as to why you don’t think that the US could have 3-4% GDP growth right now, at least as a brief catch-up period. What evidence is there that the US is at overfull capacity?
13. April 2012 at 02:40
W. Peden,
The length of the adjustment period is debatable. The fact is that the Japanese had a huge bubble burst and doubled down on bad economic policies. How much of the problem was due to statism and regulation vs. bad monetary policy is unknowable, but I would argue that it is ultimately their bad policies that keep them growing at the same rate as European countries that issued the same policies and got the same poor growth results with differing monetary policies.
I don’t think the U.S. could have 3-4% growth right now simply by raising nominal GDP (creating inflation). The labor market will stay depressed as long as we have extended unemployment insurance; an argument I took from Scott. Banks and financial are chafing under radically overhauled capital and lending requirements due to Dodd-Frank. Many banks are simply piling into government bonds in order to score better on stress tests according to “The Economist” magazine. The housing market is still depressed and I don’t think we’ll see any optimism inspiring growth until that turns around. For these reasons I think that the economy is unlikely to grow at 3-4% without policy overhaul. Monetary policy alone can’t do the trick.
13. April 2012 at 05:35
Are there any studies of historic cases where monetary stimulus was used in an attempt to restore normal NGDP growth following a banking crisis? When has this been achieved without creating problematic inflation?
13. April 2012 at 06:55
Kevin Johnson,
NGDP targeting is an untried policy proposal. However, in every case that I know of, a big monetary stimulus after a financial crisis has always lead to strong RGDP growth and no inflationary problems. At the extreme, a big monetary stimulus in 1933 took the US out of depression after the most severe financial crisis on record.
13. April 2012 at 06:59
John,
As far as I know, Japan has been doing relatively well in RGDP growth if one takes demographic factors into account, but only after the last 10 years or so. Before that, they were in a period of prolonged RGDP stagnation that correlates perfectly with a period of unusually low NGDP growth. Prima facie, that gives us a timeline of at least 10 years before Japan began to adapt to a much lower growth rate of nominal expenditure than what they had had for decades.
I don’t doubt that there are labour market problems holding back the US right now. However, before we can say that 3-4% growth is out of the question, we need evidence of an absence of spare capacity e.g. a frothy wage market and full order books. That’s not the US situation right now or so I’ve heard.
13. April 2012 at 07:13
John:
“There are no rigid relationships like this in economics”
“You can’t run experiments as there are too many possible variables”
So you readily admit you know nothing about money & central banking? The proof is incontestable…& no one will coax it out of me. It’s worth billions to investors & trillions to the U.S. government. But forecasting isn’t the primary problem. Neither is the FED’s contribution to inflation as compared to Congress’s.
The 80-82 & 08-12 recessions were brought about thru rapid increases in the transactions velocity of money which is the direct result of a resurgence in the proliferation of financial innovations. The housing bubble was characterized by its colossal money flows (money X velocity).
13. April 2012 at 07:44
Dan Kervick, You said;
“If we had 5% steady NGDP growth, right on target, but the inflation-based component was steadily around 4% and the RGDP component was steadily 1%, everyone would scream at the Fed to do something different.”
Britain disproves that theory. That’s roughly what’s happened in Britain, and there is little pressure on the BOE to change course. The reason is 1/2 of the people want tighter money to fight inflation, and 1/2 want easier money to boost growth, so it balances out.
Actually, your argument better applies to inflation targeting. If inflation is on target and growth is too low–then people would pressure for higher growth. But there will be no pressure to change inflation.
You said;
“because no one will think recession levels of real growth are ever acceptable”
No one except almost all conservatives in America. Like right now.
MF, It’s both a means and an end.
flow5, I don’t follow your comment.
Paul, I agree that larger central bank balance sheets (as a share of GDP) are highly correlated with slower NGDP growth.
John, Stable NGDP growth is more likely to produce stable RGDP growth (as compared to an inflation target) because it handles supply shocks better.
Frederic, You said;
“Also, what about Dan Kervin’s point? As I noted before (and I am not sure you answered clearly), the stagflation of the 80s probably saw an NGDP of 5%. Except it was achieved with 0% RGDP (or below) and 5% and more of inflation. No one was happy about that split.”
I am afraid your are wrong about this. The stagflation was in the 1970s. And in both the 1970s and the 1980s RGDP growth averaged about 3%, so NGDP targeting would work just fine.
In any case, regardless of trend RGDP, you want stable NGDP growth. That’s because all the costs typically associated with inflation are actually associated with NGDP growth. The government shouldn’t even collecting inflation data, inflation doesn’t matter. NGDP targeting is both a means and an end. Low and stable NGDP growth reduces the costs normally associated with inflation (an end) and stabilizes RGDP (a means.)
Kevin Johnson, Yes, Volcker tried to restore NGDP growth in the 1983-84 period without triggering high inflation, and he succeeded.
I did a post on that a few months back.
13. April 2012 at 07:57
W. Peden,
I don’t know the exact breakdown of Japanese GDPPC growth at PPP over the last 20 years but I do know that it went from around $20000 in 1990 to around $35,000 now which puts it in the same boat as most of the European countries in the same time period who ran “normal” monetary policies. According to this logic either a lower NGDP target is better in the long term after an adjustment period or the “lost decade” is largely a myth.
Flow5,
I’m not sure where to start answering your rather incoherant response. What exactly is worth billions to the investors and the U.S. government? If it is the mathematical models you are talking about, you’d think that hedge funds would be on the cutting edge of modeling (they are) and that if these techniques were valid they would be greatly outperforming the market. They aren’t. As Scott pointed out the average return to an investor is between 2-3% in a hedge fund. Use all the math you want, the chances of a price going up or down after you buy it are around 50-50. This is the EMH.
“The FED’s contribution to inflation as compared to congress”
This is a nonsense sentence. Inflation is about a falling value of money due to changes in the supply or demand for money. The driver of inflation over the years is increases in the money supply broadly defined. I don’t think any economists disagree over this basic cause of rising prices. Since Congress has no control over the monetary system, it is impossible for them to directly contribute to inflation outside of passing a law like making dollars illegal.
Second, FED doesn’t have to be capitalized. It is not an acronym, it is shorthand for Federal Reserve. It is the Fed.
80-82 wasn’t the primary recession, 1983 was. Both 1983 and late 2008-2009 saw falling amounts of transactions. That is one of the characteristics of a recession. Money X Velocity is part of the macroeconomic equation of exchange and has nothing to do with an individual market like housing.
I can see that overall you are very confused on economic topics and unless you can come up with answers that show some book learnin’ I don’t think it’s worthwhile to debate you on here.
13. April 2012 at 08:37
ssumner:
MF, It’s both a means and an end.
This is, IMO, unfortunately in line with Dewey’s philosophy, and is against Hume’s and Aristotle’s philosophy.
In Dewey’s philosophy, there is no way to empirically discern, no empirical assurance, on what is truly valuable. This is because it leads to inevitable circular logic. Why is NGDP targeting optimal? Because it is the optimal means. Why is it the optimal means? Because it achieves the optimal end, namely itself. Why is it an optimal end? Because it is the necessary result of the optimal means.
And so on.
I’ve noticed this with you. You tend to devolve quite often into circular logic. If it’s not circular logic in explicating EMH, it’s circular logic in explicating NGDP targeting.
I think market monetarists need a good healthy exposure to epistemology and metaphysics, because it seems you are completely lost, and you’re just chasing your own tails.
13. April 2012 at 13:00
There is no debate. Your just completely wrong.
“you’d think that hedge funds would be on the cutting edge of modeling”
Sure, & smarter than the FED’s technical staff. LOL
“The driver of inflation over the years is increases in the money supply broadly defined”
The principal driver of inflation over the periods (as defined by Wikipedia& that I quoted), is the phenomenal increase in the transactions velocity of our means-of-payment money. This is elementary. Everyone is wrong but me.
POSTED: Dec 13 06:55 PM 2007|
10/1/2007,,,,,,,-0.47,,,,,,, -0.22 * temporary bottom
11/1/2007,,,,,,, 0.14,,,,,,, -0.18
12/1/2007,,,,,,, 0.44,,,,,,,-0.23
1/1/2008,,,,,,, 0.59,,,,,,, 0.06
2/1/2008,,,,,,, 0.45,,,,,,, 0.10
3/1/2008,,,,,,, 0.06,,,,,,, 0.04
4/1/2008,,,,,,, 0.04,,,,,,, 0.02
5/1/2008,,,,,,, 0.09,,,,,,, 0.04
6/1/2008,,,,,,, 0.20,,,,,,, 0.05
7/1/2008,,,,,,, 0.32,,,,,,, 0.10
8/1/2008,,,,,,, 0.15,,,,,,, 0.05
9/1/2008,,,,,,, 0.00,,,,,,, 0.13
10/1/2008,,,,,,, -0.20,,,,,,, 0.10 * possible recession
11/1/2008,,,,,,, -0.10,,,,,,, 0.00 * possible recession
12/1/2008,,,,,,, 0.10,,,,,,, -0.06 * possible recession
Exactly as predicted:
(Dec 2007) And my forecast is remarkable as the Commerce Department said Retail sales increased by 1.2% over October 2006, & up a huge 6.3% from November 2006.
Bernanke is not only stupid, he is an outright liar & I can prove every word.
And Scott Sumner is one of the few people that has explained how poorly Bernanke ran his ship.
13. April 2012 at 13:31
flow5:
Saying inflation is caused by velocity is horribly flawed.
Velocity is essentially just how many times a dollar is turned over in exchanges over a period of time. A dollar cannot be turned over more often unless there is an accompanying increase in sales, i.e. production. One cannot spend a dollar more often unless there are sales being made more often, which requires productivity. But because more productivity LOWERS prices all else equal, it means that velocity cannot by itself explain the inflation.
Inflation is always and everywhere a monetary phenomenon.
13. April 2012 at 13:34
flow5:
The principal driver of inflation over the periods (as defined by Wikipedia& that I quoted), is the phenomenal increase in the transactions velocity of our means-of-payment money. This is elementary. Everyone is wrong but me.
Velocity of M2 has been falling since 2000, and velocity of MZM has been falling since 1980.
What “phenomenal increase” are you talking about?
13. April 2012 at 14:14
@flow5
the Feds pay scale is poor compared to what hedge funds and some banks pay. in general, yes i would say hedge funds like DE Shaw have “better” models. does not do much good in many cases! take LTCM, please.
13. April 2012 at 14:18
@MF,
Inflation is always and everywhere a monetary phenomenon.
glad to see we are gradually turning you into a market monetarist.
resistance is futile. prepare to be assimilated.
13. April 2012 at 15:45
“I don’t follow your comment”
Of course you don’t, you matriculated at the wrong school. My prof had an IQ of 200.
13. April 2012 at 16:15
Major_Freedom
“Velocity of M2 has been falling since 2000, and velocity of MZM has been falling since 1980”
NO, Friedman’s income velocity (Vi) is a contrived figure. The transactions velocity of bank deposits has soared ever since OCT 2002 (& it abruptly slowed in FEB 2006). Velocity has started falling again in the last 2 weeks. Money flows (MVt),will start falling in May & then the roc in MVt will crash in JUNE.
“Saying inflation is caused by velocity is horribly flawed”
For those who need a reminder, the equation of exchange is an algebraic way of stating a truism; that the product of the unit prices, and quantities of goods and services exchanged, is equal (for the same time period), to the product of the volume, and transactions velocity of money. Velocity is the rate of speed at which money is being spent. It is self-evident from the equation that an increase in the volume, and or velocity of money, will cause a rise in unit prices, if the volume of transactions increases less, and vice versa.
The real impact of monetary demand on the prices of goods and serves requires the analysis of “monetary flows”, and the only valid velocity figure in calculating monetary flows is Vt. Income velocity (Vi) is a contrived figure (Vi = Nominal GDP/M). The product of MVI is obviously nominal GDP. So where does that leave us? In an economic sea without a rudder or an anchor.
A rise in nominal GDP can be the result of (1) an increased rate of monetary flows (MVt) (which by definition the Keynesians have excluded from their analysis), (2) an increase in real GDP, (3) an increasing number of housewives selling their labor in the marketplace, etc. The income velocity approach obviously provides no tool by which we can dissect and explain the inflation process.
To the Keynesians, aggregate monetary demand is nominal GDP, the demand for services (human) and final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning (with raw material prices and processing costs at all stages of production) and continues through to the end.
To ignore the aggregate effect of money flows (MVt), on prices is to ignore the inflation process. And to dismiss the concept of Vt by saying it is meaningless (that people can only spend their income once) is to ignore the fact that Vt is a function of three factors: (1) the number of transactions; (2) the prices of goods and services; (3) the volume of M.
Inflation analysis cannot be limited to the volume of wages and salaries spent. To do so is to overlook the principal “engine” of inflation – which is of course, the volume of credit (new money) created by the Reserve and the commercial banks, plus the expenditure rate (velocity) of these funds. Also overlooked is the effect of the expenditure of the savings of the non-bank public on prices. The (MVt) figure encompasses the total effect of all these monetary flows (MVt).
13. April 2012 at 17:27
Paul Andrews:
“this piece of empirical evidence suggests contraction, not expansion, of the central bank’s balance sheet (relative to total credit) is correlated with increases in real GDP”
Neither the Central Bank’s balance sheet, nor the monetary base, is in any way related to the growth rate of nominal or real (gDp), or even the implicit price deflator.
The Monetary Base:
Flawed as the AMBLR figure is (Adjusted Member Bank Legal Reserves), it was superior to the Domestic Adjusted Monetary Base (DAMB) figure, which is generally cited. The DAMB figure included AMBLR plus the volume of currency held by the nonblank public (Milton Friedman’s “high powered money”).
Any expansion or contraction of DAMB is neither proof that the Fed intends to follow an expansive, nor a contractive monetary policy. Furthermore any expansion of the non-bank public’s holdings of currency merely changes the composition (but not the total volume) of the money supply. There is a shift out of demand deposits, NOW or ATS accounts, into currency. But this shift does reduce member bank legal reserves by an equal, or approximately equal, amount.
An expansion of the public’s holdings of currency will cause a multiple contraction of bank credit and checking accounts (relative to the increase in currency outflows from the banks) ceteris paribus. To avoid such a contraction the Fed offsets currency withdrawals by open market operations of the buying type (e.g., purchases of governments for the portfolios of the 12 Reserve Banks). The reverse is true if there is a return flow of currency to the banks. Since the trend of the non-bank public’s holdings of currency is up (ever since 1930), return flows are purely seasonal and cannot therefore provide a permanent basis for bank credit and money expansion.
An aside note: all currency gets into circulation, directly or indirectly, through the liquidation of time deposits, by the cashing of demand deposits. There is one exception in demand deposit creation; those historical instances when the U.S. Treasury borrowed from the Federal Reserve Banks. However, it cannot be said (as of time deposits), that increases in the public’s holdings of currency reflect prior commercial bank credit creation. It is more appropriate to say that expansions of currency are accompanied by concurrent expansions of Reserve Bank Credit.
Although the DIDMCA of March 1980 made all depository institutions maintain uniform reserve requirements (thereby expanding the “source base” from 65% of the commercial banks to 100% of the money creating depository institutions), Paul Volcker’s unconventional reserves-based-operating-procedure” was unsuccessful. This was because the BOG attempted to target only non-borrowed reserves (when at times, 10% of all legal reserves were borrowed). I.e., $1b of reserves in 1980 (borrowed or otherwise), supported $16b of M1. I say Volcker “attempted” because legal reserves grew at a 17% annual rate-of-change, from April 1980, until the end of that year. This presaged a 19.1% surge in nominal GNP in the 1st qtr 1981. Contrariwise, this so-called “operating procedure” (monetarism), was never “abandoned”, it was never tried.
Between 1942 and September 2008, member commercial banks operated with no excess legal reserves of consequence. However legal reserves were actually only “binding” between c. 1942 until 1995. Since 1995, increasing levels of vault cash (larger ATM networks), retail and commercial deposit sweep programs, fewer applicable deposit classifications (including the “low-reserve tranche” & “exemption amounts”), & lower reserve ratios, have combined to remove most reserve, & reserve ratio, restrictions.
Subsequent to this period (in conjunction with the Emergency Economic Stabilization Act of 2008), Regulation D was amended, & the Board gave the District Reserve Banks the authority to pay the member banks quarterly interest on their (1) required and (2) excess reserves. As a result of the FED’s quantitative easing programs, unused excess reserves expanded dramatically (reserves contingent upon the FOMC’s remuneration rate, vis a’ vis competing returns). This new policy instrument (IOeRs), are contractionary & induce dis-intermediation within the non-banks (where the non-banks shrink in size & the commercial banking system’s size remains the same).
The DIDMCA’s legislation also permitted the Federal Reserve Banks to offer the money creating depository institutions, monthly earning credits on their contractual clearing balances (prudential reserves). These clearing balances are not included in the “source base” (the base for the expansion of money and transmission of credit). The growth in these balances accelerated after the December 1990-92 cuts in, and removal of, specified reserve requirements. Since then, clearing balances have moved inversely (as a replacement), with the diminishing volume of required reserves.
Intra & inter-bank clearings, (debits and credits) are safeguarded from imbalances (overdrafts), using supplementary reserves (known as day-light-credit). Thus the actual “source base” includes 4 inter-bank balances held at their District bank, (owned by the member banks): (1) excess, (2) required, (3) contractual clearing, & (4) supplementary.
Excess reserves are equal to total reserves (which since 1959 includes liquidity reserves, i.e., surplus and applied vault cash), minus the member bank’s (2) required reserves, minus (3) required contractual clearing balances. The volume of excess reserves represents the banking system’s, unused, or its potential, incremental lending capacity. With this incremental lending capacity the banks have the legal capacity to “create credit”.
The Reserve Requirements Simplification Rule (scheduled for introduction on July 12, 2012), amends Regulation D (Reserve Requirements of Depository Institutions), by reducing the member bank’s administrative and operational costs by:
(1) creating a common two-week maintenance period
(2) creating a penalty-free band around reserve balance requirements in place of using carryover and routine penalty waivers
(3) discontinuing as-of adjustments related to deposit report revisions and replacing all other as-of adjustments with direct compensation
(4) eliminating the contractual clearing balance program
Regulation D, by commingling legal reserves with required reserves, has made the job of monetary management more difficult.
In our Federal Reserve System, 90 percent of “MO” (domestic adjusted monetary base) is currency. There is no “expansion coefficient” assigned to the currency component. And the currency component of MO is so prominent, and the proportion of legal reserves so negligible (and declining); that to measure the rate-of-change in currency held by the non-bank public, to the rate-of-change in M1 (where 54% is currency), is, yes, to measure currency vs. currency (cum hoc ergo propter hoc); in probability theory and statistics, not a cause and effect relationship.
Complicating the measurement of the monetary base is the fluctuation in the percentage of foreign currency circulation, to domestic currency circulation. The FED’s research staff estimates that foreigners hold one half to two thirds of all U.S. currency (this spread can result in a wide margin of error). Inflows and outflows of foreign-held U.S. currency (seldom repatriated) are attributed to political, and price, instability (as well as to seasonal flows), and all are immeasurable in the short run. I.e., the domestic monetary source base equals the monetary source base minus the estimated amount of foreign-held U.S. currency.
The “shipments proxy” estimate of foreign-held U.S. currency uses data on the receipts and shipments of currency, by denomination, at the Federal Reserve’s 37 cash offices nationwide (note: > 80 percent of foreign-held U.S. currency are $100.00 bills). Because of its influence on the DAMB, quarterly estimates of foreign-held U.S. currency are reported in the Feds “Flow of Funds Accounts of the United States” & in the BEAs estimates of the net international investment position of the United States.
The volatility of the (1) K-ratio, the public’s desired ratio of currency to transactions deposits (or currency-deposit-ratio), and the volatility in (2) the ratio of foreign-held, to domestic U.S. currency, both influence the trend rate for the cash drain factor (the movement of the domestic currency component of the DAMB). And the evidence points to sizable (& unpredictable), shifts in the money multiplier (MULT – St. Louis), for the constantly changing shifts in the composition of the “M’s”.
The Federal Reserve Bank of Chicago uses legal reserves (“t”-accounts), exclusively, to explain the creation of new money and credit in the booklet “Modern Money Mechanics”. The booklet is a workbook on bank reserves and deposit expansion (changes in a bank’s deposits-loans resulting from open market operations). The stated purpose of the booklet is to “describe the basic process of money creation in a “fractional reserve” banking system” – the monetary base plays no role at all in this analysis.
It is therefore both incorrect in theory, and thus inaccurate in practice, to refer the DAMB figure as a monetary base [sic]. The only base for an expansion of total bank credit and the money supply is the volume of legal reserves supplied to the member banks by the Fed, in excess of the volume necessary to (1) offset currency outflows from the banking system & (2) offset fluctuations in the level of member bank’s reserve balances (diverted & detained via the remuneration rate), in the 12 District Reserve Banks. The adjusted member bank legal reserve figure is that base.
14. April 2012 at 04:50
There is widespread agreement that legal reserves are no longer “binding”, i.e., reserve requirements no longer constrain the expansion of commercial bank credit. Legal reserves were binding from 1942 until 1995 (& the money multiplier was applicable). However the pundits are wrong insofar as a contraction in legal reserves today will immediately shrink commercial bank credit.
Bernanke is an outright liar: Some people think Feb 27, 2007 started across the ocean. “On Feb. 28, Bernanke told the House Budget Committee he could see no single factor that caused the market’s pullback a day earlier”. In fact, it was home grown. Legal Reserves tanked. It was the seventh biggest one-day point drop ever for the Dow. On a percentage basis, the Dow lost about 3.3 percent – its biggest one-day percentage loss since March 2003.
The Fed has finally (just recently), almost discovered the real expansion coefficient:
See: http://bit.ly/yUdRIZ
Quantitative Easing and Money Growth:
Potential for Higher Inflation?
Daniel L. Thornton
14. April 2012 at 10:36
There is widespread agreement among economists that legal reserves are no longer “binding”, i.e., reserve requirements no longer constrain the expansion of commercial bank credit. Legal reserves were binding from 1942 until 1995 (& the money multiplier was applicable then). However the pundits are wrong insofar as: a contraction in legal reserves even today will immediately shrink reservable liabilities & commercial bank credit.
Some people think Feb 27, 2007 started across the ocean. “On Feb. 28, Bernanke told the House Budget Committee he could see no single factor that caused the market’s pullback a day earlier”. In fact, it was home grown. Legal Reserves tanked. It was the seventh biggest one-day point drop ever for the Dow. On a percentage basis, the Dow lost about 3.3 percent – its biggest one-day percentage loss since March 2003.
The Fed has finally (just recently), almost discovered the real expansion coefficient:
See: http://bit.ly/yUdRIZ
Quantitative Easing and Money Growth:
Potential for Higher Inflation?
Daniel L. Thornton
14. April 2012 at 11:51
MF, I appreciate the comparison to Dewey.
Flow5, You said;
“Of course you don’t, you matriculated at the wrong school. My prof had an IQ of 200.”
Several of mine won Nobel prizes, but I still can’t figure out what you are talking about.
15. April 2012 at 06:09
MVt can be used to see the future — but you can’t always tell what happened in retrospect — because the FED tries to fix their mistakes.
Targeting nominal gDp is for dummies. I.e., the target should be real-gDp. I just don’t think the FED would be as good at forecasting real-gDp vs. nominal gDp.
The upcoming 2 month downswing is almost on top of us. This particular period would make a good case for targeting nominal gDp. Real gDp will fall (for 2 months), but inflation will not change much (i.e., it looks like stagflation). In order to smooth out the disruption you need to target nominal gDp in the next 2 months. Any blip in inflation will later be erased as the FED holds nominal gDp constant (because the constant time lag for inflation is longer than that for real-output). I.e., inflation will subside in the longer-term & real-gDp will recover.
15. April 2012 at 07:48
repost
“Contrary to economic theory, & Nobel laureate Dr. Milton Friedman, monetary lags are not “long & variable”. The lags for monetary flows (MVt), i.e., the proxies for (1) real-growth, and for (2) inflation indices, are historically, always, fixed in length (mathematical constants). However the lag for nominal gdp (the FED’s target??), varies widely.”
Assuming no quick countervailing stimulus:
MVt can be used to see the future — but you can’t always tell what happened in retrospect — because the FED tries to fix their mistakes. For example you can’t even tell (by the historic measure of MVt), there was a downdraft in May of 2010.
Targeting nominal-gDp is for dummies. I.e., the target should be real-gDp. I just don’t think the FED would be as good at forecasting real-gDp vs. nominal-gDp.
The upcoming 2 month downswing is almost on top of us. This particular period would make a good case for targeting nominal-gDp. Real-gDp will fall (for 2 months), but inflation will not change much (i.e., it looks like stagflation).
In order to smooth out the upcoming disruption (change in job creation), the FED should target nominal-gDp in the next 2 months. Any blip in inflation will later be erased (be transitory as Bernanke says), as the FED targets nominal-gDp (because the constant time lag for inflation is longer than the constant time lag for real-output). Thus the longer-term time lag for inflation will serve to reduce any short-term injection of liquidity by the FED (an injection accompanied by the resultant short-term increase in inflation’s rate-of-change (roc)).
This is just because both the longer-term average (roc) for inflation (as well as its historical ratio to real-output), is mathematically lower, than the longer term (roc) in real-gDp (given that real-gDp is allowed to recover & the inflation component of nominal-gDp moderates).. I.e., it extremely unlikely by targeting nominal-gDp — that the (roc) in inflation will grow faster in the longer-run than the (roc) in real-output.
This process (concept), is more pronounced coming out of a recession. The FED can boost real-gDp (with a larger injection of liquidity), for up to 3 qtrs, & then apply the brakes. Real-gDp will then increase at a faster (roc) than re-flation does during this period. And later inflation will subside as the FED shifts to a “tighter” (de facto), money policy (nominal-gDp target).
18. April 2012 at 05:44
dwb:
“Inflation is always and everywhere a monetary phenomenon.”
glad to see we are gradually turning you into a market monetarist.
One can accept that without being a market monetarist. I knew this before I even knew what market monetarism is. You’ll never convert me to something I know is fallacious and destructive to my own interests.
18. April 2012 at 05:46
ssumner:
MF, I appreciate the comparison to Dewey.
It wasn’t a comparison to Dewey. It was an explanation of who’s philosophy I think you adhere to.