We’re getting closer

The blogosphere response to the recent Swiss move is quite interesting.  But let’s back up a minute so that I can better explain why I am bemused by the discussion.  Recall that I look at monetary policy from an asset price approach.  Easy money is a policy that pushes NGDP futures prices above target, and vice versa.  If the government is so monumentally stupid that it hasn’t spent a few million dollars to create and subsidize trading in an NGDP futures market, and is doing monetary policy with a blindfold on, then look at a collection of assets like stocks, commodities, TIPS, etc, and then estimate NGDP growth expectations.

I spent lots of time studying the 1930s, when FDR routinely moved the price of gold around as a lever of monetary policy, and all the markets responded exactly as you’d expect if the policy was credible and effective.  I’m very comfortable operating in a world where the central bank pegs the price of some sort of nominal anchor.  That’s how I think monetary policy works, or should work.

Lots of proponents of monetary stimulus on both the left and the right are basically saying “Look, if the Swiss can do it, why can’t we?”  JimP sent me an excellent Ryan Avent post that makes this point clearly.  First he discusses the Swiss move, and then says:

There seems to be more scepticism that the Fed could similarly talk the economy toward a specific inflation or nominal growth rate. I understand the reason for the intuition; prices and wages aren’t set in the same clear way that security prices are. The principle is the same, however. If the Fed declared””credibly””that it would intervene in markets such that nominal growth in 2012 was 6%, asset-market prices should adjust immediately, pushing firms and households to behave in a more optimistic way, leading to faster growth. Expectations for growth couldn’t rise too high, however, lest the spectre of Fed tightening be raised, leading actors to push the economy toward the desired nominal target.

The Fed would need to act enough to demonstrate its credibility, and nominal growth of 6% wouldn’t guarantee anything about real growth. But examination of the Swiss National Bank’s action, and the resulting effect, should give us pause. From it, we can either conclude that the Fed is implicitly targeting a higher rate of nominal growth but isn’t credible, or that the Fed is credibly targeting growth within a range consistent with actual recent experience. In fact, I think it’s a bit of both. Ben Bernanke may say he wants a faster recovery, but the Fed’s actions are inconsistent with his statements, and markets and economic actors have therefore concluded that the Fed is happy with current growth rates. Nominal growth above 5% per year is not the rate the markets are looking for. And so it’s not the rate they get.

At first I was slightly annoyed by the “Ben wants more growth” comment.  Bernanke has consistently said the Fed has plenty more ammunition.  If they aren’t using it, it’s because the Fed doesn’t think it’s needed.  It doesn’t think faster expected NGDP growth would be desirable.  I imagine Bernanke is disappointed by NGDP growth in the recent past, but he favors growth rate targeting, not level targeting.

But on second thought I realized that the Fed isn’t Avent’s intended audience.  Very few people know what Avant and Yglesias and us quasi-monetarists know–that the only solution for the recession is faster NGDP growth, and only the Fed can deliver it.  It’s almost pathetic to listen to NPR these days.  You have all these earnest liberals who sincerely want Obama to succeed, talking about various screwball ideas to create a few thousand jobs here or there, when we need 10 million jobs.  Only the Fed can to that.  We need to wake up Congress, the WaPo editorial board, and all the other movers and shakers.  We need for them to suddenly realize; “You mean to tell me if the Fed did something analogous to what the SNB did, it would create millions of jobs!  And they know they can do it, but just don’t happen to think the economy needs more demand, more spending, more NGDP!”  When that happens the Fed will suddenly be under tremendous pressure to create jobs.  NPR also has lots of heart-wrenching stories about what happens to average people in America when they’ve been unemployed for a long time.  I wonder how the hawks at the Fed can be so confident that more stimulus wouldn’t help those people.  Do they even listen to those stories?

One person at the Fed does realize the severity of the jobs problem, and that the Fed has the duty to address it.  Several commenters sent me an excellent speech by Chicago Fed President Evans:

Some believe that this pause is entirely appropriate. They claim that the economy faces some kind of impediment that limits how much more monetary policy can do to stimulate growth. And, on the price front, they note that the disinflationary pressures of 2009 and 2010 have given way to inflation rates closer to what I and the majority of Fed policymakers see as the Fed’s objective of 2%. These considerations lead many to say that when adding up the costs and benefits of further accommodation, the risk of over-shooting our inflation objective through further policy accommodation exceeds the potential benefits of speeding the improvement in labor markets.

I would argue that this view is extremely, and inappropriately, asymmetric in its weighting of the Fed’s dual objectives to support maximum employment and price stability.

Suppose we faced a very different economic environment: Imagine that inflation was running at 5% against our inflation objective of 2%. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.

In the United States, the Federal Reserve Act charges us with maintaining monetary and financial conditions that support maximum employment and price stability. This is referred to as the Fed’s dual mandate and it has the force of law behind it.

The most reasonable interpretation of our maximum employment objective is an unemployment rate near its natural rate, and a fairly conservative estimate of that natural rate is 6%. So, when unemployment stands at 9%, we’re missing on our employment mandate by 3 full percentage points. That’s just as bad as 5% inflation versus a 2% target. So, if 5% inflation would have our hair on fire, so should 9% unemployment.

And he saves the best for last:

There are other policies that could give clearer communications of our policy conditionality with respect to observable data. For example, I have previously discussed how state-contingent, price-level targeting would work in this regard.  Another possibility might be to target the level of nominal GDP, with the goal of bringing it back to the growth trend that existed before the recession. I think these kinds of policies are worth contemplating””they may provide useful monetary policy guidance during extraordinary circumstances such as we find ourselves in today.

Evans makes me seem like a hawk.  I think it’s too late to go back to the old trend line (we’re about 12% below it.  I’d be happy going 1/3 of the way back—7% NGDP growth for two years and 5% thereafter.

I hope this doesn’t sound too conceited, but I can’t help taking satisfaction with the way the conversation over monetary policy is developing:

1.  Fed people discussing NGDP targeting, level targeting.

2.  The Economist magazine comes close to endorsing NGDP targeting.

3.  Ryan Avent talking about monetary policy in terms of pegging asset prices, and then drawing analogies with NGDP targeting.

4.  Nick Rowe is drawing upward sloping IS curves (I plan a post when I have time.)

My very first paper was written in 1986, presented at the AEA in 1987, sent 4 times to the JME with revise and resubmits before being rejected, then published in 1989 in an obscure British journal.  The topic was how the central bank should create NGDP futures contracts, and then peg the price in such a way that the market determines the money supply and interest rates.  NGDP expectations are always on target.  I still feel that’s the end of macro.  No more fiscal multipliers.  No more broken windows fallacies.  No more confusing of structural and demand problems  No more mercantilist arguments for reducing unemployment.  No more demands that GM must be saved to preserve jobs.  Students could just take one semester of econ—we could stop calling it “microeconomics” and start calling it “economics.”

I feel we are getting closer every day.  I just hope I live long enough to see it happen.

PS.  I’m still running way behind on comments–I know there are many from before my vacation that I haven’t even read.  My priorities are:

1.  Get my ideas out there before the critical Sept. meeting.

2.  My job.

3.  Dealing with flooding in my basement.

4.  Dealing with papers people send me for comments.

5.  Buy a new toilet.

6.  Answer comments.

You’ll just have to wait.


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62 Responses to “We’re getting closer”

  1. Gravatar of JimP JimP
    8. September 2011 at 10:50

    I do have an idea about how to get Scott’s ideas more out there:

    Bernanke gave a speech just now in which he said not much. Then he took questions – and it was all on CNBC.

    He will be giving more speeches we can presume. We need to find a speech (at a college or something) in which we (whoever that we is) could talk to a member of the audience and get that person to ask about targeting NGDP. Just ask him – see what he says. I bet that would be one way to get into the NYT or WashPo. if some reporter heard that and then wondered about it.

  2. Gravatar of Lars Christensen Lars Christensen
    8. September 2011 at 11:07

    Scott, I like your priorities!

  3. Gravatar of Andrew Andrew
    8. September 2011 at 11:38

    now we have something in common!

    I spent a few hours last night fixing my toiled and stopping the leak into the basement!

  4. Gravatar of Morgan Warstler Morgan Warstler
    8. September 2011 at 11:57

    “Very few people know what Avant and Yglesias and us quasi-monetarists know-that the only solution for the recession is faster NGDP growth”

    Yeah, but that’s wrong.

    Matty STILL wants Fiscal deep down. If he had to choose, just like DeKrugman, he’d take more government spending.

    It’s when liberals let go of Fiscal stimulus, and they cling to your plan and your plan alone, conservatives will make it happen.

    We’ll probably only have a 3-4% NGDP target, but still your point is well taken.

  5. Gravatar of Benjamin Cole Benjamin Cole
    8. September 2011 at 12:33

    Hmm. I would have put the toilet priority up higher. But maybe you have a bigger backyard. And I hope the toilet problem is not connected to the basement flooding.

    Excellent blogging, really superb.

    “It’s almost pathetic to listen to NPR these days. You have all these earnest liberals who sincerely want Obama to succeed, talking about various screwball ideas to create a few thousand jobs here or there, when we need 10 million jobs.”

    Perfect, perfect, perfect.

  6. Gravatar of Nick Nick
    8. September 2011 at 12:45

    Between Irene and the latest drenching, I can attest to the following basement flooding fix. Buy a pump like this:

    http://www.amazon.com/gp/product/B000X05G1A/ref=wms_ohs_product_T2

    and hook it up to your garden hose, and send the water out through a basement window. Then you will have more time to convince everybody of the need for NGDP targeting.

  7. Gravatar of Lars Christensen Lars Christensen
    8. September 2011 at 12:48

    Ben, so would I, but I know that Scott have important papers to read;-)

  8. Gravatar of Lorenzo from Oz Lorenzo from Oz
    8. September 2011 at 13:11

    What Benjamin C said, but with more Aussie reticence :)

  9. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    8. September 2011 at 13:20

    ‘My very first paper was written in 1986, presented at the AEA in 1987, sent 4 times to the JME with revise and resubmits before being rejected, then published in 1989 in an obscure British journal.’

    What was the journal? I ask because a friend who is an academic economist recently told me he’d been hearing about NGDP targeting for years, but had never seen a formal presentation of the idea.

  10. Gravatar of Martin Martin
    8. September 2011 at 13:33

    Patrick: http://onlinelibrary.wiley.com/doi/10.1111/j.1467-8586.1989.tb00287.x/abstract

    I believe this is the one Scott is talking about. (Some of) His other stuff can be found here: http://ideas.repec.org/f/psu244.html#works

    Scott also wrote something for the Adam Smith institute on this, don’t know if you’re familiar with that:
    http://www.adamsmith.org/files/ASI_NGDP_WEB.pdf

  11. Gravatar of TA TA
    8. September 2011 at 13:40

    I take it you listened to Tom Ashbrook this morning, with Bernstein and Gross. I was surprised at how useless those guys were.

  12. Gravatar of marcus nunes marcus nunes
    8. September 2011 at 13:48

    I gather the Fed is a “multicultural” institution, therefore very PC. It embraces the likes of Plosser and Evans, only connected connected by their common christian name: Charles!
    http://thefaintofheart.wordpress.com/2011/09/08/%E2%80%9Cmulticulturalism%E2%80%9D/

  13. Gravatar of bill woolsey bill woolsey
    8. September 2011 at 14:09

    Sumner, Scott. “Using Future Instrument Prices to Target Nominal Income.”
    Bulletin of Economic Research 41 (April 1989): 157″”62.

  14. Gravatar of bill woolsey bill woolsey
    8. September 2011 at 14:11

    Scott:

    It should be:

    1. Flooding
    2. Toliet
    3. Job (and you better fit classes into project 1 and 2)
    .
    .
    .
    Other stuff.

    But then, I guess that is why the NYT counts you as a “big name.”

  15. Gravatar of Bababooey Bababooey
    8. September 2011 at 14:18

    You mean to tell me if the Fed did something analogous to what the SNB did, it would create millions of jobs! And they know they can do it, but just don’t happen to think the economy needs more demand, more spending, more NGDP!”

    So, Rick Perry is right? The Bernanke is a traitor?

  16. Gravatar of malavel malavel
    8. September 2011 at 14:23

    So the extra day for the September meeting is so they can decide whether to go with price or NGDP level targeting. Shiny!

    Is this the time to take out a larger mortgage and invest in some stocks?

  17. Gravatar of Morgan Warstler Morgan Warstler
    8. September 2011 at 14:41

    Here is woolsey on sumner:

    http://www.cato.org/pubs/journal/cj12n2/cj12n2-11.pdf

    if there is more please post.

    Beyond the loss of Fed control, the most compelling Tea Party aspect of the Futures market is that the new money printed money goes directly into the hands of the bettor – and anyone can bet. Not letting GS belly up to sell when they know beforehand they will get to, is great.

  18. Gravatar of Quote of the day « Economic Sophisms Quote of the day « Economic Sophisms
    8. September 2011 at 16:35

    […] From Sumner It’s almost pathetic to listen to NPR these days.  You have all these earnest liberals who sincerely want Obama to succeed, talking about various screwball ideas to create a few thousand jobs here or there, when we need 10 million jobs. Like this:LikeBe the first to like this post. Categories: Uncategorized Comments (0) Trackbacks (0) Leave a comment Trackback […]

  19. Gravatar of Full Employment Hawk Full Employment Hawk
    8. September 2011 at 16:48

    “the way the conversation over monetary policy is developing:”

    5. Brad DeLong now supports NGDP targeting.

  20. Gravatar of Full Employment Hawk Full Employment Hawk
    8. September 2011 at 16:50

    Somebody has to explaing to Obama that by far the most important thing he can do to help himself politically is to recess appoint two people who take the Fed’s mandate to achieve maximum employment seriously. Ideally these would be people who favor NGDP targeting. Like the bipartisan combination of DeSummers.

  21. Gravatar of cato cato
    8. September 2011 at 16:54

    some interesting charts:

    http://www.zerohedge.com/article/exclusive-feds-600-billion-stealth-bailout-foreign-banks-continues-expense-domestic-economy-

    seems like one of those crank sites, but data is from the H8 fed data, you can chart the fed data here:

    http://www.federalreserve.gov/datadownload/Chart.aspx?rel=H8&series=3a710b2a6003cf94bc20b86d27decb66&lastObs=7&from=&to=&filetype=csv&label=include&layout=seriescolumn&pp=Download

    it would be worth looking at where the fed bought the securities for QE2 from.

    also, shouldn’t bank balance sheets remain unchanged as they simply swap cash assets for other assets, (you can chart total assets and see that they have gone up)

  22. Gravatar of JimP JimP
    8. September 2011 at 17:14

    FEH

    People here have been saying that for months – even years. And the horrible fact is that no-one from the Obama administration reads this blog or even knows it exists. As can be seen utterly clearly from the jobs speech tonite.

    It is just so totally frustrating.

  23. Gravatar of marcus nunes marcus nunes
    8. September 2011 at 17:36

    Closer, yes! But there are still those that could be “mouthpieces”, in addition to RA, Clive Crook, etc, that still show some resistance: This is Greg Ip at Fre exchange:
    There are a lot of ideas floating around for operational frameworks that would better motivate the Fed to boost output and employment. Price-level targeting and nominal-GDP targeting are among these. The thinking is that when either falls below their long-run preferred path, the Fed would undertake more aggressive monetary easing to get them back. This would raise inflation but hopefully, also raise employment.

    There are merits to these ideas but they seem to be weak substitutes for simply raising the inflation target. When nominal rates are stuck at zero, a higher inflation target makes real interest rates more deeply negative, which should boost demand and employment through the usual channels. However, raising the inflation target subtracts from the central bank credibility which could be costly to recover. Given the dire state of the world economy this may be a tradeoff worth making, but it must be dealt with, not brushed under the rug by adopting a new regime.
    http://www.economist.com/blogs/freeexchange/2011/09/monetary-policy?fsrc=rss

  24. Gravatar of W. Peden W. Peden
    8. September 2011 at 18:26

    Cato,

    Internal exchanges of assets are only one way that financial instutions try to get back to their preferred proportions of cash holdings after an OMO. Indeed, if that was the only way, then securities would just go up and up in price forever, in an unbreakable cycle.

    If a company looks at the price of corporate bonds and decides it’s worth investing, then the bank’s purchase of a corporate bond from that company expands the bank’s balance sheet.

    So while a bank’s balance sheet isn’t directly impacted by an OMO, the system’s only ultimate way of getting back to cash equilibrium is to expand balance sheets. Therefore, we can say that the effects of an OMO on balance sheets is indirect.

  25. Gravatar of W. Peden W. Peden
    8. September 2011 at 18:26

    The SIZE of balance sheets, that is. It directly changes the composition of balance sheets.

  26. Gravatar of MikeDC MikeDC
    8. September 2011 at 19:29

    One question I’d like settled before the Fed (as a collection of interested parties)- rather than a notional futures market – engages in NGDP targeting is how to set the target. Without hand-waving, can anyone reasonably say why a 6% target is the right target and not 7%? How’s about 10%? I mean, if we want more growth, why not?!

    It’s not hard to see where this would go. Replace all the above-mentioned political hand-wringing about multipliers and GM with political pressuring for “just a little bit more” income and jobs. That could be a hell of a Pandora to let out
    of the box in any case… but especially if our theory of target-setting is essentially taking a swag.

  27. Gravatar of Alex Godofsky Alex Godofsky
    8. September 2011 at 19:56

    MikeDC: the Fed picks a level target. Scott’s proposed 5%, but it doesn’t really matter – at full employment a higher target just implies higher stable inflation, given trend GDP growth.

  28. Gravatar of Morgan Warstler Morgan Warstler
    8. September 2011 at 20:24

    MikeDC, the correct target is one that allows us to cheer lower prices.

    At 3% NGDP. we happily promote any and all deflationary tech improvements.

    We want prices to fall A LOT. That makes for a good target. After all, we can always print.

    At 3%, we HATE it when labor unions get pay raises they don’t deserve. That increase means we shot our growth wad on some nominal nothing.

  29. Gravatar of Morgan Warstler Morgan Warstler
    8. September 2011 at 20:24

    Alex, this isn’t about full employment, this is about PROVING our unemployment is structural.

  30. Gravatar of MikeDC MikeDC
    8. September 2011 at 20:54

    Morgan: 3% NGDP growth won’t generate many deflationary tech improvements to promote.

    Alex: Again, if it doesn’t matter, may I mentally note that you favor a 20% annual NGDP target? Related question: why does Scott seem to think it’s too late to revert to trend?

  31. Gravatar of Liberal Roman Liberal Roman
    8. September 2011 at 20:59

    I don’t know how we can say “we are getting closer” when I think we just had our first Republican debate ever where the central bank chairman was criticized for monetary policy that was too loose. And that central bank chairman was Ben Bernanke, who is conducting the tightest monetary policy in 70 years.

    We are getting closer to utter disaster is what I would say.

  32. Gravatar of Morgan Warstler Morgan Warstler
    8. September 2011 at 21:05

    I didn’t say it would generate, I said it would make us WANT to generate them.

    We set the NGDP at 3%, we start now and we go level from there.

    Every real bit of growth, as in productivity gains, that reduces prices, like say shutting down unons, or ending David-Bacon, or ending minimum wage….

    These things used to be “oh noes! slower growth!” but under a 3% NGDP target, we think “GREAT now we can have a RGDP of 4% or 5%!”

    Look, we are going to start with the premise that the current fiscal government spending regulatory system is broken, and that Dems suck.

    As such we’re going to benchmark in such a way that makes EVERYBODY, no matter who you are, CHEER lower wages for unproductive people, we’re going to CHEER for firing losers and wastoids.

    The correct monetary system, like the private market, hunts down inefficiencies and raises the fist high of those the end them.

  33. Gravatar of gnikivar gnikivar
    8. September 2011 at 21:32

    @ MikeDC,

    I think the optimum NGDP target would take two factors into account. Wages tend to be sticky, so that the NGDP target should be so high that large scale real wage cuts higher than the target are rare. On the other hand, menu and shoe leather costs can mount if the target is too high. People would have to be constantly changing the prices of goods, and going and coming to the bank to take money out of accounts because cash loses value so fast. I think 5% is a pretty good target, though I’d be happy with anything between 3% and 8%.

  34. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. September 2011 at 21:47

    My priorities are:

    1. My several jobs.
    I’m teaching Principles of Micro at Rowan U and the second semester of engineering calc at UD. Crazy. They love me at both places. (I still wonder why?!?)

    2. Dealing with weeds in my garden.
    I don’t employ illegal Mexican labor like my neighbors so I do everything myself. I have 1.5 acres to tend so most days my muscles are sore. Some days I can hardly get out of bed.

    3. Dealing with emails and mail people send me for comments.
    I’m overwhelmed. Mostly I tell people to think for themselves and leave me the $%^& alone.

    4. Fix my gutters.
    New Castle County is taking me to court because my gutters are falling down and my fascia need repair. Oh well, I guess I’ve been antisocial. Go suck my bunghole.

    5. Deal with crap in general.
    You’ll just have to wait.

    It’s days like this that make me wonder why my father thought Capitalism was so superior to Socialism:

    http://www.youtube.com/watch?v=ny2lDPp7tnc

    In short, things could be worse, but, on the other hand they could be better.

    P.S. If you want things to be better for me, well, why don’t you just send me some money?

  35. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. September 2011 at 21:59

    P.S. BTW thanks for the earlier HT Scott. It makes all the suffering worthwhile. Somehow I’ll make it through the next day. (Groan!)

  36. Gravatar of cato cato
    8. September 2011 at 23:17

    w.peden,

    thanks for replying, i know this should be the case, but how does the accounting actually work.

    if a bank buys a bond (swaps cash for the bond) don’t cash assets decline by X while other assets increase by X.

    ..

    also, slightly different topic, what are the people called that think OMO doesn’t do anything because it swaps cash for short term t-bonds which are like cash…whats that school of thought? (i don’t subscribe to this, btw)

  37. Gravatar of Rien Huizer Rien Huizer
    9. September 2011 at 00:03

    Scott,

    You must be ready to retire now. Only a few ignorants (= people who do not know ” Very few people know what Avant and Yglesias and us quasi-monetarists know-that the only solution for the recession is faster NGDP growth, and only the Fed can deliver it”) left after all this media pressure has found its way into relevant heads.

    What is there left to achieve, and worse, what if this gets tried (Perry will of course punish anyone who saves the economy in an election year, so stay away from the Mason-Dixon line, but that is a sidetrack) and does not work?

    I like the idea, am all for trying something new that appeals intuitively to me, biut how do you make this work in a way that the accountability lawyers are convinced that doing this, without proper models, precedents and bullet-proof design, does not expose the Fed and its staff to criticism that could have effects on that staff. Let’s keep it for the next bounce of the recession, say 2014/5. Under President Paul.

  38. Gravatar of Tomasz Wegrzanowski Tomasz Wegrzanowski
    9. September 2011 at 01:15

    > If the government is so monumentally stupid that it hasn’t spent a few million dollars to create and subsidize trading in an NGDP futures market,

    Just open a few such markets on intrade.net play money servers and try convincing people to bet on them. This would take you one evening of your life, a few posts to start it, and a post every now and then to keep it going.

    Or you could ask intrade.com real money markets to run it, but US has weird anti-gambling laws, so it would be mostly Europeans who could bet there.

  39. Gravatar of Omelettes | Eggshells and Fury Omelettes | Eggshells and Fury
    9. September 2011 at 02:20

    […] Posted on September 9, 2011 by sanchk Scott Sumner, vindicated (Money […]

  40. Gravatar of W. Peden W. Peden
    9. September 2011 at 03:56

    Cato,

    “if a bank buys a bond (swaps cash for the bond) don’t cash assets decline by X while other assets increase by X.”

    Let’s see how this isn’t the case in two different kinds of case-

    1. The bank buys a bond from another financial institution. Unless the bank decides to pay cash-in-hand for some reason, it creates a new deposit and uses this as a liability on its cash reserves in order to purchase the bond. So, to simplify, if we have two banks with the following balance sheets-

    BANK 1

    — Assets —

    Loans: 70

    Securities: 22

    Cash reserves: 5

    Other assets: 2

    — Liabilities —

    Deposits: 65

    Borrowings: 22

    Shareholder’s equity: 15

    &

    BANK 2

    — Assets —

    Loans: 70

    Securities: 25

    Cash reserves: 2

    Other assets: 2

    — Liabilities —

    Deposits: 65

    Borrowings: 22

    Shareholder’s equity: 15

    – then the purchase of 3 whatevers’ worth of bonds from bank 2 by bank 1 leaves them with the following balance sheets-

    BANK 1

    — Assets —

    Loans: 70

    Securities: 25

    Cash reserves: 2

    Other assets: 2

    — Liabilities —

    Deposits: 65

    Borrowings: 22

    Shareholder’s equity: 15

    &

    BANK 2

    — Assets —

    Loans: 70

    Securities: 22

    Cash reserves: 5

    Other assets: 2

    — Liabilities —

    Deposits: 65

    Borrowings: 22

    Shareholder’s equity: 15

    – note that the net cash reserves is unchanged, which demonstrates what Irving Fisher noted: any closed system cannot shed itself of excess cash. Assuming that the banks’ preferred asset portfolio has 25% securities and 2% cash reserves, now bank 2 has excess cash! The only way of attaining equilibrium is-

    2. The bank buys a new security. Say it buys the security from a corporation. When a bank buys a bond, it pays for it with a totally new deposit; recall that assets = liabilities. So enough new corporate bonds to reach its desired cash ratio, bank 2’s balance sheet looks like this-

    BANK 2

    — Assets —

    Loans: 70

    Securities: 173

    Cash reserves: 5

    Other assets: 2

    — Liabilities —

    Deposits: 214

    Borrowings: 22

    Shareholder’s equity: 15

    (Note that bank 2 is not yet in equilibrium, e.g. its loans as a proportion of its portfolio are still below its desired level. In a real case, the bank would go to a lot of effort to maintain this level by extending loans whenever it could. It would also be much more able to raise equity, given the expansion of its deposits-to-liabilities ratio.)

    In this simplified economy, the volume of deposits has increased to about 215% of its original level, all because of a 3% increase in the cash reserves of one bank!

    A good little list to remember is the 3 ways that deposits are created in modern banking-

    1. A customer deposits cash in the bank.

    2. A bank extends a loan to a customer.

    3. A bank buys a security.

    The reason I like to look at the effect of OMOs on #3 is that it shows how an increase in the money supply can result from an increase in the monetary base [i]even without an increase in loans[/i]. There are obviously other channels, most notable: an increase in asset prices from the “dance of the dollar” within the financial system, which I described in a simplified two-bank economy above, makes banks more willing to extend loans and customers more willing to borrow.

    “what are the people called that think OMO doesn’t do anything because it swaps cash for short term t-bonds which are like cash…whats that school of thought?”

    It’s not so much a school as a theory-

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

    – which, like all theories of endogenous money, is largely a product of a narrow view of banking e.g. treating banks as if extending loans were the only means of creating liabilities to the public.

  41. Gravatar of Bonnie Bonnie
    9. September 2011 at 04:29

    “No more fiscal multipliers. No more broken windows fallacies. No more confusing of structural and demand problems No more mercantilist arguments for reducing unemployment.”

    Herein lies the problem of why we’re not likely to see a full-blown NGDP level-targeting regime, ever. These other things provide too much political expediency, too much need for politicians to “fix” things they don’t want anyone to know they broke, and more benefits for legalized extortion and cronyism in the political system. Providing a more honest, stable, and market driven and ordered system means giving up power and all the perks that come with it.

  42. Gravatar of W. Peden W. Peden
    9. September 2011 at 05:18

    Bonnie,

    Perhaps, but one could have said the same thing about inflation targeting in 1961. After all, fiscal multipliers and broken windows fallacies don’t really have a place in understanding inflation targeting economies either.

  43. Gravatar of flow5 flow5
    9. September 2011 at 05:33

    central bank should create NGDP futures contracts”

    NO WAY. Historically, speculators have been no more accurate in the economic assessments than professional gDp forecasters.

    The correct method (and most current indicator), is to use the old bank debits metric. It is an historical fact, economic prognostications are infallible (for less than one year).

  44. Gravatar of Rob Rob
    9. September 2011 at 05:33

    But Scott, you answer your own question. Your personal infrastructure (toilet, basement) is in shambles. It sounds like the perfect summer job!

    If only you had a broken window…..!!

  45. Gravatar of MikeDC MikeDC
    9. September 2011 at 06:01

    W. Peden,
    They do if the target is ultimately created through a political process. That’s the point I’m largely trying to make above. I see two major components to what Scott’s ideal monetary regime, and I think the emphasis is largely on the wrong one. That is, yes, NGDP targeting is maybe/probably better than inflation targeting, but it’s still a system where political appointees take a swag at the target. Saying anything between 3% and 8% is “fine” is not a credible spread.

    That’s why the futures market is such a great idea. With NGDP targeting, it’s automatic and self-correcting. We can’t screw it up.

    Put another way, the monetary crisis since 2008 hasn’t been due to inflation targeting. It’s been due to missing the inflation target. Human error. Replacing inflation targets with NGDP targets doesn’t get us very far if we’re still relying on an extremely fallible set of people to make the decisions.

    Beyond that, while we really don’t know what the hell we’re doing when it comes to inflation targeting, there’s at least pretty substantial research on the question of what the target should be. Which is, you know, a better start than “the actual target doesn’t matter”.

  46. Gravatar of pct pct
    9. September 2011 at 07:01

    Get a Toto. They flush reliably.

  47. Gravatar of B B
    9. September 2011 at 07:28

    I’m TAing intermediate macro right now. The IS-LM made no sense to me when I was an undergrad. And worse I didn’t know why I was confused, which I think is the biggest sin of all. Not my sin, but the sin of people that try to teach a bastardized simple version of the model in the second week of a junior level class.

    Only after reading Nick Rowe’s many posts have I started to understand things. And the more I understand, the more I hate the undergraduate treatment of macro.

  48. Gravatar of Russ Anderson Russ Anderson
    9. September 2011 at 07:35

    “It’s almost pathetic to listen to NPR these days. You have all these earnest liberals”

    Why do you always give conservatives who oppose more NGDP a pass? Many liberals may be clueless, or in the case of Krugman sceptical of monetary only solutions, but they are not openly hostile to more monetary stimulus the way conservatives/republicans are. Conservatives like John Taylor are openly opposed to more easing: “So I think the economy would be better off if the Fed started moving to a higher funds rate now rather than later, and I certainly see no rationale for another round of quantitative easing. Unfortunately, it looks like the Fed will continue with its zero interest rate for a while longer, and traders will continue to debate whether or not there will be a QE3 adding volatility to the market.” http://johnbtaylorsblog.blogspot.com/2011/05/taylor-rule-recommends-raising-rates.html http://johnbtaylorsblog.blogspot.com/2010/11/certainly-milton-friedman-would-not.html

    Likewise Republican politicians like Mit Romney and Rick Perry are openly hostile to more easing. Why do they get a pass?

    While NPR has been pathetic, conservative talk radio has been MUCH WORSE.

    “Only the Fed can to that. We need to wake up Congress, the WaPo editorial board, and all the other movers and shakers.”

    Why give the Fed a pass? The Fed is _supposed_ to have real economist that understand issues like NGDP or the lack thereof. Instead Minneapolis Fed’s Narayana Kocherlakota is out insisting the economy does not need additional accommodation. “Kocherlakota says standard rules of monetary policy seem to call for the central bank to stand pat or even starting to raise interest rates. ” http://minnesota.publicradio.org/display/web/2011/09/06/economy-doesnt-need-additional-stimulus-banking-head-says/

    The irony of course is expecting Congress, the WaPo editorial board, and “other movers and shakers” to force the Fed to DO THEIR JOB. In a sane world it would be the Fed that explains economics to politicians, WaPo editorial board, and “other movers and shakers”, not the other way around. Of course that is what is happening, except the Fed IS WRONG.

    “I wonder how the hawks at the Fed can be so confident that more stimulus wouldn’t help those people.” Easy, they listen to John Taylor and conservatives insisting that the Fed should raise rates and more easing is not needed. Are you really unaware of conservative/republican open hostility to Fed easing?

  49. Gravatar of johnleemk johnleemk
    9. September 2011 at 07:44

    Same here, B. I wish I had the time to read Nick Rowe more regularly, but what I have read helped clarify IS-LM. I just could not understand it as an undergrad, and am not sure I understand it now.

  50. Gravatar of morgan warstler morgan warstler
    9. September 2011 at 07:46

    MikeDC

    God I hate when you guys do this. IF WE HAD been targeting NGDP we would have raised rates in the mid wights and gone through the structural reforms we are going through.
    We never would have hired or given raises to so many public employees because tax receipts would have been lower.

    Wages would be lower at the low end, necause construction wouldn’t have taken off. We’d likely be even more digital than today as lower revenues would have forced greater productivity gains.

    All roads lead to Rome, in practice Scott’s system ends euphorphia when we stop paying attention to the Nicole’s and dimes. THAT is the real benefit.

    One way or the other employing people at the bottom will result in less in nominal terms for the rest of the folks at the botttom.

    Think of the employed as a giant union and the unemployed as scabs… Scott’s system busts that union up to give the scabs jobs too.

  51. Gravatar of morgan warstler morgan warstler
    9. September 2011 at 07:48

    Posting mobile in new browser doesn’t work

  52. Gravatar of Richard W Richard W
    9. September 2011 at 10:43

    Russ Anderson
    9. September 2011 at 07:35

    ” Likewise Republican politicians like Mit Romney and Rick Perry are openly hostile to more easing. Why do they get a pass? ”

    I don’t think Professor Sumner gives them a pass. For instance, he called Perry ‘ truly evil.’

    http://www.themoneyillusion.com/?p=10540

  53. Gravatar of Full Employment Hawk Full Employment Hawk
    9. September 2011 at 10:59

    “Likewise Republican politicians like Mit Romney and Rick Perry are openly hostile to more easing. Why do they get a pass?”

    It is time for RomPerry to replace DeKrugman as the axis of evil.

  54. Gravatar of johnleemk johnleemk
    9. September 2011 at 11:04

    Russ Anderson,

    Like Scott I blame the progressives more. They keep wasting their time and energy on pointless bullcrap like the healthcare law and new fiscal stimulus that won’t create a fraction of a percentage point of the jobs necessary to bring the economy back. Ask any garden variety progressive about monetary policy, and they won’t give a crap, when unlike the Republicans, they are the ones who actually are supposed to care about job creation, protecting the middle class, etc. Ask any garden variety conservative about monetary policy, and they’re freaking out about >2% inflation being the death of the dollar.

    Until the left liberals attack the conservative rhetoric about monetary policy, instead of shrugging their shoulders, there will be zero traction for monetary easing politically. The Fed needs political cover to ease — by de facto it already has lost its independence. Morgan’s idea that conservatives will support easing once one of their own is in office is interesting, but I have little appetite for waiting a year or two and hoping that President Perry or whoever won’t **** up. (One ok thing about President Romney is that it’s more plausible he’d listen to good advice about monetary policy once in office — isn’t Mankiw advising him?)

    What’s so frustrating about the left is that they actually share the goals of quasi-monetarism, but are spinning their wheels focusing on the totally stupid way to actually reach our shared goals of minimal unemployment and economic suffering.

  55. Gravatar of MikeDC MikeDC
    9. September 2011 at 12:22

    johnleemk,
    Perhaps you only think you share those goals with the left. I’ve never seen much evidence that they have the goals you outlined.

    On the flip side…

    Morgan,
    It’s just as easy to imagine Scott’s system in the hands of fallible bureaucrats and politicians making the same sorts of mistakes they make with every system. That’s why the truly novel part of Scott’s system would be taking it out of their hands altogether.

  56. Gravatar of Morgan Warstler Morgan Warstler
    9. September 2011 at 12:52

    MikeDC,

    I’m in agreement, but Scott brings a couple things to table:

    1. Liberals have to give up fiscal. After all the fed neutralizes it. Near as I can tell this is really Sumner’s.

    2. The Fed gives up control. This is Friedman’s, with Sumner twists, in particular futures.

    3. Immediately structural issues are exposed. And under a Sumner NGDP regime, slashing sticky wage policies is a moral good without argument.

  57. Gravatar of beowulf beowulf
    9. September 2011 at 14:46

    I spent lots of time studying the 1930s, when FDR routinely moved the price of gold around as a lever of monetary policy, and all the markets responded exactly as you’d expect if the policy was credible and effective.

    True, but FDR’s pajama blogger work habits were a bit unsettling.
    “Congress gave the president the power first to seize the private gold holdings of American citizens and then to fix the price of gold. One morning, as Roosevelt ate eggs in bed, he and Secretary of the Treasury Henry Morgenthau decided to change the ratio between gold and paper dollars. After weighing his options, Roosevelt settled on a 21 cent price hike because “it’s a lucky number.” In his diary, Morgenthau wrote, “If anybody ever knew how we really set the gold price through a combination of lucky numbers, I think they would be frightened.”
    http://www.fee.org/articles/great-myths-of-the-great-depression/

  58. Gravatar of Scott Sumner Scott Sumner
    9. September 2011 at 16:51

    I’ll skip over a few social remarks posts:

    Patrick, Martin and Bill have the right paper.

    TA, That’s one example.

    bababooey, Good one.

    FEH, I laughed a few months back with DeLong had a post “Sumner Plumps for NGDP targeting.” That would be like someone in 1980 saying “Milton Friedman joins my crusade for money supply targeting.”

    cato, If I’m not mistaken a lot of the IOR goes to foreign banks. I’m not particularly nationalistic, but I think the public might have a problem with that.

    Marcus, But the Fed denies they are inflation targeters!! They have a dual mandate. So how can Ip talk about new regimes? NGDP is a way to address the dual mandate. In any case, inflation has averaged 1% for three years–so they should have a dramatically more expansionary policy even if they don’t care a fig for the suffering of 15 million unemployed.

    And it’s a bit late to talk about not trying new things in an emergency–they Fed’s done all sorts of new things.

    MikeDC, I’m a realist. If they do NGDP it will be 5%, not 7%. But even 5% is more expansionary than we have now. It would probably be about 1.5% inflation and 3.5% real. Not great, but better than the last year.

    Liberal Roman, Morgan has assured us that Perry will become a dove once he’s elected. I trust Morgan.

    Mark, Sounds like your problems are worse than mine.

    Rien, I’ve said many times that all my work is for the next recession. Milton Friedman’s work didn’t pay off until the 1982 recession. Did I just compare myself to Friedman? I really need to take a break.

    Tomasz, I don’t have enough money to subsidize it.

    Bonnie, Good point, but I like Peden’s counter as well.

    flow5, You said;

    “NO WAY. Historically, speculators have been no more accurate in the economic assessments than professional gDp forecasters.”

    They don’t need to be. The forecasters knew money was way too tight in late 2008.

    B, Nick’s great, I plan a post.

    Russ, You said;

    “Why do you always give conservatives who oppose more NGDP a pass?”

    Like when I criticized Anna Schwartz? Or the post on Meltzer? Or the post trashing Forbes? Or the recent post calling Perry “evil?”

    You said;

    “Why give the Fed a pass?”

    I guess you don’t read my blog very often.

    johnleemk, I don’t blame the liberals more. The right is more to blame for the recession.

    beowolf, I cited that story in one of my papers. I love it because it’s a rare example of a 100% exogenous policy shock.

  59. Gravatar of steve from virginia steve from virginia
    9. September 2011 at 16:59

    Hello. Mr Entropy here!

    “we need 10 million jobs. Only the Fed can to that.”

    The Fed will need a much bigger ‘Fed’ building. I don’t know what those ten million Fed employees will do with themselves. Maybe they can stamp out little gold coins by hand …

    Funny, the Fed can’t print oil, which is what your waste-based enterprises run on. Hah! Your Fed cannot even make monetary policy, that is, it cannot set the value of money. This is done by millions of stupid motorists around the world every day pulling up to the pump. They exchange on demand dollars for a valuable physical good. This makes the dollar a hard currency, which is the trap that your Fed cannot escape, regardless of his knavery, his manipulations, his wiles and his accomplices.

    Heh, heh … burning that valuable physical good up for absolutely zero return … Wow. Good thing you humans cannot burn your gold or you would be doing so right now!

    Since the gasoline/dollar swap sets the value of dollars (and the other internationally traded currencies) what is it that the Fed does, again?

    Bernanke has no control over GDP, I do. I make all the rules and they are iron. From more to less, from order into chaos, from complexity into simplicity, without end, Amen! How do ya like me, now? There is nothing you or anyone else can do to create more GDP growth, no matter what animal sacrifices you attempt. It’s too late, you could have taken caution back in the early 1970s when your country’s energy production slipped into terminal decline but you decided to cheat me, instead. You bought some fun time but you traded away all of your other resources for it and now your time — and the world’s cheap oil — has run out.

    Having a central bank set a NGDP target is the exact same thing as Michele Bachmann claiming that she can bring back $2 gas. She can … at the end of a cascading deleveraging event which reduces your country to ruin. She might indeed trigger such an event, if given the chance.

    If she doesn’t, someone else will. It’s entropy.

    Let me tell you something, you better listen and listen well because I am in no mood to fool! One way or another I am coming to ruin your f*cking day and smash your toys and your vanities to dust …

    … and there isn’t a goddamned thing you can do about it but make things worse.

    The road you fear to tread is the one you are on …

    Mr Entropy signing off. Have a nice day, suckers.

  60. Gravatar of johnleemk johnleemk
    9. September 2011 at 17:36

    MikeDC,

    I pal around with enough Tea Partiers and socialists to know that “They don’t really mean that, the socialists/Tea Partiers want to destroy our economy!” isn’t a fair representation of a lot of people’s views. I’m sure it’s a fair characterisation of some people’s views (Michele Bachmann, probably) but there’s a reason the Marxist view of false consciousness never really caught on. Occam’s razor…

    Scott,

    Fair enough. I think conservative economists definitely deserve more blame. The liberal economists mostly escape it because most of them have returned to the fold of orthodox macro after spending a couple years chasing the wild goose of fiscal policy. (Having said that, Larry Summers has been a huge disappointment.)

    On the political side however, the left liberals had a brilliant chance to save the economy and strengthen public support for them and their goals with better monetary policy. What did they do with the presidency and Congressional majorities instead? Waste it on a useless healthcare law and ineffective fiscal stimulus packages. From the political standpoint, I would blame the Democrats, although the Republicans deserve no praise.

  61. Gravatar of How to Make Central Banks More Accountable For Passive Tightening-Economic News | Coffee At Joe's How to Make Central Banks More Accountable For Passive Tightening-Economic News | Coffee At Joe's
    10. September 2011 at 05:20

    […] judged in real time would make it far more accountable. This is why Scott Sumner has been arguing for it for so many years.  And this is why we need it so badly […]

  62. Gravatar of ssumner ssumner
    10. September 2011 at 06:24

    Hi Mr. Entropy. How’s it going?

    Johnleemk, Yes, it was a wasted opportunity.

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