Archive for October 2011


We need more journalists like Kelly Evans

I had not heard of Kelly Evans until a few days ago, when I ran across an anti-NGDP targeting piece that she wrote for the WSJ.  I did a post that was very critical of the article.  Lots of people might have taken that personally, but Evans came over here and engaged in a discussion with me and the other commenters.  That showed class.

Now she has a new piece on NGDP targeting, which clearly shows that she’s done her homework.  It’s very fair, presenting both sides of the debate.

I applaud her willingness to overlook the sometimes harsh tone of blogosphere debate, and engage with those of us who are working hard to change Fed policy.

The natural human revulsion against unconventional monetary stimulus

Harvard economist Al Roth claims there’s natural human revulsion against all sorts of things.  We all know about the sight of blood or sewerage sewage.  But there’s also a revulsion against certain concepts, such as the sale of human body parts.  I’d like to add unconventional monetary stimulus to that list.

Start with the fact that getting progressives interested in the notion has been like pulling teeth—even though it fits in well with their pro-stimulus agenda.  But it’s even worse with conservatives.  I used to read the newspapers from the 1930s, and I kept scratching my head over what I read.  The conservative business press hated unconventional monetary stimulus, even more than they hated socialism.  Indeed their hatred was so intense that at times it became absolutely irrational.  This may sound preposterous, but you’ll have to take my word.  They actually claimed two flaws in monetary stimulus; it wouldn’t work (the so-called pushing on a string argument) and it would lead to hyperinflation, such as what Germany had recently experienced.  Yes, I know that both arguments can’t be true, but that didn’t stop them from making them.

At the time I assumed we were much superior.  We had models like AD/AD AS/AD that clarified things; that eliminated this sort of sloppy thinking.  But consider the following from Mikihiro Matsuoka at Deutsche Securities:

The Bank of Japan (BoJ) may conduct additional easing operations after the scheduled 27 October monetary policy meeting on the back of persistent JPY strength and uncertainty over the Euro sovereign crisis, according to an article in today’s Nikkei. The article suggested that easing options might include an expansion of the ongoing asset purchase program, with more emphasis on the purchase of long-dated government debt. In our view, it is certainly better to have something, rather than nothing. That said, if the BoJ response were to simply expand the asset purchase program, say by another JPY 5trn, we would be disappointed because it represents nothing more than their typical backward-looking, reactive response without any strategic commitment over the long-run.

The BoJ is highly unlikely to change its behavior as long as Mr Shirakawa, whose term end term ends on 8 April 2013, is in charge. He has continued to reinforce the Bank’s view that QE failed to stimulate the economy from 2001-06. But is this really true? This view does not explain why the Japanese economy enjoyed the longest economic expansion (2001-08), supported by stable and weak exchange rates, even as fiscal policy continued to tighten during those seven years. The BoJ has also made a habit of reiterating the warning that if the central bank embarks on unprecedented actions such as financing government debt, it would lead to accelerating inflation. Wait. How can this ‘ineffective’ monetary policy stimulate economic activity and lead to accelerating inflation? Obviously, these two arguments (ineffective QE and inflation fear) contradict. Until the BoJ recants their statement of ineffective QE, we cannot expect monetary policy to be used as an instrument to rescue for the Japanese economy.

OK, but we all know the Japanese have strange views of monetary policy (as Ben Bernanke informed us.)  Thank God we don’t see that at the Fed.  To be sure, there are some Fed officials who share the BOJ’s excessive fear of inflation:

Federal Reserve Bank of Dallas President Richard Fisher said the central bank faces a “significant” risk of providing record stimulus for too long and should weigh curtailing its $600 billion bond-purchase plan.  . . .

“Continued accommodation presents significant risks,” Fisher said. “In my view, no amount of further accommodation by the Fed would be wise,” whether it is adding more purchases or “tapering” the plan to purchase Treasuries beyond June.

“Indeed, it may well be that we should consider curtailing what remains” of the bond-purchase program, he said. . . .

“We’re there” in terms of the need to end accommodation now, Fisher said, when asked whether he would prefer to wait until June. He added that inflation is “not out of hand yet.”

But at least Fisher’s not also claiming that monetary stimulus would be merely pushing on a string.  Oh wait:

Until our fiscal authorities get their act together, further monetary accommodation — be it in the form of quantitative easing or performing ‘jujitsu’ on the yield curve through efforts such as Operation Twist — will represent nothing more than pushing on a string.

Oh dear, it seems to be spreading.

Seriously, here’s what I think is going on.  If interest rates were 8% right now, TIPS spreads were 1.5%, unemployment was 9.1%, and this blog recommended cutting the fed funds target to 7.5%, then NO ONE WOULD OBJECT.  Not Richard Fisher.  Not Bob Murphy.  Not Stephen Williamson.  Not John Taylor.  Not Allan Meltzer.  Not Rick Perry.  No one.

So why do people object to my proposal for monetary stimulus?  Because it’s a proposal for unconventional monetary stimulus.  For “printing money” at a time when most people (including most people who agree with me) think money is already incredibly easy.  Rate cuts are acceptable, there’s no natural human revulsion against cutting rates from 8% to 7.5%.

Now it just so happens that right now money is tighter than when interest rates were 8% in the 1970s, but you me and about 23 other people are the only humans on the planet who realize that.  Hence it seems like I’m proposing Zimbabwe, whereas I’m actually proposing a monetary policy far tighter than the one implemented by Paul Volcker.  And that’s one of many reasons why we are where we are.

Still buried with work, but enough of a break where I’ll try to start on the comments.

Supply shocks and NGDP targeting

Sorry, still no time for comments–I’ll try to get to them gradually over the next week.

Meanwhile I wanted to link to this excellent discussion of NGDP targeting by Ryan Avent:

Now, in a situation in which a central bank has credibly established an NGDP target, recessions would by definition be due to real shocks. In those cases, maintaining the target would mean higher inflation to go with lower real growth. So if the American economy is hit by a real shock, an NGDP target might mean inflation at 5% and zero real growth, rather than what we might observe today””inflation around 3% and a drop in real growth of perhaps 2%. I’m happy to have a debate about which Americans are likely to prefer, provided that we stipulate that in the meantime, the NGDP target is also preventing major episodes of cyclical unemployment. It’s worth mentioning that given a positive productivity shock, an NGDP target would imply real growth above normal levels and inflation below normal levels. An inflation-targeting central bank, by contrast, might respond by adding more stimulus to an economy, potentially inflating bubbles.

This is a good response to Kevin Drum, but I’d like to add a footnote.  Supply shocks aren’t bad because they cause “inflation,” they are bad because they reduce resources available to our society (often oil and food) and hence reduce real GDP, real living standards.  Let’s start with a perfectly flexible wage price model, then add sticky prices.  With complete flexibility, a supply shock that reduces real output by 3% might lead to 5% inflation and 0% RGDP growth (assuming a 5% NGDP target.)  That’s unpleasant.  But exactly the same reduction in real output and living standards would occur with any inflation rate, including the normal 2%, or even 0%.  With perfect wage and price flexibility, the supply shock will immediately reduce real wages, so whatever the inflation rate is, wage growth will be even lower (relative to trend.)  It makes no sense (in that case) to talk about supply shocks being bad because the cause “inflation;” they are bad because the are real shocks, they reduce real output.

Now consider the more realistic sticky wage/price case.  If the Fed keeps inflation at 2% during the supply shock, then the adjustment in real living standards must occur via nominal wage reductions.  We know that nominal wages are sticky, the evidence is overwhelming.  Thus an inflation targeting regime will lead to a situation where supply shocks push actual nominal wages above equilibrium, until they have fully adjusted.  This will lead to needless cyclical unemployment, above and beyond the direct effect of the real shock.  America will suffer from less food and oil, and in addition a wave of involuntary “vacations” due to nominal wage stickiness.  Real GDP and hence real living standards will fall by even more than in the flexible price case.  Yet when most people are told that a downside of NGDP targeting is that it will allow higher inflation during recessions, they form a mental picture of Americans suffering a loss of living standards due to the inflation the Fed is allowing during the supply shock.  In fact, just the opposite is true–any inflation allowed by the Fed raises living standards (i.e. makes the reduction smaller.)

In contrast, NGDP targeting allows just enough inflation during supply shocks so that workers don’t need to take nominal wage cuts.  The necessary loss in living standards occurs via prices rising faster than wages, but there is no unnecessary cyclical unemployment to add to our woes.  It allows the price of the two problem goods (food and energy) to rise to reflect their scarcity, but doesn’t impose all sorts of other wage and price changes on the economy.  Because wages are sticky, forcing all sorts of other wages and prices to adjust adds needless “misallocation” to the economy.  That’s why Austrians like Friedrich Hayek favored NGDP targeting.

[I love the fact that my more Rothbardian Austrian readers get enraged every time I mention Hayek.]

HT:  Marcus Nunes

About those 4 million jobs

I see that Joe Gagnon’s new housing plan has garnered attention from Paul Krugman and Matt Yglesias.   You might wonder why I call it Gagnon’s plan, not Obama’s plan.  Here’s why:

Even more important, if the Federal Reserve supported the refinancing boom by purchasing $2 trillion of new MBS, for example, the existing MBS holders would have to find another market in which to invest $2 trillion. This avalanche of money would surely push up stock prices, push down bond yields, support real estate prices, and push up the value of foreign currencies. All of these financial developments would stimulate US economic activity. Based on a recent Fed study (Chung et al 2011) Fed purchases of this magnitude would increase US GDP by more than 2 percent after about two years, creating nearly 3 million additional jobs. This estimate includes only a small part of the effects operating through the mortgage refinance channel discussed above, so that the total effects on the economy would be even larger, perhaps creating 4 million extra jobs or more.

A few comments:

1.  I don’t want to get into any “how many angels . . .” arguments here.  The plan contemplates massive open market purchases by the Federal Reserve.  I’d call that “monetary policy,” you are free to call it whatever you like.  Whatever you call it, the decision is up to Bernanke, not Obama.

2.  My hunch is that the housing refinance angle wouldn’t create many jobs.  I say “hunch” because I’m not really qualified to judge.

3.  As you know I am a big fan of Gagnon, so this post shouldn’t be viewed as criticism.  I would strongly support a $2 trillion OMP.  I don’t really have any idea how many jobs it would create, but it would be worth a shot.

Occupy the Wall Street Journal

What’s happened to the Wall Street Journal?  They seem to be increasingly veering toward the Rick Perry school of monetary analysis.  Here’s an example of an article that’s wrong about almost everything:

There are at least three problems with this [NGDP targeting] strategy, however. First, it assumes that the Fed can sensibly determine the “right” trend for nominal GDP. Second, it isn’t clear that it can actually achieve any such target. And third, doing so would run a huge risk of conflicting with the Fed’s congressional mandate to promote “stable prices”””something that can’t unilaterally be rewritten. This is because any boost to nominal GDP may well come more from higher inflation rather than from faster growth in underlying GDP, which Goldman acknowledges. After all, the economy’s real potential growth rate has been slowing for decades.

1.  But doesn’t inflation targeting also assume you can determine the “right” level of inflation?  And also determine the “right” inflation index (there are many, whereas there’s basically one NGDP.)

2.  If they can’t achieve an NGDP target, then ipso facto they can’t achieve an inflation target.

3.  There is no Fed mandate for “stable prices.”  Indeed if the Fed thought that price stability was the mandate they’d be violating the law.  The Fed mandate is stable prices and high employment.  If you targeted stable prices, you’d be implicitly putting a weight of zero on employment.  In contrast, NGDP targeting addresses both sides of the dual mandate.

I can’t imagine any reputable economist disagreeing with me on any of these three points, even if he or she hated NGDP targeting.  The WSJ is simply flat out wrong.

First, it is tempting, but probably mistaken, to assume the Great Recession came along and knocked the U.S. off an otherwise sustainable growth track. It wasn’t an external shock, but internal weakness, that led to the economy’s collapse.

One worrying aspect of GDP growth prior to 2007 was that it came even as real household incomes stagnated. Assuming that boom-era growth rates were sustainable, and not fueled by a surge in house prices and a credit boom that simply pulled forward demand from the future, is a huge leap in logic.

Um, the target is NGDP, not RGDP.

Second, even if the Fed were to aim at a particular nominal GDP target, it isn’t clear policy makers could successfully hit it. Consider how recent gains in the consumer-price index, particularly in food and energy, have outstripped any increase in wages. This has hurt real income growth, undermined consumer confidence, and weakened, not strengthened, the economy.

For the Fed to generate inflation, it needs households to believe the central bank is fueling not just higher prices but wage gains, too, so that they start spending more. Otherwise, households will simply tighten the purse strings instead.

The whole point of monetary stimulus is that wages are sticky, and hence higher aggregate incomes would lead to more jobs, and more hours worked.  “Whether households “tighten purse strings” has no bearing on whether NGDP targeting can work.  Don’t you love it how the WSJ switches over to Keynesian economics, just after they’ve trashed the idea that the economy needs demand stimulus.  Is there any model there?

In addition, the food and energy price increases are mostly supply-side phenomena.  When the Fed generates inflation, real incomes rise (assuming there is economic slack.)

Moreover, the level of general inflation it would take to transform housing, the thorniest problem facing the economy, would be huge. Boosting home prices by the 15% to 25% that Barclays Capital reckons many households are underwater “would in all likelihood be prohibitively expensive in economic and social terms,” says the firm.

That underlines the third concern. Success in nominal GDP targeting would probably mean ignoring the Fed’s current mandate on price stability. If the central bank were to even consider such a dramatic shift, Congress may want its say on the matter.

We favor NGDP targeting precisely because we don’t favor targeting specific sectors like housing.  The market should determine where the extra spending goes.

I’m tempted to say “The dual mandate; it’s not just a good idea, it’s the law.”  The WSJ might not like the actual mandate, but wishing it wasn’t there won’t make it go away.   Of course you don’t want the Fed to literally target two variables; that would create a mess.  They should target NGDP.  But they should do so because they care about economic losses created by inflation (actually NGDP growth) and unemployment.  The Congress is telling them which problems to address; they let the Fed decide how to actually implement those vague policy goals.  NGDP targeting is far more consistent with the dual mandate than inflation targeting.

Is that all they got?  Then I’m even more confident about the merits of NGDP targeting.  OK, back to grading.

PS.  I don’t have time to comment on all the stuff that has come out recently, but here are some pieces worth reading:

1.  Clark Johnson has an outstanding analysis of the Great Recession.  (Although I’d quibble slightly with his discussion of exchange rates and policy coordination.)

2.  Add Interfluidity to the list of NGDP targeting supporters.

3.  And Bennett McCallum remains the most respected NGDP advocate in the entire world (even after a certain high profile conversion.)

HT:  Marcus Nunes