Suddenly we have everyone from Charles Evans to Mark Carney talking about NGDPLT.  Now that the idea is no longer confined within the tiny market monetarist community, perhaps it’s a good time to re-examine how policymakers stack up using this benchmark.

The US experience is well known.  Our NGDP is up 9.59% from 2008:2 to 2012:3.  If it keeps chugging along at 1% per quarter it will be up 12.9% by 2013:2, a period of five years.  Recently I decided to take a look at the European numbers, but I never seem to be able to find NGDP numbers for the eurozone.  Fortunately one of my best students ever (Garrett MacDonald) sent me the data.  I knew it would be bad, but I expected bad like the US, not bad like Japan.

Eurozone NGDP is up only 2.47% since 2008:2.  The ECB expects contraction in 2013.  I could not find NGDP forecasts, but the deflator has been rising about 1.1% per year over the past nine quarters.  So NGDP growth will probably be very low.  A reasonable guesstimate is that three quarters from now the eurozone NGDP is likely to be up about 3% from 2008:2.

If you think that the 12.9% number for the US 5 year NGDP growth rate is horrible, how can we even begin to describe 3% NGDP growth over 5 years?  Even accounting for the fact that American trend NGDP growth is a bit higher (4.7% per year over the 8 years before 2008:2, whereas in the eurozone the previous 8 years saw 4.1% annual NGDP growth), these numbers are simply astonishing.

Even more appalling is the reaction of the economics community to this NGDP catastrophe.  Consider the following two hypotheses:

A.  The eurozone crisis was caused by a lack of competitiveness in the peripheral countries, banking distress, and huge public debt problems.

B.  The eurozone problem was caused by ultra-tight money at the ECB, which caused NGDP growth to fall 18.5% below trend.

Suppose you polled economists at January’s AEA meeting.  Which one would get 98% of the votes?

Now let’s compare the two hypotheses.  Suppose tight money was the cause, hypothesis B.  What does economic theory suggest would happen if a central bank ran a tight money policy that reduced NGDP growth 19% below trend?  The answer is simple; high unemployment, lack of competitiveness, banking distress and debt problems.  Of course this theory doesn’t explain why some regions are doing better than others, but that’s true of almost any adverse demand shock.  There will be regional differences based on different industry mixes, public debt burdens, etc.

Now look at hypothesis A.  How do we account for the sharp fall in NGDP?  Recall that people like Evans and Carney are increasingly likely to see stable NGDP growth as evidence of sound monetary policy.  Are we to believe that items listed in hypothesis A just happened to coincide with the biggest NGDP crash since the Great Depression? Obviously not.  Even the proponents of hypothesis A would see a link, but presumably with causation running from A to B.  OK, but then what if the ECB had not let NGDP growth crash, what then?  If you actually believe that tight money did not cause the crisis, you’d be forced to argue that the crisis would have happened anyway, even with sound monetary policy.  That would be absurd, as it would amount to claiming that an 19% crash in NGDP growth over 5 years would not slow RGDP growth, because the “real problem” was the items in hypothesis A.  A medical analogy would be that shooting a flu patient in the heart with a 45 would not worsen their condition, as their real problem was having the flu.

Now some will argue that the ECB cannot do more, as they have an inflation mandate.  Maybe so, but let’s look at the increase in the GDP deflator over the past 9 quarters:

1.58%, 0.96%, 0.82%, 0.44%, 0.50%, 0.87%, 1.16%, 1.07%, 1.31%.

What don’t you see?  Unlike the US and Britain, I don’t see any GDP deflator rates above 2%.  Yes, the CPI has been above 2% at times, but which variable matters more for economic stability, the price of stuff Europeans consume, like Saudi oil, or the price of stuff European companies produce?  In fact, inflation is probably even lower than the numbers I just quoted, as I am pretty sure they include the recent increases in indirect taxes, which is part of the fiscal austerity.  Tight fiscal policy triggers tight monetary policy–what a wonderful system!

Even if the eurozone was still operating as a fixed exchange rate system, as in the 1980s and 1990s, this data would represent a catastrophic policy failure.  But now that they have a single currency, it’s even worse.  Now individual countries are not able to fix their competitiveness problems with devaluation.  This makes it especially important to get monetary policy right–to provide the optimal amount of AD for the overall eurozone region–not the healthiest member of the group.  How far are they from the optimum?  Angela Merkel is now suggesting that even Germany needs fiscal stimulus.  Given that the entire edifice is teetering on the edge of disaster, don’t you think the European elite would go out of their way to do whatever it could?  Look at those GDP deflator numbers again.  The ECB seems willing to cross all sorts of previous lines in the sand, with radical policies such as buying sovereign debt and bailing out banks, but isn’t willing to produce enough AD to get GDP inflation up to say 1.9%, or 1.8%, 0r 1.7%, or even 1.6%, even in a single quarter.  Are they masochists, or do they not have a clue as to what’s actually going on?

Ultimately the eurozone crisis is a massive failure of imagination among the Very Serious People than run Europe.  We have a huge demand shock creating a depression with year after year of high (and still rising) unemployment, just as all the textbooks say it should.  You have a severe NGDP growth plunge producing a debt crisis, just as the textbooks say it should.  We have low interest rates being a very poor indicator of the stance of monetary policy, just as the textbooks say it is.  And even with this massive demand shock occurring right in front of their eyes, they can’t see it.  All they can see are the symptoms, and they assume those symptoms are the causes.

We spend years trying to teach our students to get beyond the superficial “common sense” explanations of macro events, to look deeper into the root causes.  And yet when our best and brightest are faced with the defining challenge of our era, they react like a bunch of ignorant freshman students, unable to see beyond the news headlines.

PS.  Marcus Nunes has a post showing the scale of the disaster.

In the early 2000s Paul Krugman was outraged by the Bush administration’s fiscal deficits, and rightly so.  Bush ran sizable deficits during the 2001 recession, which is appropriate.  And those deficits raised the ratio of public debt to GDP, which is also appropriate.  But what Bush failed to do is pay off those debts during the goods years that followed (2004-07).  The debt ratio merely leveled off during the expansion.  Then the debt ratio rose again during the 2008-09 recession, and the subsequent sluggish recovery.  With this sort of fiscal policy the ratio of debt to GDP looks like a sort of staircase stairway to heaven; flat stretches during good years, followed by steep increases during recessions.   You need to offset the increases in the debt ratio during bad years, with declines during good years.  Otherwise you end up like Japan, with an ever-increasing debt ratio.  Instead the US and Europe seem to be edging toward the Japanese model.

Here’s Paul Krugman on the current situation:

So, in fiscal 2012 (which ended September 30) we did in fact have a federal deficit of $1.1 trillion (pdf). The question is, however, whether this deficit represents, as everyone claims, a fundamental mismatch between what we want and what we’re willing to pay for “” or whether it’s mainly just a reflection of the depressed state of the economy.

For starters, we need to be aware that we don’t need a balanced budget to have a stable fiscal situation; all we need is for debt to grow no faster than GDP. At the beginning of fiscal 2012, federal debt in the hands of the public was $10 trillion. Meanwhile, most estimates of long-run growth and inflation put them at a bit more than 2 and 2 respectively; so we can reasonably say that nominal GDP growth can be expected to be more than 4 percent per year. If debt grew at 4 percent, it would grow by $400 billion. So the deficit should be scaled down by that much.

I’d say it is a fundamental mismatch, partly because I am less optimistic than Krugman that programs like food stamps, unemployment compensation and disability will ever return to normal (I hope I am wrong.)  But mostly because I’m afraid we may become complacent if we eventually get to a stable debt/GDP ratio, with a $400b deficit.  Most likely that will occur many years into the recovery, and our “success” will be almost immediately followed by another recession, and another increase in the debt/GDP ratio.

Just to clarify, this isn’t so much a critique of Krugman’s overall views as a warning that we shouldn’t become complacent.  It’s true that some level of deficits are sustainable if NGDP is rising.  Ironically the country that this argument is most applicable to is Australia, as they seem to have decided not to have recessions.  (They lack our Puritanism.)  Yet they have a tiny national debt.  Nor do I disagree with Krugman’s view that the current budget deficit is not the big issue; it’s a lack of AD on the one hand, and a looming medical/demographic problem on the other.  And I’d add that I expect real interest rates to stay very low for many years to come.

On the other hand I expect countries with low national debts (Australia, Singapore, Switzerland, some of the Nordic countries) to do much better in future years than places like Japan and Italy, which have very large debts.  So we shouldn’t become complacent about a fiscal policy that barely reaches a stable debt/GDP ratio at the peak of the business cycle.

In conclusion, I’d rather not “scale down” the deficit by $400 billion, but rather work very hard to eliminate even that deficit, so that we can again see a falling debt to GDP ratio.  The best way of doing so?  Fiscal austerity plus a much higher NGDP target, level targeting.

PS.  Never once has anyone asked me whether I propose to target NGDP with monetary or fiscal policy.  Gee, I wonder why?

HT:  Clark Johnson

In the past I’ve often touted Singapore’s high saving model.  Last year I noted that 15% of Singaporeans were millionaires in 2010, and I predicted that the number would rise sharply over the next few decades.  The numbers for 2011 are in and the share of millionaires is up to 17.1%, nearly twice as high as the next “real country.”  (Although I suppose one could argue that Singapore, Hong Kong and Switzerland are also not real countries, as they attract the rich from elsewhere. That would make the US number one among the bigger economies.  But the number of millionaires in the US declined 2011.)

I would argue that this table actually understates Singapore’s success:

1.  These numbers exclude housing wealth (which seems reasonable) but also excludes investor-owned businesses and luxury goods.  So the actual number is somewhat higher–probably around 20%, even without housing wealth and luxury goods.

2.  Many older Singaporeans grew up in a period where Singapore was much poorer.  Thus if the current steady-state is maintained, the number of Singaporean millionaires should rise to 25% to 30% of the population, even without further rapid growth.  The younger generation will eventually include many more millionaires.

3.  This number ignores life-cycle effects, as do almost 100% of discussions of income inequality.  These are huge.  The number of very young millionaires will generally be much lower that the percentage of millionaires who are 50 or 60 years old, at least in the steady state (This is obviously less true of fast-changing countries like China.)  So if Singapore ends up with a steady state of 25% to 30% millionaires, that steady state will imply that roughly half of all Singaporeans will be millionaires at some time during their lives.

This will make the Singaporean electorate much more “conservative” i.e. anxious to have government policies that preserve wealth.  It will also allow Singapore to get away with a smaller set of social welfare programs, and lower tax rates.  A virtuous circle of growth creating good economic policies, which will create even more growth.

Could the US do something similar?  Should it try to create a country where 100 million people will become millionaires at some time in their lives?  And another 100 million will at some point become $500,000 aires, or $600,000 aires, or $800,000 aires?

I’d say the answer is yes, but I would caution that it would be much more difficult to do.  In addition to all the practical problems that will be listed in the comment section, I’d add that I expect rates of return on safe investments to remain very low going forward, even if the US government doesn’t force Americans into a Singapore-style high saving model.  And of course if it does, then real interest rates will plunge even lower.

But I also think there is something to be said for going this way, even if it did depress real interest rates further.  (I won’t insult your intelligence by explaining why Keynes’s fear that saving leads to depression is nonsense.)  The advantages to conservatives are obvious–a more sensible electorate that is self-reliant, not dependent on government programs.  But there are also huge advantages to liberals. This massive pool of saving would need useful outlets. There’s only so many more car factories or office buildings or shopping centers that could plausible be built. At some point the money would flood over (perhaps through public–private partnerships) into infrastructure, medical research, new energy alternatives, education, environmental cleanup and lots of other forms of “investment” that liberals favor.

What’s not to like?

Matt O’Brien at The Atlantic has an excellent article on the new Fed policy:

It’s okay if you have that Animal Farm feeling. There’s been a revolution, but nothing has changed. The Fed still thinks it’s first rate hike will come in 2015-ish, and it’s still buying $85 billion of bonds a month. This is a true fact. But it undersells the intellectual shift at the Fed. It’s gone from mostly thinking about inflation to creating a framework to guide its thinking about inflation and unemployment. And it’s done that in just a year. This framework, the Evans rule, is really just a quasi-NGDP target. It’s not exactly the catchiest of phrases, but NGDP, or nominal GDP, targeting would be a real revolution in central banking. In plain English, it’s the idea that central banks should target the size of the economy, unadjusted for inflation, and make up for any past over-or-undershooting. In theory, a flexible enough inflation target should mimic an NGDP target, which is why the Evans rule is so historic. It’s an incremental step on the way to regime change at the Fed.

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That doesn’t mean we should expect the Fed to move towards NGDP targeting anytime soon. A risk-averse institution like the Fed will want to see another country try it first — and it might get that chance soon. Incoming Bank of England chief Mark Carney, who currently heads the Bank of Canada, endorsed the idea in a recent speech, and British Treasury officials indicated they might be open to it too — which is significant because the British Treasury can unilaterally change its central bank’s mandate. It might not be long till NGDP targeting comes to Britain, and from there, the world. If it does, you can be sure that Charles Evans will be figuring out how to make it work here.

As far as I can tell there is a pretty strong desire on the part of both Mark Carney and the Cameron coalition government for a more pro-growth policy from the Bank of England.  A policy that would allow them to continue with fiscal austerity, while still providing for reasonable levels of demand growth.  We know that Carney has some interest in NGDPLT, as do some people in the Cameron government.  But there is also substantial opposition to abandoning the 2% inflation target.  Doing so risks a loss of credibility and confusion among the public (some claim), as NGDPLT is not well understood.   I have a proposal that would deliver at least 95% of the anti-cyclical benefits of NGDPLT, while preserving 2% inflation as a long run target.  It’s actually a variant of flexible inflation targeting, with strong NGDP stabilizing properties.  First I’ll describe the policy if we were starting from full employment.  Here’s how it works:

1.  The Treasury estimates Britain’s long term sustainable trend RGDP growth each 2 years.  Suppose the initial forecast is 2%.

2.  The Treasury instructs the BOE to set a 4% NGDP growth target for the next 4 years, with level targeting.  This would be 2012 to 2016.  The target will be updated every two years as new long term growth estimates come in from the Treasury.

3.  Suppose in 2014 the Treasury estimates Britain’s long term trend growth has fallen to 1.8%.  They would instruct the BOE to aim for 3.8% NGDP growth between 2016 and 2018.  That gives markets plenty of time to adjust.  The growth target would remain at 4.0% from 2014 to 2016.

4.  Suppose that by 2016 the Cameron supply-side reforms seem to be working, and long term trend growth is estimated at 2.1%.  Now the Treasury instructs the BOE to aim for 4.1% trend growth between 2018 and 2020.  The target remains 3.8% between 2016 and 2018.

If we started from a position of high unemployment, the initial target path would involve some catch-up in NGDP, before leveling off at the steady state.  How much is a judgment call.  After that the only discretion is the Treasury’s trend growth estimates.

To some NGDPLT supporters it might seem I’m giving away the store with this compromise.  Not so.  Trend RGDP estimates evolve slowly over time, and hence the adjustments in the NGDPLT path would be very gradual.  Now imagine a trend line with those sorts of modest adjustments superimposed over the dramatic crash in NGDP that occurred in Britain and elsewhere in 2008-09.  It’s easy to see that you’d still get at least 95% of the anti-cyclical properties in a recession, maybe even more.  Remember that at any point it time a minimum of two years in trend NGDP growth would be “locked in,” and as much as 4 years of nominal growth.  The target NGDP growth path would not be perfectly smooth, but it would be smooth enough to dramatically stabilize the business cycle.

The other advantage is that the government could still adhere to its 2% long run inflation objective.  Note that 2% inflation is the only number built in to the policy.  The NGDP target paths are those believed to be most likely to produce 2% inflation in the long run.  I don’t see how it would be wrong to describe this as “flexible inflation targeting” if the government thinks that label is essential for political purposes.  Remember, it’s not as if the current policy rigidly adheres to aiming for 2% inflation at each and every moment in time.  The BOE has already been one of the most “flexible” of the flexible inflation targeting central banks.  It’s failure in 2009 (and again in 2011) was not due to a lack of flexibility, it was due to a lack of level targeting, and a lack of recognition that NGDP, not inflation, is the key short term variable to focus on.

All the agonizing decisions about how fast to proceed with fiscal austerity are not agonizing because of how fast they might reduce inflation, they are agonizing because of worry about how fast they’ll reduce NGDP.  The public cares more about NGDP than people think; it’s just that the public doesn’t really understand the term.  They think in terms of “the economy.”  But anyone who thinks the public doesn’t care about NGDP should consider the following:  Ask people if they care about their own personal nominal incomes.  About how big a raise their boss gives them, or whether they’ll see more investment income, or whether they lose their jobs.  Then think about the fact that NGDP is simply the sum of all (gross) nominal incomes in the economy.

Yes, people also care about real incomes over time, but the central bank can’t control that in the long run.  And in the short run NGDP and RGDP are highly correlated.  So tell me again why the public doesn’t care about NGDP instability.

PS.  Astute readers will notice that I get this seemingly miraculous compromise by applying “let bygones be bygones” to errors in RGDP trend growth estimates, but adhere to rigorous level targeting of NGDP.  That does lead to a policy that fails to stabilize the price level along a 2% trend line, but we already have that sort of base drift in the price level in the various inflation targeting regimes used throughout the world.

PPS.  If the proposal is not destroyed in the comment section, I would appreciate if influential readers would pass this along to important policymakers that they know.