Saturos directed me (via Mark Thoma) to this post by David Altig:

In the post on NGDP targeting I was in fact thinking about level targeting, and Gregor Bush’s last sentence gets to””in fact is“”the heart of our disagreement. I am just not willing to concede that anchoring long-term inflation by saying something like “2 percent, 3 percent, whatever” is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy:

I suppose I’ve also said that inflation is all the Fed can control in the long run.  But when an economist makes that claim, they implicitly mean “any nominal aggregate,” not inflation per se.  So I’m puzzled by the way Altig phrases this, as if it’s an argument against NGDPLT.

But let’s say I’m misreading him on that narrow point.  Suppose he does agree that NGDPLT is an alternative feasible target.  What about the claim that inflation credibility is important to a central bank?

I’d argue that some sort of nominal anchor is important, but it need not be inflation.  The real argument here is which of the following two is better:

1.  Unstable inflation and stable NGDP growth

2.  Stable inflation and unstable NGDP growth.

I’ve often argued that number one is better, for two reasons:

1.  Almost all the welfare problems allegedly caused by unstable inflation are, on closer inspection, actually more closely correlated with unstable NGDP.

2.  Almost all the welfare problems allegedly caused by changes in the trend rate of inflation are, on closer inspection, caused by changes in the trend rate of NGDP growth.

These include labor market disequilibrium, lender/borrower unfairness, excess taxes on savings and investment due to high inflation/nominal yields, etc.

One possible exception is menu costs of price changes.  But the differences there are slight and NGDP targeting might better stabilize input prices, especially wages.

NGDPLT also has the advantage of eliminating the perceived need for suboptimal fiscal stimulus/bailouts, etc.

It’s not about credibility.  It’s not about which variable can the Fed control in the long run.  It’s about whether the economy does better on a stable inflation (or price level) path, or a stable NGDP path.

Standard economic theory predicts that monetary stimulus boosts inflation, which helps debtors.  More specifically, it reduces the real value of outstanding debts.  The nominal interest rate on future debts may rise, but the real interest rate should not rise.  And if you are at the zero bound, nominal rates are likely to rise by less than inflation expectations.

Martin Feldstein recently argued the opposite; that a policy of monetary stimulus by the Bank of Japan would worsen their debt situation:

The interest rate on Japan’s ten-year government bonds is now less than 1% – the lowest in the world, despite a very high level of government debt and annual budget deficits. Indeed, Japan’s debt is now roughly 230% of GDP, higher than that of Greece (175% of GDP) and nearly twice that of Italy (125% of GDP). The annual budget deficit is nearly 10% of GDP, higher than any of the eurozone countries. With nominal GDP stagnating, that deficit is causing the debt/GDP ratio to rise by 10% annually.

Japan’s government is able to pay such a low rate of interest because domestic prices have been falling for more than a decade, while the yen has been strengthening against other major currencies. Domestic deflation means that the real interest rate on Japanese bonds is higher than the nominal rate. The yen’s rising value raises the yield on Japanese bonds relative to the yield on bonds denominated in other currencies.

That may be about to come to an end. Abe has demanded that the Bank of Japan pursue a quantitative-easing strategy that will deliver an inflation rate of 2-3% and weaken the yen. He will soon appoint a new BOJ governor and two deputy governors, who will, one presumes, be committed to this goal.

The financial markets are taking Abe’s strategy seriously. The yen’s value against the US dollar has declined by more than 7% in the last month. With the euro rising relative to the dollar, the yen’s fall relative to the euro has been even greater.

The yen’s weakening will mean higher import costs, and therefore a higher rate of inflation. An aggressive BOJ policy of money creation could cause further weakening of the yen’s exchange rate – and a rise in domestic prices that is more rapid than what Abe wants.

With Japanese prices rising and the yen falling relative to other currencies, investors will be willing to hold Japanese government bonds (JGBs) only if their nominal yield is significantly higher than it has been in the past. A direct effect of the higher interest rate would be to increase the budget deficit and the rate of growth of government debt. With a debt/GDP ratio of 230%, a four-percentage-point rise in borrowing costs would cause the annual deficit to double, to 20% of GDP.

The government might be tempted to rely on rapid inflation to try to reduce the real value of its debt. Fear of that strategy could cause investors to demand even higher real interest rates.hThe combination of exploding debt and rising interest rates is a recipe for economic disaster. The BOJ’s widely respected governor, Masaaki Shirakawa, whose term expires in April, summarized the situation in his usual restrained way, saying that “long-term interest rates may spike and have a negative effect on the economy.”

Feldstein’s right that the markets are taking Abe’s proposal seriously.  The yen has plunged and inflation expectations have risen.  But nominal interest rates have not risen.  When you are at the zero bound you can modestly raise inflation without any impact on nominal interest rates.  At a minimum, the Japanese government needs to raise inflation enough so that short term nominal rates are slightly above zero.  Otherwise they are leaving 10,000 yen bills lying on the sidewalk.

Just to be clear, my views are somewhere between those of Feldstein and the more extreme Keynesians.  I agree with Feldstein that Japan has big debt problems and big structural problems, and needs to address both.  And that fiscal stimulus is foolish (as even Adam Posen recently argued.)  Unlike Feldstein I also think they have an AD problem that calls for modestly higher inflation and NGDP growth.  At a minimum they should be shooting for 2% to 3% NGDP growth, instead of the negative NGDP growth of the past 20 years.

HT:  Felipe

Evan Soltas sent me the following Jim Cramer blog post, from the day I referred to in the previous post:

TheStreet.com’s Jim Cramer says the paltry half-point cut means we’re headed lower once again.

Wrong!

The European Central Bank needed to move in lock step with the Bank of England. It left us hanging with a half-point cut.

That means we’re sunk again.

The near-term tug of war just got uglier. Without the ECB cutting as much as the BOE, we have no reason to buy.

Period.

Last night, in a meeting with a bunch of hedge fund managers, there was uniform agreement that the market has to be bought with huge rate cuts, that you need to ignore the near-term Cisco (NASDAQ: CSCO) (Cramer’s Take) (to use the generic version of crummy earnings) and go with the Wells Fargo (NYSE: WFC) (Cramer’s Take) offering that will make it so lending will come again and demand be spurred.

Without ECB and BOE in lock step with huge cuts, we go down. The persistent bid — made up of the room full of people I was with last night and their ilk — needed big cuts.They didn’t get one.

They will sell.

Cisco overshadows BOE because ECB didn’t go along.

So we’ll go lower slower than we would have otherwise.

Or should I say the nominal problem . . .

There’s been a lot of discussion of the release of the 2007 Fed minutes.  I tend to agree with Matt Yglesias—the real problem was the following year.  Stocks did pretty well in 2007, until very late in the year.  It would be nice if we had an NGDP futures market and didn’t have to make inferences from equity markets, but that’s not the world we live in.  Ross Brown send me a WaPo article by Neil Irwin that’s a bit tougher on the Fed than I would be.  Still, he makes a number of good points:

One lesson here is that our public officials, even the hard-working, highly intelligent ones, are far from demi-gods. They have the same blind spots and tendency toward analytical failures of anyone else. Secrecy allows public officials, whether in the world of monetary policy or others like national security, to create a Wizard of Oz like illusion of holding great power, of maneuvering levers with information in hand that mere mortals can only dream of. When reporters interview a high official, there is often a subtext the high official aims to convey: If you knew what I know, you would understand the supreme wisdom of my actions.

Seeing what the Fed officials were saying privately, to each other, in 2007 is a reminder that this isn’t always so, and just because a person has more information, it doesn’t mean he or she has the right answer.

This is why I don’t believe our medical experts when they assure us that there is no danger from scientists experimenting with deadly viruses in the laboratory.

Irwin also made this observation:

It should also be added that there’s not much reason to think the crisis could have been prevented if the Fed had been quicker on the draw. If you honestly believe that we would have skirted recession if the Fed had cut rates by 0.5 percentage points at the December 2007 meeting, not 0.25 percentage points, you have a distorted sense of the power of a central bank to shape the course of the economy.

When put that way, it’s hard to disagree.  But FWIW, on December 11, 2007, the Fed cut rates by 0.25% and Dow finished between 600 and 800 points lower than it would have had the Fed cut rates by 0.5%.  That’s not the difference between recession and no recession, but it’s still HUGE.  And monetary policy most certainly could have prevented a severe slump.  It could have prevented me from becoming a blogger.

Still, until the December 2007 fumble I thought the Fed was doing a reasonably good job. On the other hand in late 2008 it was patently obvious that the Fed was way off course, that NGDP was falling sharply.  This is where people ought to get outraged.  But not just outraged at the Fed, it was the entire macro establishment that screwed up in late 2008.  I was watching things pretty closely by that time, and I honestly recall only one cri de coeur that was appropriately intense—by Jim Cramer of all people.  I’ve pretty much given up on ever finding it, so if you’ll allow me a bit (actually a lot) of poetic license, I’ll try to reconstruct what I recall.  It probably occurred on November 6th, 2008, and was something like this:

For a moment this morning I thought there was some hope.  The BOE cut rates by 150 basis points and the stock futures rallied.  It looked like things might finally be stabilizing in the equity markets.  Then the morons at the ECB came in with a measly 50 basis point cut and the markets tanked.  They’re killing us!  They just don’t get it!  The whole economy is collapsing and the policymakers are just twiddling their thumbs!

These are my words not Cramer’s.  If you want to see what the real Cramer sounds like, take a look at the following August 2007 video.  As I said, I think Cramer was a bit early here.  But given how things panned out he looked pretty prescient.  But by 2008 all the elite macroeconomists should have been screaming at the top of their lungs that money was way too tight.  That massive monetary stimulus was needed.  And I heard almost nothing—except Cramer’s rant.  He was in the trenches watching how the markets were reacting to the massive policy failure, so he saw what was happening much more clearly that academic macroeconomists in their ivory towers.  This rant was probably one of the things that pushed me into blogging.  It gave me hope to know that I wasn’t alone.

Thanks to Evan Soltas for sending me the 2007 video:

PS.  A few technical details.  On December 11, 2007 I recall that the Dow fell about 350 points after the 2:15 Fed announcement (the market was actually up 50 at 2:14pm.)  Fed funds futures priced in only about a 42% chance of a 0.5% cut, and a 58% chance of a 0.25% cut.  You do the math.

The S&P closed at 1005.75 on November 4, at 952.77 on November 5, and at 904.88 on November 6, 2008.

More evidence that the so-called liquidity trap is not a trap at all:

The yen hit a fresh 2-1/2 year low on Friday and was vulnerable to more losses on bets the Bank of Japan will ease monetary policy aggressively at a meeting early next week.

The dollar broke above reported options barriers at 90 yen to reach 90.21 yen on the EBS trading platform. It was last nearly flat at 89.81 yen.

The U.S. currency has gained around 14 percent against the yen since early November, but further gains were expected if Japan’s central bank takes measures beyond the market’s central expectations in an attempt to stave off deflation.

Sources familiar with the BOJ’s thinking told Reuters the central bank, under relentless pressure from Prime Minister Shinzo Abe, will consider making an open-ended commitment to buy assets until 2 percent inflation is in sight.

Yes, the BOJ may do less than expected (and I’m still skeptical):

Such an plan would exceed market expectations, which have centered on the BOJ setting a 2 percent inflation target at its two-day meeting that ends on Tuesday and possibly increasing its asset-buying program.

“A lot is priced in for next week’s BOJ meeting. If asset purchases by the BOJ were unlimited that could lead to significantly higher levels in dollar/yen and euro/yen levels,” said Peter Kinsella, currency strategist at Commerzbank. “Levels past 93 to 95 yen within the next two to three weeks is not unreasonable.”

But some analysts warned the BOJ could undershoot expectations and this could see the yen rebound.

But even the recent stock and forex market reactions to hints that the BOJ might move ahead are a pretty big problem for theories of monetary policy impotence at the zero bound.  (I’m looking at you MMTers, Wallace Neutrality fans, Krugman/Woodford expectations trappers, Cochrane FTPLers.)