Let’s filter out the noise and look at three big turning points:

1.  The 1930s:  A deep and prolonged deflation from 1929 to 1933 was associated with sharply higher unemployment.  Economists drew the conclusion that policymakers needed to err on the side of expansionary policies, to prevent a repeat of the Great Depression.  They did.  And it worked.

2.  The Great Inflation (1966-81):  Higher and unstable inflation was associated with several problems such as unstable unemployment and distortions in capital markets.  Though not as bad as the Great Depression, economists agreed that the Fed needed to hold inflation at low and stable levels.  They continued to view business cycles as a significant problem, but noticed that the worst cycle in recent decades (the recession of 1981-82) was caused by a sharp slowdown in inflation. Thus inflation targeting should also stabilize growth, killing two birds with one stone.  They said we needed a Taylor-Rule type policy to stabilize inflation around 2%.  They succeeded.  No more Great Depressions and no more Great Inflations.

3.  The Great Recession:  Now economists noticed that even if inflation was pretty well anchored, we could have quite a bit of real instability.  Once low rates of inflation were achieved, it seemed like high and unstable unemployment was a much bigger problem than modest variations in inflation (say in the 0% to 4% range.)  Now we need a nominal aggregate that will stabilize output better than an inflation target, while still producing fairly well-anchored inflation over the business cycle.  That’s going to be NGDP targeting, or something closely related.   It will happen. And they will once again succeed.  And then no more Great Depressions and no more Great Inflations and no more Great Recessions.  That’s called progress.

Economists on both the left and the right are gradually moving to NGDPT.  Nick Rowe says that what convinced him is that it would have done much better in the recent severe business cycle. Severe problems are the problems you most want to prevent.  NGDPT does that.  Just today commenter W. Peden pointed to an endorsement of George Selgin’s (closely related) productivity norm by Allister Heath in The Telegraph.   He offers a conservative version of the idea, but center-left economists like Michael Woodford, Christy Romer and Jeffrey Frankel are also switching to NGDP targeting.

This isn’t rocket science–economists learn fairly predictable lessons from each major policy failure. This one is no different.  Central banks are conservative institutions so it will take a while for it to show up in the actual policy.  But you can be sure they are paying attention, and know that NGDPLT would have done better than IT in 2008-09. (Of course when I talk about central banks understanding what went wrong I am excluding the ECB.  There are in an entirely different category–still working on the lessons form the 1930s.)

The intellectual battle is almost over—time to consider what will go wrong under NGDPLT, and start working on the next improvement in monetary policy.  I vote for nominal aggregate labor compensation (per capita) targeting as the next iteration.

PS.  Check out Joe Leider’s blog, which makes some nice market monetarist arguments.

We plan to wrap up the donations for iPredict this week.  We will look at where we are at that time, and then Ken will also make a donation.  Hopefully the market will be up and running soon.  BTW, the Hypermind full year contract is at 45 (4.5%), I hope to have the link embedded here soon, but for a low tech guy like myself the wheels turn slowly. . . .

PS.  Benn Steil and Dinah Walker have a good post on monetary offset.  Mark Sadowski did some similar empirical work last year, and reached the same conclusion.

I have spent the past 6 years trying to do two jobs at once, my teaching job at Bentley and lots of blogging/writing/speaking on monetary reform.  I am pleased to announce that from now on I’ll be able to focus on monetary policy. Through a very generous donation of Kenneth Duda (a Silicon Valley entrepreneur who is supportive of market monetarism), the Mercatus Center has created a new program on monetary policy, and appointed me as director.  I’m sure people will have some questions about this, so let me provide a bit more detail.

A few months back I began raising money to set up a NGDP futures market.  At the time, Ken Duda offered to support the project with a large donation.  He also expressed an interest in supporting my NGDP targeting in any way he could. Initially he suggested setting up a foundation to promote monetary reform, and having me direct the foundation.  I thought it might make more sense to work within an institution such as a university or a think tank, where I could get managerial support.  We eventually decided to embed the project within the Mercatus Center.

The Mercatus Center is a bit different from Washington DC think tanks.  It is often regarded as the world’s premier university-based research center with a focus on free market ideas. I was reassured by the fact that Mercatus is attached to George Mason University (my favorite econ program), and that Tyler Cowen is the Chairman of the Board. One nice thing about Mercatus is that they are focused on funding serious academic research, and don’t insist that researchers follow any particular party line.  I’ve done three papers for Mercatus in recent years, but they’ve also funded other researchers with very different views of monetary policy.

Here I might add that at this stage of my life I’m not too worried about a lack of academic freedom. I’ve always been the type to say what I thought, even though my research topics were so unconventional that I often had a hard time getting published, and almost didn’t get tenure. Nonetheless, it’s nice to be in a situation where no one is likely to question my academic independence.  Not only does Mercatus allow me academic freedom, Ken Duda also wants me to follow the implications of my research where ever it leads, even if it leads me away from NGDP targeting.

As you might expect from someone who has donated money to both MoveOn.org and Mercatus, Ken Duda is not a strongly partisan or ideological person.  He has told me that he’s basically a pragmatist, who became very frustrated by the condition of the US economy after 2008 and thought that my monetary policy ideas made sense.  He’s been a long time reader of my blog and has commented on numerous occasions.

I actually wouldn’t have had any problem taking a position funded by a much more partisan donor, and/or at a highly ideological think tank.  My policy is to always say what I think and let the chips fall where they may.  But I can’t deny it’s nice to be involved with a donor and research center that encourage academic freedom.

Although I am done teaching, I will actually be a Bentley employee for another 18 months, and after that I hope to maintain my Bentley affiliation through some sort “emeritus” relationship.  I will continue to live in the Boston area, although long term we plan to retire in Southern California. (In a sense I’ll never retire, as I’ll keep promoting NGDP.)  My contract with Mercatus runs through mid-2018.  I won’t discuss the monetary details, other than to say I’ll make roughly as much doing this project over the next 3 and 1/2 years as I would have made teaching at Bentley over the next 2 and 1/2 years.  More work for the money, but that’s fine as I won’t be so stressed trying to do 100 things at once.

I hope to achieve many goals, but the one that might be of greatest interest to MoneyIllusion readers is a book on NGDP targeting and market monetarism, based on this blog.  Mark Sadowski has agreed to work as a research assistant on the project.  I also hope to support academic research that provides more “rigorous” empirical and theoretical support for NGDPLT and related ideas. And I’ll continue to do shorter papers, op eds, speak to academics, business people and policymakers, work on the NGDP futures markets, etc.

And of course I’ll keep blogging here and at Econlog.

I’ve known this was likely to happen for several months, but kept it secret until the funding was in place.  Even my colleagues didn’t know (except my chair.)  It was a bittersweet feeling going down the final stretch last semester after 34 years of teaching.  I always envisioned telling my students it was my last class, but life never plays out as you envision it will.

I’ve started noticing restaurants that offer senior discounts to the over 60 group, a milestone I’ll reach later this year.  But you know what they say, 60 is the new 50.

PS.  I have a new post at Econlog on the zero bound problem.

Update:  Stocks open sharply higher on the news!  🙂

A number of Keynesian bloggers have recently expressed dismay that the rest of us don’t buy their model.  Maybe it would help if they’d stop ignoring our criticisms of their model, and respond to our complaints.  Here are some questions:

1.  What is the proper measure of austerity?  The textbooks talk about deficits.  But most of the Keynesian bloggers focus on government purchases.  So which is it?  And if it’s purchases, why did these same bloggers claim that austerity would result from big tax increases in the US in 2013, and a big tax increase in Japan in 2014?  And why does the measure chosen (ex post) usually seem to be the one that best supports their argument in that particular case?

2.  Why do Keynesians show cross-sectional graphs of fiscal austerity and growth, mixing in countries that have their own independent monetary policy, with those that do not? (I.e. those lacking monetary offset.)  And why don’t they respond to criticisms of those graphs?  And why tout cross-sectional studies of fiscal policy at the level of American states, when no American state has an independent monetary policy?

3.  Why claim that fiscal policy can be effective in the special case where a country is at the zero bound, and then claim that austerity caused the eurozone double-dip recession even though at the time the eurozone was not at the zero bound?  The eurozone’s positive interest rates were prima facie evidence that the ECB had inflation right where it wanted it until 2013, or else they would have further cut their interest rate target.

4.  When claiming that fiscal austerity reduced aggregate demand, why do Keynesians almost always provide data for RGDP growth, when NGDP growth is a much better proxy for AD?  NGDP is a direct test for AD shocks, whereas RGDP can be impacted by either AD or AS.  RGDP doesn’t show AD changes, it shows aggregate quantity demanded.  RGDP rose in the US between 1865-96, was that more AD, or more quantity demand as supply rose?

5.  The transmission mechanism between AD and RGDP in the Keynesian model runs through jobs.  So why claim that low British RGDP growth was due to austerity when in an accounting sense it was almost all productivity—employment keeps hitting record highs?  Is there a new Keynesian model I don’t know about where austerity kills output without killing jobs?  A sort of reverse neutron bomb?

6.  Why did Keynesians say that 2013 austerity in the US will be a test of market monetarism, and that slow growth in Britain “proves” austerity doesn’t work, but then when 2013 comes out with almost twice the US RGDP growth as 2012 (Q4 over Q4), they suddenly say that anecdotal evidence doesn’t matter?

7.  Why act like anti-Keynesians are bizarre heterodox economists, who reject mainstream macroeconomics, when it is the modern Keynesians who have recently rejected the claim in the #1 monetary textbook in America that monetary policy remains effective at the zero bound. Keynesians have walked away from the standard textbook natural rate model that after 4 or 5 years wages and prices will adjust to a demand shock and employment will go back to the natural rate. Keynesians now talk about “paradox of toil,” and claim that employer-side payroll tax cuts (or wage flexibility) are not expansionary.  Keynesians now claim that extended unemployment insurance doesn’t increase unemployment, even though they once said it did, and empirical studies show that the effect on unemployment was even positive in cities with extremely high unemployment rates.

Here’s Paul Krugman in 1999, a year after he wrote his famous “expectations trap” paper of 1998:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?

Yes, and when you are done then please explain it to me.

Update:  I’d also love to know what Keynesians think of the Dems having a socialist as their lead member on the Senate Budget Committee, who then appoints a MMTer to be chief economist. And Krugman says the GOP relies on voodoo economics!

HT:  Jon

Back in 2013 I argued that the low Labor Force Participation Rate was not evidence of lots of labor market slack:

It’s true the payroll gains and falling unemployment rate overlook the low labor force participation. In my view the falling LFPR is not a cyclical issue, even though the variable is itself cyclical.  This is very confusing to most people.  Imagine a LFPR that has a strong downward trend for structural (non cyclical) reasons.  Also assume the actual LFPR falls in a more cyclical pattern, falling steeply during recessions and leveling off during booms.  The level periods look like “nothing happening,” whereas the LFPR is actually growing relative to the declining trend line.  My prediction is that the LFPR will stay low even after we recover from the recession, and we always recover from recessions.  It’s not a cyclical problem.  This will become obvious by 2016.

Last October I explained the point further:

I noticed that the labor force participation ratio fell to 62.7%, the lowest rate since February 1978. Folks, it’s not coming back.  In less than a year the recession will completely end and we will get a normal unemployment rate (about 5%).  Jobs will be available and those people simply aren’t coming back.  They are early boomer retirements (perhaps discouraged by the previous job market), disabled (perhaps partly discouraged by the job market in previous years) and young people staying in school longer, or choosing to work less (as is true in affluent towns like my own Newton, Massachusetts.)  It pains me to say this but it’s pretty clear they aren’t coming back””the job market is good enough where the LFPR rate should not still be falling, if it really were nothing more than discouraged workers sitting there ready to plunge in again when things got a bit better.

Now it’s 2015 and the progressive mainstream media is finally beginning to contemplate the unthinkable.  Here’s the (Keynesian) New Yorker:

Despite the subsequent economic recovery, which has now lasted for more than five years, the rate has continued to fall. Last month, it stood at just 62.7 per cent, a tie for the lowest level since 1978 (a time when more women stayed at home and did domestic labor rather than join the official workforce).  .  .  .

Most policy-makers, including Janet Yellen, the chair of the Federal Reserve, have been assuming that much of the decline is cyclical and that, as the recovery picks up, more and more discouraged workers will return to the labor force.  .  .  .

I agree with that argument: indeed, I’ve used it myself. By now, though, we should be seeing signs of the participation rate rebounding. The fact that it isn’t is somewhat alarming.

But not surprising to readers of TheMoneyIllusion.