It’s silly Sunday, and as I take a break from shoveling another 18 inches (plus high winds and bitter cold and ice dams causing roof leaks, etc.), I’d like to offer some thoughts on Tyler Cowen’s recent post asking whom we most admire (among people still alive.)  I’m more interested in what it means to admire someone, and also what we mean by “someone.”

I might refer to “my” arm or my kidney, or my left foot.  That suggests there is some sort of personal identity—me—that possesses these things.  And this doesn’t just apply to parts of the body, but also intangible attributes.  I could speak of Paul Krugman’s analytical brilliance, or Tom Cruise’s charisma, or Russell Westbrook’s athleticism. Then there’s my memory, or my consciousness, etc.  In the end, I’m skeptical of the idea that there is some sort of core personal identity that possesses all these things—people are probably just a bundle of attributes. It’s not even clear where “Scott Sumner” ends and “not Scott Sumner” begins.  Are my tooth fillings part of me?  What about an artificial limb (if I had one.)  In the future we may have brain implants.  How about our clothing?

One theme that comes up in Tyler’s discussion is that people seem a bit embarrassed to admire people for certain personal attributes (say artistic or athletic skill that is partly genetic) as opposed to attributes like courage and hard work, which may require lots of self-sacrifice.  Of course courage and willingness to work hard may also be partly genetic.

I also wonder whether ability to understand something reduces our admiration. The behavior of a very good person (Gandhi) or a very bad person (Hitler) seems mysterious in some way, and I think at some level we want it that way.  There’s an old saying, “to understand all is to forgive all.”  We don’t really want to be able to say, “I know how Hitler felt” because we don’t want to forgive him.  Now of course there’s something illogical about assuming that understanding goodness or evil makes it less good, or less evil, but I think that’s how most people look at things.

I have sort of contrarian views on this.  I don’t believe in free will, and yet oddly I think we should admire good people, and scorn evil people, because people react to incentives.  By admiring people who do good things, we encourage good behavior. Deep down we feel that we should devote more effort to encouraging Aung San Suu Kyi to fight for freedom in Burma, than to encourage Tom Cruise to be even more charismatic when he smiles.  So that provides some justification for thinking heroes are more worthy of admiration, although we may underestimate how much pleasure we derive from artists, athletes and other people engaged in seemingly “superficial” activities.

Not sure anyone cares, but I’ll list people I admire, in two categories.  The first is heroic figures, who fight for classical liberalism at great personal risk:

Heroes:  Aung San Suu Kyi, Liu Xiaobo

Now I’ll list people I admire for specific talents or attributes.  Oddly I don’t have any scientists, and the only economist is not admired for his economics.  If Einstein was alive I might include him, but I don’t know much about modern science.  The people I admire most for attributes is artists.  (Here I don’t care about what the person is like “deep down,” whether they cheat on their wives, etc.)  I’m most admiring of people whose achievements seem miraculous.  Recall the earlier discussion of good and evil; we want to think it’s somehow mysterious, as if demystifying the achievement would drain it of any real meaning.

Music:  Bob Dylan — My favorite living artist, even though I’m not a musically-oriented person (I prefer literature and the visual arts.)  His achievements in the first 25 years of his life seem incomprehensible to me.  Perhaps that’s because I know little about music. Please don’t demystify it in the comment section.

Writers:  Karl Ove Knausgaard, Haruki Murakami, Orhan Pamuk

Athletes:  Kareem Abdul Jabbar, Russell Westbrook, Giannis Antetokounmpo

Directors:  Wong Kar Wai, David Lynch

Actors:  Tony Leung, Gong Li

Intellectuals:  He is an infovore who’s read everything, heard everything, and travelled everywhere.  He seems to have an Apollonian view of the planet that us mere mortals struggle to comprehend.  He’s an economist.  And a blogger.  And I sort of work for him.  Can you guess?

Business:  I don’t admire business leaders, except perhaps Elon Musk

Politicians:  Can’t think of any

Good people:  Mom, former colleague Ted Woodruff

PS.  I sort of admire some other bloggers, but I decided not to start down that road, as I don’t know where to draw the line.

One of the things that makes me believe that we are on the right track is that our Keynesian critics seem unable or unwilling to respond to actual market monetarist arguments, particularly regarding monetary offset of fiscal austerity.  Marcus Nunes directed me to another example, this time from Robert Waldmann at Angry Bear:

In any case, Japanese inflation expectations appear to have been successfully managed and to have caused higher output (including construction) as should be the result of the resulting reduced expected real interest rates. It is important to note that the extremely radical expansionary monetary policy was not enough to prevent a recession starting Spring 2014 following a 3% increase in the value added tax. Monetary policy at the ZLB isn’t helpless, but it can be overwhelmed by fiscal policy. The assertion that a sufficiently determined monetary authority can target nominal GDP has been pretty much disproven (again).

This is wrong on so many levels one hardly knows where to begin:

1.  Neither the Japanese government nor any other government that I am aware of has ever targeted NGDP.  More importantly, they have never done level targeting of NGDP, which is what everyone from Christina Romer to Michael Woodford to various market monetarists have advocated.  (At the zero bound, level targeting is far more powerful than growth rate targeting.)  How a policy that has never been tried has failed, is beyond my comprehension.

2.  Yes, the BOJ did establish a 2% inflation target.  FWIW the Japanese inflation rate in 2014 was 2.4%.  In fairness to Waldmann, that was partly due to the sales tax increase, it was running at 1.6% before the tax increase, and will likely fall below 2% this year.  Still, it’s better than deflation.  If Abenomics turned deflation into inflation, why not do even more?  As far as I know Japan has not run out of ink and paper.

3.  Japan did experience two quarters of falling RGDP in 2014, but (despite press reports to the contrary) certainly did not experience a recession.  Or if it did, it would be the first recession year in human history associated with a significant fall in the unemployment rate.  If we could have a “recession” that brought down our unemployment rate to 3.4%, I’d be thrilled.

4.  Of course what actually happened is that RGDP soared in Q1 and then fell sharply in Q2, and a bit more in Q3.  This is what roughly I expected, and is completely consistent with the monetary offset model.  Waldmann seems to think that the fact that the Japanese public is smart enough to move April auto purchases up to March in order to avoid the hefty sales tax increase is inconsistent with our model (which incorporates rational expectation and efficient markets.)  Monetary policy is not a surgical tool that can move AD from one month to the next.

5.  In any case, monetary offset refers to the fact that the central bank will prevent a negative demand shock on the fiscal side from reducing inflation below target.  But this tax increase was a negative supply shock that increased inflation.  I’ve consistently argued that if a central bank is targeting inflation then a fiscal action that affects aggregate supply (like a employer-side tax cut or a VAT cut), may impact real GDP without impacting inflation.  Monetary offset does not apply in that case.

6.  And since when is a monetary policy that leads to only 2.4% inflation considered “extremely radical expansionary monetary policy”?  I mean seriously, what is so radical about a government swapping one risk-free near-zero interest rate government liability (reserves) with another risk-free near-zero interest rate government liability (government bonds)?

7.  And what does the phrase “sufficiently determined” mean?  The recent stimulus passed by a 5-4 vote.  That doesn’t seem very determined to me.  There was one quite determined stimulus advocate at the BOJ, but that hardly makes the overall BOJ sufficiently determined.  If we assume they fell a bit short of their inflation target (stripping the VAT out of the inflation rate), then obviously they were not sufficiently determined. Now if someone wants to argue that conservative central bankers are not likely to be sufficiently determined at the zero bound, you’ll get no argument from me.

Meanwhile Paul Krugman continues to complain about critics of fiscal stimulus, without actually responding to our criticisms.

In another post he addresses the challenges faced by Greece:

Now, you might think that 3 percent of GDP is not that big a deal (although try finding $500 billion a year of spending cuts in the United States!)

It just so happens that the US budget deficit declined by $500 billion in calendar year (not fiscal year) 2013 compared to calendar year 2012.  And we all know what happened .  .  . er, didn’t happen.

On the positive side, Krugman’s recent post on high tech firms is excellent.

John Taylor has written a number of articles that are critical of the Fed’s current discretionary regime.  It’s difficult to know what the Fed is trying to achieve, and how they intend to get there.  This creates uncertainty in the marketplace, and greater macroeconomic instability stability.  Naturally Taylor focuses on the need for something like the Taylor Rule.  In contrast, I’ve advocated NGDPLT, with the same goal—reducing discretion and making the Fed more accountable.

In this post I plan to talk about a policy that I don’t favor, in the sense that it’s not my first choice.  On the other hand it’s a policy I do favor, in the sense that I’d vastly prefer it to current Fed policy.  I’m hoping that if Taylor Rule supporters read this post they’ll have a better idea as to where I’m coming from.

My proposed rule is CPCELT, that’s “core PCE level targeting.”  Why this target?

I see two big sources of discretion and ambiguity in the current target, which is PCE inflation targeting:

1.  One problem is supply shocks.  It’s widely known that pragmatic central banks may want to allow some price level variation when there is a supply shock.  For instance, if oil prices suddenly change, then keeping overall inflation on target would require moving “all other prices” in the opposite direction.  But those other prices are often stickier than oil prices, and trying to move them suddenly can create business cycles. Thus central banks often allow some inflation variation when there are supply shocks, especially to food and energy, and in some cases they point to core inflation as being more meaningful, at least in the short run.

And yet central banks also insist that they are targeting headline inflation in the long run.  This is supposed to reassure the public, because the public cares about headline inflation.  There are two problems with catering to public opinion in this case.  First you are pandering to ignorance.  Even if the Fed prevents supply shocks from increasing the price level in the long run, they will not be able to prevent the associated loss of real income, which is why the public cares about inflation in the first place.  Economists know that the public misunderstands the effect of inflation on living standards, but we pander to that ignorance when we insist we’ll stabilize headline inflation in the long run.  The second problem is that the public thinks of inflation in terms of the CPI, but the Fed targets the PCE.  So we aren’t really targeting what the public thinks of as “inflation,” even with a headline PCE inflation target.  PCE inflation runs about 0.35% below CPI inflation.

So I propose the Fed target what they actually care about, core PCE inflation.  That increases accountability, as the Fed can no longer point to temporary oil and food price changes as excuses.

2.  The second problem is growth rate targeting.  Under growth rate targeting we have no idea where the price level will be in 10 or 20 years, making long term planning more difficult.  Suppose prices fall, as in 2009.  Is the Fed trying to make up some of that fall, or shoot for 2% inflation from that point forward?  It’s hard to say.  Perhaps errors are a sort of random walk, and the price level gradually drifts further and further from that trend line. Even worse, a central bank that pays lip service to inflation targeting, but doesn’t seriously try to get there (say the Pre-Abe BOJ) can let the price level gradually drift lower for 20 years, each year claiming they just missed by 1% or so.  At the other extreme, the dovish Bank of England can consistently run slightly above target.

Level targeting is a way of forcing central banks to do what they claim they are trying to do.  Under level targeting you always have a precise point estimate of where PCE core price level is supposed to be in 2 or 3 or 5 years.  It’s a way of holding central banks accountable.  You still allow some variation in the very short run, assuming there is the dual mandate.  But they can no longer act like magicians, directing your attention somewhere else when they persistently fail to hit their goals.  “Look at oil.”  “Look at unemployment.”  “Don’t worry, we’ll get there eventually, despite the TIPS market saying we won’t.”  Those excuses won’t work; they’ll eventually be exposed if they persistently miss.

If there is to be a dual target (which is something I don’t like, and why I favor NGDPLT instead) then central banks must also be held accountable on the unemployment front. In recent years, inflation has run below target when unemployment is high, and vice versa. The Fed should be instructed to do the opposite, and its effectiveness should be judged on that basis.  They should have to explain to Congress why inflation is below target when unemployment is high, as that’s even worse that a rigid single mandate for inflation.

To summarize, with CPCELT central banks will no longer be able to offer the following excuses:

1.  We missed because of temporary factors like food and energy prices.

2.  We keep missing by 1/2% on the low or high side, year after year, but in the future we promise to do better.

But there are other advantages as well.  When prices fall, as in 2009, inflation expectations automatically rise (they actually fell under the current regime) and this reduces real interest rates, boosting the economy. During the housing boom the market would have understood that core inflation was overshooting, and that awareness would have led to more bearish expectations—reducing speculation.  In addition, some macro models suggest that you want to target the stickiest price, which might be wages.  Core inflation is more closely correlated with wage inflation than is headline inflation.

Everyone knows that a NGDP target would have called for a more expansionary monetary policy in recent years.  But the same is true for core PCE.  Core PCE inflation averaged 2.03% between December 1990 and December 2007, then the inflation rate fell to 1.4% between December 2007 and December 2014.  Under the dual mandate you’d prefer slightly lower inflation during the booming 1990-2007 period, and slightly above 2% inflation during the depressed 2007-14 period.  Even under a single inflation mandate this sort of variation is unacceptable, as it creates macroeconomic instability. Under a dual mandate it’s even more unacceptable.

To conclude, my critique of the Fed goes far beyond the fact that they are targeting inflation and I’d prefer NGDP.  Even under inflation/price level targeting there could be vast improvements, which would reduce discretion, increase accountability, and make the economy more stable.

Of course there’d still have to be a conversation about the instrument rules needed to hit this target.  But I firmly believe this sort of regime would vastly reduce the discretion/accountability/ambiguity problems that John Taylor worries about, even before we moved on to the policy instrument issue.

PS.  This post is a response to commenter SG.

Commenter Nick directed me to this FT story:

Mr Williams spoke amid speculation about when the Fed will pull the trigger following more than six years of rates at near-zero levels. Economists including Lawrence Summers, a former US Treasury secretary, have urged the Fed to leave rates unchanged until there is clear evidence that inflation, and inflation expectations, are set to breach its 2 per cent target.

However Mr Williams dismissed such calls, warning of the risk that the Fed gets behind the curve on inflation and that it could end up being forced to hike rates “much more dramatically” to rein in inflation, provoking market turmoil. Given the trails with which monetary policy operates it was better to start raising interest rates “gradually, thoughtfully”, he said.

When I hear Wall Street types talk about the danger of a sudden and dramatic tightening of interest rates, they often refer to the awful 1994 “bloodbath” in the bond market, triggered by the Fed’s decision to tighten monetary policy after a period of low rates during the 1991 recession and weak recovery.  Here’s a graph showing the rise in 10-year bond yields, which sharply depressed bond prices in 1994.

Fortunately, there was no “bloodbath” in the labor market, which is the market I care about:

Nor was there a bloodbath in the stock market.  The 1994 move was an example of highly effective stabilization policy by the Fed, despite all the gnashing of teeth in the bond market.  I wonder if the Fed is overly concerned about the impact of its policies on the bond market, and insufficiently concerned about the impact on the labor market.

In contrast, during April to September 2008 the labor market was deteriorating rapidly—clearly headed into a recession—while the Fed twiddled its thumbs.  Unemployment rose from 5.0% in April to 6.1% in August, which was 1.7% above the low point reached at the cyclical peak (4.4%.)  In the past, a recession has occurred 100% of the time when unemployment rose by more than 0.8% above the cyclical low, so the 1.7% rise was a completely unambiguous signal.  How did the Fed respond?  They did nothing at their September 2008 meeting, 2 days after Lehman failed.

Free Exchange has a post showing that the musical chairs model doesn’t work as well for the UK as for the US.  Here’s the graph for the UK:

It does explain the rise in the unemployment rate during the 2008-09 recession, and the fall over the past 18 months, but not the flat (8%) unemployment rate in between.  Free Exchange comments:

Why did unemployment remain stubbornly high? One explanation could be a negative supply-side shock: commodity prices increased sharply in 2011, which might have caused additional structural unemployment. Another could be the swathes of public sector redundancies overseen by the coalition government. If public sector workers find it hard to move to the private sector, this might interfere with the predictions of the model.

Supply shocks should not cause any problem for the musical chairs model, as what matters is NGDP, not the P/Y split.  Instead I think there are two main areas it might fail, one of more concern than the other:

1.  The musical chairs model might fail to explain shifts in hours worked, due to a changing share of national income going to labor.  Or wages that are not sticky.

2.  The model might fail if changes in hours worked failed to explain the unemployment rate.  I would regard this as a lesser problem, as hours worked are arguably just as valid a business cycle indicator as the unemployment rate.

Fortunately the discrepancy between hours and unemployment seems to have been the issue.  Over the past few years I’ve seen many articles talking about how the UK was creating an amazing number of jobs, despite low GDP growth and stubborn unemployment.  This was partly due to strong growth in the labor force, which is why the unemployment rate only began falling recently. Here’s a typical article (from The Economist, in June 2014):

LOOKING at Britain’s latest jobs data, published last week, it seems Britons have almost never had it so good. In the three months to the end of April, the number of people in work rose at its fastest level on record. Unemployment fell to its lowest level in five years. Participation in the workforce is now within a whisker of its all-time high. George Osborne, Britain’s Chancellor, concerned about his party’s ratings in the run up to next year’s election, has done his best to try and take credit for this remarkable performance. At his annual Mansion House speech last week, he told the City of London’s top brass that Britain is “growing faster than any advanced economy in the world”, with “a record number of people at work” due to his policies. But Britain’s jobful recovery””to some extent””is as much due to the failure of government initiatives as to their success.

America’s actually done better than the UK in terms of unemployment, but far worse in terms of employment.  Our workforce participation is far below the all-time high.  So Britain created lots of jobs, lots of hours worked (as the musical chairs model predicts), but this has not had much impact on the unemployment rate, until recently.

Here’s a graph showing hours worked in the UK, which has been rising ever since early 2010:

So the musical chairs model seems to explain British hours worked during the recovery, but hours worked doesn’t seem to have explained the unemployment rate, until the past 18 months, when unemployment has finally started declining.

PS.  I hope Britmouse will chime in, as he has a much better grasp of the British economy than I do.

Update:  As expected, Britmouse adds some useful perspective.  He also provides graphs using NGDP net of VATs, as well as aggregate nominal wages.