Avent and Rowe: Required reading for developed country central bankers

Nick Rowe called Ryan Avent’s new essay “superb,” and that’s not hyperbole.  Ryan provides a careful step by step analysis of how we’ve reached our current policy predicament, and what can be done.  I have a few comments, but you should read his entire post.

Ryan treats QE and expectations management as alternative polices.  In a sense that’s right, as they’ve been used that way.  However I’d like to note that in a perfect world they are complements, not alternatives.  QE can be seen as having “worked” in one of the two following ways:

a.  Hot potato effect—reserves aren’t a perfect substitute for bonds, even at the zero bound.

b.  Signals of future policy intentions.

But that’s not really how QE should be used, rather it reflects a deep ambiguity within central banks, plus confusion about how various policy tools work. And it’s also why the effects have been so modest.  In a perfect world they’d set an explicit NGDP target, and then let the public determine how much base money they wanted to hold, given the target expected rate of growth in NGDP (say 5%).  If rates are near zero even when expected NGDP growth is on target, then central banks might have to make some new and potentially awkward decisions—i.e. what to buy when all the T-bonds are gone.  Or do we raise the target?  In practice, with a 5% NGDPLT regime and zero IOR they would not run out of bonds to buy, at least in the US.  But it’s theoretically possible.

In either case the real “policy” is the target.  Do we want 2% inflation targeting?  Price level targeting?  NGDPLT at 5%?  These are policy decisions.  QE is (should be) simply a way to insure the market for base money is in equilibrium given the policy target is expected to be hit.  (Think NGDP futures targeting.) But central banks haven’t used it that way.  They’ve used it as a substitute for setting an explicit target, as a covert form of signaling a desire for higher inflation.  Thus it’s a bit misleading to talk about switching from QE to expectations management (although correct in the sense Ryan claims) as it is more like a switch from a marginally effectively form of expectations management to a slightly more effective form.  But as we’ve seen from the recent “tapering” fiasco, QE has not yet disappeared from the policy arsenal, no matter how much central banks wish it would.

Ryan ends up discussing the advantages of NGDP as an indicator of aggregate demand, and also how a higher inflation target might also be helpful.  Here’s where Nick Rowe’s recent post comes in.  Nick pointed out that NGDPLT isn’t just an alternative to inflation targeting, or a secret way to get a higher inflation target, rather it’s a more powerful way of avoiding policy ineffectiveness at the zero bound.  Thus for any given acceptable level of zero bound incidents, NGDPLT beats inflation targeting.

Let me be more specific.  Suppose central banks decide that the zero bound is a big problem, and then instruct their staff to come up with an inflation target that will leave the country at the zero bound no more than 5% of the time—one year in 20.  Nicks shows that that same frequency of zero bound cases could be achieved with a NGDPLT regime that produces a lower average rate of inflation than an inflation target also aimed at no more than 5% liquidity traps years.  That’s a free lunch!

Suppose the US trend rate of RGDP growth is 2.2% going forward.  Nick is claiming that an NGDPLT target of less than 4.2% can achieve as good or better macroeconomic stabilization as an inflation target of 2%, all while achieving a below 2% average inflation rate.  So while I agree with virtually everything in Ryan’s post, I think he ends up on a slightly too pessimistic note.  I believe that our current problems have less to do with the fact that the vast American and European middle classes are happy with their jobs and/or pensions and low inflation rates, and more with the fact that inept monetary policy has created the false impression that lots of inflation would be necessary to cure unemployment, whereas what we really need is a more effective policy, not a higher average inflation rate.

So here’s what I say to pensioners.  NGDPLT would deliver more inflation in years like 2009, but less inflation in years like 2005-06.  Overall, about the same or less.

By now (2013) wages have moderated so much that the US could probably get a robust recovery with 2% inflation.  Not the UK, however.



16 Responses to “Avent and Rowe: Required reading for developed country central bankers”

  1. Gravatar of Tom Brown Tom Brown
    9. August 2013 at 12:05

    “In a perfect world they’d set an explicit NGDP target, and then let the public determine how much base money they wanted to hold”

    If by “public” you mean the non-bank private sector, then “base money” can only mean one thing: physical cash. But I suppose you could mean the banks too, in which case, assuming ER = $0, “base money” is uniquely determined by cash and inside money… and the “public” determines those.

    More importantly in this “perfect world,” this sounds a lot like something I’ve heard before… Jared seems to be asking the exact same thing of David Beckworth, here:


  2. Gravatar of ssumner ssumner
    9. August 2013 at 12:22

    Tom, The long run impact of more base money is via the hot potato effect. I think almost everyone accepts that (except perhaps MMTers). Otherwise there’d be no way to predict the impact of an 87-fold increase in the base, on the price level and NGDP. What sort of change in interest rates would make prices rise 87 fold?

    The short run impact comes from expectations of the long run effect, expectations of the HPE. That is, expectations of higher NGDP in the future. Of course the short run effect comes from lots of other factors as well, higher asset prices (stocks, commodities, real estate, foreign exchange) combined with sticky wages, etc.

  3. Gravatar of Tom Brown Tom Brown
    9. August 2013 at 12:38

    Thanks Scott. I confess that I thought/hoped you were perhaps taking on David’s position a bit more (David seems to now claim that “base money” before or after inside money makes no difference… the important thing is a commitment by the CB to provide it!), at least regarding this hypothetical “perfect world” you postulated. I’m still not completely on board/understanding exactly where you stand, but no matter. I’ll just watch for a bit. Thanks!

    (And maybe I’m misreading David too… he hasn’t confirmed whether or not Jared was reading him right)

  4. Gravatar of Tom Brown Tom Brown
    9. August 2013 at 12:53

    and to clarify, I’m getting that David thinks this is true even in the long run:

    “My point is that the CB commits to a permanent increase in the monetary base. How it chronologically unfolds is besides the point.”

    “I have never argued (or meant to argue) that the monetary base has to increase first. What I have argued is that the CB promises first to allow the monetary base expansion to occur or if it has already occurred (like now) that it will not be reversed. As noted earlier, there can be no increase in inside money if this monetary base expansion does not occur.”

    I’ll guess I’ll find out for sure when he get’s back to Jared on this.

  5. Gravatar of Tom Brown Tom Brown
    9. August 2013 at 13:08

    OK, one more thing, you write:

    “The long run impact of more base money is via the hot potato effect. I think almost everyone accepts that (except perhaps MMTers)”

    Well perhaps not Glasner either:

    “This result is often described as the hot potato effect. Somebody has to hold the hot potato, but no one wants to, so it gets passed from one person to the next. (Sorry, but the metaphor works in only one direction.)

    But not everyone agrees with this view of how the quantity of inside money is determined. There are those (like Scott and me) who believe that the quantity of inside money created by the banks is not some fixed amount that bears no relationship to the demand of the public to hold it, but that the incentives of the banks to create inside money change as the demand of the public to hold inside money changes. In other words, the quantity of inside money is determined endogenously.”


    “But not everyone” … “like Scott and me” ??

    That’s you, right Scott? You’re in the “not everyone” crowd regarding the hot potato here? Did Glasner get that right?

    So this must be a different kind of hot potato?! … I’ll dig into it more and try to understand. Thanks again!

  6. Gravatar of marcus nunes marcus nunes
    9. August 2013 at 14:22

    But there´s also the “Dark Side”

  7. Gravatar of Doug M Doug M
    9. August 2013 at 15:19

    It seem to me that the Fed doesn’t have an inflation target or growth target.

    The Fed doesn’t have any sense of destination, only direction.

    With that sense of direction they can go — easier, tighter or hold steady. And where that takes them they don’t know. They can adjust again in 6 weeks time if they feel like it.

  8. Gravatar of benjamin cole benjamin cole
    9. August 2013 at 16:05

    Exclent blogging. I think the USA much less Inflation-prone than in 1970s. The Fed has the field wide open…but timidity and indecision rule the day, and a theomonetaristic faith in microscopic inflation rates.

  9. Gravatar of dtoh dtoh
    9. August 2013 at 16:32

    I sound like a broken record, but you need to radically simplify the model (with no loss of accuracy).

    1. NGDPLT is the policy GOAL

    2. OMO (stop calling it a lot of other things) is the TOOL to achieve the GOAL.

    3. Expectations and higher real prices of financial assets is the MECHANISM by which the TOOL works.

    That’s all there is to it. Stop making it more complicated than it is. It is mind blowingly simple and obvious.

  10. Gravatar of ssumner ssumner
    9. August 2013 at 16:33

    Tom, I agree with David Glasner that inside money is endogenous, but outside money is exogenous in one important sense. Unfortunately outside money is endogenous in the short run and exogenous in the long run under a wide range of monetary regimes, so this all gets extremely confusing.

    I like to think of monetary policy as if the base was exogenous, and then think about the long run effect of changes in the base. Then think about actual policy as moving some instrument (interest rates or exchange rates, etc) until the base moved enough to cause the desired impact on prices.

    I agree with David that the long run expected change in the base is by far the most important consideration, but short run effects can matter too, even for a given long run expected change. It’s just that they usually don’t matter very much.

  11. Gravatar of Bill Ellis Bill Ellis
    9. August 2013 at 18:20

    PK is right about one thing… Milton Friedman’s political authority or clout, is at this time, at a low ebb.

    There was a time in politics and the popular press when his name was constantly evoked. He was the father and defender of the right wing swing establishment econ took starting in the 80’s. For a long time the sliver of his ideas that had taken hold in pop culture seemed to be believable… But then the recession happened. His pop culture ideas could no longer be sold. The politicos and “journalist” that depended on his Authority to construct their world views could no longer evoke his name.

    Now who carries his banner ?… A bunch of ghettoized Market Monetarist who rightly see a complete Milton… but forget that to the press and politicos, most of the complete Milton is esoterica.

  12. Gravatar of Geoff Geoff
    9. August 2013 at 19:53


  13. Gravatar of Steve Steve
    9. August 2013 at 20:45

    Obama tipped his hand when he said “Bernanke has been here longer than he was supposed to be.”

    Obama wanted to appoint Summers in 2009, but felt he couldn’t chance additional market turmoil at that fragile moment.

    The original deal was Summers works for Obama for a year, then gets rewarded with appointment to Fed Chair. Summers has had to wait four additional years.

    Just a guess.

  14. Gravatar of ssumner ssumner
    10. August 2013 at 04:59

    dtoh, Yes, KISS.

    Bill, But his ideas are still very influential:

    Floating exchange rates
    School Vouchers
    End the military draft
    Monetary policy controls inflation
    The BOJ can inflate if it wants to.
    Privatise SOEs
    End rent and price controls

    And many, many others

    Steve, That’s plausible.

  15. Gravatar of Steve Steve
    10. August 2013 at 11:52

    Avent’s column has a rather significant factual error:

    Avent: “In one corner stands a group with a long and proud history: those ready to give up on monetary policy. Some have been in the corner since rates first touched zero in 2008 while others have joined over time as unconventional policies failed to bring back full employment.”

    Correction: “In one corner stands a group with a long and proud history: those ready to give up on monetary policy. Some have been in the corner since rates first touched TWO in 2008 while others have joined over time as unconventional policies failed to bring back full employment.”

  16. Gravatar of ssumner ssumner
    11. August 2013 at 06:18

    Steve, Technically they got close to zero in mid-December, but I also thought that was misleading, as it creates the impression that the Fed did all it could in late 2008. Not so.

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