Bean on NGDPLT

Ben Southwood sent me an article discussing Charlie Bean’s views on NGDPLT.  Let me first apologize to regular readers; much of this will be going over ground I’ve already discussed dozens of times.  Unfortunately many of the leading economists now jumping into the NGDPLT debate do not keep up with the blogosphere, and hence are not aware that their arguments have been addressed numerous times.

Charlie Bean argues that the main difference between an inflation target and a nominal income growth target relates to communication – and he asks which framework would be a better way to describe policy. One argument in favour of a nominal income growth target is that there may be fewer divergences from the stated target for income growth than from an inflation target if there are a lot of costs shocks that are accommodated. But set against that, nominal GDP is more prone to revision than inflation which makes it harder to hold the MPC to account. And income growth targeting would be harder to explain to households and firms and so be less effective at anchoring inflation expectations.

NGDP targeting is actually far easier to explain to households than inflation targeting.  In 2010 Bernanke indicated that the Fed was determined to raise the cost of living of the average America.  People reacted with shock and outrage, and there was a firestorm of criticism.  Most people associate the term “higher cost of living” with “falling living standards”—i.e. supply-side inflation.  Thus they have no understanding of inflation targeting at all, which deals with stabilizing demand-side inflation.  Tell the average person about the need to be symmetrical when missing the target (i.e. low inflation is just as bad as high inflation) and you’ll see a blank look on their faces.  The press still reports below target inflation as “good news,” so they are no better than the man on the street.  In contrast, if Bernanke has announced in 2010 that he was trying to speed up growth in the average income of Americans to boost the recovery, QE2 would have been far more popular, and the public would have had a much better idea of what the Fed was actually trying to do.

And of course the BoE trying to boost inflation when it was already well above target created all sorts of confusion in Britain, and contributed to their sub-optimal fiscal policy decisions.

I’ve dealt with the data revisions issue before.  In this paragraph Bean was discussing NGDP growth rate targeting, not level targeting, hence all that needs to be said is that the central bank should target the forecast.  In that case revisions are not a problem.  In the case of NGDPLT, I’d refer you to this earlier post.  The article continues:

Charlie Bean argues that a nominal income levels target would involve rather different policy settings to an inflation target. Under such a regime the MPC would be tasked with returning nominal income to a continuation of its pre-crisis trend line in response to economic shocks. In theory, such a target may be a useful way to influence expectations, particularly when policy is constrained by the zero lower bound on interest rates. It acts to persuade people that if there is a large negative demand shock, interest rates will be “loose for longer” than under the present inflation targeting regime because they know the MPC will need to close the shortfall in the level of nominal income. Those lower expected future interest rates directly boost demand today.

This is true, but slides over the more important point—NGDPLT greatly moderates the initial move away from the trend line.

But the policy also generates higher inflation in the future, thus producing a second source of downward pressure on future real interest rates, which also raises demand today. Charlie Bean shows that in standard economic models this expectations channel can be powerful enough to deliver a substantial economic benefit when interest rates are at their zero floor. But he raises three real world caveats.

First he notes that in standard model simulations, a large negative demand shock generates deflation, which drives up real interest rates, further depressing demand. But in contrast, inflation in the UK has averaged well above target in recent years, suggesting there have been negative supply shocks as well as negative demand shocks. The advantage of a levels target for nominal income is less clear under those circumstances.

Not at all, if NGDP growth was well below target in Britain then a level targeting regime would have led to a smaller drop in AD, and hence a milder recession.

Second, a nominal income level target will mean tolerating periods of higher than normal inflation. Models don’t capture the risk of such a policy. Demand may be depressed as savers worry about the real value of their assets. Long term inflation expectations may get pushed up and it could be costly to bring them back under control.

As long as NGDP growth is on target, higher inflation expectations will not feed into higher nominal interest rates or higher nominal wage rates.  Hence the higher inflation will not distort the capital and labor markets in the way that standard models suggest.  The problem here is that what is usually regarded as the welfare loss of inflation, is on closer inspection the welfare loss of excessively high and unstable NGDP growth.

Third, holding interest rates at very low levels for a long period, which would be required by a nominal income levels target, may generate credit / asset price booms and financial imbalances and so threaten financial stability. Overall one needs to be cautious about committing to loose monetary policy long after the economy has normalised.

Low nominal interest rates are a sign money has been tight.  That’s why the lowest interest rates in the world are in Japan, which has the lowest NGDP growth.  The developed country with the fastest NGDP growth is Australia, and it has the highest interest rates among the major developed economies.  So Bean has things exactly backwards.  In any case the central bank should not worry about bubbles.  As we saw in 1987, bubbles do not cause significant problems as long as the central bank keeps NGDP growing at a steady rate.  Problems with the financial system should be addressed through regulation, not driving all sectors of the economy into a recession in order to punish the one sector that is misbehaving.  The Fed tried that in 1929—to say it didn’t work out too well would be an understatement.

Charlie Bean concludes that it is sensible to review the monetary framework from time to time, but there is a danger in expecting too much from monetary policy.

I agree.  I think Britain has significant supply-side issues that need to be addressed.

“The Great Recession of 2008-9 was unlike earlier policy-induced downturns….it should not be surprising that the recovery since the middle of 2009 has been so muted”. Central bank policies “cannot – and should not seek to – prevent the necessary de-leveraging and rebalancing of production away from non-tradables towards tradables. That is a real process that takes time and means that the recovery is likely to remain somewhat subdued by historical standards.”

Yes, real adjustments need to occur, but they can occur most effectively against the backdrop of stable NGDP growth. The recovery process that Bean wishes to see is exactly what NGDP proponents favor, and yet is nearly the opposite of the policies that have actually been adopted.  In the US the huge drop in NGDP led to a big fall in the production of tradables (and other types of-non-residential construction output), making the adjustment far more difficult and prolonged.  I believe something similar occurred in Britain.



20 Responses to “Bean on NGDPLT”

  1. Gravatar of marcus nunes marcus nunes
    27. February 2013 at 08:57

    I did a short version (a quick ‘knock-out’):

  2. Gravatar of – -
    27. February 2013 at 09:28

    I presume you’ve read Bean’s 1983 paper “Targeting nominal income: an appraisal”:

  3. Gravatar of Doug M Doug M
    27. February 2013 at 10:14

    The press’ coverage of economic news is always bad. If inflation is high, seniors are getting screwed because their savings don’t go as far. If inflation is low, seniors are getting screwed because their social security cost of living adjustment is reduced — the lower increase is reffered to as a cut.

    The press deals in hyperbole, and every story must have a victim.

  4. Gravatar of Gregor Bush Gregor Bush
    27. February 2013 at 10:20

    Sorry to get off topic, but I thought this comment from MarketWatch summerized things perfectly:

    “Partisan divide over central bank policy already evident. Republican leadership of the House panel think the Fed has gone too far. Democrat leadership expresses contentment.”

    Money is always and everywhere either too easy or about right. No one would dare suggest that its too tight.

  5. Gravatar of Peter Peter
    27. February 2013 at 10:37

    > The press still reports below target inflation as “good news,”

    The best is “lower inflation is good since it will give Bernanke more room to maneuver.”

    But I’m not so sure that NGDP targeting will improve the media situation. I’m sure someone will complain that Bernanke trying to raise wages will lead to higher unemployment.

  6. Gravatar of marcus nunes marcus nunes
    27. February 2013 at 10:38

    Bean´s 1983 paper is better than his comments today on NGDP targeting. 30 years ago he had already concluded that level targeting is preferable to growth targeting. But 30 years ago no one had ‘heard’ about IT, so he compared NGDPT to Money growth targets.

  7. Gravatar of TallDave TallDave
    27. February 2013 at 11:30

    That’s why the lowest interest rates in the world are in Japan, which has the lowest NGDP growth. The developed country with the fastest NGDP growth is Australia, and it has the highest interest rates among the major developed economies.

    That’s interesting, I had to look that up.

  8. Gravatar of TallDave TallDave
    27. February 2013 at 11:32

    The press’ coverage of economic news is always bad.

    Their coverage of nearly everything is always bad, it’s very hard to report on subjects you’re not expert in. Gell-Mann amnesia.

  9. Gravatar of ssumner ssumner
    27. February 2013 at 11:36

    Marcus, Yes, I was thinking or mentioning that as well, but I figured I had enough.

    Dash, Yes, but long ago.

    Gregor, Yes, that pretty much sums it up!

  10. Gravatar of Geoff Geoff
    27. February 2013 at 18:19

    Inflation does not raise everyone’s income equally at the same time.

    Higher inflation benefits the initial receivers and deflation benefits the later receivers, since asset prices are the most sensitive and volatile to monetary changes.

  11. Gravatar of Chris Chris
    28. February 2013 at 14:27

    Hi Scott,

    First of all, great blog. Bean, I think, is being harsh on NGDPLT probably because if he supported it, it would imply that he and everyone else at the Bank had been wrong the entire time. Human nature I suppose.

    Also, I’m sure you will have answered this numerous times before but I haven’t been able to find it.

    I don’t understand why “higher inflation expectations will not feed into higher nominal interest rates or higher nominal wage rates” so long as NGDP is on target.

    My thinking is that high inflation expectations would lead to workers demanding higher wages or index linking their salaries etc, now why wouldn’t that happen if NGDP was on target?

  12. Gravatar of ssumner ssumner
    28. February 2013 at 16:34

    Geoff, You said;

    “Higher inflation benefits the initial receivers”‘

    No, inflation hurts initial receivers.

    Chris, Wages tend to follow per capita NGDP, not the price level. That’s why wages in China are rising so fast.

  13. Gravatar of Chris Chris
    1. March 2013 at 05:17

    Of course they do, yes, they makes much more intuitive sense. Thanks.

    You’ll have to forgive me again for raising an issue I’m sure you’ve become annoyed at dealing with but I’ve trawled though previous posts and can’t find it and it seems to be a recurring criticism from people critical of NGDP targeting, at least those who I’ve discussed it with.

    What happens when you have 0% RGDP growth due to supply side issues, perhaps we reach the limits of technology or everybody becomes content with what they have or some such hypothetical. Do you persist with 5% inflation (or w/e the target is)? Do you claim that in the long run this has no impact on the real economy? Or would you revise the target?

    Or would you argue as you seem to have done above, that supply side reform is most effective when NGDP growth is stable? What if you run out of possible supply side improvements?

  14. Gravatar of ssumner ssumner
    1. March 2013 at 18:31

    Chris, Yes, I’d stick with 5%, or whatever the target NGDP growth rate is. My hunch is that the actual number chosen will be lower than 5%.

  15. Gravatar of Saturos Saturos
    2. March 2013 at 01:30

    I just don’t like the term “cost of living”, which sounds like it talks about a real variable when in fact economists use it for a nominal variable. People are confused enough as it is when it comes to separating real and nominal, and this doesn’t help. Interestingly though your talk of “income targeting” is almost exploiting this confusion…

    And I wish we’d always talk about “real” and “nominal” policies instead of “supply-side” and “demand-side”, as the Keynesian separation of supply and demand no longer makes sense after NGDPLT.

  16. Gravatar of Becky Hargrove Becky Hargrove
    2. March 2013 at 06:14

    Perhaps a little framing would help here. Thinking about nominal output/income instead of – say, sum totals of debt, just makes it easier to see how various components of the economy actually line up with one another in aggregate terms. The reason that matters: better optimality among aggregates also means less inflation takes place during “stimulus”. NGDPLT of course not about cost of living but allows people to think about cost of living more clearly, which is another selling point for NGDPLT.

  17. Gravatar of Geoff Geoff
    2. March 2013 at 12:37

    Dr. Sumner:

    “Higher inflation benefits the initial receivers”’

    “No, inflation hurts initial receivers.”

    Oh so that’s why so many institutions are fighting tooth and nail to get on the primary dealer list, and why existing primary dealers aren’t wanting off the list as fast as they can.

    It’s because inflation is HURTING them!

    Well stop the presses, a zillion market participants are all idiots.

    “Inflation hurts the initial receivers.” Now that is something to put in the vault of knee slappers.

    So please, enlighten me. How in the world does receiving money, new or otherwise, HURT someone? Inquiring minds like to know.

  18. Gravatar of ssumner ssumner
    2. March 2013 at 15:37

    Saturos, Yes, but the public is just as confused about “inflation” as “cost of living.” I think the public correctly understands that inflation is a rise in the cost of living–but they are confused by both concepts.

    I’d love to replace AS/AD with nominal/real.

    Geoff, I never said Fed bond purchases hurt the person selling bonds to the Fed. I said inflation reduces the value of cash they receive in exchange for their bonds.

  19. Gravatar of Geoff Geoff
    3. March 2013 at 21:31

    Dr. Sumner:

    “Geoff, I never said Fed bond purchases hurt the person selling bonds to the Fed. I said inflation reduces the value of cash they receive in exchange for their bonds.”

    Uh, hello, you said:

    “No, inflation hurts initial receivers.”

    You never said it? It’s right there!


    If inflation reduces the value of “the” cash they receive, then why would the bond holders agree to receive that cash from the Fed in the first place? Wouldn’t they receive higher valued cash if they sold the bonds to only non-Fed agents?

    There is either a hole in your argument, or else every primary dealer is an idiot.

    If the bond holders find it worthwhile to sell bonds to the Fed, and not just to other market participants who don’t print money, then doesn’t it stand to reason that the bond sellers are benefiting in some way as initial receivers of Fed money? Why else would they sell to the Fed and not only other market participants?

  20. Gravatar of How Tight Money and Fiscal Stimulus Failed in 2008 | uneconomical How Tight Money and Fiscal Stimulus Failed in 2008 | uneconomical
    7. March 2013 at 07:49

    […] Scott Sumner, Marcus Nunes and Simon Wren-Lewis have all commented on Charlie Bean’s speech on NGDP targeting.  With such illustrious company I doubt I can add anything of substance to the debate, but I wanted to pick up on what Marcus said since I think it helps better frame the debate that’s going on in the UK regarding the use of fiscal and/or monetary “stimulus”. […]

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