Bernanke favors NGDP targeting, he just doesn’t realize it

Here’s the conventional wisdom from Renee Haltom at the Richmond Fed:

Changing the Rules

The Fed’s policymaking committee discussed NGDP targeting at its November 2011 meeting and provided a hint that major changes are not on the table. “We are not contemplating at this time any radical change in framework,” Chairman Bernanke said after the meeting. “We are going to stay within the dual mandate approach that we’ve been using until this point.”

Central bankers don’t take changes to the conduct of policy lightly. All central banks face the temptation to boost growth for temporary gain at the expense of longer-run price stability. To convince the public that monetary policy won’t give in to that temptation “” to therefore maintain credibility and keep inflation anchored “” many central banks stick to consistent “rules,” either explicit or implicit, to effectively tie their own hands.

Radical change?  Bernanke has recently emphasized that the Fed takes its dual mandate seriously.  He indicated that they put equal weight on both sides of the mandate.  I recall he responded to a conservative senator with something to the effect that if Congress wasn’t happy with their policy they should give them a different mandate.  And of course the Fed influences employment by affecting RGDP growth.  I wouldn’t say the Fed puts equal weight on inflation and RGDP growth, but Bernanke’s comments about the dual mandate suggest their policy is pretty close to NGDP targeting.

And yet Haltom is right that a switch to NGDP targeting is generally viewed as a major change in Fed policy.  That got me wondering if it would be possible to do a policy that looked very much like current policy, and yet was almost identical to NGDP targeting.  Given Bernanke’s insistence that both sides of the mandate (inflation and employment) are treated equally by the Fed, it ought not be too difficult.  I’d like to hear your suggestions, but here’s one idea.    The Fed announces that it will fulfill its dual mandate as follows.

1.  It will aim for 2% core PCE inflation every single year.

2.  It will aim for RGDP growth equal to the average RGDP growth rate of the previous 20 years.

This policy will tend to produce roughly 2% headline inflation over any long period of time.  Importantly, it will aim for 2% core inflation even in the short run.  The RGDP target is aimed at the Fed’s employment target.  High employment is more likely to occur in an environment where RGDP growth and inflation are relatively stable.  Indeed my preference would be for the Fed to “target the forecast”, that is, set policy such that it is expected to hit this target.

Now let me anticipate objections:

1.  No, this isn’t trying to hit two targets at once, it is a single target; NGDP growth equal to the 20 year moving average rate of RGDP growth plus 2% inflation.  That’s a single number, a single target.

2.  It answers one popular objection to NGDP targeting, the fear that the price level would no longer be anchored.  This still anchors inflation at 2% over the long run.   The math is kind of complicated, but the average inflation rate would approach 2% as the time period approached infinity.  Thus if trend growth fell from 3% to 2%, as may be occurring right now, there would be a transition period when inflation would temporarily exceed the 2% goal.  But then it would asymptotically fall back to 2%.  And the reverse would occur when the trend rate of RGDP growth rose.  When trend growth is stable then inflation should be stable at 2%.

In contrast, under NGDP targeting a fall in trend RGDP growth from 3% to 2% would leave inflation permanently higher.

The more I think about this idea the more I like it.  The 2% inflation target is “locked in” to this system, not left to chance.  It’s an explicit 2% inflation target.  The system gives equal weight to inflation and employment fluctuations.  The Fed is trying to keep inflation at 2%, and trying to stabilize employment.  This gives it a definite target, no more of the ambiguity that drives both liberals and conservatives nuts when they are trying to evaluate Fed policy.  We can finally hold them accountable.  We can say; “We’ve instructed them to do X, now let’s see how close they came to doing X.”  As it is, it’s hard to hold them accountable, because their interpretation of the mandate is so vague.

Consider Haltom’s second paragraph quoted above.  I think she expresses the conventional wisdom, but I’m not sure that’s true.  Ever since Lehman failed inflation has averaged just over 1%.  This is quite odd, given the Fed’s dual mandate.  If you think about it, even 2% inflation would have violated the dual mandate, as it would have implicitly given zero weight to jobs.  If inflation had been 2% over the past three years, the Fed should have been trying to raise inflation above 2% to reduce unemployment.  Does anyone serious believe they would have, given that even at slightly over 1% inflation it was really hard to get them to explicitly try to raise inflation?

And how about the BOJ, or the ECB under Trichet?  Do they seem like central banks just chomping at the bit to print money, but help back by inflation targets?  Japan’s had mild deflation for nearly 2 decades.  And Trichet bragged that he drove inflation to a level far below that of the Bundesbank in the midst of the greatest debt crisis in European history.

As I look at world history, it looks to me like the major central banks were constantly trying to boost growth until about the early 1980s, and since then have constantly been obsessed with reducing inflation.

I don’t know why these multi-decade long mood swings affect our central banks, but it needs to stop.  NGDP targeting would be ideal, producing a perfectly calm ocean surface over which the ship of free market capitalism could sail.  But my “20 year average of RGDP growth plus 2% inflation” idea is almost as good.  It would produce very long and graceful swells in the economy’s surface, barely detectable to most people.  Even a tsunami is hardly noticeable in the middle of the ocean.  A 20 year moving RGDP average plus 2% inflation isn’t much different from a fixed NGDP target, but looks much more like a dual mandate featuring 2% inflation targeting, and it also anchors inflation in the long run.  What’s not to like Mr. Bernanke?

PS.  I’ve ignored the level targeting vs. growth rate targeting issue, as I think we first need to get a consensus on what type of target.  This proposal could be amended to go either way, although I obviously prefer level targeting.


Tags:

 
 
 

70 Responses to “Bernanke favors NGDP targeting, he just doesn’t realize it”

  1. Gravatar of John John
    24. February 2012 at 06:24

    Just admit it. The PhD standard is a far bigger failure than the gold standard.

  2. Gravatar of Morgan Warstler Morgan Warstler
    24. February 2012 at 06:25

    “In contrast, under NGDP targeting a fall in trend RGDP growth from 3% to 2% would leave inflation permanently higher.”

    That’s why 4% NGDP (or Woolsey’s 3%) level targeted is better.

    Then you expect the opportunistic dis-inflation to stay locked in under 2% for the long term.

    Scott, now is the time you admit I got ya:

    https://www.themoneyillusion.com/?p=6244

    “I recall reading about opportunistic disinflation in the 1990s, and making a mental note that it was a silly idea, obviously procyclical, and that surely the Fed would not take the idea seriously. Shame on me. The Fed warned us what they planned to do as far back as 1989. We ignored them. Then they went ahead and did it. And they are still doing it. This expansion will have even lower inflation that the last one.”

    This is you ADMITTING that expecting a 5% trend was WRONG – the Fed made clear your assumption was wrong.

    Now that you remember it, you are trying to lock in those 2%.

    That’s not what the royal WE wants Scott, we want it running under 2%.

    Not everyone is crying about Greece or Wisconsin, Scott.

    Why aim for 2%, if under 2% helps us force Obama to drill baby drill?

  3. Gravatar of anon anon
    24. February 2012 at 06:35

    Isn’t this approach equivalent to defining “potential RGDP” as a moving average of RGDP growth in the last 20 years? Given the uncertainty inherent in any measure of “potential output”, this is not obviously worse than current policy. But I’m not sure how it improves on simply adopting price-level forecast targeting and dropping the RGDP term entirely.

  4. Gravatar of anon anon
    24. February 2012 at 06:51

    Re: Morgan, I’d argue that price level targeting may be politically preferable to NGDP targeting because it rewards RGDP-boosting policies with a short-term expansion. (BTW, this also implies that nominal wage targeting is problematic, because it biases policy-makers towards lowering the labor share of GDP.) But “opportunistic” disinflation would seem to hurt that goal by increasing policy uncertainty.

  5. Gravatar of Major_Freedom Major_Freedom
    24. February 2012 at 07:02

    NGDP targeting would be ideal, producing a perfectly calm ocean surface over which the ship of free market capitalism could sail.

    Now that’s funny.

    I don’t know why these multi-decade long mood swings affect our central banks, but it needs to stop.

    I know why: it’s because central economic planning doesn’t work.

    I would have thought a “free market” (hahaha) advocate would have known that.

    Thus if trend growth fell from 3% to 2%, as may be occurring right now, there would be a transition period when inflation would temporarily exceed the 2% goal. But then it would asymptotically fall back to 2%. And the reverse would occur when the trend rate of RGDP growth rose. When trend growth is stable then inflation should be stable at 2%.

    I notice you did not spell it out in actual numbers when the trend rate of RGDP growth rose. You just said “the reverse would occur.” So let’s spell it out. Thus, if the trend growth rose from 2% to 5%, there would be a transition period when inflation would temporarily be -1%, i.e. there would be deflation of 1%. Deflation. DEFLATION. DEFLATION.

    It other words, with growths in productivity, prices would fall. This is what Sumner is advocating on February 24th. He is advocating for price deflation when productivity is high.

    Now let’s rewind to February 17th, to this article called “The Problem of Gold”, where Sumner approvingly quotes Ramesh Ponnuru saying:

    “If industrial demand for gold rises anywhere in the world, the real price of gold must rise “” which means that the price of everything else must drop if it is measured in terms of gold. Because workers resist wage cuts, this kind of deflation is typically accompanied by a spike in unemployment and a drop in output: in other words, by a recession or depression.”

    Deflation is only “bad” in a gold standard. Deflation is “good” in a fiat standard.

  6. Gravatar of Cthorm Cthorm
    24. February 2012 at 07:10

    Scott,

    My impression is that this “RGDP 20-year trend + average 2% inflation” policy rule is more inferior than you are letting on. It’s especially weaker if this is not an explicit policy target (explicit does not mean ‘badly hidden secret’). While you’ve made the case for RGDP + inflation as a single target, this kind of a target badly misses some of the great benefits of a true aggregate like NGDP. When you just target NGDP the Fed has a much more defined role and will not have to interpret secular trends in RGDP that could effect their policy actions (e.g. major ‘productivity shocks’ in one sector or another would lead Fed officials to doubt if their targets are still appropriate, JUST LIKE TODAY).

  7. Gravatar of Anon1 Anon1
    24. February 2012 at 07:11

    Overall a good piece, but a glaring omission. Haltom fails to mention why NGDP targeting became fashionable again. She goes on and on about McCallum who was an early advocate of NGDP targeting, but he was not the reason it came back. In fact, he was silent until just recently . She mentions Romer, Krugman, and the FOMC’s discussion of it. But none of them nor the wider public discussion would have taken place had it not been for Scott and other’s efforts in the blogosphere.

  8. Gravatar of Negation of Ideology Negation of Ideology
    24. February 2012 at 07:13

    Alright, since we’re throwing out new ideas for a target, let me try one I’ve been formulating for a while. How about a compensated dollar NGDP per person standard. This would be based on Irving Fisher’s compensated dollar plan, but with NGDP per person futures taking the role of gold. I’m thinking it should be per adult rather than per capita.

    So for a given year, assume the target is $75,000 NGDP per adult. The Fed buys and sells unlimited futures at $75000. (It would probably use 1/1000 shares at $75 so anyone could buy them but it’s the same idea). The next year the target changes based on the PCE. You could do it based on a fixed PCE in the base year, or you could do it with a PCE level increasing at some rate such as 2% per year. I actually prefer the 0% rate after a transition period to account for current expectations of low inflation, but either would be fine with me.

  9. Gravatar of Cthorm Cthorm
    24. February 2012 at 07:17

    @anon

    Nominal wage targeting is not a bad idea because it puts a bias on lowering the labor share of NGDP, it’s a bad policy idea because it looks to only one type of income. Let’s say the workforce is paid 90% in wages and 10% in equity/options/benefits before the wage target; after the wage target the workforce would demand an increasing share of their pay be in the form of equity/options/benefits. Don’t believe me? Look at what happened during & after World War II, when the Gov’t implemented a nominal wage target (price controls on wages, it’s the same thing!): that’s how we got our employer-provided health insurance system. The inefficiencies of that system lead the USA to spend more on healthcare as a share of NGDP than any other country.

  10. Gravatar of marcus nunes marcus nunes
    24. February 2012 at 07:54

    Scott
    “As I look at world history, it looks to me like the major central banks were constantly trying to boost growth until about the early 1980s, and since then have constantly been obsessed with reducing inflation”.
    That´s right!
    http://thefaintofheart.wordpress.com/2012/02/23/obsessions-are-a-formidable-barrier-to-economic-progress/

  11. Gravatar of bill woolsey bill woolsey
    24. February 2012 at 08:27

    So, if inflation is above 2% and real GDP growth is above 3%, then “tighten.”

    If inflation is 2% and real GDP is above 3% tighten.

    If inflation is below 2% and real GDP is above 3%, then?

    If inflation is above 2% and real GDP is below 3%, then?

    If inflation is below 2% and real GDP is at 3%, loosen.

    If inflation inflatino is below 2% and real GDP is below 3% loosen.

    It is the two middle scenarios that are doubtful. Of course, we want if inflation plus real GDP growth is below 3% + 2% loosen. If they are above, tighten.

    By the way, this is not, “growth path or growth rate.” Read it. It is all growth rate. Not good.

  12. Gravatar of Negation of Ideology Negation of Ideology
    24. February 2012 at 08:40

    “It other words, with growths in productivity, prices would fall. This is what Sumner is advocating on February 24th. He is advocating for price deflation when productivity is high.”

    Exactly! You finally understand. A benign deflation is one caused by productivity increases. A malignant deflation is caused by a disruption in the unit of account itself.

    “Deflation is only “bad” in a gold standard. Deflation is “good” in a fiat standard.”

    Not necessarily. It could be good or bad in either case. If the government controls the price of gold by government edict (commonly called the Gold Standard), then if there is a change in the supply or demand for gold you could have a malignant deflation or inflation. This could be caused by wealthy bankers (as it was in the case of JP Morgan), or foreign powers (such as when Germany dumped its silver on the market and bought gold in the 1870’s), or any other reason. But you could also have a benign deflation under the gold standard.

    Likewise, deflation could be could or bad with a free market floating currency. If deflation is caused by a sudden dramatic decrease in M2 or velocity, for example. On the other hand, if real GDP was growing at 7% and NDGP was growing at 5% we’d be dancing in the streets because our nominal income would be increasing while prices are falling 2% per year. Our standard of living would be increasing.

    Ultimately, all economic value is relative to the wants and needs of human beings. The only reason people want money is to buy goods and services with it. We should simply recognize that by basing our money on the output of goods and services, i.e. GDP. Reality is not optional.

  13. Gravatar of ssumner ssumner
    24. February 2012 at 08:54

    Morgan, Yes, we might have expected a bit less that 5% after the banking crisis–perhaps 4.5%. But we got NEGATIVE 4%.

    anon, Inflation targeting is horrible, as it makes the real economy very unstable during supply shocks.

    Major Freeman, You said;

    “It other words, with growths in productivity, prices would fall. This is what Sumner is advocating on February 24th. He is advocating for price deflation when productivity is high.”

    I have to say Major that you are always good for a few laughs. After commenting here every day for a year you’ve finally figured what NGDP targeting means.

    And no, there is absolutely no conflict with my praising Ponnuru’s quotation. Maybe in another year you’ll figure out why.

    Cthorm, I don’t follow your comment. My proposal is an explicit target, virtually identical to NGDP targeting.

    Anon1, I thought something was missing!

    Negation, You could do that, but it wouldn’t work as well, and would be much more politically unpopular. So I don’t see the advantage.

    Marcus, That’s right.

    Bill, I don’t quite follow. There is nothing ambiguous at all. You base policy on the moving average of RGDP growth plus 2%. The 2% and 3% numbers you cite are only ambiguous, because you don’t tell me the past 20 years RGDP growth. If it’s less than 3%, as I suspect, then there’s nothing ambiguous about those cases.

    I think you overlooked my PS.

  14. Gravatar of D R D R
    24. February 2012 at 09:07

    Yes, we might have expected a bit less that 5% after the banking crisis-perhaps 4.5%. But we got NEGATIVE 4%.”

    But… WHY did we get negative 4%? What happened in the economy that the Fed’s monetary policy proved insufficient to prevent a large fall in NGDP?

  15. Gravatar of Cthorm Cthorm
    24. February 2012 at 09:17

    Scott,

    I was thinking of your proposal in two ways, because it wasn’t clear to me whether this was a proposal for an ‘explicit target’ or an ‘implicit target’ or a ‘highly discretionary policy rule’.

    I’m convinced that it makes a big difference whether the Fed comes out and announces “This is the policy rule/target we are using” versus internally setting policy based on the rule without making it clear to the public. Similarly I think it makes a big difference if the Fed itself interprets the rule as ‘hard’ or ‘soft’, i.e. is it deterministic or is it discretionary. Like Bill, I’m not comfortable with the two uncertainty situations he outlines. I’m particularly concerned with the scenario where RGDP >3% and Inflation <2%. But the immediate concern is what the Fed does when RGDP <3% and Inflation = 2%. The way I understand it, under NGDP targeting Inflation would increase until the sum is 5%, but it's unclear if the same is true for this proposal.

  16. Gravatar of anon anon
    24. February 2012 at 09:19

    Scott, OK, so what you’re proposing amounts to a kind of “flexible” price-path targeting where NGDP only varies with very low frequency, because NGDP variations are sort of filtered by the 20-yr moving average. Makes sense to me. Two questions: (1) could we get away with a shorter window, say 10 years? Though Japan suggests that monetary effects can be long-lasting. (2) can this policy be improved thru market mechanisms, without altering its overall character?

  17. Gravatar of Mark Mark
    24. February 2012 at 09:50

    Scott,

    When you wrote:

    “That got me wondering if it would be possible to do a policy that looked very much like current policy, and yet was almost identical to NGDP targeting.”

    … I was sure you were going to say something like this. The Fed should announce:

    “We have a dual mandate.”

    “Mandate 1 is 2% inflation.”

    “Mandate 2 is 3% RGDP growth.”

    “We weight these two equally.”

    “So we’ll target the sum of inflation and RGDP growth at 5%.”

    Voila – NGDP growth target.

    So what am I missing? I don’t mean what’s to like or not to like about an NGDP growth target, just why didn’t this simple approach to your question get a mention.

    –Mark

  18. Gravatar of Benjamin Cole Benjamin Cole
    24. February 2012 at 09:51

    The idea that central bankers are like money-a-holics, just one drink away from printing money to the moon is deeply entrenched in certain Theo-Monetarist tropes and sermons and other pompous pettifogging.

    But in fact, the opposite has become true in nearly all Western economies. Central bankers in Japan, the USA and the ECB have a feverish devotion to price stability before all else, and many even say that a central bank’s only obligation is to price stability.

    The danger is that we do a Japan—once a globe-beating nation, where now wages are down 15 percent, industrial output is off 20 percent, and the stock market down 75 percent and the property market is off 80 percent in 20 years.

    The biggest threats to American security and prosperity are the Chicken Inflation Littles.

  19. Gravatar of Benjamin Cole Benjamin Cole
    24. February 2012 at 09:52

    Oh, and Scott Sumner is the Best Economist, as proven again by his latest post.

  20. Gravatar of Steve Steve
    24. February 2012 at 10:15

    Scott, I kind of agree with this post but I prefer the “KISS” method as described by Mark. It’s just easier to explain the simpler approach over a technocratic one, especially when we have the problem described below:

    Fed’s Bullard says willing to adopt single mandate
    http://www.reuters.com/article/2012/02/24/us-usa-fed-bullard-mandate-idUSTRE81N0RD20120224

    Republican House bill would strip Fed’s jobs mandate
    http://www.reuters.com/article/2012/02/24/us-usa-fed-congress-idUSTRE81N03L20120224

  21. Gravatar of Steve Steve
    24. February 2012 at 10:17

    “Republican House bill would strip Fed’s jobs mandate”

    I don’t understand how this doesn’t get reinterpreted by the electorate as “Republicans oppose jobs”

    Combined with the Keystone decision from Obama, we have two political parties both opposed to growth.

  22. Gravatar of Steve Steve
    24. February 2012 at 10:18

    Why do links to Reuters require moderation???

  23. Gravatar of Morgan Warstler Morgan Warstler
    24. February 2012 at 10:19

    Ya know… it would help you to sometimes think a bit further ahead with little old me.

    IF YOU WOULD JUST TRY focusing people’s minds on the simple actual effects of a version of your policy:

    Under a 4% level target (probably 4.5%), we are essentially CAPPING yearly growth, AND EVERYONE WILL KNOW IT.

    Anytime a public employee gets a raise, until they really are the bottom of the barrel, the private sector will go APESHIT, because we artificially increased RGDP…

    Because public employees get raises without delivering productivity gains.

    Admitting this will help people think through the real choice between status quo and NGDP.

    NGDP is less confusing, less confusing favors the “REAL” in RGDP/

    Look at Woolsey’s interesting points:

    “If inflation is below 2% and real GDP is above 3%, then?”

    Then we make big cuts to public sector to drive RGDP down under 3%.

    “If inflation is above 2% and real GDP is below 3%, then?”

    Then raise rates (to reduce inflation to 2%), we cut regulations, increase human health risks, and drill baby drill.

  24. Gravatar of Dennis Dennis
    24. February 2012 at 10:24

    Brilliant!

  25. Gravatar of Benjamin Cole Benjamin Cole
    24. February 2012 at 10:36

    As an aside—is there any evidence that the much-ballyhooed “2 percent inflation” is the right amount of inflation?

    What if the real world works better with 3 percent inflation?

    From 1982 to 2008, the USA had a CPI almost always between 2 percent and 6 percent. We flourished!

    China and India are growing robustly with even higher rates of inflation.

    Should not we worship that rate of inflation connected to the highest rates of real growth? And what is that rate?

    Perhaps there is danger in the 2 percent target–too close to deflation.

  26. Gravatar of Ron Ronson Ron Ronson
    24. February 2012 at 11:05

    The idea expressed in today’s post appear to rest on the assumptions that:

    1. 2% inflation is a good thing – I agree that this can be justified on the grounds that it allows for changes in relative wages in a situation where they may be sticky

    2. NGDP needs to increase in line with RGDP growth. This makes less sense to me. Why wouldn’t you want prices to fall as productivity increases ? Wages would not have to fall so I don’t see how sticky wages would be an issue here.

    3. You are able to accurately measure what part of NGDP growth is down to RGDP growth and what part is inflation. Wouldn’t this be open to all sorts of interpretations and political interference and be very hard to get right ?

    So – I think that the long term goal should just be a gentle long term (2-3%) increase in NGDP that would allow relative wages to adjust over time. No need to worry about potential changes in RGDP growth or whether inflation is measured correctly or not.

  27. Gravatar of Greg Ransom Greg Ransom
    24. February 2012 at 11:07

    New paper — housing is over 1/2 of slump:

    http://economix.blogs.nytimes.com/2012/02/24/measuring-housings-drag-on-the-economy/

    Quotable:

    “The paper offers a striking way of thinking about the depth of this housing problem. It calculates that at the end of 2010, the total value of American homes exceeded demand by about 9 percent, or about $1.5 trillion.

    Lower interest rates attract more buyers by reducing the cost of buying a home. But the authors calculate that rates would have needed to drop into negative territory to attract enough buyers. In other words, rather than charging people for money, lenders would have needed to give money to borrowers for free “” and then pay them for agreeing to take it.”

  28. Gravatar of D R D R
    24. February 2012 at 11:24

    “Voila – NGDP growth target.”

    Wrong. You can hit the NGDP target year in and year out and never come close to fulfilling either mandate. Failing at two mandates by an equal and opposite number of percentage points doesn’t imply success.

  29. Gravatar of Greg Ransom Greg Ransom
    24. February 2012 at 11:28

    Here are some _massive_ causal patterns in the macroeconomy which any causally viable or adequate explanation of the the boom and bust cycle needs to explain:

    “Economists would generally expect a stronger rebound in areas where the downturn was sharper, but the authors reached the opposite conclusion.

    “The recovery actually is stronger in areas that did not have a severe decline in housing prices,” said Amir Sufi, a professor of finance at the university’s business school and one of the authors of the paper.

    The weakness is concentrated in the states hit hardest by the housing crash, the “sand states” of Arizona, California, Florida and Nevada. These are the states where the Fed’s efforts to bolster the economy had the least effect, because so many residents are constrained in their ability to take advantage of lower rates.

    I described the impact on the Orlando area last year.

    The new paper offers some striking numbers underscoring the problem.

    The issuing of permits for remodeling activity has increased every year since 2000 in states with relatively modest housing bubbles; the housing crash only slowed the pace of growth. By contrast, in the states with the largest bubble, issuing of permits has collapsed.

    Auto sales declined everywhere during the recession, but the drop was much larger in the housing bubble states, and the recovery has come more slowly. Sales have returned to roughly 90 percent of the pre-recession level in states where housing prices remained relatively stable, but sales have reached only about 60 percent of the pre-recession level in states where housing prices fell sharply.”

    If you are punting on this stuff ….

  30. Gravatar of Major_Freedom Major_Freedom
    24. February 2012 at 11:43

    ssumner:

    “In other words, with growths in productivity, prices would fall. This is what Sumner is advocating on February 24th. He is advocating for price deflation when productivity is high.”

    I have to say Major that you are always good for a few laughs. After commenting here every day for a year you’ve finally figured what NGDP targeting means.

    Negation of Ideology:

    Exactly! You finally understand. A benign deflation is one caused by productivity increases. A malignant deflation is caused by a disruption in the unit of account itself.

    Speaking of laughs, you two are hilarious. I’ve always known that NGDP targeting would result in falling prices if productivity is high enough. This isn’t some light bulb that just went off. The only reason why I brought it up is because I thought it was interesting that it contradicts Sumner’s prior post on gold when he suggested that falling prices is a bad thing, despite the fact that total economic spending in gold money terms is also being outpaced by productivity growth and thus leads to falling prices, all of which is what NGDP is trying to mimic in the first place.

    And no, there is absolutely no conflict with my praising Ponnuru’s quotation. Maybe in another year you’ll figure out why.

    Nice try, but if there is no conflict, then there is no reason not to spell it out here and now. You see, I know exactly what you’re going to say, and I know what I am going to say in return.

    You’re going to say that it’s “bad” deflation if a geographical territory of land, called “my country”, experiences a fall in local nominal spending and incomes, brought about by increased productivity in other geographical territories of land somewhere else, called “foreign countries.” This is “bad” deflation because there is less nominal spending in “my country.” Booooo!

    Then I will say that this would contradict your existing position that it would be “good” deflation if a geographical territory of land, called “my home state”, experiences a fall in local nominal spending and incomes, brought about by increased productivity in other geographical territories of land somewhere else, called “other US states.” This is NOT “bad” deflation because although there is less nominal spending in “my home state”, there is greater nominal spending and incomes in other states, and hence there is the same nominal spending in “my country.” Yeeeeeah!

    The best part of all this, is that the more you guys think to go out on a limb to finally get me, the more I show the fallacious mercantilist inspired foundations of your views.

    You know what would be hilarious? Getting Sumner to explain why a gold outflow from Arizona and into Texas due to Texas experiencing a boom in productivity is a “good” deflation, whereas a gold outflow from the US to China due to a boom in Mexican productivity is a “bad” deflation.

    Sumner is, unwittingly, a stooge of the feds.

    But yeah, let’s focus on why I don’t “get” what he isn’t saying explicitly and what we’re all supposed to know anyway.

    PS Every day for a year? Maybe it seems like that long to you, but it’s only been a few months tops.

  31. Gravatar of Major_Freedom Major_Freedom
    24. February 2012 at 11:45

    You know what would be hilarious? Getting Sumner to explain why a gold outflow from Arizona and into Texas due to Texas experiencing a boom in productivity is a “good” deflation, whereas a gold outflow from the US to China due to a boom in Mexican productivity is a “bad” deflation.

    should read

    You know what would be hilarious? Getting Sumner to explain why a gold outflow from Arizona and into Texas due to Texas experiencing a boom in productivity is a “good” deflation, whereas a gold outflow from the US to China due to a boom in Chinese productivity is a “bad” deflation.

  32. Gravatar of Peter Peter
    24. February 2012 at 12:03

    Interesting idea. But I suspect that it would be easier to get them to adopt an official loss function. I think that would be good enough.

    L = (p – p*)^2 + lambda (u – u*)^2,

    where p-p* is the deviation of inflation from its target and u-u* the deviation of unemployment. lambda is a positive constant that the central bank should decide. L is the loss function that the central bank will try to minimize.

    From the last part of this: http://blog.ngdp.info/2011/10/central-bank-transparency.html

  33. Gravatar of anon anon
    24. February 2012 at 12:06

    Major_Freedom, an outflow of dollars from AZ into TX would be considered bad to the extent that it alters NGDP per capita in both AZ and TX. It would be beneficial to use state-level fiscal policy in order to nudge these money flows, say by subsidizing investment if you’re AZ and taxing it if you’re TX. But such policies must necessarily lead to non-trivial real effects (since the nominal anchor is fixed by the US currency union), so there’s a balancing act involved.

    This is not “mercantilism”, because mercantilism, to the extent that it was a consistent policy at all (as opposed to an ideology favoring export manufactures) aimed to boost NGDP given the constraints of the gold standard as opposed to stabilizing it over time.

  34. Gravatar of bill woolsey bill woolsey
    24. February 2012 at 12:54

    Major Freedom:

    Suppose there is a major fad for dressing like rap stars.

    The demand for gold rises. It is extreme. It doubles.

    With a gold standard, this requires the price level to fall by 50%. Prices, wages, ect.

    The signal and incentive to make these cuts is a decrease in demand. Sales fall, production falls, surpluses of resources develop. Firms pay less for resources, including labor. Wages and other costs fall. Prices fall by more. As wages and prices fall, real demand recovers, and production and employment return to the initial level.

    All nominal contracts generate a massive a transfer from debtor to creditor. The purpose of these contracts was not to speculate on the gold market, but to share the gains and risk from particular investments. But, they are simultaneously speculations about the possibility of a rap fashion statement.

    We all believe that what should happen when there is rap fad is that the price of gold double and other wages and prices stay about the same, and most contracts are not much effected, other than those of the jewelers and mines.

    There was no doubling of productivity.

    Industrial demand for gold is not an increase in the demand for money because of industrial development. It is a demand for gold for dentistry, jewelry, circuitry, or something else of the sort.

    Further, it isn’t at all the case that a gold standard requires gold to flow between Arizona and Texas depending on economic development in Texas (or whatever you have in mind.) Only if the greater wealth causes whomever to want more gold, like in jewelry, does that happen.

    The same is true between countries.

    Second, you are entirely confused if you think that the “benign” deflation due to productivity growth involves pulling money out of regions or industries where there has been no productivity growth towards where there has been.

    If there is unit elastic demand for an industry with improved productivty, the real volume of sales rises in inverse proportion to the decease in prices. The nominal volume of spending on that product is unchanged. The nominal incomes of those in that industry are unchanged. Their customers are all better off, getting a lower price and more output. And they can use more of their own output too. But they don’t get more money. The money expenditures everywhere else is the same.

    Now, if we imagine the improved productivity is in one “state” or “country.” Then their particular products become cheaper and they produce more of them. The rest of the world gets more products for lower prices. And the rest of the world carries on as before. (And the country with the productivity gain gets the benefits when its trading partners have such gains.

    If the demand for the product in question is _elastic_ then spending on it rises with the improved productivity. If total spending is unchanged, then spending on everything else falls.

    In this case, the deflation is not perfectly benign. There is an need to reallocate resources.

    If this is regional, and people can move between regions and capital can move between regions, then the shifts in spending are accompanied by people moving. If people cannot move, then there are persistent changes in real incomes. With a gold standard, these must be accomplished by changes in nominal incomes. These changes in nominal incomes are the opposite of benign deflation. Sales fall, and sellers cut prices and demand fewer resources. And then, they cut wages and other resources payments because they can due to surpluses. And then they lower prices more sell more and hire them back. Painful.

    With different monies and flexible exchange rates, the nominal incomes can carry on growing as before, but the exchange rate changes and the prices of foreign goods change. For the people losing demand, they get paid the same and goods produced locally cost the same, but goods from places where other monies are used get more expensive.

    Again, is this better or worse? Well, if people can move when this happens (and really, want to move,) then maybe the change in nominal incomes is the best signal of what needs to be done. But if people don’t move, or can’t move, then it is very disruptive.

    Your apparent notion that the gold standard is great because gold is sucked into regions with growing productivity and so those areas that lag behind have to lower wages and prices, so deflation. Well, that isn’t very benign.

    Also, the actual causual factor is that regions with growing real incomes demand more gold. This could be just jewelry, but since the demand to hold money is positively related to real income, and if the demand for monetary gold is positively related to the supply of money, (one for one for 100% reserve advocates,) then areas with growing real incomes have growing demands for monetary gold. If a region grows more quickly, then gold will flow into that region for monetary reasons.

    That other parts of the world lose gold in that case is not benign at all. If the people can move, it might be the best approach. If not, having a common money for the whole world is probably a bad idea.

    Wages are falling in our country (and rising in some other area.) This creates a signal that workers in our country should move to the properous country. Well, if that is possible or likely, then that signal and incentive is greater. But if it is impossible because of emigration restrictions or language problems, then the lower wages only signal that we can’t afford as much foreign stuff. Well, higher prices for foreign goods signal that as well, and it seems cleaner to me.

    By the way, why don’t you use your real name. Believe or not, I really am Bill Woolsey!

  35. Gravatar of Morgan Warstler Morgan Warstler
    24. February 2012 at 14:02

    “If not, having a common money for the whole world is probably a bad idea.”

    We need at least one global digital currency whose supply does not increase, and is infinitely divisible.

    It should not be anonymous. The company that manages it should track ownership of ever single unit, making theft very hard to accomplish.

  36. Gravatar of Mike Sax Mike Sax
    24. February 2012 at 14:28

    Scott this morning your buddy Bulliard was on CNBC and they were trying to get him to say that the Fed should just scrap the dual mandate-just target inlfation of course.

    He more or less obliged saying that “it makes no difference” whether they target both or inflation alone. This is of course because for Buliard at least inflation is the only mandate he cares about.

    “As I look at world history, it looks to me like the major central banks were constantly trying to boost growth until about the early 1980s, and since then have constantly been obsessed with reducing inflation”

    “I don’t know why these multi-decade long mood swings affect our central banks, but it needs to stop”

    I can explain the mood swing. In the pre-Volcker age the Fed cared most about full employment-they asically had a Keynesian framework.

    Since the early 80s with a change in doctrine and the memory of high inflation in the 70s the Fed has come to now to prefer low inflation to low unemployment.

  37. Gravatar of Mike Sax Mike Sax
    24. February 2012 at 14:31

    This is why concetputaly at least NGDP sounds like a good idea-it would seem to take care of both sides of teh mandate at once.

    As Romer suggests for the Fed to do this would take another major change in ideology as they had starting with Volcker when low inlfation-you have rightly in the past emphasized that central banks care about low inflation not stable inflation- became more important than full employment.

  38. Gravatar of D R D R
    24. February 2012 at 15:29

    “We need at least one global digital currency whose supply does not increase, and is infinitely divisible.

    “It should not be anonymous. The company that manages it should track ownership of ever single unit, making theft very hard to accomplish.”

    And a pony and ice cream! And transporter beams!

  39. Gravatar of Mike Sax Mike Sax
    24. February 2012 at 15:34

    Morgan, now you’re a Bulliard man. How about Ron Paul you and him probably have a lot in common other than he claims to be against military inteventiuon

  40. Gravatar of Morgan Warstler Morgan Warstler
    24. February 2012 at 16:10

    Mike,

    I’m against military intervention as long as all the money saved goes to cut the taxes of people who actually pay income taxes.

    If it is going to pay off Dem voters, I’d rather invade Canada.

  41. Gravatar of Mike Sax Mike Sax
    24. February 2012 at 16:25

    So are you a Ron Paul man? If not why not?

  42. Gravatar of Mark Mark
    24. February 2012 at 16:36

    DR:

    “Voila – NGDP growth target.”

    “Wrong. You can hit the NGDP target year in and year out and never come close to fulfilling either mandate. Failing at two mandates by an equal and opposite number of percentage points doesn’t imply success.”

    No no no – you miss my point. Of course this is true, but Scott’s question was how to state a policy that sounds like current Fed policy, but in fact is or is nearly NGDP targeting. Steve got it – it’s a KISS answer. It’s very simple and very obvious. My question was, why did Scott not even mention it?

    –Mark

  43. Gravatar of D R D R
    24. February 2012 at 16:53

    … and my point is that it is not nearly NGDP targeting.

  44. Gravatar of dtoh dtoh
    24. February 2012 at 18:02

    Scott,
    I don’t think this works. If inflation is on target at 2% and RGDP is below target, the FED will just say 1 out of 2 is not bad. Right now they’re 0 for 2 and aren’t doing anything about it.

    STAY FOCUSED ON NGDP LEVEL TARGETING!

  45. Gravatar of dtoh dtoh
    24. February 2012 at 18:06

    Morgan,
    You said, “It should not be anonymous. The company that manages it should track ownership of ever single unit, making theft very hard to accomplish.”

    This is the single dumbest idea you have ever had. There are plenty of other ways to better minimize theft. Anonymity (especially of money) is the only way to protect freedom in the modern world.

  46. Gravatar of Major_Freedom Major_Freedom
    24. February 2012 at 21:40

    anon:

    Major_Freedom, an outflow of dollars from AZ into TX would be considered bad to the extent that it alters NGDP per capita in both AZ and TX. It would be beneficial to use state-level fiscal policy in order to nudge these money flows, say by subsidizing investment if you’re AZ and taxing it if you’re TX. But such policies must necessarily lead to non-trivial real effects (since the nominal anchor is fixed by the US currency union), so there’s a balancing act involved.

    Do you realize the absurd end of the line this thinking would take you?

    First off, states cannot print their own money, so state fiscal policy cannot expand NGDP. They tax and they borrow, and that reduces what the private sector can spend.

    Secondly, and more importantly, instead of considering states, consider counties, then cities, then neighborhoods, then individual business firms. Your logic would lead you to having to say that an outflow of gold from an individual business firm to another business firm, such that the nominal spending to the first business firm decreases, is “bad”, and that individual business firm must be given some sort of government handout financed by inflation.

    In other words, there is no economic calculation in what you’re saying. There’s no losses to go along with profits. If you’re saying states losing nominal spending to other states is “bad”, because it reduces state NGDP, then you must also view individual companies losing nominal spending (revenues/investment) to other individual companies in economic competition as “bad”, because it reduces “NGDP” for the individual company.

    If you’re saying that individual businesses that are outcompeted for revenues should not be given printed money by the state to raise its NGDP back up, then by logical extension, neither should you advocate that individual cities be bailed out by inflation when they lose revenues to other cities that outcompete it, and then counties, and then states, and then whole countries.

    There is no logical consistency in what you’re saying. There’s a fuzzy grey area where somewhere between individual firms (where they are “allowed” to incur reductions in “NGDP” in competition with other companies), and larger areas like states and countries (where they are “not allowed” to incur reductions in “NGDP” in competition with other states and countries), economic logic gets turned upside down and black becomes white.

    This is not “mercantilism”, because mercantilism, to the extent that it was a consistent policy at all (as opposed to an ideology favoring export manufactures) aimed to boost NGDP given the constraints of the gold standard as opposed to stabilizing it over time.

    That’s a terrible argument. NGDP targeting has its own constraints as well that can lead to individual economic units (companies, cities, states, etc) being outcompeted for revenues by other economic units (companies, cities, states, etc), such that they incur reductions in “nominal spending” or “NGDP” at those economic units.

    For a country’s central bank to print money every time existing money is outcompeted away to foreign countries that boost their productivity, such that the relatively inefficient domestic companies and industries are propped up, the end result is higher prices and lower quality goods for the consumer, and more importantly, long run reductions in international competitiveness.

    This is, contrary to your claims otherwise, indeed a mercantilist based economic policy. Ensuring domestic industries don’t lose profits to international competitors, by bailing out domestic companies via inflation, is textbook mercantilism.

  47. Gravatar of Major_Freedom Major_Freedom
    24. February 2012 at 23:37

    bill woolsey:

    Suppose there is a major fad for dressing like rap stars.

    The demand for gold rises. It is extreme. It doubles.

    With a gold standard, this requires the price level to fall by 50%. Prices, wages, ect.

    The signal and incentive to make these cuts is a decrease in demand. Sales fall, production falls, surpluses of resources develop. Firms pay less for resources, including labor. Wages and other costs fall. Prices fall by more. As wages and prices fall, real demand recovers, and production and employment return to the initial level.

    Production does fall. An increased demand for gold hoarding of 50%(!!!), is not only so outlandish as to be rejected outright on the basis that it is very obvious that you have no other way to argue against gold than to imagine a sudden increase in money holding to 50%, which has never happened before, even in the greatest depths of the deflationary Great Depression.

    But just for argument’s sake, to humor you, then even if the demand for gold holding rose to 50%, the process you described above is not correct. It is tacitly resting on the fallacious assumption that production and employment are grounded on the demand from consumers. That is not true. Most of the spending that takes place in the economy, most of the money that finances economic activity, is through savings and investment, NOT consumption spending. Consumption spending actually only takes up a minority of all spending at any one time. Yes, consumption spending ultimately covers all the saving and investment, but in any given time period, the spending that originates from saving almost always outweighs the spending that originates from consumption.

    To see this, just consider the fact that after tax profit margins tend to average around 10%. This means that for every $1.00 spent on consumption, there is roughly $0.90 being invested (saved) at those consumer goods companies. But that $0.90 saved and invested by the consumer goods companies is equivalent sales revenues for labor and capital goods companies one step removed. If we assume a 60% capital to 40% labor split for all companies that invest, then for consumer goods companies, every $1.00 in consumption spending is accompanied by 0.6x$0.90 = $0.54 capital investment and thus $0.54 sales revenues to capital goods companies one step removed. Since they too have a profit margin of 10%, they would be making capital investments of 0.9×0.6x$0.54=$0.292, which is $0.292 sales to revenues to capital goods companies another step removed, who must be making investments of 0.9×0.6x$0.292=$0.157….this leads to total sales for products as being $1.00+$0.54+$0.292+$0.157+$0.085+$0.046…=$2.11

    Since all this spending is taking place concurrently, it means that consumption spending takes up a minority of total spending. Most incomes and ALL wages are financed by saving, not consumption spending. In the aggregate, consumption spending and investment spending are in competition with each other.

    All nominal contracts generate a massive a transfer from debtor to creditor. The purpose of these contracts was not to speculate on the gold market, but to share the gains and risk from particular investments. But, they are simultaneously speculations about the possibility of a rap fashion statement.

    If people want to wear more gold as a fashion statement, then obviously it’s because they perceive gold as a highly valuable commodity. It would totally defeat the purpose of it if gold could be created at will like fiat paper money, should people start to wear more gold. A central alchemist bank that created enough gold to replace the gold “lost” to being worn as jewelry, would nullify the very reason people wore it, for creating more gold would devalue the gold, and make people wear less of it, contrary to their desired intentions.

    You see, if you start with the prejudicial worldview that consumers should not be the “masters of capitalism”, then of course you can invent all sorts of frivolous choices in your mind that would belittle the consumer’s sovereignty. Imagining them to be a bunch of rappers who want to wear pounds of gold jewelry, instead of doing the “moral duty” to keep spending that gold and being pawns in maintaining “NGDP” so the state doesn’t have to, is just an upside down topsy turvy bigotry against the consumer.

    Here I am thinking that consumers should be the ultimate deciders of who makes money and who incurs losses, in deciding on whether or not jewelry manufacturers should get their gold money and everyone else getting less gold money, so that resources and labor can be freed up and redirected towards more jewelry making, rather than some frivolous whatever-it-is-you-are-interested-in-that-I-will-belittle consumer goods.

    How can people get more jewelry to wear if labor and resources aren’t being freed up from other industries to make it possible to produce more jewelry, because they’re constantly being bailed out by the central alchemist bank? You tell me that. You tell me why you are ignoring economic calculation and why you are instead worrying about ensuring that no businesses are ever to suffer losses because they are making investments in things that the consumers want less of in the first place.

    We all believe that what should happen when there is rap fad is that the price of gold double and other wages and prices stay about the same, and most contracts are not much effected, other than those of the jewelers and mines.

    There was no doubling of productivity.

    There doesn’t have to be a doubling of productivity. If the consumers want more gold jewelry, it means that they want less gold as money and less of other consumer goods. The law of demand is how investors are signalled to produce less of other things and more jewelry. In addition, by wanting less money and more jewelry, consumers are clearly desiring to have increased purchasing power of gold money. But if the central alchemist bank creates more gold, it will short circuit this process.

    Industrial demand for gold is not an increase in the demand for money because of industrial development. It is a demand for gold for dentistry, jewelry, circuitry, or something else of the sort.

    What’s the problem? If more gold money is used for dentistry, jewelry, circuitry, etc, then the value of the remaining gold will be higher. Since in the real world any “loss” of gold to these uses would be gradual and not the 50% craziness you’re suggesting, there is no reason why there would be a sudden business shock of a 50% decline in revenues across the board. If you look at the history of gold production and uses of gold, the amount of hold “lost” to jewelry and dentistry and whatnot, is minimal. At any rate, even gold in these forms is STILL “money”, and can be used to make purchases at any time. There is no difference in principle between these uses of gold, and people holding 10% of their wealth in cash in a fiat money system.

    Further, it isn’t at all the case that a gold standard requires gold to flow between Arizona and Texas depending on economic development in Texas (or whatever you have in mind.) Only if the greater wealth causes whomever to want more gold, like in jewelry, does that happen.

    Absolutely false. As Adam Smith showed centuries ago, economies that are more capital intensive tend to attract the most gold money, but NOT because there are people in these areas that want to hoard more gold, but rather because the very increase in the size of economic activity, of capital investment, attracts gold to circulate there instead of less capital intensive areas. With relatively more capital investment, relatively more money will be attracted there facilitating trade. The US attracts the most fiat money for investment in the world of countries not because Americans are the biggest cash hoarders, but because the US has the largest capital intensiveness out of all other countries. That alone attracts money to circulate in the US to facilitate trading.

    The same is true between countries.

    Nope. See above.

    Note that I am not the only one who is making this argument. In this article: https://www.themoneyillusion.com/?p=13155, Ramesh Ponnuru (with Sumner’s approval) gave an example of a rise in relative productivity and capital intensiveness in China, which attracts gold away from the US and into China.

    Seems like you’re alone on the whole “only if it’s for jewelry” thing.

    Second, you are entirely confused if you think that the “benign” deflation due to productivity growth involves pulling money out of regions or industries where there has been no productivity growth towards where there has been.

    No Bill, it is precisely you who is confused, yet again. In a gold standard, that sees real production outstrip gold production, what you will tend to see is a gradual decrease in nominal gold spending at each economic unit as more economic units and more production is created.

    As more laborers come into the workforce, average wage rates in gold, i.e. “nominal spending” or “NGDP”, per worker will fall. As more companies come into existence, average revenues in gold, i.e. “nominal spending” or “NGDP”, per company will fall.

    As production expands, as the labor force expands, then it is absolutely the case that you will see gold money “pulling out” of regions, areas, business units, laborers, everyone and everything. It is the exact opposite, the exact mirror image, of money “pushing in” to regions, areas, business units, laborers, everyone and everything with fiat money INFLATION. If inflation can push money in to companies as more money is created, then it is obviously the case that production can pull money out of companies as more companies are created.

    This is a good, benign, healthy deflation. A gold standard will see average revenues, wages, costs, all gradually fall as more competition from new projects, “pulls” money away from their previous circulations with the lesser populated economy of fewer companies and fewer laborers in the past. As more companies and more laborers come into existence, that outpace gold production, the value of gold will rise, which is the flip side of the coin that sees money being spread out over more and more companies and laborers and thus less money circulating per economic unit on average.

    If there is unit elastic demand for an industry with improved productivty, the real volume of sales rises in inverse proportion to the decease in prices. The nominal volume of spending on that product is unchanged. The nominal incomes of those in that industry are unchanged. Their customers are all better off, getting a lower price and more output. And they can use more of their own output too. But they don’t get more money. The money expenditures everywhere else is the same.

    You are completely ignoring economic competition, and how increased production always occurs at individual companies before all other companies. You’re imagining a weird, static, unchanging economy where nominal revenues per economic unit somehow never change, and the only thing that changes is each economic units’ productivity which leads to lower prices for each economic unit, but unchanged revenues.

    In the real world market, this is not what happens. In the real world market, companies that are inefficient will LOSE revenues to other companies that produce better than they do. This results in money being PULLED AWAY from “bad” companies, and towards “good” companies. This is a healthy phenomena. Again you are ignoring economic calculation. LOSSES are a healthy phenomena of growing economies. It is a way for wasteful and inefficient investment to be purged from the system. This requires that companies that do poorly relative to their peers, lose gold revenues to them, such that they incur losses.

    You want to essentially dope up US companies on fiat money opium, placating them in the international economy so that they never have to experience a collective loss to other nations that outcompete them for revenues. For some strange reason, you and Sumner both have this weird schizophrenia where individual companies are “allowed” to lose money revenues to other companies that outcompete them, but for some reason, you don’t want “US companies” as a whole to lose money revenues to “Chinese companies” as a whole.

    My question to you anti-competition ideologues is how else are US companies going to know if they are being outcompeted with the rest of the world if they never suffer losses relative to the rest of the world? What incentive is there for US companies to improve their performance and do a much better job if they can always invest and earn profits by investing in a US index of “US NGDP”? Do you have any idea what damage you are calling for by coddling US companies and doping them up constantly with inflation? You’re like parents who spoil their children and resulting in children who can’t compete in the real world.

    Now, if we imagine the improved productivity is in one “state” or “country.” Then their particular products become cheaper and they produce more of them. The rest of the world gets more products for lower prices. And the rest of the world carries on as before. (And the country with the productivity gain gets the benefits when its trading partners have such gains.

    What if states become less competitive relative to other states, and what if countries become less competitive to other countries? Shouldn’t you use the same bloody logic that you use for individual companies when you say “Yes, they should incur nominal spending (revenue) decreases, and other, more efficient and more productive individual companies should be rewarded with nominal spending (revenues) increases”?

    If whole states and whole countries should not experience a decline in nominal spending (revenues), why not individual counties, individual cities, individual companies, indeed, individual humans? We can take this NGDP absurdity to its logical conclusion, and call for free inflation money to any individual who experiences a reduction in their nominal spending incomes. We can totally kill economic calculation and economic competition! No more half way nonsense of letting individuals fail within a country market, but never letting whole countries fail in the international market. We can ensure that no individual ever experiences a decline in NGDP for themselves! Nobody has to work or compete any more!

    If the demand for the product in question is _elastic_ then spending on it rises with the improved productivity. If total spending is unchanged, then spending on everything else falls.

    Why is that a bad thing?

    So what if the demand for the products of one economic unit (company or state or country) FALLS, because other economic units made an innovation and are producing those products better such that their demand rises at the expense of the inefficient economic unit (company or state or country)?

    Isn’t this what sends a signal to investors that those products which experience a fall in demand on the basis that their marginal utility has fallen relative to other goods, newer goods, etc, are investments that should be reduced, not maintained or increased?

    If you think a gold standard is so “tight” that it will be impossible for there to be a general profit since it seems like any gain by one company requires a loss at another company, thus preventing a general growth, then think again. Even with an invariable money, aggregate profits will still tend to be positive, since there will be consumption demand from capitalists/investors/businessmen (i.e. those who make investments) that don’t have equivalent costs associated with it. Since each company will require investors to eat and live, the dividends from equity financing and interest payments from debt financing are sources of funds that once spent, will generate a net profit in the economy, while every other expenditure have equal revenue and cost components and thus zero net profit generated.

    In this case, the deflation is not perfectly benign. There is an need to reallocate resources.

    If this is regional, and people can move between regions and capital can move between regions, then the shifts in spending are accompanied by people moving. If people cannot move, then there are persistent changes in real incomes. With a gold standard, these must be accomplished by changes in nominal incomes. These changes in nominal incomes are the opposite of benign deflation. Sales fall, and sellers cut prices and demand fewer resources. And then, they cut wages and other resources payments because they can due to surpluses. And then they lower prices more sell more and hire them back. Painful.

    Pain is what inefficient, uncompetitive economic units SHOULD suffer when other economic units innovate and improve production relative to their peers.

    You’re also completely ignoring the fact that with less nominal spending, comes lower demand, and with lower demand, comes lower prices. Lower prices make those poor souls who lost revenues more competitive once again with their peers. They can compete on price with the world market, exactly like poor China can compete with the world market on price. Yes, their currency is deliberately devalued, but the same exact effect can be had with a gold standard. Their economy is less productive and has less capital invested per capita than the US, and so would attract less gold money to facilitate their trading (remember Adam Smith!). This will make their prices more competitive in the world market, and can enable them to earn profits and reinvest them into their productivity, and grow their economy.

    With different monies and flexible exchange rates, the nominal incomes can carry on growing as before, but the exchange rate changes and the prices of foreign goods change. For the people losing demand, they get paid the same and goods produced locally cost the same, but goods from places where other monies are used get more expensive.

    And they get doped up in the process, economic calculation subject to profit and loss is stilted, and inefficient investments have no way to be calculated as losers because funny money from that investor’s home central bank is keeping his bad investments afloat. Housing bubble anyone?

    Again, is this better or worse? Well, if people can move when this happens (and really, want to move,) then maybe the change in nominal incomes is the best signal of what needs to be done. But if people don’t move, or can’t move, then it is very disruptive.

    It is not as disruptive as you make it appear, because in the real world, we don’t see sudden increases of 50% money hoarding. We see gradual increases in hoarding if there is hoarding. We see in the real world periods of rapid cash hoarding precisely because the fiat monetary standard is so fragile. Periods of rapid money growth to target various statistics (even NGDP would suffer from this) are followed by periods of rapid money declines (to avoid overshooting the target). Thus we get the business cycle. NGDP would not eliminate this because NGDP ignores, indeed attacks, cash balance desires. Cash balance desires are no less a part of the market as is spending cash money. If people want to reduce their consumption and hold more money, then NGDP inflation targeting will attack their preferences, the central bank will print money, and keep printing it until NGDP is raised back up, thus totally nullifying the desire for increased purchasing power in the present, less consumption in the present, and more consumption in the future (since people are holding cash and not burning it).

    Your apparent notion that the gold standard is great because gold is sucked into regions with growing productivity and so those areas that lag behind have to lower wages and prices, so deflation. Well, that isn’t very benign.

    You bet it is. Punishing inefficient companies and workers, who are outcompeted by more efficient companies and workers, is how everyone benefits, including those who are outcompeted! This is because by punishing the less efficient, it leads to more resources being put into the hands of the more productive, and when that occurs, TOTAL PRODUCTION INCREASES. Since even the productive produce for the mass market, it will be a bonanza for the common man, the unproductive man. He’s going to have very little control over means of production, but in a division of labor society, and this is what so many economists, even Nobel winners, fail to comprehend, in a division of labor society people don’t have to own means of production in order to maximally benefit from them. I can tell you that I am better off that Toyota’s means of production are owned by their current owners, and not me. If I owned it all, the company would go bankrupt by next week. I am actually better off that those resources are controlled by others. I benefit more by being a customer. My place in the division of labor is where I am relatively better at managing means of production for my business affairs. Everyone else is better off because of that. This is how the market best works, and yet you’re scared of it and thus you attack it like it’s an enemy.

    You don’t seem to realize that the more competitive the market is, the better off everyone becomes. Even those who lose nominal revenues to others, end up winning.

    And here’s something even more benevolent about the gold standard. Not only does it create a brutally more competitive, efficient, and productive market, but, and this is something that makes me pull my hair out whenever it is attacked by fiat bugs, a gold standard can make the common man who is outcompeted in every way, to earn a risk free return merely by holding gold money. All he has to do is earn money somehow, any money, and he can put aside a portion of that gold, and watch its purchasing power rise to the extent that all other producers are working their arses off increasing their productivity lest they lose revenues to other producers. Producers are going to explode the supply of resources, and make gold money more valuable, and the common man can benefit simply by being a gold money earner.

    Compare that to our current system where the common man is essentially compelled into trying to become Warren Buffet and investing money, or spending money on consumption before it loses purchasing power. Gold, contrary to what is almost certainly your mentality is about it, is literally the poor man’s money. It is not the money of the rich and wealthy. All those cartoon images of fat cats hoarding mountains of gold like billionaire Scrooge McDuck, while everyone else is dirty poor, is exactly the opposite of what gold money really is. Gold can protect the poor man from the ravages of inflation.

    Also, the actual causual factor is that regions with growing real incomes demand more gold. This could be just jewelry, but since the demand to hold money is positively related to real income, and if the demand for monetary gold is positively related to the supply of money, (one for one for 100% reserve advocates,) then areas with growing real incomes have growing demands for monetary gold. If a region grows more quickly, then gold will flow into that region for monetary reasons.

    As explained above, real incomes grow on the basis of capital accumulation. Capital accumulation by itself would attract gold money to circulate within that area. A more capital intensive economy would attract more gold money not because people with real incomes want to hoard more gold money, but because more capital intensive economies attract capital investment which attracts more gold. It feeds on itself.

    That other parts of the world lose gold in that case is not benign at all. If the people can move, it might be the best approach. If not, having a common money for the whole world is probably a bad idea.

    Nope, it’s the best international money there could possibly be. People don’t have to move. Their nominal wages can be reduced, and the costs of what they produce will hence be lower, and therefore the prices of what is produced will be lower. That will make those products more attractive to the workers themselves (since workers pay lower prices), and it will make those goods more competitive in the market. That stops the gold outflow down to what is conducive to their relative productivity.

    Wages are falling in our country (and rising in some other area.) This creates a signal that workers in our country should move to the properous country. Well, if that is possible or likely, then that signal and incentive is greater. But if it is impossible because of emigration restrictions or language problems, then the lower wages only signal that we can’t afford as much foreign stuff. Well, higher prices for foreign goods signal that as well, and it seems cleaner to me.

    In other words, pile one more absurdity on top of the absurdities you thankfully recognize, but refuse to morally challenge on the basis of capitulation and exploitative pragmatism.

    By the way, why don’t you use your real name. Believe or not, I really am Bill Woolsey!

    My philosophy is that by remaining anonymous, myself and those who I debate with, are far more honest and less worrying of offending the other. My calling card around the blogosphere is that I have a caustic and take no prisoners style. In my experience, I have been incredibly successful at not only learning and improving myself, but “converting” others as well. I am concerned only with ideas. I don’t care about anything else. By remaining anonymous, ideas take center stage, which is where I want them. Notice how the fact that you have no face, no real name to attach to my words, that you are compelled to consider just my words and nothing else? That’s exactly what I want. So thanks for the invitation to reveal myself, but I prefer to remain Major_Freedom…that is, until I get promoted again. I started out as Private_Freedom, and you might find it funny to know that I have been changing my name one rank at a time after some random person on the blogoshere tells me that I should be promoted. I never told this to anyone before, but there you go.

  48. Gravatar of Bill Woolsey Bill Woolsey
    25. February 2012 at 07:57

    Major Freedom:

    The industrial demand for gold is the demand for gold for nonmonetary purposes. I could find nowhere that Ponruru confused this with greater economic growth in China, or that Sumner endorsed this view. If Ponruru was confused on the matter, I wouldn’t be shocked. If Sumnner was using “industrial demand for gold” in that way, I would be surprised. I think Sumner somewhere argued that as the Chinese economy grows, Chinese people would demand for gold for industrial purposes. That would be an increase in demand for dental work, jewelry, and the like.

    Suppose we have a gold standard. If the demand for silver should rise, because everyone in America wanted a silver tea service, then the result would be a higher price of silver. Less silver would be used for other things, like silver jewelry. Silver mines would operate more intensively.

    If the demand for silver were to double for this reason, the result would be a much higher price of silver. But certainly, the production of all other goods would not fall in half. There would be a relatively small decrease in the demand for other goods. If silver is currently 1% of output, a doubling of silver demand would roughly cause a 1% decline in the demand for other goods. Once the price of silver rose, then the resulting decrease in the quantity demanded of silver would be matched by an increase in the demand for other goods, so that the doubling of silver demand would cause some miniscule decrease in the demand for other goods. Yes, miners, mining equipment, silversmiths, and silversmithing equipment would expand and other industries contract. But with a growing economy, they would just expand less than usual. Only a tiny bit more than usual.

    Now, if we came up with magic silver alchemy, then I would have absolutely no problem with having silver produced at a very low price. Why not?

    My view is that the gold market should be the same.

    The notion that doubling of the demand for gold, (because poeple like gold teeth) should result in a halving of the demand for everything else absurd. In the end, like with the silver example, only a tiny shift in resources would be necessary.

    If there is no gold standard, the price of gold rises. People use less gold for jewelry, and the mines operate more intensively. The actual shift in the allocation of resources is tiny.

    But if there is a gold standard, and this would require a doubling of the relative price of gold (compeltely possible,) then it would require a halving of the price level, and that includes wages.

    Your long discussion about consumption vs. “saving” is irrelevant. What you call “saving” (nominal demand for labor and intermediate goods) would then fall in half with consumption if the relative price of gold doubled. Again, once prices and wages fell enough, the real demands for “saving” as you call it, and consumption would recover to there initial level, excepting only the tiny relalocation of resources to gold mining.

    Smith’s explanation of the allocation of gold across countries was sound. It is driven by demand. But you are mistaken in identifying an improvement in productivity with “more capital circulating.” Total factor productivity is how much output is generated by given resources, including labor and capital.

    The benign delfation is that unit costs fall, so firms sell more at proportionately lower prices, so total spending on the product is the same.

    New product innovation doesn’t work that way. The demand for the new product rises and the obslete product falls. However, from those of us favoring nominal GDP targeting, this process leaves total demand unchanged.

    I would say, and most economists would say, that if there is more business activity, business cash flow would be bigger. This would tend to raise money demand. If you assume a 100% reserve gold standard, then this creates a derived demand for gold. If, like Smith, you favor free banking, then the supply of bank money can increase to meet the demand, and if the banks demand more gold reserves, then this creates a much smaller derived demand for monetary gold.

    However, I think the bigger effect would be that if households have higher incomes, they would choose to hold more money. And this creates a greater or smaller derived demand for monetary gold–if there is a gold standard.

    I think it is pretty clear that I have a much better understanding of how a market system returns to equilibrium when there is an increase in the demand for gold with a gold standard. Your “intellectual ammunition” that is aimed at the other “side’s” “intellectual ammunition” that purpors to show that there is no equilibrarting process is pointless. There is an equilibriating process. It is painful and disruptive.

    Monetary institutions that adjust the quantity of money to the demand to hold it, leaving spending on output growing at a slow, steady rate, is much less disruptive.

    P.S. A doubling of the industrial demand for gold in..I don’t know.. one day, is unrealistic. But a 10% increase over 3 years is more realistic and very disruptive. That doesn’t mean that the prices and wages couldn’t drop enough after a few years, and all the bankruptcies couldn’t be dealt with. The economy could recover. But why would anyone want a monetary system that works like that?

    And, by the way, when the fad runs its course, there will be inflation of prices and wages, and a transfer from creditors to debtors.

  49. Gravatar of ssumner ssumner
    25. February 2012 at 08:46

    DR, There were many factors; a sharp slowdown in monetary base growth in late 2007 and early 2008. After that a big increase in the demand for money, which occurred partly for external reasons (low interest rates due to the housing slump) and partly for Fed reasons (low intereat rates due to a failure to communicate future policy intentions, and IOR.)

    Cthorm, I still think you aren’t understanding the proposal, it’s just as explicit as NGDP targeting. If the cumulative 20 year RGDP growth rate is 2.8%, then you shoot for 4.8% NGDP growth. That’s the policy. Preferably with level targeting.

    Because 20 year averages change only slightly from year to year, it would be almost indistinguishable from a stable NGDP target.

    anon, I’d prefer to stick with 20 years, as 10 years can reflect a single business cycle. Yes, I’d prefer it be combined with futures targeting, and also level targeting.

    Mark, The Fed can’t control RGDP in the long run, so if trend RGDP fell to 2%, then inflation would permanently rise to 3%. I don’t care about that, but others do–so this is politically more feasible.

    Steve, See my answer to Mark. Double links require moderation. I’ve been trying to change that filter for a year, but still no luck.

    Thanks Dennis and Ben.

    Ben, 2% is fine under NGDP targeting, but too low for inflation targeting.

    Ron Ronson, I agree and have made the same points many times. I prefer a simple NGDP target. This is a compromise to make it politically more appealing.

    Greg, Once again, the great housing bust in the 27 months after January 2006 raised unemployment by 0.2%. Nice try.

    Major freeman, Surely you understand the difference between AS and AD shocks.

    Peter, Maybe, but the problem is that no one would agree on the function. KISS.

    Mike Sax, Yes, it’s plausible to argue they went from an old Keynesian to a new Keynesian framework.

    dtoh, You don’t understand, I am not proposing two targets, but rather one target. They will be judged solely in terms of the sum of those two variables. We should ban them from even discussing the individual components in their quarterly reports to Congress on how they’re doing.

    more to come . . .

  50. Gravatar of ssumner ssumner
    25. February 2012 at 08:51

    Major Freeman, Thanks for providing your PhD dissertation. I’ll just make one comment. If China absorbs lots of gold because it grows rapidly, that’s a positive supply shock for China and a demand shock for the US. It’s contractionary for the US but not for China. Again, just basic AS/AD theory.

  51. Gravatar of Major_Freedom Major_Freedom
    25. February 2012 at 11:17

    If China absorbs lots of gold because it grows rapidly, that’s a positive supply shock for China and a demand shock for the US. It’s contractionary for the US but not for China. Again, just basic AS/AD theory.

    Now apply that same logic to US states, then counties, then cities, then individual business firms, and realize how silly it is to say that individual business firms and cities and states should not be bailed out by inflation when money leaves the economic units, but countries should be bailed out by inflation when money leaves the country.

    Why not say individual cities experience a “demand shock”, thus necessitating an inflation bailout?

  52. Gravatar of dwb dwb
    25. February 2012 at 11:52

    It answers one popular objection to NGDP targeting, the fear that the price level would no longer be anchored.

    I still do not get this. wages are 70% of GDP. if nominal gdp is constrained, so are wages. therefore, wage-push demand inflation should in the long run be constrained by ngdp growth. conversely, on the supply side, prices rising faster than wages with ngdp growth constant means real output is declining (which encourages supply-side efficieny) or consumption is increasing and savings is declining (which means interest rates should rise to correct this). I see how inflation might temporarily be out of whack, but i just don’t see how long term inflation gets permanently too high unless we have too high an ngdp target (which is easy to fix!)

    Actually, I kinda think Bernanke might favor NGDP targeting and does know it. A little algebra suggests to me that an equal-weight taylor rule (using PCE and the output gap) is equivalent to NGDP growth targeting if the phillips curve relationship is constant, and i constrain inflation to 2%. Even ignoring the philips curve, the total deviation around the equal-weight taylor rule is going to be the same as that around a gdp growth target (depends on what you mean by “taylor rule” too since there are many of them). the issues to me are: 1) the catch-up growth ; 2) the practical issues around “potential growth” (personally i think few people would favor higher trend inflation – if we overestimate potential output, they would argue for a lower ngdp growth target); 3) practical data issues around measuring money velocity monthly (or equivalently, knowing real-time rgdp).

    unfortunately #1 and 2 are what i see as the biggest stumbling block. As the Richmond Fed article puts it very well (quoting McCallum), the the phillips curve is unstable in the short run and a big advantage to ngdp targeting is in allowing the economy to “decide” how to parcel it between growth and inflation. However, that requires a huge leap of faith on the part of economists embedded in forecasting, who have deep-seated belief they can actually nail this relationship down. If the Fed forecasters really thought that a big QE money injection would have resulted in more growth (vs more inflation) last summer, they would have done it I have no doubt (put differently, $1 of QE should result in >=.5 rgdp <=.5 inflation, at the margin). Now that inflation has tamed, its a 40-60 bet IMO that we'll get more QE (40 for, 60 against).

    I just don't think there is a risk appetite for 4% inflation. I do not think there actually would be 4% inflation, but I think some people at the Fed spend way too much time looking into the bowels of models not at the market. anyway..

  53. Gravatar of Central Bank News Central Bank News
    25. February 2012 at 18:53

    I’ve always thought the idea of a central bank having an explicit employment growth mandate as a bit silly. Monetary policy is for controlling inflation, fiscal policy and regulation are for influencing market structure, incentives, etc. Fiscal policy e.g. tax structures have a direct impact on employment decisions; likewise regulations have a direct impact on the way people can do business and how their perceptions and behavior will form. So employment should be a hard target for the government and not the central bank.

  54. Gravatar of Major_Freedom Major_Freedom
    25. February 2012 at 22:14

    ssumer:

    Major freeman, Surely you understand the difference between AS and AD shocks

    That’s right, just keep evading the argument I am making, and instead ask more rhetorical questions. It’s much better than actually addressing it.

    There is no difference in principle between an individual company or industry experiencing an “AD shock” (BZZZZT! hahaha) by being outcompeted by other individual companies or industries that innovate, and a whole country experiencing an “AD shock” (BZZZZT!!!) by being outcompeted by other countries that innovate.

    If you say it’s a good thing that a relatively inefficient individual company should be outcompeted for revenues, thus experiencing a reduction in “NGDP”, or, a “demand shock”, and it should face the music and not be bailed out by inflation from the state, then if you’re logically consistent you should also say that it is a good thing if a relatively inefficient city, or county, or state, or whole country should be outcompeted for revenues, to other cities, counties, states, or countries, thus experiencing a reduction in “NGDP”, or, a “demand shock”, then they too should face the music and not be bailed out by inflation from the state.

    How else can relatively inefficient and relatively bad investments be corrected? They can’t correct if there is no market incentive to correct (i.e. no reduction in profits, i.e. no losses).

    bill woolsey:

    The industrial demand for gold is the demand for gold for nonmonetary purposes. I could find nowhere that Ponruru confused this with greater economic growth in China, or that Sumner endorsed this view. If Ponruru was confused on the matter, I wouldn’t be shocked. If Sumnner was using “industrial demand for gold” in that way, I would be surprised. I think Sumner somewhere argued that as the Chinese economy grows, Chinese people would demand for gold for industrial purposes. That would be an increase in demand for dental work, jewelry, and the like.

    It doesn’t matter if the gold demand that leaves the US and goes to China because of China increasing its productivity and attracting circulating gold, or attracting gold for use in industrial demand. China could not even attract gold away from the US unless China sold US goods and services to the US. Whatever the reason that Chinese goods and services would be more attractive to US customers than US goods services, this is economic competition. If we allow, indeed encourage, money to flow out of a company that is outcompeted by other companies, then we should allow, and encourage, the same thing for whole countries.

    Suppose we have a gold standard. If the demand for silver should rise, because everyone in America wanted a silver tea service, then the result would be a higher price of silver. Less silver would be used for other things, like silver jewelry. Silver mines would operate more intensively.

    If the demand for silver were to double for this reason, the result would be a much higher price of silver. But certainly, the production of all other goods would not fall in half. There would be a relatively small decrease in the demand for other goods. If silver is currently 1% of output, a doubling of silver demand would roughly cause a 1% decline in the demand for other goods. Once the price of silver rose, then the resulting decrease in the quantity demanded of silver would be matched by an increase in the demand for other goods, so that the doubling of silver demand would cause some miniscule decrease in the demand for other goods. Yes, miners, mining equipment, silversmiths, and silversmithing equipment would expand and other industries contract. But with a growing economy, they would just expand less than usual. Only a tiny bit more than usual.

    Now, if we came up with magic silver alchemy, then I would have absolutely no problem with having silver produced at a very low price. Why not?

    My view is that the gold market should be the same.

    The notion that doubling of the demand for gold, (because poeple like gold teeth) should result in a halving of the demand for everything else absurd.

    It’s only “absurd” if you start with the anti-capitalist ideology that the consumers are not to be sovereign, and that their preferences should be attacked, so that those in the state are instead sovereign, and their preferences should be defended. That’s all you’re doing when you attack the outcomes of non-state monopoly money.

    It’s also absurd to believe that half the world’s gold supply will all of a sudden become valued for gold teeth. The fact that you have to conjure up these exaggerated and almost impossibly unlikely scenarios to attack gold, means that you have no strong argument against gold. It would be like me saying “Imagine we had a fiat standard, and everyone at the Fed, and everyone in the banking system, and everyone in the state, and everyone in the civilian population, all of a sudden developed a fetish for taking half their dollars and making wallpaper out of it. That would collapse NGDP and we’d all suffer and starve and die! Clearly fiat money is not a good money to have.” Then of course you’ll say I’m speaking nonsense, because the chances of that happening is so low as to become practically irrelevant. Well, I think the same thing with your “People take half the world’s gold supply and they turn it into gold teeth.” The fear that people will change their marginal value of gold teeth to such a high degree that they will reduce their consumption of everything else by half(!), is laughable. Are you taking half your dollars and turning them into wallpaper? No? Why not? Because other things are more valuable to with your money, right? Well, same thing with gold money.

    If there is no gold standard, the price of gold rises. People use less gold for jewelry, and the mines operate more intensively. The actual shift in the allocation of resources is tiny.

    That’s against what the people want if they did in fact take half their gold and turn it into gold teeth.

    But if there is a gold standard, and this would require a doubling of the relative price of gold (compeltely possible,) then it would require a halving of the price level, and that includes wages.

    So what? With lower wages, business costs will be lower to the same degree. Companies can charge lower prices and still earn profits.

    Your long discussion about consumption vs. “saving” is irrelevant. What you call “saving” (nominal demand for labor and intermediate goods) would then fall in half with consumption if the relative price of gold doubled. Again, once prices and wages fell enough, the real demands for “saving” as you call it, and consumption would recover to there initial level, excepting only the tiny relalocation of resources to gold mining.

    The discussion on consumption versus saving is PARAMOUNT. It is literally the exact opposite of being irrelevant.

    And you’re wrong about the nominal demand for labor and capital goods falling to half if consumption spending fell by 50% and cash balances increased. Consumption spending falling by 50% doesn’t mean that total spending decreases by 50%. Consumption spending takes up only a portion of total spending.

    Smith’s explanation of the allocation of gold across countries was sound. It is driven by demand. But you are mistaken in identifying an improvement in productivity with “more capital circulating.” Total factor productivity is how much output is generated by given resources, including labor and capital.

    No, that’s not correct. I wasn’t referring to productivity gains as implying more capital circulating. I was referring to the capital accumulation itself as attracting more gold for circulation. Economies that are rapidly growing in terms of capital accumulation, tend to attract more capital into the economy, and it is this circulating capital based on capital accumulation that I was referring to. I wasn’t just talking about output increasing on the basis of given resources. That of course has a limit based on marginal productivity of capital. But if the capital itself increases, then this can by itself be a foundation for attracting more capital investment.

    The argument from Adam Smith that I was referring to what that Smith showed that the larger is a country’s economy in terms of capital accumulation and production, the more money will be circulating in that country. You’re incorrectly thinking that higher productivity and more capital should accompany the same demands but only lower prices. No. If a country represented 10% of the world’s economy, it will tend to posses and circulate 10% of the world’s gold money supply.

    The benign delfation is that unit costs fall, so firms sell more at proportionately lower prices, so total spending on the product is the same.

    Not if the value of the capital increases relative to the competition, which is the case when there is more capital accumulation.

    New product innovation doesn’t work that way. The demand for the new product rises and the obslete product falls. However, from those of us favoring nominal GDP targeting, this process leaves total demand unchanged.

    No, you guys who favor NGDP targeting want total demand to increase all the time in the home country, so that if another country outcompetes the home country in any way, be it the case of one foreign company or a whole slew of them, you want to bail out the home country companies by ensuring that the home countries never have to innovate to reduce their prices, because total domestic demand won’t ever fall.

    Why are you OK with a single company experiencing reduced revenues because of innovation, but not whole countries that get outcompeted? How else can companies as a whole compete and innovate if the state will always be there to bail them out when money is attracted to other countries due to innovation?

    It’s funny. When you think of gold, you can only think of gold being attracted away from a country’s aggregate demand due to gold teeth, or gold in industrial production, etc, but when the context is fiat money inflation, then you are totally open to scenarios where companies experience reduced revenues because of economic competition and product innovation in the marketplace.

    Your pro-fiat anti-gold bias is very obvious.

    I would say, and most economists would say, that if there is more business activity, business cash flow would be bigger. This would tend to raise money demand. If you assume a 100% reserve gold standard, then this creates a derived demand for gold.

    Bingo. You do get it.

    If, like Smith, you favor free banking, then the supply of bank money can increase to meet the demand, and if the banks demand more gold reserves, then this creates a much smaller derived demand for monetary gold.

    Banks have no incentive to lend out money unless there are profitable opportunities. They won’t lend money out just because people desire more money than they have.

    However, I think the bigger effect would be that if households have higher incomes, they would choose to hold more money. And this creates a greater or smaller derived demand for monetary gold-if there is a gold standard.

    They can’t earn higher incomes unless they are relatively more productive. This is founded upon capital accumulation, which is what I was referring to as the real source for determining how much money is circulating there.

    I think it is pretty clear that I have a much better understanding of how a market system returns to equilibrium when there is an increase in the demand for gold with a gold standard. Your “intellectual ammunition” that is aimed at the other “side’s” “intellectual ammunition” that purpors to show that there is no equilibrarting process is pointless. There is an equilibriating process. It is painful and disruptive.

    LOL, you’re funny. I am not even sure what you’re saying here. Are you saying that I am accusing you fiat bugs of advocating for a monetary system that allegedly has no equilibrating process that in reality does one, and according to you, this equilibrating process in the system you advocate is “painful and disruptive”? Or are you saying that I have argued that a gold money system somehow does not have an equilibrating process, but that in reality it does, and you are telling me it is “painful and disruptive”? If you meant the former, then you’re arguing against fiat and for gold. If you meant the latter, then that’s not even what I said, in fact, I said the exact opposite. In either case, what you’re saying isn’t making sense.

    More importantly, the market is never in equilibrium. Imagining these equilibriums should be a mental tool only, to give you a picture of how to understand the market that isn’t in equilibrium, ever.

    I don’t see that you are fully grasping how a gold standard works. You see pain and disruption, whereas there is brutal economic competition that ends up benefiting everyone, including those who experience a reduction in their revenues because other business units are innovating and increasing productivity of what consumers want.

    You simply have no clue that INFLATION is what is painful and disruptive. You see the ability to print money as being a doping agent that “eases” the effects of “volatile” consumer sovereignty based preferences. What you are completely blind in understanding is that inflation destroys not only the middle class, but it punishes the consumers who receive the new money later on, it attacks capital accumulation, it falsifies economic calculation, it punishes efficient companies and rewards inefficient companies, and distorts the temporal structure of the economy.

    You incorrectly view inflation as raising everyone’s incomes all nice and equal and smooth, when in reality it is terribly disruptive and painful to people’s lives.

    I am doubting that you have a better understanding of the gold standard, because you don’t even realize the benefits to an economy that experiences a net gold outflow due to being outcompeted for goods and services. All you see is “DEFLATION!!!!!!” and that’s enough for you to attack gold.

    Monetary institutions that adjust the quantity of money to the demand to hold it, leaving spending on output growing at a slow, steady rate, is much less disruptive.

    No, it’s more disruptive. It attacks economic calculation and distorts the economy, setting it up for a bust later on. Sure, you might have “great moderations”, but eventually the piper must be paid.

    P.S. A doubling of the industrial demand for gold in..I don’t know.. one day, is unrealistic. But a 10% increase over 3 years is more realistic and very disruptive. That doesn’t mean that the prices and wages couldn’t drop enough after a few years, and all the bankruptcies couldn’t be dealt with. The economy could recover. But why would anyone want a monetary system that works like that?

    Because it protects the poor, it protects those who earn money and do nothing wrong to anyone but they choose to hold money, it punishes bad investments, it is MORE stable than fiat money systems, it encourages capital formation, it prevents the government from growing (central banking facilitates growing government by monetizing debt), it makes clear that the government is dependent on the people rather than the people dependent on the government, it discourages the welfare/warfare state, it regulates international balance of trade according to market forces rather than the whims of central economic planners, etc, etc, etc.

    And, by the way, when the fad runs its course, there will be inflation of prices and wages, and a transfer from creditors to debtors.

    You mean that whereas initially there was a transfer from debtors to creditors, there is a subsequent transfer back from creditors to lenders? Oh the horror! Yes, we should have perpetual arbitrary transfers from creditors to debtors as in fiat money systems instead. That way, people who aren’t very savvy investors like the poor and middle class, who tend to invest in safer securities like debt, will be the hardest hit.

  55. Gravatar of Greg Ransom Greg Ransom
    26. February 2012 at 00:37

    Punt.

  56. Gravatar of Bill Woolsey Bill Woolsey
    26. February 2012 at 05:17

    Major Freedom:

    With a gold standard, an increase in the relative price of gold requires that all prices fall more or less in proportion. Your notion that it just involves consumer prices falling since consumption is a small portion of output of gross output, and so there is only a small decrease in the demand for output is mistaken. However you cut it, if the relative price of gold rises, all the prices need to fall.

    A very significant increase in the demand for gold requires a small reallocation of resources towards mining. The real shift in the equilibrium quantity of gold is small. The equilibirum real decrease in the demands for other goods is small, and probably just results in slightly smaller growth.

    But the market signal to get the price level to fall in proportion to the increase in the relative price of gold is decreases in the nominal demands for everything else.

    I well understand the process of creative destruction and see it as desirable. The “brutal” (or destructive) elements of it are not the benign deflation from productivity gains.

    The shifts in demand between products and industries due to competition involve offsetting increases and decreases in demand. There is no deflation. The “bengin” deflation doesn’t work that way. It involves lower prices and higher output. Total spending on output doesn’t change, and prices are reduced with lower costs.

    Struggling over a fixed quantity of money (or flow of nominal expenditure or flow of nominal income) is not “benign deflation.” That isn’t what we are talking about.

    You are wrong that increases in income require that someone become relatively more productive. If Americans become 10% more productive and the Chinese become 5% more productive, the real income of the Americans increase by 10% and the real incomes of the Chinese increase 5%. And vice versa.

    Your notion that stable nominal income growth “bails out” American firms because they fail to compete is mistaken. You are confusing absolute and comparative advantage. U.S. firms fail because they are less productive relative to other U.S. firms. That the opportunity to trade with foreigners impacts what is a more or less productive use of U.S. resources is what the theory of comparative advantage is about. Anyway, nominal GDP targeting does not prevent this from occuring. The ability of relatively less productive firms to pay growing nominal wages will drive them out of business, with the labor and other resources being pulled into firms that are relatively more productive.

    If China targeting nominal GDP and had a growth rate that reflects growth in Chinese potential output, then Chinese costs will grow in line with Chineses productivity, leaving Chinese prices stable. If the U.S. does the same, our prices are left stable. And the exchange rate between the countries is left stable. If their productivity grows more rapidly, then their nominal incomes grow more rapidly. By stable, I mean without any trend. The exchange rate would rise and fall to clear markets.

    If China has nominal income growing more slowly than productivity, their prices will fall. If the U.S. nominal income grows more rapidly than productivity, our prices rise. Equilibrium is maintained by the Chinese currency appreciating over time relative to the U.S. currency.

    U.S. real incomes increase with U.S. productivity and Chinese incomes rise with Chinese productivity. There is no “bailout” of U.S. firms.

    As for your weak arguments, my point was that I understand quite well the equilibrating process of a gold standard. They exist, they are painful and disruptive.

    Many of your arguments seem directed at someone who believes that there are no such equilibrating processes. Keynes did make such arguments sometimes. I think he was mistaken. They miss the mark because I am not arguing that a gold standard is inconsistent with a return to equilibrium.

    Please be mindful that I once was a dogmatic Rothbardian and am well aware of all of the arguments in favor of that position. I have come to understand that it is mistaken. I also can pick out arguments (that I frequently made years ago,) that aim to prove that there is no permanent unemployment equilibrium.

    Finally, I will try one more time. Suppose people decide that looking like a rap star is uncool. They replace their gold teeth with ceramic ones and they quit wearing massive jewelery. If this results in a 10% decrease in the relative price of gold, the result will be 10% inflation. All creditors will see their wealth decrease by 10%.

    I favor nominal GDP targeting. This doesn’t happen. Only if some disaster resulted in the ability to produce goods and services to decrease by 10% would creditors suffer such a loss. Of course, debtors would also suffer a loss in that situation. Wage and profit income, like interest income, would purchase 10% less reflected the 10% loss in output.

    Further, with a gold standard, a 10% loss in output would also have the same effect. At least if the demand for gold has unit income elasticty. Real income falls, the demand for gold falls, and there is inflation.

    What nominal GDP targeting avoids is inflation or deflation due to changes idiosyncratic to the market for gold.

    It would be possible to keep nominal GDP constant so that there is a trend deflation equal to the trend growith in real GDP. Then people who wanted to save by accumulating hand-to-hand currency could earn real interest equal to the real growth rate of the economy. However, that real interst rate would change, and fall and perhaps be negative if some disaster reduces productive capacity.

    I don’t support that approach but rather favor a trend growth of nominal GDP equal to the trend growth of output, which tends to keep the price level stable. Then, people who want to earn interest have to hold some interest bearing asset. The nominal interest rate is the real interest rate in that circumstance.

    On the other hand, I favor privatized hand to hand currency, and I believe that banks would credit interest to deposit accounts based upon currency that has been withdrawn but not cleared. Admittedly, people who don’t have bank accounts and just hold currency that they receive in payment would not earn interest on it. It is true that most people like that are poor. On the other hand, I don’t think that this is a problem for the “middle class.”

    With a gold standard, there is still real risk because of changes in the supply and demand for gold. In my view, the notion that people can earn a risk-free return is an illusion. Supporting a gold standard so that people can imagine that gold is providing a risk free return is not an advantage of the system.

  57. Gravatar of ssumner ssumner
    26. February 2012 at 07:41

    Major freeman, You said;

    “Now apply that same logic to US states, then counties,”

    Ever read the optimal currency zone literature?

    dwb, Consider the case where trend RGDP growth permanently falls from 3% to 2%. Under 5% NGDP targeting inflation would permanently rise from 2% to 3%. That’s all I’m saying.

    Some people worry about that, I don’t.

    I agree with this comment:

    “I just don’t think there is a risk appetite for 4% inflation. I do not think there actually would be 4% inflation, but I think some people at the Fed spend way too much time looking into the bowels of models not at the market. anyway..”

    Central bank news, Neither the Fed or Congress should target employment. Inflation is a lousy Fed target, because measured inflation has little or nothing to do with “inflation” as described in macro models. Measured inflation is a number bureaucrats pull out of thin air.

    Major Freedom, You said;

    “There is no difference in principle between an individual company or industry experiencing an “AD shock” (BZZZZT! hahaha) by being outcompeted by other individual companies or industries that innovate, and a whole country experiencing an “AD shock” (BZZZZT!!!) by being outcompeted by other countries that innovate.”

    Countries don’t “compete” with each other. That’s one of the most basic fallacies in economics. I suggest reading Krugman’s Pop Internationalism–he explodes that fallacy.

  58. Gravatar of dwb dwb
    26. February 2012 at 07:49

    Major Freedom:

    A rapid increase in gold consumption is not only plausible, its very likely. A large chunk of gold demand on the world market comes from India for jewelry and other non-monetary uses (which, will increase with income in those countries). As income grows in asia, gold demand for jewelry will rise, which will create deflationary pressure in the US just as in the 30s when France hoarded gold. The history of governments sticking to it and avoiding devaluation is lousy. I think what you wish for is a central bank that stocks to a rule (like a slow constant increase in the money supply).

    There is no evidence that the “creative destruction” brought on by the recent great recession had anything to being “outcompeted.” nor was there any sudden productivity shock. 70% of the trade deficit is crude oil. period. The U.S. is a net exporter if industrial materials and agricultural goods aside from petroleum (and exports almost as much in capital goods as we import). If anything, devaluation of the dollar which makes oil more expensive results in energy efficiency (in fact, in 2011, the US became a net exporter of refined products, imagine that). It also makes imported comsumer goods more expensive and we consume less (thats ok to in my mind).

    The real problem is the excessive NIMBYism in this country which prevents infrastructure from being built (I mean Keystone, port/rail projects, LNG terminals….). There is a lot of coal, natural gas, and other resources here, but its hard to get to export markets because of poor infrastructure (few deep water ports are a key issue – we just dont have enough ports that can handle the the 200k ton capemax vessels linked to rail) to export. We have plenty of shale gas but try to get an import terminal like Cove Point turned into an export terminal along with some pipeline to Marcellius shale and suddenly we have an issue. China would take all the coal we could deliver, and Europe would be happy to have gas and be out from under the thumb of Putin/Gazprom.

    There is absolutely nothing wrong with the competitiveness in the US (automakers like GM Toyota, are expanding factories here). If we are uncompetitive anywhere, its in the fact that China can decree that thousands of villagers move so they can built a giant dam, or that factories move or shut down to lighten the smog for the Olympics and present a good image. We can’t even get a simple pipeline approved after 4 years.

  59. Gravatar of dwb dwb
    26. February 2012 at 08:16

    Consider the case where trend RGDP growth permanently falls from 3% to 2% Under 5% NGDP targeting inflation would permanently rise from 2% to 3%.

    yes, i agree, and I think thats partly where people are getting hung up – a discomfort with permanently higher trend inflation. My take is that (ala, Romer’s endorsement for example), many people envision an ngdp growth target (say, 4.5%) where the ngdp growth target is equal to “potential output” plus an adder to compensate for the perceived bias in PCE (if there is an upwards bias in PCE does that mean there is a downward bias in rgdp, so they net??), plus a deflation-insurance premium (which is probably far less necessary under an ngdp growth target anyway). Put another way, seems to me there is a strong desire (belief?) to really nail down (or that the FOMC can nail down?) how much of the ngdp growth comes from inflation and how much from real growth, and a lack of faith that market forces could efficiently parcel it. thats my 2 cents.

  60. Gravatar of dwb dwb
    26. February 2012 at 08:51

    … in the spirit of what i said above, and your idea, the more i think about it i could definitely see people getting comfortable with a “conditional” ngdp target: that is, an ngdp target of x conditional on inflation expectations being anchored around 2% (or 1% if you prefer). everyone on the fed could fill in x depending on their view of potential output. Take the median… and thats the target. It gives some wiggle room for the FOMC to ensure trend inflation stays low – they could lower x if inflation trended too high (or conversely, raise it).

  61. Gravatar of Major_Freedom Major_Freedom
    26. February 2012 at 16:04

    ssumer:

    “There is no difference in principle between an individual company or industry experiencing an “AD shock” (BZZZZT! hahaha) by being outcompeted by other individual companies or industries that innovate, and a whole country experiencing an “AD shock” (BZZZZT!!!) by being outcompeted by other countries that innovate.”

    Countries don’t “compete” with each other. That’s one of the most basic fallacies in economics. I suggest reading Krugman’s Pop Internationalism-he explodes that fallacy.

    Obviously I was using the concept “country” to refer to “those individual economic actors who within a country who compete with economic actors outside the country”, the same way I was using the concept “state” to refer to “those individual economic actors within a state who compete with economic actors outside the state”, the same I was using the concept “city” to refer to “those individual economic actors within a city who compete with economic actors outside that city”, the same way I was using the concept “business firm” to refer to “those individual economic actors within a business firm who compete with economic actors outside that business firm.”

    I didn’t mean the location, or the government, or anything like that. I use universals like “country” as a shorthand to refer to the individual economic actors who are being considered.

    Countries in this understanding do in fact compete with each other. The “country” called US (meaning the individual economic actors within the US) compete internationally, and domestically, with the “country” called China (meaning the individual economic actors within China).

    I notice you have a very obvious habit of ignoring the substantive aspects of what I write that seriously call your claims into question (e.g. your inconsistency of being in favor of a national bank inflating the domestic money supply for an individual country in order to ensure that the individuals in that country, as a group, don’t experience a decline in “spending” on account of being outcompeted, as a group, by individuals in businesses outside the country, and yet you do a 180 and say that you are against individual states and individual counties and individual cities and individual business firms being bailed out by inflation if those individual states, counties, cities, and business firms experience a decline in “spending” on account of being outcompeted by economic actors in other states, other counties, other cities, or other firms respectively.

    It’s like you’re OK with half a country’s businesses going bankrupt as long as the other half of the country’s businesses see growing revenues, but if those who go bankrupt were instead their own country, then all of a sudden you would say “they should get bailed out by a central bank printing money to ensure that “spending” doesn’t fall for them.

    For example, in our current monetary system, you would no doubt be against the Fed printing money and specifically sending it to the city of Phoenix, AZ if it experienced a decline in local “spending”, if the decline in spending there was on account of other US cities outcompeting businesses in Phoenix and attracting revenues/investment away from what would have gone to Phoenix.

    Now suppose that tomorrow Phoenix seceded from the state of Arizona as well as the country. Now if businesses in the country of Phoenix experience a decline in “spending” due to being outcompeted for revenues/investment elsewhere, say in the US, and abroad, then you would say that Phoenix should be bailed out by inflation from a central bank to ensure that its “NGDP” doesn’t fall.

    In other words, your entire worldview is based on the totally arbitrary, non-economic, and prejudicial concept of mercantilism. You don’t want US businesses to collectively experience a decline in revenues/investment due to being outcompeted by businesses outside the US, but you’re totally fine with Phoenix experiencing a decline in “spending” as long as other cities in the US see increased revenues/investment to compensate, so that you can get your mercantilistic “retaining of money and spending within the King’s borders.”

    You do know that your thinking is derived from mercantilists, who believed (and many today still believe) that the King (in your case it’s the President or Fed Chairman) should not let gold leave the King’s “domain”, lest the King be unable to finance wars and the King’s military. Your worldview is just a watered down version of this middle age superstition. Speaking of exploding fallacies of people who actually hold the fallacies being addressed, Adam Smith exploded that fallacy hundreds of years ago.

    If US citizens begin buying a whole bunch of Chinese goods and they start making a whole bunch of investments in China, then this means that they find China to be more attractive relative to the US for those particular goods and those particular investment opportunities. In a better world not run by NGDP neo-mercantilists, that would result in a decline in local nominal spending, which will act as a balancing mechanism to regulate international trade through price competition. But with a fiat system, one even with flexible exchange rates, this regulating mechanism is distorted, and new wasteful industries are born, such as international currency speculation, as well as economics departments that waste money, time, labor and resources year after year after year trying to find the magic holy grail metric for central bankers to target.

    What Woolsey called “painful and disruptive” is in actuality a better system of economic calculation and international coordination, with minimum waste, and far higher living standards.

    If the world adopted a free banking system, or a gold standard, you’d be out of a job, even if you’re tenured. Your university department would lose funding, and you’d end up a PhD in witchdoctory to show the HR department at Wal-Mart. This is why I brought up that Upton Sinclair quote “It is difficult to get a man to understand something when his job depends on not understanding it.” It applies to all monetarists and Keynesians and everyone else who have an incentive to not understand the problems in their own worldview.

  62. Gravatar of bill woolsey bill woolsey
    27. February 2012 at 09:42

    People should be able to use whatever money they like.

    I have no problem with people using multiple monies if they so desire. I have no problem with there being regional or municipal currencies in the U.S.

    If there were a world money, I think slow stable growth of world nominal GDP would be the best approach.

    A gold standard will still be a bad idea, because it would be subject to changes due to the supply and demand for gold.

    (I think a 100% reserve gold standard is a terrible violation of freedom of contract and individual liberty and am not really considering that.)

    The notion that regional monies with flexible exchange rates involve merchantist ideas is absurd. It is rather international monies that lead that merchantilism. The trade balance is like a national profit or less.

    Anyway, the key reason for having regional money has to do with mobility of resources between regions. Lower nominal incomes in a region would be a signal to move. If moving is not a realistic option, lower nominal incomes signals nothing useful. Having a regional money and a lower exchange rate creates a better signal of what is true–you have to buy fewer goods from outside the region.

    To the degree that economic development in China requires lower nominal incomes in the U.S. (which I guess is possible with a gold standard,) this does not create a signal to move from the U.S. to China because nominal incomes are much lower. What is it creating a signal for?

    Is it that U.S. productivity is falling? No, it would be rising. Is it that the U.S. must purchase fewer goods? No, because prices would be falling by more.

    What is the point? Is it to signal that China is catching up? Well, so?

    In fact, the reality of such a regime would be all sorts of crazy merchantlist policies aimed at keeping “our” gold in the country and avoiding these deflationary effects.

    By targeting nominal GDP in the U.S., nothing like that happens.

    P.S. I would have plenty to teach if the U.S. (or the world) had a gold standard. You must be kidding. What would be determining the price level? What is the interaction between banks and other financial intitutions and spending on output? There is way more economics to teach than I have time to teach. Lots of cool stuff.

  63. Gravatar of Major_Freedom Major_Freedom
    27. February 2012 at 14:31

    A gold standard will still be a bad idea, because it would be subject to changes due to the supply and demand for gold.

    What the heck is wrong with supply and demand? You accept that supply and demand should determine the price and production of potatoes, computers, insurance, the price of labor, and everything else, why not money itself as well? It’s monetary crankness to apply and recognize economic laws to everything except money. Money is just the most marketable, most universally accepted commodity, that’s all. It’s not a magic commodity where suddenly we have to apply difference economic laws to it. Economic laws apply to ALL scarce goods, and money is a scarce good!

    Are you not able to understand that the reason there is no “potato crises” or “computer crises” is because at least a semblance of supply and demand driven prices and production is able to function? On the other hand we have massive financial apocalypses precisely because supply and demand is constantly attacked by the continued enforcement of central fiat money monopolies run by central “planners.”

    Do you honestly think it’s a coincidence that problems in the financial/money sector is correlated with the financial/money sector being monopolized by the state? You market monetarist’s logic is all upside down. You see all kinds of problems in the monetary system today, and you make the incorrect inference that there is something special about money that makes a free market precious metals standard, that is constrained by the same property rights as everything else (i.e. 100% reserve), a bad idea.

    Having money itself also subject to supply and demand and unconditional private property rights (see below) would be the optimal solution, and putting the money production back into the market, where the free market process will almost certainly result in a precious metals standard, and allow money “price” (meaning purchasing power) and production itself to be determined by supply and demand, you couldn’t ask for a better way for money to be managed.

    You’re imagining crazy scenarios of people suddenly hoarding 50% of their gold money in a 100% reserve gold standard, for teeth or whatever, and yet never before in history has anything even come close to that. The largest spending deflation in US history was the early years of the Great Depression, and that was AFTER the classical gold standard was abandoned and after almost 20 years of Federal Reserve control over the nation’s money supply. In other words, the very thing that you fear the most, happens not under a classical gold standard, but under a monopolized monetary system that moves AWAY from gold.

    And then you start to connect instability with money, and so you say a 100% reserve gold standard is a bad idea.

    (I think a 100% reserve gold standard is a terrible violation of freedom of contract and individual liberty and am not really considering that.)

    You only think that because you don’t understand the nature of property rights, or banking history.

    First, throughout history fractional reserve banks never informed their depositors that some or all of their money will be loaned out and hence could not possibly be ready for redemption at any time. They also did not inform their borrowers that the money they lend was created out of thin air, and can be recalled at any time either.

    Second, and most importantly, the claim that fractional reserve banking should fall under freedom of contract, contradicts the very meaning of freedom of contract. The freedom to contract does not include ALL mutually beneficial contracts. A and B cannot contract to defraud or rob C. What freedom of contract means is that A and B can freely contract using their own property. But fractional reserve banking entails the making of contracts regarding the property of third parties.

    When a bank loans out its excess reserves that have been deposited via demand deposit, the bank affects third parties by A. Reducing the purchasing power of all other money owners, B. Harming all depositors by reducing the probability of having their redemptions satisfied, and C. Harming borrowers’ interests because fractional reserve banking impairs the safety of the whole credit system structure and increases the risk of loss for every investor of commodity credit.

    Selgin and White offer the solution of an “option” in demand deposits, whereby depositors are notified that the bank may suspend redemption, and that borrower’s loans may be instantly recalled. This will of course solve the fraud issue, but a new problem will arise, and that is the entire concept of money would be lost. In order for a thing to be money property, it must bestow on its owner absolute, unconditional property rights. A note with an option attached to it is by contrast not an unconditional property title at all. It is more like a gambling ticket, the true owner of which will be settled randomly by whoever decides to redeem their note first. If all depositors try to redeem their notes at the same time, then it is inevitable that some depositors will end up holding worthless gambling tickets.

    Interestingly, for almost all fractional reserve supporters who yammer on about freedom of contract being the basis to allow the practise, nevertheless turn around and call for freedom of contract to be violated through violating property rights to finance government guaranteed FDIC insurance. It’s like they can’t even see that the reason the violation of property rights backed FDIC insurance is even seen as necessary, is because of a pre-existing violation of property rights backed fractional reserve system. One absurdity is piled on top of another.

  64. Gravatar of Major_Freedom Major_Freedom
    27. February 2012 at 15:05

    Bill Woolsey:

    The notion that regional monies with flexible exchange rates involve merchantist ideas is absurd. It is rather international monies that lead that merchantilism. The trade balance is like a national profit or less.

    It is not absurd. By inflating the domestic money supply, all foreign holders of dollars are essentially taxed, exploited for the purposes of benefiting domestic industries, who are not to be outcompeted and bankrupted by having revenues attracted away to foreign competitors.

    It is a policy of propping up inefficient domestic industries, and transferring the costs to all holders of dollars, including efficient domestic industries as well as more efficient foreign competitors.

    Somebody has to pay for the free lunch to inefficient firms.

    It is precisely the idea that the presence of flexible exchange rates somehow removes the mercantilist foundation of it, that is absurd.

    Anyway, the key reason for having regional money has to do with mobility of resources between regions. Lower nominal incomes in a region would be a signal to move.

    No, that’s false. Lower nominal incomes does not necessarily signal a requirement to move. It could signal a decreased marginal value of the local labor and output, which will result in lower prices of production. Yes, they will be outcompeted, but everyone gains because those more capable end up making more profits but not at the expense of the inefficient local labor and output.

    And even if it were a signal to move, that fact alone cannot possibly justify transferring those costs to everyone who holds dollars. You are oh so typically ignoring the costs, and sloppily lumping those costs in to “aggregate demand”, such that as long as there is enough local “spending”, then it is allegedly cost free.

    Furthermore, your position rests on a totally arbitrary and absurd conception of what it means for moving to be “too costly” to justify a gold standard. Those costs cannot disappear by inflation. Inflation can only transfer the costs to everyone. It gives the illusion of being cost free because the cost to each individual holder of dollars is relatively low. But those costs add up, and the result is a lower general standard of living that would otherwise have been the case. Do you know why real wages have stagnated for the last 40 years? It’s because of leaving the last vestiges of the gold standard, and since then, inflation has not only been used to transfer the myriad of costs of production and competition of the US vis a vis the world onto all workers who earn and hold dollars, but it has also decimated capital accumulation by reducing the efficiency of production and artificially increasing profits, giving the illusion of prosperity when in reality there is impoverishment and capital consumption taking place.

    If moving is not a realistic option, lower nominal incomes signals nothing useful.

    Yes it does. It signals to investors that if they want to produce a marginal product that can only be profitable with lower costs, then that location of lower wages and lower spending can be used to produce goods that can be sold elsewhere. That raises the skills and efficiency of production and capital accumulation in the low cost area, thus paving the way for growth in that area.

    Having a regional money and a lower exchange rate creates a better signal of what is true-you have to buy fewer goods from outside the region.

    That is had with a rigid gold standard already.

    To the degree that economic development in China requires lower nominal incomes in the U.S. (which I guess is possible with a gold standard,) this does not create a signal to move from the U.S. to China because nominal incomes are much lower. What is it creating a signal for?

    It creates a signal to investors that the US is now a lower cost area of production, just like investors are currently attracted to China in part because of its low costs.

    US workers don’t have to move from the US to China. It would defeat the purpose of why there are lower prices in the US because of being outcompeted for revenues by China in the first place.

    A lower cost US would make the US very attractive to the world’s investors, because not only is there real capital in the US that boosts worker productivity, but there is also lower nominal prices and wage rates.

    Is it that U.S. productivity is falling? No, it would be rising. Is it that the U.S. must purchase fewer goods? No, because prices would be falling by more.

    US productivity would be rising absolutely, but relatively speaking, China would be growing faster. That’s why there was a reduction in spending in the US. Not because the US is shrinking in absolute terms.

    What is the point? Is it to signal that China is catching up? Well, so?

    It is to signal to investors that China is now better at producing the more higher quality higher marginal value goods, and the US is now better at producing the lower quality lower marginal value goods, again, relatively speaking. Both countries are growing in absolute terms, but the relative degree of specialization and marginal productivity is changing.

    In fact, the reality of such a regime would be all sorts of crazy merchantlist policies aimed at keeping “our” gold in the country and avoiding these deflationary effects.

    Not if there are enough economists who have at least read Adam Smith’s demolition of that myth. I refuse to advocate for a particular monetary system that I consider to be optimal, based on fear of what policy makers might do. If economists and policy makers can be committed to targeting NGDP, then they can be committed to protecting a 100% reserve gold standard. All it takes is choice.

    Yes, there is always the chance that policy makers and economists will start to champion mercantilist policies aimed at preventing gold outflow. But a fiat money system has worse problems, and that is mercantilism through currency wars, which has its own detrimental affects that exceed gold wars, namely massive economic booms and depressions, which is what were are actually experiencing.

    By targeting nominal GDP in the U.S., nothing like that happens.

    By protecting a 100% reserve gold standard and property rights, nothing like that happens either.

    P.S. I would have plenty to teach if the U.S. (or the world) had a gold standard. You must be kidding.

    I don’t think you do fully understand it. Your whole conception of it seems to be based on an irrational fear of falling prices, and fear is always a product of ignorance.

    What would be determining the price level?

    The price level would finally be understood as meaningless, since no seller sells into and no investor invests into aggregate demand or aggregate price levels anyway. Price levels are only interesting to central planners who want to print money for themselves and their friends without raising prices for everyone else by too much, to prevent revolt.

    For economists, the important statistics are RELATIVE prices, and these would be a function of relative supply and demand and time preferences.

    What would determine the price level, if anyone is interested in it for whatever reason, would be a combination of the supply of gold money in existence, coupled with the supply of real goods and services. In other words, the price level would be determined by (GASP!) aggregate supply and aggregate demand. Oh the horror.

  65. Gravatar of ssumner ssumner
    27. February 2012 at 19:12

    dwb, I totally agree that that view (that the P/Y split matters) is irrational, but it’s out there. So I’m trying to sell the basic concept of NGDP targeting to a superstitious world.

    Major Freeman, You said;

    “It’s like you’re OK with half a country’s businesses going bankrupt as long as the other half of the country’s businesses see growing revenues, but if those who go bankrupt were instead their own country, then all of a sudden you would say “they should get bailed out by a central bank printing money to ensure that “spending” doesn’t fall for them.”

    I responded to this by referring you to the optimal currency zone literature. It appears you ignored my advice, but you accuse me of ignoring your points.

    As far as why money is different from other goods, it’s quite simple. For other goods when their value changes you can just adjust one price. When the value of the medium of account changes, you must adjust all other prices. That’s a problem.

  66. Gravatar of Major_Freedom Major_Freedom
    28. February 2012 at 11:41

    ssumner:

    Major Freeman, You said;

    “It’s like you’re OK with half a country’s businesses going bankrupt as long as the other half of the country’s businesses see growing revenues, but if those who go bankrupt were instead their own country, then all of a sudden you would say “they should get bailed out by a central bank printing money to ensure that “spending” doesn’t fall for them.”

    I responded to this by referring you to the optimal currency zone literature. It appears you ignored my advice, but you accuse me of ignoring your points.

    You did not refer me to any optimal currency zone literature, and if you did I would have remembered it.

    At any rate, the optimal currency area literature not only does not even address the point I am making with regards to the obvious mercentalist nationalism that accompanies your posts, but it also does not explain what it purports to explain. All the main criteria are completely subjective and arbitrary.

    There is no such thing as an optimal currency area that makes centralized fiat money control superior to free banking, or gold.

    I don’t see you saying the US should be split up into smaller currency zones as some economists are saying, despite the fact that many are too poor to move across the country when local conditions change for the worse as a direct result of monetary policy. They would benefit from being free of the Federal Reserve System, and yet you’re saying they should be kept under the yoke of the Fed even if NGDP doesn’t rise in their local area, because you’re focused on national NGDP only.

    As far as why money is different from other goods, it’s quite simple. For other goods when their value changes you can just adjust one price. When the value of the medium of account changes, you must adjust all other prices. That’s a problem.

    First, that’s absolutely false. A change in the price of one good that is brought about by a change relative demands, doesn’t just affect the price of that one good. It affects the suppliers’ prices, and their supplier’s prices, and this gets us into broader and broader markets. These price changes will then affect the entire economy in the other direction for all goods that are priced on cost.

    For example, if the demand for cars falls, then so will the demand for metal steel sheet that goes into cars, since car companies give steel sheet makers a portion of their revenues. This gets us closer into a broader market. Steel sheet makers will then reduce their demand for energy somewhat (not total since other things can be made from steel sheet). This gets us into an even broader market. Energy suppliers will then reduce their demand for oil somewhat. This is one of the broadest markets there is. This will then result in price changes back up the line for all goods that utilize oil/energy/steel/etc.

    A drastic example would be if the demand for cars fell to zero, and the demand for hookers and jewelry increased by the original demand for cars. This will affect the demand and hence prices for gasoline, steel, oil, plastics, and everything else that goes into the production of cars, and it will affect the demand and hence prices for tight fitting clothing, liquor, tobacco, limousines, as well as mining equipment, and labor prices for jewelers.

    So it’s certainly not the case that a changed value in one good only changes that good’s price. It has demand and price repercussions throughout the entire economy.

    If you think price changes are an evil, then why are you calling for monetary inflation, which of course changes the value of money, which of course leads to all prices having to change? If changing prices is a “problem” (I cannot believe an economist can actually believe the law of supply and demand and changing prices is a “problem”), then why change the value of money at all by central banking? Why not advocate for ZERO inflation from the Fed, that way, there is one less entity in the market that is bringing about an arbitrary change in the value of money? You can even keep the Fed! All they have to do is hold the same supply of aggregate money in the economy, and that’s it. No more changes in the value of money on account of monetary deflation or inflation! How about it? We would only have to worry about changes in the demand for cash. But this won’t be a problem, because with zero inflation of the aggregate money supply, the business cycle would disappear, and you won’t see sudden economy changes short of a natural disaster.

    Oh that’s right, I forgot, you only see a problem with price changes caused by actions taken by people OTHER than those at the Fed. Woops! Here we have a centralized monolith bringing about a change in the value of money, and thus a requirement for economy wide price changes, and there you are just shrugging your shoulders, and then you turn around and say that a free market in money is bad because…just look at the extent of needed price changes on account of the Fed?! So it’s a good thing that the Fed is there to….combat a problem….that they create?! And because they create such price system chaos, it’s a good thing we don’t have a free market gold standard, because….”obviously” it will be even worse! How do I know? I look at past periods of fiat money destruction of course, like the 1930s, when there wasn’t a classical gold standard! That ought to suffice for criticizing gold.

    If you are OK with prices changing on account of supply and demand of real goods, due to changes in preferences/technology/etc, which brings about changes in prices all over the place, why not be OK with changes in the demand for money itself as well? You’re being completely arbitrary when it comes to money.

    Since you are a self-professed “advisor” to the Fed, an entity that brings about changes in the value of money, and hence changes in economy wide prices, you are in no position to attack gold by reasoning from price changes. That would be hypocritical.

    You’re treating money differently than goods when you really shouldn’t. Economic laws are ubiquitous. Price changes all over the economy are brought about by changes in preferences and technological/supply factors, and yet I don’t see you calling for a centralized government supply store that has a warehouse full of cars and computers and cans of tuna, ready to sell more or less, depending on the changes in consumer demands for these things, to ensure that the exchange value of cars, computers, and cans of tuna don’t change, so that the suppliers don’t have to change their prices, so that their suppliers don’t have to change their prices, and so on.

    Prices are changing all over the economy on a daily basis. It is silly to say that the price system is a “problem”. Your worldview is so messed up that you find value in stagnation, I mean “stability.” You don’t want changes, even though people’s preferences are in fact changing, and require a change in the economy’s structure, in real terms and in terms of prices. Fighting this can only generate problems. Just let it go.

  67. Gravatar of anon anon
    28. February 2012 at 12:31

    Major_Freedom, money is not neutral, as a matter of fact. There is plenty of evidence that price stickiness matters. This means that, given a currency area, there is something to be gained by stabilizing local GDP in each region (state, county, city) even though this distorts resource allocation and decreases the accuracy of local price signals. That’s because price stickiness creates large distortions on its own (imperfect competition exacerbates these distortions). There is no first-best solution, other than leaving folks free to quote prices in a local complementary currency whenever they would so choose.

    “Merchantilism”, properly revised, is in fact optimal policy within a large currency area (given that the nominal anchor is set independently) to a varying extent depending on the scale of non-tradable activity and factor mobility. I’m not sure why you’re objecting to this.

  68. Gravatar of Major_Freedom Major_Freedom
    29. February 2012 at 11:10

    anon:

    Major_Freedom, money is not neutral, as a matter of fact.

    I know. The non-neutrality of money is in fact a vital and necessary requirement for what I am saying.

    There is plenty of evidence that price stickiness matters.

    No, there is plenty of empirical data that we all agree on that is being misinterpreted because the wrong theories are being applied to it.

    This means that, given a currency area, there is something to be gained by stabilizing local GDP in each region (state, county, city) even though this distorts resource allocation and decreases the accuracy of local price signals.

    Gained by whom? Obviously not savers, nor holders of the currency who receive the new money later on after prices are already higher, nor those whose jobs and careers are affected because of the central planning of inflation.

    That’s because price stickiness creates large distortions on its own (imperfect competition exacerbates these distortions).

    Perfect price flexibility, which is presumably the standard by which you are comparing actual price movements, would be even worse.

    There is no first-best solution, other than leaving folks free to quote prices in a local complementary currency whenever they would so choose.

    Egads man, you get it. Although your choice of words is a little weird. You’re saying there is no first best solution…other than a particular first best solution you know about.

    It’s like saying “There is no conceivable answer that can ever possibly be given to the question of what is 2 + 2…other than the answer of 4.”

    It’s right, it just sounds weird.

    “Merchantilism”, properly revised, is in fact optimal policy within a large currency area (given that the nominal anchor is set independently) to a varying extent depending on the scale of non-tradable activity and factor mobility. I’m not sure why you’re objecting to this.

    No, that’s not mercantilism. Mercantilism is a state policy of using force to benefit local inefficient businesses and laborers at the expense of the consumers, who are compelled to buy products from a less competitive and less productive population of producers.

    The mercantilism behind central banking is the state using force to compel the people to pay them in taxes of that currency, thus retaining a demand for the currency, the money of which is then inflated by the central bank to benefit the state and the state’s politically favored special interest groups. This of course comes at the expense of everyone who wants to not pay taxes in dollars, or even use that currency at all, and it also comes at the expense of consumers who pay higher prices due to being compelled to buy products from a population of less productive producers.

    Mercantilism is not “optimal” for the general population. It is only optimal for special interests who benefit at the expense of others.

  69. Gravatar of ssumner ssumner
    1. March 2012 at 12:05

    Major Freeman, So money is just like any other good. Then why has the nominal price of $1 bills stayed exactly constant for 150 years, while all other nominal prices have changed radically?

  70. Gravatar of Major_Freedom Major_Freedom
    1. March 2012 at 22:17

    Major Freeman, So money is just like any other good. Then why has the nominal price of $1 bills stayed exactly constant for 150 years, while all other nominal prices have changed radically?

    Are you insane? There is no nominal price in dollars, for the dollar itself. You’re using circular logic. This is absolutely incredible. A tenured economist has no clue how money works. Like you said, “I am in awe.”

    By your logic, if I said that a book is like every other good, you’d say “Oh yeah? Then why has the nominal book price of this ancient book stayed exactly constant for 1000 years, while all other nominal prices in dollars have changed radically?

    You’d probably reply and say “Hey wait a minute, that ancient book is priced in dollars, not in that same exact book, in which case of course it would be one for one!”

    Then I will say “Duh, the same thing holds true for a dollar bill. A dollar bill is itself. It is not priced in itself. It is priced according to other goods in exchange. That’s how prices are formed. In exchanges. No exchanges means no price. A dollar bill cannot be exchanged for that exact same dollar bill such that it has a “price” of $1. It would be like saying that ancient book has a “price” of “that same one ancient book.”

    The reason why nominal prices of goods in dollars have changed so radically is because the supply of dollars has changed so radically compared to the supply of goods exchanged for dollars.

    It’s the exact same reason why the nominal prices of electronics (in dollars) has changed so radically, namely, because the supply of electronics has changed so radically compared to the supply of dollars.

    Money is a commodity. I cannot believe I have to say this. Money is a commodity and as such all the economic laws that we know apply to commodities, applies to dollars as well.

    All money really is, is just the most marketable, most widely accepted commodity in exchanges. Money is absolutely NOT immune or transcendent of economic laws.

Leave a Reply