Bill Woolsey on Bennett McCallum

Bennett McCallum has a new paper arguing that NGDP growth rate targeting is superior to NGDPLT. McCallum is right that NGDPLT doesn’t work well if it is used as a temporary expedient.  But I much prefer NGDPLT as a policy regime.

Bill Woolsey has an excellent reply.  I’ll just quote a few passages, but you should read the entire post:

It is great to see more new work from McCallum on nominal GDP level targeting.

He emphasizes discretionary and time invariant approaches to policy rules.    He also mentions a purported rule he calls strategically incoherent.   I am not sure I fully understand, but it looks to me that this is exactly the approach that Market Monetarists favor.   Right now, we have to decide where the initial growth path for nominal GDP will commence, and then we stick with it.   This is supposedly incoherent because why don’t we start it all up again every period?    Next year, why don’t we imagine we have no rule, and we will start it all up again.

Suppose we are considering the institution of  very strict gold standard.   In the future, the price of gold will be fixed.   The price next period will equal the price this period which equals the price last period.   Now, at what price do we set the price of gold?   Is it strategically incoherent to use anything other than last period’s market price of gold?   I don’t think so.   The relative price of gold can easily be impacted by using it as medium of account.   We are instituting a regime.   The logic for choosing a rule initially is not the same as the logic for sticking to the rule.

.  .  .

The studies McCallum refers to presumably use calculations of utility loss from inflation rather than a simple “loss” function.

But to what degree are these utility calculations based on the assumption of Calvo pricing?  That seem to me to put too much weight on an obviously unrealistic model whose only virtue is that it can be used to make calculations of utility in rational expectations models.

If instead, some prices are flexible and others are sticky, reversing the changes in the flexible ones so that the sticky ones don’t have to change is desirable.   This reasoning also applies when the sticky prices are those of labor–wages.   And that seems much more plausible.   Rather that keep the price level change and then make wages adjust, it makes much more sense to reverse the price level change so that labor markets clear at the sticky wage levels.

What about supply shocks?   While nominal GDP level targeting is the same as price level targeting when there are no aggregate supply shocks, one of the chief virtues of nominal GDP level targeting is that it does much better than price level targeting when there is a supply shock.

The model McCallum uses has an inflation shock.   It is just a random term at the end of the quasi-Phillips curve.   It seems to me that any such shock would push nominal GDP above target.   A growth rate target would just leave nominal GDP on a new, higher growth path.   In my view, that would be best.   (At least if these price level shocks are really just random and not regime dependent.)   Pushing the price level back down the next period would be pointless.   Nominal GDP level targeting would require a return of nominal GDP to target, and would likely push output below capacity.

However, what these random shocks in the model represent are real microeconomic events that impact both prices and capacity.   Negative covariance is very likely, and so just when the price level is shocked up, real output and capacity are both pushed down.   Any deviation of nominal GDP from target is likely to be small.

All I would add here is that if the price shocks were changes in VAT rates, it would make more sense to target NGDP net of indirect business taxes.

I happen to think that there is very little difference between NGDP growth rate targeting and NGDPLT when the central bank is competent, i.e. when it is targeting the forecast.  When central banks are incompetent (as the Fed was in 2008) then NGDPLT is a vastly superior policy—NGDP growth rate targeting doesn’t even come close.  NGDPLT almost forces central banks to “do the right thing.”



4 Responses to “Bill Woolsey on Bennett McCallum”

  1. Gravatar of flow5 flow5
    30. September 2013 at 07:14

    If China pursued a policy which targeted nominal-gDp, its employment rates, poverty rates, & PRC’s standard-of-living would have been severely stunted as a result (because China’s real-output averaged 10% over 30 year – presumably much higher than any target).

    Monetary policy objectives should be formulated in terms of desired roc’s in monetary flows -MVt (our means-of-payment money times its transactions rate-of-turnover) relative to roc’s in real-gDp (not nominal-gDp). This is of course, inviolate & sacrosanct.

    The lags for monetary flows (MVt), i.e. the proxies for (1) real-growth, & for (2) inflation indices (for the last 100 years), have been mathematical constants. However, the FED’s target (interest rates), is indirect, varies widely over time, & in magnitude.

    Think not? Then your either ignorant, arrogant, or both.

  2. Gravatar of Morgan Warstler Morgan Warstler
    30. September 2013 at 09:39

    I’d add here, that not only do output gaps / overshoots close quicker using LT, but from a political perspective, it encourages ripping off the band-aid.

    I’m just winging this graph to make my point but…

    If we set Q2 GDP at $16,633T

    And then say a 2% make up, then we should have been at just under $17T right?and at 4.5% by end of Q2 2014, we’d need to be at $17,679.

    So we’d need like $1.1T “make up” by Q2, 2014.

    Or if we rip off the bandaid we’re at $17,268. so the “make up” is like $550B.

    Because the moment we hit that LT, we’ve made the jump.

    I know this sounds a little whack but hear me out:

    1. To me this sounds nominally / politically better because the level of “make up” is smaller. Scott, I know this is rube material, but thats where my head is.

    2. It is more SHOCKING as in Chuck Norris style, I don’t know kind of action it takes to add $550B in NGDP in thee months, but it’s definitely more shocking than what it takes to maybe it in Jan 2015.

    Meaning once you say we’re gonna hit a LT and have make up, that damn LT is running out in front rising each month while we chase after it. The longer it takes, the more chance there is for people to call the idea stupid.

    3. Politically hitting that LT is teh awesome. It means we’re able to start MANAGING THE PIE. EVERY MONTH we got about $X in NGDP we gotta add.

    Now we start to talk about how government spending is basically inflation, and private spending is basically real growth.

    Anyway, here’s my graph:

    Sadowski, tell me what I did wrong.

  3. Gravatar of Don Geddis Don Geddis
    2. October 2013 at 09:45

    flow5: 5% NGDPLT is an appropriate target for a wealthy, mature economy like the US. As you suggest, a massively poor country experiencing high annual growth, like China, would be better served by a higher target.

    There’s no reason at all for China not to institute an NGDPLT monetary policy with a 10% annual target.

  4. Gravatar of flow5 flow5
    2. October 2013 at 10:57

    Common sense dictates that real-gDp be used as a policy standard. Unless money expands at least at the rate prices are being pushed up, output can’t be sold & therefore the work force will be cut back. It’s about limited upward & downward price flexibility within in our product & labor markets.

    Also, because its the most effecient way.

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