Bullard: The biggest demand shock since the 1930s didn’t cause any unemployment
I’m still in a state of shock after reading the newest PowerPoint slides by James Bullard, sent to me by Bill Woolsey. He seems to think monetary policy was right on target during 2008-09, despite the biggest fall in NGDP since the Great Depression. For some miraculous reason that is not stated, the 4% drop in NGDP between mid 2008 and mid-2009 didn’t cause any unemployment. Rather for some mysterious reason there was a huge downshift in the natural rate of employment, and the natural rate of output. Why did this occur? He doesn’t say. We know it wasn’t housing, as most of the housing collapse occurred well before mid-2008, and was not accompanied by any fall in RGDP, and only a trivial rise in unemployment. Rather for some mysterious reason the trend rate of output and employment in industries all across the economy plunged in 2009. And so there was no “output gap,” we stayed right near full employment, it’s just that the definition of full employment changed radically. Here’s one graph:
And here’s the graph for real GDP:
Even many of the conservative critics of market monetarism concede money was too tight in 2008-09, when NGDP plunged. Bullard says it wasn’t too tight, and the plunge did not raise unemployment. He’s not a conservative, he’s ventured into radical RBC territory. Bullard keeps citing Rogoff and Reinhart. I’d love to hear what they think of what Bullard has done with their model.
Believe it or not I think there might actually be some people at the Fed who are receptive to this view. After all, it suggests the Fed was not to blame. Some sort of financial crisis hit the US in 2008 for reasons having nothing to do with falling NGDP, even though throughout history falling NGDP almost always triggers financial crises (think of the US in 1931, Argentina in 2000, Europe in 2009, etc.) In his view the post-Lehman crisis just happened for some mysterious reason in the fall of 2008, unrelated to the crash in NGDP that began in July 2008.
It’s too bad Bullard could not go back in a time machine and warn FDR against devaluing the dollar in early 1933. After all February and March 1933 saw the worst banking crisis in American history, so trend output must have fallen to a new and lower level. All FDR would get is inflation, with no real growth. And it’s too bad he couldn’t go back in time and warn the Argentines not to devalue in 2002. It would just cause inflation, not real growth.
And finally, we have a graph showing NGDP is right on track:
I do agree with Bullard on one point. If you draw the trend line to reflect wherever the economy happens to be at any given time, then the economy will always be right on track. And how could it be otherwise, as that would imply the Fed had made a mistake. All those stock market investors who (since 2008) seem to suddenly favor higher inflation? They’re simply deluded, they haven’t had the good fortune to study Bullard’s PowerPoint slides.
PS. There’s lots more. He says the price level was way too high in mid-2008, so at the time Lehman failed we needed a deflationary monetary policy to bring prices back to the trend line. Mission accomplished.
PPS. If this is a satirical prank that some grad student posted on the internet to mock the Fed then I apologize to Mr. Bullard for all the snark. If not . . . well I’d rather not even think about that possibility.
Update: Tim Duy sent me an email suggesting that Bullard seems to have abandoned the hp-filter approach he used earlier. See this Tim Duy post for a good discussion of Bullard’s earlier proposal. I think that one was also wrong, but it was somewhat more defensible.
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28. September 2012 at 05:41
This is like Prescott “proving” that the Great Depression was a real shock by using an H-P filter on the level of GDP. If you set lambda low enough, you can always show that any sharp drop in real GDP is always a drop in potential output (AS) and that AD shocks are “monetary myths”. No need to look at any other variables or ask any other questions. What does Bullard have to say about the fact that average hourly earnings growth over the past three years has been the slowest since the 1930s? Could that have anything to do with the fact that NGDP growth in 12% below its pre-crisis trend? My guess is we won’t get an answer to that question in his next PowerPoint presentation.
28. September 2012 at 05:53
“Why did this occur? He doesn’t say. We know it wasn’t housing, as most of the housing collapse occurred well before mid-2008, and was not accompanied by any fall in RGDP, and only a trivial rise in unemployment.”
Though I do not wish to be understood as defending Bullard’s extreme position, I daresay this is going too far in the way of the opposite fallacy of denying that there was any structural component to the post-2007 unemployment. Surely it can’t be denied that housing was in excess supply, and that unemployed construction workers, among others whose employment depended upon a buoyant housing market, did not find themselves out of work merely owing to a shortage of exchange media. That the unemployment in question was separated by a lag from the actual decline in house prices itself isn’t especially hard to explain.
“I think there might actually be some people at the Fed who are receptive to this view. After all, it suggests the Fed was not to blame.”
It does, only if one accepts the view that the Fed contributed little to the housing boom and bust. I think the jury is far from having reached a verdict on that, and am myself find it hard to believe that the Fed’s commitment to maintaining low, if not negative, real interest rates for an extended period contributed very little to the overheating of the mortgage market. The claim that there are as yet no very satisfying formal models capable of accounting for the Fed’s influence suggests to me, not that there was in fact no such influence, but that better theories are needed concerning the real consequences of “unnaturally” low interest rates.
28. September 2012 at 06:27
If I put together a PDF slide show, I would have a chart showing the following:
Contribution to RDGP:
Bullard -50bp
Lacker -50bp
Poole -100bp
Hoenig -100bp
Plosser -100bp
Fisher -200bp
28. September 2012 at 06:34
The way you are in shock for reading about claims that a supply shock caused the 2008 collapse, is the same shock I am in for reading claims that a demand shock caused the 2008 collapse.
Neither demand qua demand, nor supply qua supply, can act independently as causes for 2008-2009. They are not independent phenomena. Goods are valued by way of trading against money, and money is valued by way of trading against goods. They are connected through a common foundation of valuations that were adversely affected, and that caused the 2008 collapse.
For some reason, most entrepreneurs at the same time made incorrect valuations as to the future demand for their products. Why? Why didn’t most of them forecast correctly the size of their own sales? It’s not enough to say it’s because NGDP fell due the Fed fell asleep at the wheel, because NGDP is the totality of individual demands. It isn’t dropped from above like manna from heaven. NGDP has to work its way from investors outward, one by one as new money is spent and respent.
If the actual individual demands were lower than individual investor expectations, then we have to ask why their valuations were so off, in terms of the relationship between cash holding and spending. In other words, without falling back on spending only, and thus without falling back on “the Fed didn’t generate enough spending to make the investments profitable”.
Money isn’t only spent, it is also held. The relationship between holding cash and spending cash is the door to which the answers can be found. Starting with spending as the causa sui can only ever lead to spending as the gatekeeper.
Why didn’t investors forecast the rise in demand for money relative to spending that led to a decline in spending from one period to the next? The job of an investor is essentially to convince others to part with their cash balances. Well, why where so many investors wrong about the ratio between spending and cash balances? Why did so many people NOT part with their cash balances relative to spending in 2008-2009? It can’t be because the Fed didn’t print enough money, because printed money can only spread throughout the economy by way of spending, not cash hoarding. We are concerned with the relationship between spending and cash hoarding.
This is where market monetarism falls flat. The relationship between cash and spending gets divorced into two, where on the one hand, people allegedly want cash for the sake of holding cash, as if more cash is in and of itself what people want when they hold it, while on the other hand people allegedly want to get rid of their cash for the sake of getting rid of their cash, as if less cash is in and of itself what people want when they spend it.
Thus, market monetarism holds that the job of the Fed is to add to the supply of money when people “want more money”, and subtract from the supply when people “want less money”. But then we run into the problem of identifying just how much more money people have to want before the Fed is to purchase assets, and just how much less money people have to want before the Fed is to sell assets.
This is where the arbitrary 5% NGDP comes in. An individual can hold more cash, as long as the totality of spending keeps rising at 5%. An individual can hold less cash, as long as the totality of spending keeps rising at 5%. There is no communication between an individual’s cash and spending patterns, and everyone else’s cash and spending patterns. The communication signal is completely lost. If an individual reduces his consumption and holds more cash, then the Fed has to print an indefinite quantity of money to coax others into “spending” however much our individual reduced his “spending”.
In other words, if our individual reduces his consumption of entertainment by $500 a month, then if the Fed prints $1000 to coax a Wall Street investor to speculate $800 into the mortgage market, such that it results in $500 of additional spending on final goods, then according to market monetarism, “the Fed is doing its job.” But how can this not result in anything but bad communication between economic actors? Here we have an individual who is communicating one thing, namely, he wants to spend less on the particular entertainment he used to spend his money on, and yet the Fed is bringing about a completely different set of signals to investors when it prints money for the Wall Street speculator. There, the Fed is bringing about the signal that the relative demand for that which the $500 went into purchasing.
In a free market, if our man reduced his entertainment and held $500 more in cash, that would send a signal to investors as a class in a more cleat way that does not exist with NGDP targeting.
This signalling mismatch phenomena introduced into the pricing system by way of central bank overruling the market’s NGDP determination, is the common ground that explains the incorrect valuations that investors suddenly found themselves in during 2008. They made investments not according to the signals that individual market actor behavior and actions results in, but rather, in signals jammed by Fed inflation as they engage in their non-market aggregate spending targeting.
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Neither Bullard nor Sumner, nor the supply shock and demand shock crowds in general, seem to grasp the concept of economic calculation. This coordinating aspect of market activity, is the key to a healthy and sustainable economy. The key is not this globular, money flow, demand oriented wishy washy “stimulus” that refers to abstract aggregates only.
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It all goes back to how we think about the world. To market monetarists, the “economy” has a reality unto itself. The economy is a living “system”, and money is its lifeblood. This blood needs to flow throughout the “system” at a minimum rate (known by only a few of the “system’s” messengers), or else the “system” will go into a state of “shock”, and like a person who lost a lot of blood, will become ill and sick. Only more blood can help the “system” recover.
Austrians on the other hand view the “economy” as but an abstract that refers to individual actors acting in a division of labor. Money is not a lifeblood, but is rather a tool of economic calculation. Rather than “flows”, money is viewed as a commodity, that is valued both for use as a means to store value for future use, and for use as a means to make exchanges of one’s goods and services, for other actor’s goods and services. The quantity of dollars and quantity of spending are not significant. It’s the relative demands and relative prices, it’s the calculation aspect of money, that is decisive.
Austrians view money as a sort of calculator for use by a higher, more important center of study that is human action. We don’t put money above human action the way market monetarists do. Yes, that is what you are doing when you make statements such as “5% spending growth controlled by the Fed come hell or high water”. You are putting money above individual human action whose control would otherwise lead to an NGDP that you cannot predict nor plan nor control.
Austrians know that money is valued by individuals, and is a tool used by individuals to calculate their means to achieve their ends, and so, politically speaking, if you want to avoid the kinds of crises like 2008, which are the result of signal distortions of prices, then we OUGHT to subject money to individual action also, rather than what market monetarists are doing, which is trying to develop a socialist plan which puts money above individual human action of those who are planned.
28. September 2012 at 06:39
George Selgin:
The claim that there are as yet no very satisfying formal models capable of accounting for the Fed’s influence suggests to me, not that there was in fact no such influence, but that better theories are needed concerning the real consequences of “unnaturally” low interest rates.
Meanwhile, overheard at the Mises Institute: “Thump thump thump, is this thing on?”
28. September 2012 at 06:52
“For some miraculous reason that is not stated, the 4% drop in NGDP between mid 2008 and mid-2009 didn’t cause any unemployment.”
Bullard probably thinks like Angus does, he would say that of course if employment falls, then RGDP falls, and this naturally leads to falling NGDP, which is simply RGDP times the price level.
Come on, how many economics graduates even think about supply and demand for the money stock like we do? Didn’t even Tyler Cowen recently say that NGDP is a mix of real and nominal? How many people even think about the circular flow of income as the intersection of two distinct phenomena (despite it being explained that way in all the textbooks)? So most people still don’t get how you can think of NGDP as an independent causal force. That’s the context under which you should actually find Bullard’s misconceptions quite unsurprising.
28. September 2012 at 06:54
“even though throughout history falling NGDP almost always triggers financial crises”
You have your cart before the horse. Financial crises trigger falling NGDP. Financial crises ARE monitary contraction.
28. September 2012 at 06:55
This is why I say that you shouldn’t talk about NGDP at all, you should say “nominal spending”, despite being longer, as this would somewhat reduce the confusion. Of course it would go against the NGDP-acronym meme you’ve nicely set up, but perhaps it needs to be done now. NGDP-ism, as it’s now being called, also deflects attention from the fact that level-targeting is more important. In fact that was one of Ritwik’s criticisms in a comment on MarginalRevolution: http://marginalrevolution.com/marginalrevolution/2012/09/more-on-the-ngdp-debates.html#comments
28. September 2012 at 06:56
Case in point: doug M. This shit literally writes itself.
28. September 2012 at 07:10
Relative prices and relative spending are more important than aggregate price levels and aggregate spending.
Relative prices and relative spending cannot change in the world market unless country level price levels and country level spending are free to change.
The world market, as Hayek noted, can become distorted if countries pursue monetary policies that diverge from what would prevail in a world central banking order. Country level NGDP targeting would definitely qualify as one such policy.
In other words, in a free market, if the size of the US economy grew relative to the rest of the world, then as Adam Smith noted, it will tend to result in a relatively higher quantity of money and volume of spending in the US and relatively lower quantity of money and volume of spending elsewhere in the world. Contrary to being destructive and in need of reversal via domestic inflation from a country central bank, this had the benevolent outcome of regulating world trade, just like demand fluctuations within the US state to state regulated trading within the US. If every individual earned 5% more income every year, there would be no regulating mechanism between individuals. This principle is no less true at the country level. If every country had a central bank that generated a 5% increase in “spending” every year, then the country to country regulating mechanism will be lost.
If market monetarists insist that declining demand is so important that it cannot fall at the country level, and inflationary policies to ensure it doesn’t fall are accompanied by “I don’t care if inflation is 20% or -20%”, then wouldn’t demand at the individual state level, or firm level, or individual level, be even better?
Inflationary policies that ensure each state receives 5% growing income can ensure that there is never any demand side unemployment at the state level.
Inflationary policies that ensure each firm receives 5% growing income can ensure that there is never any demand side unemployment at the firm level.
Inflationary policies that ensure each individual receives 5% growing income can ensure that there is never any demand side unemployment in the individual level!
Do you know what this means? This means that the logical conclusion of the ideology behind market monetarism is that we can eliminate demand side unemployment altogether, if everyone works to produce goods and services for the benefit of the Fed, and we all get a steady 5% annual increase of green pieces of paper in return!
This may sound trite, boorish, and unfair, but this logical conclusion at the extreme is still present when the Fed buys any assets whatsoever. When the Fed buys assets, those not in the Fed give the Fed claims to real assets, and in return, they get green pieces of paper with claims to nothing. This destruction of real value is supposed to provide the impetus for stimulating more employment and output. Monetarism, in this sense, really is nothing else than the old dogma that destroying values is the source of creating values.
28. September 2012 at 07:17
doug M:
“even though throughout history falling NGDP almost always triggers financial crises”
You have your cart before the horse. Financial crises trigger falling NGDP. Financial crises ARE monitary contraction.
You’re right, but the MM response is that NGDP would not have fallen if the Fed printed whatever sum of money is required to coax some people into spending more so as to “reverse” the spending declines of other individuals (it isn’t really a reversal, but it only looks that way when you give reality to the aggregate spending sum).
In this way, MM traps people into repeating the past in terms of spending, as a group, no matter what. In MM world, past spending is sacred. It is not to be drastically changed. 5% change per year…tops. No more, no less. OK, maybe less, but not too much less! I am God among men. I control their spending. Yes, I am elitist. I don’t care. Money is too important, and needs to be run by important, intelligent people, namely, myself and those who share my views. Everyone else can go f themselves.
28. September 2012 at 07:20
Gregor, A very good point I forgot to mention. The sharp slowdown in nominal wage growth completely undercuts his theory.
George, Yes, construction workers lose jobs, but because NGDP kept growing other jobs get created elsewhere, which is why unemployment merely rose from 4.7% in January 2006 to 4.9% in April 2008 (when most of the hopusing construction crash occurred), and then soared to 10% in late 2009 after NGDP fell sharply.
28. September 2012 at 07:24
Strongly second Saturos’s sentiments. While I don’t know if it’s feasible or desirable to switch messaging away from “NGDP” to “nominal spending”, it’s far too easy for people to confusedly hone in on the “GDP” part of “NGDP” and go down rabbit holes the way Angus did. The reason NGDP targeting is superior to the current regime is because it targets nominal spending — not inflation, not P, not employment/output, not Y.
28. September 2012 at 08:01
A twitter account purporting to be St. Louis Fed tweeted them around last week, so probably not a prank.
Let me just say this, if I can immediately see multiple errors in your presentation, after my grand total of I think four undergrad econ classes (and, okay, lots of econ blogs), you probably are doing something drastically wrong.
I’ll have to remember to send things that need criticism to Scott directly given his lack of twitter.
But the notion that R&R means there is nothing that policy can do to get growth back to pre-crisis levels seems to be a popular one around the Fed, as I took Plosser to be adopting the similar notion in the speech Yglesias reacts to here:
http://www.slate.com/blogs/moneybox/2012/09/27/charles_plosser_on_qe_3_philadelphia_federal_reserve_president_charles_plosser_warns_that_monetary_stimulus_might_work_.html
28. September 2012 at 08:02
This will probably sound noobish, but is it possible that the MM explanation is not putting enough stock into the idea that the effects of the housing crash “lagged” a bit, meaning we didn’t really see the fall out from that until 2008-2009? I feel like there is probably a simple answer to this question that I’ve overlooked while perusing the MM blogosphere, but being relatively new to the school of thought (although I kind of like the “neo-monetarist” moniker, even if the prefix “neo” makes me think of some fringe ideology for some reason) I feel like I’m missing part of the equation here…
28. September 2012 at 08:18
Real Business Cycle Theory — people choose to work less and purchase fewer new houses. People choose to purchase fewer new houses and to work less. It is the same thing.
Now, let’s say instead that there are plenty of scarce goods and if people don’t want to buy houses they instead want to buy other things. Increasing leisure is jut not significant.
And so, the production of new houses is cut back more rapidly than the expansion of other things. But other things are expanding anyway, so the net effect is just slightly lower real growth. There are more hires as people spend on other things, but that is outstripped by the layoffs. But, of course, there are lots of new hires anyway. So employment just grows a bit more slowly. And the unemployment rises a bit.
Now, that is a mild form of readjustment. If the needed adjustment is large and quicker, it could be the contraction in housing offsets all the new growth in the economy so the net effect is less production. The layoffs in construction offset all of the new hiring, and so employment falls. The unemployment rises alot.
Sumner is making the claim that the needed adjustment in housing would take the mild form. Slower real output growth, lower employment growth, and slightly higher umemployment. He looks at 2006 to mid-2008 and sees that.
Then spending on output falls, production and employment drops in nearly every sector. Unemployment spikes to very high levels.
That isn’t a reallocation.
Confused creditist/Keynesian/nonsense. People borrowed money to buy houses, and that allowed us to produce output and create jobs. Further, the construction workers spent money, creating even more production and jobs.
When the financial crisis hit, and there was no longer a way to pay for the houses, then output and employment fell. The lower level of production and employment is based on people spending the incomes they earn, and so is “sound.” This is as opposed to the excess and unsustainable production and employment generated by the unsustainble debt financed spending.
28. September 2012 at 08:30
“NGDP kept growing other jobs get created elsewhere, which is why unemployment merely rose from 4.7% in January 2006 to 4.9% in April 2008 (when most of the hopusing construction crash occurred), and then soared to 10% in late 2009 after NGDP fell sharply.”
A fall in GDP causes an increase in unemployment?!
That is tautology — Production = Productivity / hour * Hours worked.
if P fell (whether real or N) either productivity took a dive or, fare more likely, employment took a dive.
28. September 2012 at 09:32
ssumner:
George, Yes, construction workers lose jobs, but because NGDP kept growing other jobs get created elsewhere, which is why unemployment merely rose from 4.7% in January 2006 to 4.9% in April 2008 (when most of the hopusing construction crash occurred), and then soared to 10% in late 2009 after NGDP fell sharply.
Wages are not financed out of final demand for goods and services. Final demand for goods and services are financed, in part, out of wage payments. Wages are paid almost entirely before final output is ready for sale. Investment precedes production, and production precedes consumption.
Yes, jobs did not fall much January 2006 to April 2008, but that is because wage payments did not fall much January 2006 to April 2008. Jobs fell when wage payments fell. Wage payments fell not because NGDP fell. Wage payments precede NGDP both logically and temporally. If NGDP is falling, you are already talking about falling wage payments and investment spending, since the Fed relies on this form of spending when it inflates to target aggregates.
NGDP is not an abstract floating concept that is ontologically separate from specific spending like paying wages and investing in capital goods. These specific forms of spending are what NGDP actually consists of.
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Importantly, if the completion of the given complex of production and capital investments require more real savings than are available, if most investors thought there was going to be more real capital than what actually exists or will exist, then what would otherwise happen in a free market is that investors will reduce their prices and spending on the existing real structure and capital, which will then allow for relative price adjustments the resulting capital allocations of which can be made less unsustainable.
With spending targeting by central banks however, this recovery process is interrupted. In their zeal to prevent falling employment and output – on the Keynesian basis of inflation financed “spending” being the source of healthy employment and output – MMs cannot help but call for the introduction of micro-economic distortions via inflation into certain parts of the economic system, and thus they cannot help but introduce relative price signal distortions, the very source of the discoordination that is responsible for the sudden rise in the demand for money in 2008-9.
A sudden rise in the demand for money does not occur for no reason. MMs still have not explained why the Fed found itself in a position where if it didn’t accelerate its money creation by an incredibly high amount, that individuals in the market would have increased their demand for money and decreased their spending so much that NGDP greatly falls. Why would people do that? Why would people increase their desire for cash such that only inflation can prevent falling NGDP?
28. September 2012 at 09:36
We can’t blame Bullard for having on blinders, there’s a reason I can’t get a straight answer from Scott:
1. If NGDPLT has to have make-up to work, WHY is it so great?
2. If it doesn’t need make-up to work, how does the recovery happen?
28. September 2012 at 09:45
Bill Woolsey:
Sumner is making the claim that the needed adjustment in housing would take the mild form. Slower real output growth, lower employment growth, and slightly higher umemployment. He looks at 2006 to mid-2008 and sees that.
Then spending on output falls, production and employment drops in nearly every sector. Unemployment spikes to very high levels.
That isn’t a reallocation.
Sure it is. Reallocation on a nation-wide scale TAKES TIME (just like all investments and corrections to investments).
You cannot possibly expect the same prices multiplied by outputs aggregation level to be unchanged over time, as if a collapse in the housing market means that there are instantaneous investments and outputs appearing in some other sector. People don’t behave that way. They don’t buy more minor league tickets just because a major league goes bankrupt! And even if they did, there will have to be an available SUPPLY of the alternative goods they are willing to pay for. This isn’t always the case in the real world. Sometimes, it’s better that the general complex of investments go bankrupt, because they are just not what the general complex of consumers want with their money.
Resources are scarce, and resources can be misallocated. If too many resources are devoted to housing, after which there is a correction to the housing market, it will take time for those resources to find new purposes, new employments, and it takes time to find out what the actual time preferences of people really are. So aggregate spending changes are very much a part of reallocation processes, when the reallocations are about changing the entire temporal structure of the economy, rather than changing one good for another given the temporal structure remains intact.
Temporal structure adjustments are not cross-sectional reallocations like switching from major league tickets to minor league tickets.
——————
Doug M:
A fall in GDP causes an increase in unemployment?!
That is tautology “” Production = Productivity / hour * Hours worked.
GDP is not the same thing as NGDP.
28. September 2012 at 10:06
Bill, yes, people generally fail to see credit as a form of trade across parties in the economy, instead they see “borrowing demand from the future”. They miss the other half.
29. September 2012 at 22:12
Mr. Sumner, I daresay that if one opts to take the Milton Friedman approach of scapegoating the monetary policy target, one shouldn’t be surprised if some policymakers take offense (not that I’m disparaging Milton; his targeting method provided the Fed with political cover for the high interest rates they needed to break inflation in the early 80s).
The Fed does not control NGDP in the short term; even the medium term is questionable. Remember those temporary tax cuts the Fed financed with quantitative easing? That was supposed to be “dropping money from a helicopter,” but did it work?
I’m sympathetic to NGDP targeting, though not as a long-term policy target. Like Bullard said, changes in trend productivity could throw things off. But right now, what the U.S. needs is a controlled devaluation, and a great deal of monetary stimulus to offset fiscal contraction. NGDP targeting may thus be the better policy target in the short run.
29. September 2012 at 22:34
“But right now, what the U.S. needs is a controlled devaluation, and a great deal of monetary stimulus to offset fiscal contraction. NGDP targeting may thus be the better policy target in the short run.”
finally the bug becomes the feature. This is what NGDP is really for.
29. September 2012 at 23:23
Morgan Warstler, think of it this way. Devaluation was baked into the cards when the U.S. ran large current account deficits in the mid-2000s, and personal savings shrunk to virtually zero. It isn’t a “quick fix.” Moreover, combining fiscal contraction with devaluation enhances the effectiveness of the former. If the current account is simply the gap between savings and investment, fiscal contraction will increase savings, while devaluation will speed the necessary adjustments to mobilize those savings into exports.
(This is the “immaculate transfer” problem).
29. September 2012 at 23:25
“…combining fiscal contraction with devaluation enhances the effectiveness of the former”–former should be “latter,” sorry. Fiscal contraction can help make a devaluation “stick.” Export-lead growth is the whole point of expansionary fiscal austerity.
30. September 2012 at 08:01
Joe, The can control NGDP in both the short and medium term with level targeting.
Very few people, even very few economists, understand the “helicopter drop.” It’s not a good idea.
Productivity shocks have no impact on the optimal rate of NGDP growth. Read George Selgin. They will result in a changed rate of inflation, but that’s what we want in that case.
30. September 2012 at 15:00
Mr. Sumner, I fail to see how the Fed can reliably control aggregate spending in the short term. No matter how much the Fed prints money, people have to choose to spend that money. They always do””eventually””but the process takes time, and isn’t under the Fed’s direct control.
Myself, I believe the U.S. needs external demand much more than it needs internal demand. We still have a current account deficit, after all. This is the basic “global rebalancing” scenario””the U.S. shrinks domestic demand by private deleveraging and fiscal contraction, while China (and, hopefully, our other creditors) expand domestic demand while allowing their currencies to appreciate, on the understanding that supporting U.S. devaluation and fiscal contraction now is preferable to seeing the dollar (and their own foreign exchange reserves) utterly collapse later.
The Fed is not the sole actor in this drama. Foreign governments and U.S. fiscal authorities also have a role to play, and, frankly, both of them are capable of thwarting the Fed’s agenda.
4. October 2012 at 02:58
Joe, people will spend money if they have more than they want to hold. So holding the demand for money constant (which is reasonable when interest rates aren’t zero) when the Fed prints it people will spend it. It may get spent on financial assets first, but eventually it will flow through to real assets, and the workers who make them – provided the injection is permanent. Otherwise demand will rise to offset the increase in supply of money.
6. October 2012 at 12:00
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