Trills
A recent post by Robert Shiller proposed a new type of government bond, called a trill. These bonds would pay the holder one trillionth of US nominal GDP each quarter. Today this would be about $3.50, or $14 per year. He suggests that these bonds might sell for as much as $1400 given current conditions in the financial markets.
Robert Shiller and I have shared an interest in NGDP futures for almost two decades, albeit for different reasons. In 1989 I published a paper advocating that the Fed buy and sell unlimited quantities of NGDP futures at the target price, and then use those transactions to adjust the monetary base. Shiller has focused on the financial angle; he argued that NGDP futures and/or NGDP bonds could make financial markets work more effectively. It seems to me that subsequent events have strengthened both of our arguments. If mortgage payments were linked to NGDP then mortgage defaults would have been lower in 2009, and if we had targeted NGDP expectations then any crisis that did occur would have had relatively little impact on AD.
Michael Pettis also has a longstanding interest in this idea, and comments on Shiller’s essay:
In my book, The Volatility Machine, I discuss the same things, arguing that developing countries typically put on what I called “inverted” debt structures, which automatically exacerbate volatility. The worst sources of this kind of inversion are either external debt, short-term domestic debt, or contingent liabilities arising out of the banking system. All of these forms of debt perform better than expected during good times and much worse than expected during bad times, and so they are an important part of the reason why developing countries, especially highly indebted ones, seem to veer so easily from boom to bust.
One of the things developing countries need to do to help break this cycle is to restructure their balance sheets in order to reduce embedded pro-cyclical structures and so reduce volatility. The best way would be somehow for countries to sell “equity”, the closest thing to which has been long-term, fixed-rate local currency debt. Schiller’s “trills” are an even better example. The main point is that these kinds of capital structures force the users of capital to pay more when times are good and less when times are bad. This provides an important cushion for when times are bad, and the very existence of this cushion not only will reduce the tendency for capital to flee a country just when it needs inflows most, but it should reduce the overall cost of capital by reducing financial distress costs.
I think “trills” are a great idea, and I remember writing a piece many years ago for the Financial Times (“A stake in Argentina’s future”, July 2, 2003) in which I praised the attempts – however minimal – to embed such a structure in bonds issued by Argentina as part of its 2003 debt restructuring. The Argentine structure was a tiny first step (it only involved a minimal amount of GDP warrants), but if a major developed country were to issue these “trills” and make them respectable, this would be very positive for developing countries who, like China, are much too volatile, tend to fly back and forth between periods of intense growth and intense despair, and have very few options for building hedges into their national balance sheet.
I would like to comment on Michael’s statement that “This provides an important cushion for when times are bad.” It may be obvious, but this protects borrowers in two ways; they are protected against falling RGDP, and falling price levels. Of course both deflation and depression make it harder to repay loans, which is why indexing bonds to NGDP is superior to indexing to the price level.
I hate to beat a dead horse, but you guys know by now that I am anti-inflation. Not against actual inflation, rather against using the concept of inflation in economics. Statisticians just pull inflation numbers out of thin air, and they are not reliable.
BTW, that was the point of my BU dorm post. Some commenters, such as Matthew Yglesias, thought I had some kind of right-wing agenda; that I was trying to undercut Johnston’s point about inequality. Actually my only point was that the CPI is unreliable, and also that dorms are the best way of evaluating changes in living standards over time, because they bring together a wide range of people. I do concede that dorms slightly understate the true rise in living standards, as an increasing share of Americans are going to college, and thus it is becoming less and less of an elite sample. College students now come from a wide enough range of backgrounds that changes in dorm quality, which reflect changing student expectations, are much more reliable than the CPI. We should abolish the CPI and put those tax dollars into creating GDP futures markets.
I want to put my name out there along with Pettis and Shiller as an enthusiastic supporter of NGDP bonds. The coupons could be sold separately, and their value, when compared to nominal zero coupon bonds, would provide an excellent real time estimate of NGDP growth expectations. The Fed would have no excuse for ever letting those expectations get more than 1% above or below the target level. And no more liquidity traps! Were we to adopt NGDP futures targeting then I believe that we could even surpass the Aussies in number of consecutive decades without a recession.
Those readers interested in my China posts should look at Michael Pettis’ entire post. He has the best China blog that I have been able to find. He is more pessimistic about China that I am, partly because of a difference in outlook, but partly because of the old glass half full/half empty issue. I like to be a contrarian, and since there is so much skepticism about China in the US press, I like to emphasize the positive changes that I have seen. But I defer to his expertise about the microeconomic/banking problems in China.
PS. The new blog still has a few bugs to work out, for instance today it slowed to a crawl at times. But we do have a full RSS feed. I have only a vague idea of what RSS means, but if it is important to my readers, it is important to me. (I apologize to one or two commenters who mentioned the RRS issue last spring. It turns out you were right, but I was constantly dealing with so many issues that I only now got a handle on it.) To give you an idea of how bad I am with computers, it took me 20 minutes to get my office computer on today. I have no idea why.
PPS. Replying to a recent comment I cast doubt on the view that the US economy is recovering. I should have said 3rd quarter data (2.2% growth) did not indicate a recovery. Given the recent performance of the stock market I believe that the recovery probably began in the 4th quarter, and that RGDP growth is probably now well over 3%. So I guess that is some sort of progress.
PPPS. If the direct link to Shiller doesn’t work, link through the Pettis post.