Do or do not. There is no try.
I know that you are already rolling your eyes over the corny Star Wars reference, but I’ve never been more serious in my life. The Fed has a simple decision to make. Do they want to achieve some sort of nominal target, or not.
There are two metaphors one can use for monetary policy initiatives. One metaphor is the scientific experiment. The Fed will try QE to see if it works. Or they’ll try Operation Twist to see if it works. The other metaphor is steering a ship. They adjust their policy levers to keep the economy moving in the appropriate direction.
During normal times everyone assumes the steering a ship metaphor is the right one. The Fed nudges interest rates higher or lower to steer the economy in the direction they want to go. At the zero bound almost all commentators switch to the scientific experiment metaphor. The Fed tries something, and then waits 6 to 12 months to see how it works. But this is the wrong metaphor. In my view the experimental approach will almost always fail. The steering metaphor is always the right one. The Fed must stop trying, and they must decide what they actually want to do.
Let’s consider QE2 as a nudge of the steering wheel. Did it work? Almost all the indicators suggest it did, indeed both Keynesians and monetarists were proclaiming it a (very limited) success in early 2010. Relative to the non-QE2 situation, it clearly boosted AD, at least slightly.
Now let’s consider QE2 as an experiment. Did it work? I’d say no. I don’t think anyone can be satisfied with NGDP growth over the past 12 months.
And the reason for the failure of QE2 as an experiment is easy to see. Ben Bernanke is no Luke Skywalker. In order to follow Yoda’s maxim the FOMC would have to wake up every morning and ask themselves whether they were satisfied with the path of expected NGDP growth. At some point during the spring of 2011 the answer would have switched from yes to no. At that point they’d need to nudge the steering wheel enough so that expected NGDP was again on target. But they didn’t.
Given enough time, a Yoda-like commitment will always succeed, at least in terms of boosting NGDP growth. It might fail in other respects:
1. Higher NGDP growth may fail to boost RGDP.
2. The Fed might have to buy up an extraordinary amount of risky assets, and they might then suffer large capital losses.
But it will boost NGDP.
As a practical matter the two risks cited above are not serious concerns. The Fed should aim for steady 5% NGDP growth even if the monetarist/Keynesian model is completely wrong, even if NGDP has no impact on RGDP. So it’s no loss if more NGDP fails to boost RGDP. And as for capital losses, the Fed can always avoid having to buy up large quantities of risky assets by ending IOR (or even going negative) and buying Treasury notes. As a practical matter the public is not going to want to hold a massive amount of non-interest bearing cash if the Fed is committed to keeping NGDP rising at trend. Never has happened, and never will.
Many people worry about whether the Fed can boost NGDP. The market reaction to QE2 makes it obvious that the answer is yes. The only question is whether the Fed will decide to do whatever it takes. If they ever make that decision, they will be stunned to learn just how little it takes. But if they fail to make that commitment, nothing they do will ever seem to be enough. Unfortunately it looks like they will keep trying, and hence not doing.
Tags:
13. September 2011 at 15:22
And Martin Wolff says that the ECB must also do whatever it takes.
http://www.ft.com/intl/cms/s/0/fdb8cb90-ddf0-11e0-a391-00144feabdc0.html
Will they?
13. September 2011 at 15:38
Superb commentary, so vital for our times.
Please Mr. Bernanke-san, read Scott Sumner!!!!!
13. September 2011 at 15:54
Scott,
My fear is that NGDP targeting will be clunky at first, and very effective after it is established. The initial period is difficult as many opponent will throw accusations that it didn’t work.
Interest rate targeting used to require open market operations. Now it works on the announcement effect.
Here’s a video of Scott Sumner, Ben Bernanke, and Thomas Hoenig:
http://www.youtube.com/watch?v=X69NCLxwLEY
13. September 2011 at 15:54
Scott,
Back to this again?
What are you manic-depressive? bipolar?
In two more weeks you’ll lament they ARE doing exactly what they want.
—–
Forget this stuff.
FOCUS ON THE PEOPLE WHO MATTER.
Look, one of the things that gives a thinking person pause about participants at this board is tere is NEVER ANY DISCUSSION ABOUT:
1. How 2002-2008 were too hot.
2. How targeting NDGP would have stooped that from happening.
3. How when unemployment STAYS HIGH at 3 or 4% NGDP (you won’t get 5%), what silences the left from screeching we need to raise the target?
Look dude, we are winning. And with that I mean the Royal We, the GOP.
So, if you want to convince the winners to adopt your policies STOP concerning yourself with the “labor” bit, and focus on how your policy will depress labor wages.
Q: Chairmen Candidate Scott Sumner, let’s assume we the GOP Congress give you a mandate of a 3.5% NDGP level target starting Q1 2013, with the Fed running on your NGDP futures auto-pilot… aren’t structural errors in government policy more clearly the fault of government?
Q: Since there will be very little chance of things getting too hot and artificially reliving the jobs crisis, won’t there be a continuous pressure to red line job killing regulations, and reform the tax code?
Q: Isn’t targeting NGDP AFTER a conservative regime is in place, a STRONG WAY to maintain that regime?
13. September 2011 at 17:23
Fed: “I don’t believe it”
Yoda: “That is why you fail.”
——————
Scott, David, Nick, et. al.:
Lars’ paper is a nice summary. Yes, read it, still don’t like Market Monetarism. If you must, New Monetarism is better. I would suggest the following:
– clean up the grammar errors
– get rid of the hero-worship (george selgin’s “masterpiece”, etc.); it sounds like fawning groupie talk
– post the thing on all of your sites, and update it periodically; it gives new readers a starting point
13. September 2011 at 17:30
JimP, That’s a very sobering article, particularly the bit about Italy.
Thanks Ben,
Steve, I’m also counting on the announcement effect.
Morgan, We differ in two ways. You want what sells and I want what’s true. You want what’s good for the GOP and I have no partisan preference.
13. September 2011 at 17:32
Statsguy, Thanks for the suggestions.
13. September 2011 at 17:41
This post is excellent, but I think it overstates the case here:
“Many people worry about whether the Fed can boost NGDP. The market reaction to QE2 makes it obvious that the answer is yes.”
I don’t see this. The EMH (which I’ll accept for the sake of argument) doesn’t mean that the market is always right, only that it’s right on average. The market reaction tells us that, on average, market participants believed that the Fed could boost NGDP. But there were a range of opinions reflected in that average, and the average opinion may not have been right. In fact, if it was truly uncertain whether the Fed could affect NGDP, then there is a built-in bias toward getting what looks like a “yes” answer from the market. People who thought the Fed couldn’t affect NGDP would value the relevant assets (stocks, TIPS spreads, etc.) at approximately what they were previously valued. Even if these people consist of 60% of the market, the other 40% will bid up prices. (At least I think that’s what would happen. Obviously it’s not a trivial matter to model financial markets with heterogeneity and uncertainty, and the result would likely depend on the details of ones assumptions.)
Perhaps you are arguing that the financial market reaction is a mechanism by which QE2 raised NGDP, so that the very fact of the market’s reaction, whether or not the market was “right” a priori, would result in higher NGDP. But it’s not clear that the Fed can do that trick more than once. People are less optimistic about the impact of QE2 than they were at the time, so Tinkerbell might not make a return appearance.
Now let me say, I personally have little doubt that a sufficiently determined Fed can affect NGDP dramatically, though not necessarily with enough precision to approximate an intermediate-range target. At some point, enough people will decide the Fed is crazy, and you’ll get, at the least, a self-fulfilling inflation prophecy, and hopefully a lot of real growth in the process. Regardless of the response to QE2, it’s just not plausible to me that extreme actions won’t have a dramatic psychological impact. The questions are (1) How easy is it to hit the sweet spot of target NGDP? and (2) If one believes that it might be hard, will recovery still be worth the volatility risk? I’m not sure about the first question, but my support for NGDP targeting at the zero bound is based on an affirmative answer to the second.
13. September 2011 at 17:46
Congratulations. A landmark post. Probably Bernanke would like to move in your direction; will he realize that half-measures are the same as no measures at all?
13. September 2011 at 17:46
Scott
Yes – Italy is the key.
Where the world really needs NGDP targeting is in Europe.
13. September 2011 at 18:07
Scott
As the Italian man quoted in that Wolf article said – Italy is not Latvia.
Italy would never tolerate the level of deflationary depression as is now being forced on Greece. There would be a revolution first. Literally.
The left is strong in Italy. They might not be smart, but they are strong. I have watched in amazement here as a Democratic President could watch American unemployment march up and up and not care one bit about it. But that is due to the lack here of any real political threat from the unemployed. That was not true for Roosevelt, which is why he did act, and it is not true now in Italy.
13. September 2011 at 20:16
Scott, I love the Star Wars reference (though to be anal, Ben Bernanke is Luke Skywalker–Luke couldn’t lift the ship out of the swamp because he thought it was too big). But this part intrigues me:
The Fed should aim for steady 5% NGDP growth even if the monetarist/Keynesian model is completely wrong, even if NGDP has no impact on RGDP. So it’s no loss if more NGDP fails to boost RGDP.
I used to think I had your views down (and I disagreed with them). But lately you’ve been pushing this line, in which even if you’re wrong, you’re right.
How can that be? I thought Bill Woolsey over at my blog said something like, “Our views are falsifiable. Nobody doubts that the Fed could boost NGDP. If this recession is really a supply shock, as you Austrians maintain, then the rising NGDP would just boost prices, not output. Unemployment wouldn’t fall.”
(Obviously I’m paraphrasing Woolsey.)
So can you elaborate on this? I think you’re saying, “Eh so what, rising NGDP at 5% takes care of some other issues like sticky debt contracts; it would just be gravy if it lowered unemployment too.” But isn’t there something in the back of your mind, saying that just maybe having the Fed create (potentially) trillions of new dollars and having to decide which asset prices to tinker with, might have a few undesirable side effects that your model doesn’t capture?
13. September 2011 at 20:39
From 30K feet, whats true is what sells. It only looks ugly up close.
People are not stupid. History only moves forward.
That said let me correct your thinking:
Knowing the future is easy (it will be more libertarian).
Figuring our HOW to make that happen as fast as possible, that’s the moral imperative – and that’s HARD.
Strategery makes the hard easy.
—-
Please stop with the “I’m not partisan” jibber-jabber, it is beneath you.
Partisan, like Paranoia, is just a heightened sense of reality.
You ARE conservative. That’s the compass, and since you know which way to go – you ask guys like me how to get there fast.
14. September 2011 at 01:13
@morgan: “History only moves forward.”
Yes, things sure were more advanced in 800 AD than they were in 200 AD. And Stalin was a great step forward from the czars.
14. September 2011 at 04:02
Morgan – When did you become a died in the wool progressive?
14. September 2011 at 06:25
MikeDC, I’m very much a technocrat, but I’m a structural minimalist.
I favor”pretty good, digital and easy” never “really awesome, analogue, and complicated.”
Mostly I favor productivity gains and game play. I never see unemployed people, I see unearned profits.
All logic observed data points to 20% of society dragging 80% of society behind them.
So the only real imperative is not letting the 80% get in the way… done correctly, the 20% WILL NOT NOTICE, and happily let the 80% benefit from the fruit of their labor – they LOVE their customers.
The 80% are free to coast, as long as someone derives profit from their labor.
The 80% should view making it into the 20% as possible, but HARD.
Anyone who violates this premise is anti-progress.
Government is free to be staffed by the bottom 80%, as long as they do not use it to serve their interests. See Singpore.
If they try to be community organizers, they can be hacked by any means necessary.
Good government must ALWAYS be frugal government, lest taxpayers start to view government as a bad thing.
I’m contemplating a “web site” (its like a blog) based on my organizing principles: NEOPROGRESSIVE.ORG.
You can be my first member.
14. September 2011 at 06:37
I too am interested in the view that 5% NGDP level targeting is good independent of RGDP. If all the extra NGDP growth was just inflation, how does that help? “It brings the Fed closer to its current mandate” is no answer at all, as you are essentially seeking to change the Fed’s mandate.
The case that should really give you pause is the UK, and I wish you would blog about it more. It is often said that the BOE is doing NGDP targetting, and has been for some time – they’ve been outside their permitted inflation band for several years now. But UK NGDP growth is almost all inflation, with very little RGDP growth. It doesn’t need to be the case that RGDP is independent of NGDP – just that the link is attenuated. Essentially…
Does the sluggish performance of the UK economy diminish your belief in the effectiveness of NGDP targetting as a way of improving real economic outcomes?
If the BOE raised interest rates and returned inflation to its legally-mandated target, what do you think would happen to the UK economy?
14. September 2011 at 07:48
Somebody seems to think ending IOR would be deflationary. Something to do with the mechanics of banking which I don’t fully understand. Thought you’d be interested.
http://ftalphaville.ft.com/blog/2011/09/14/676701/why-cutting-ioer-could-be-suicidal/
http://ftalphaville.ft.com/blog/2011/09/14/676921/monetarists-and-ioer/
14. September 2011 at 07:58
Great stuff. Two things (one specific and one general):
1. Do you have a favorite post or posts that talk about what types of assets you’d like to see the Fed buy?
2. Krugman has a section on his blog where he lists links to a group of posts: “Some links to stuff I’ve written bearing on macroeconomic policy. Read all of them, and you’ll have a good sense of where I’m coming from”. You probably don’t have time, but I think readers (like me) would find it very useful if you did the same.
14. September 2011 at 08:01
“Higher NGDP growth may fail to boost RGDP”
Any monetarist knows that an injection of either money (& or increase in its turnover), is registered immediately in the marketplace.
Contrary to economic theory, & Nobel laureate, Dr. Milton Friedman, monetary lags are not “long and variable”. The lags for monetary flows (MVt), i.e. the proxies for (1) real-growth, and for (2) inflation indices, are historically (for the last 97 years), always, fixed in length.
Thus (when inflation is initially low), the lags & the math associated with money flows say that by targeting (n)gDp, monetary policy will impact/increase (real)-gDp at a faster clip (because of its shorter lag), than it will impact/increase the inflation indices.
14. September 2011 at 08:58
@ Bob Murphy
I don’t think Scott is saying that his theories are not falsifiable… He’s saying that even if NGDP generated no RGDP growth (all inflation, suggesting his theories are in general wrong), that at the current time a higher inflation rate by itself is probably a good thing (or at least not a bad thing). I would agree, simply due to the assymetry of the debt burden, but it depends on what you call a “good thing”.
14. September 2011 at 09:02
Is the FED as currently constructed (with its dual mandate) able to even attempt to reach this goal?
It seems to me that the best the current FED can achieve is a 2% memory-less inflation target.
How would Bernanke go about targeting 5% NGDP growth? It seems impossible to me unless our elected representatives agree to it.
14. September 2011 at 09:10
@Morgan Warstler
Knowing the future is easy (it will be more libertarian).
I can also envision a future that is significantly less libertarian:
1) ever-increasing productivity, automation, and loss of domestic low- and medium-skilled jobs create a bifurcated nation of upper- and lower-class.
2) the lower-class becomes organized and votes themselves not-insubstantial benefits, paid for by the upper-class.
3) the upper-class rationalizes financing the benefits to the lower-class as insurance against violent revolution and loss of wealth.
How could this world be described as more libertarian than the one we now inhabit?
14. September 2011 at 10:39
The cost of providing comfortable sustinence goes down and disparity does not matter.
Morally we ought to make sure our lowest and weakest have a better set up in real terms (better AC, nicer stuff, more channels with more edu broadcasts, food, medical (not the fancy expensive stuff think out of patent stuff cost determined) than other nations. But after that nada. See crawls.
In blunt terms, poor folk rich enough to be fat with 500 channels on a wall sized tv… don’t rise up ans topple the rich the same way starving dirty desperate people do.
You get that right?
14. September 2011 at 10:41
See rawls
14. September 2011 at 12:41
Salem,
The UK experience doesn’t fit the “higher NGDP would just lead to inflation”. The UK’s increase in NGDP didn’t stop translating into higher RGDP growth (including the fastest growth in over a decade in Q2 2010) until supply shocks started hitting the economy in late 2010.
The claim that higher NGDP growth can result in a zero increase in RGDP growth, ceteris paribus, is only credible if there’s a model behind it. The old Keynesian income-expenditure models are an example: make wages exogenous, and you’ll end up thinking of RGDP as being determined by current expenditure and NGDP as being determined by current expenditure + the sociology of labour relations.
14. September 2011 at 12:44
Blunt Instrument,
I’m pretty sure that premise 1) is ludditism, pure and simple. What historical or theoretical basis is there for linking automation and inequality, for instance?
As for the future, I don’t even know what the weather is going to be like in two weeks; I certainly don’t know what political culture circa 2021 will be like.
14. September 2011 at 13:14
This could be utterly silly, but I like to use the football head coach analogy in trying to make sense of the Fed’s tight monetary policy. In the NFL and college leagues, it’s common in close games to see teams punt the ball away on 4th & short yardage situations, even in the opposing team’s territory. The probability of converting on 4th and short situations is relatively high, but coaches would rather not be held accountable for losing the game on what would be perceived as a controversial decision. Analogously, is Bernanke unwilling to deal with the ramifications if QEIII doesn’t kick-start RGDP growth despite the obvious risk-reward justification in the first place? And a loss in this ‘monetary policy football game’ occurs if policymakers resort to additional fiscal stimulus and continue to balloon our deficit in an attempt to boost AD.
14. September 2011 at 15:46
Andy, You said;
“I don’t see this. The EMH (which I’ll accept for the sake of argument) doesn’t mean that the market is always right, only that it’s right on average. The market reaction tells us that, on average, market participants believed that the Fed could boost NGDP.”
But the market can’t be wrong, because if it believes the Fed can boost NGDP, then it boosts NGDP. For instance, because the market believed in QE2, the dollar depreciated in the forex market on rumors of QE2. Every single macroeconomic model from Keynesian to RBC says a falling dollar boost NGDP.
You said;
“Perhaps you are arguing that the financial market reaction is a mechanism by which QE2 raised NGDP, so that the very fact of the market’s reaction, whether or not the market was “right” a priori, would result in higher NGDP. But it’s not clear that the Fed can do that trick more than once. People are less optimistic about the impact of QE2 than they were at the time, so Tinkerbell might not make a return appearance.”
I should have read this before my previous response. But here I would say that the reaction in the forex market suggests it did boost NGDP, relative to an even more awful performance without QE2. How could it be otherwise? To be otherwise, you’d have to believe that all sorts of asset price movements had no causal effect on NGDP.
I mostly agree with your last paragraph.
Thanks pct. Unfortunately I don’t know if Bernanke gets this point–despite his use of the term “Rooseveltian resolve” when discussing what Japan needed to do.
JimP, I think you are referring to the next post, but good point. And thanks for the link.
Bob, You said;
“But isn’t there something in the back of your mind, saying that just maybe having the Fed create (potentially) trillions of new dollars and having to decide which asset prices to tinker with, might have a few undesirable side effects that your model doesn’t capture?”
I don’t think they’d have to create trillions more dollars, I think they’d have to create trillions fewer dollars. Banks are hoarding trillions of dollars in reserves precisely because with low NGDP it’s the best investment out there (plus the IOR issue). With much higher NGDP banks would not want to hoard trillions in ERs.
My theory is falsifiable, more NGDP may fail to boost RGDP. But even if the theory was false, the policy would be a good one for other reasons.
Morgan, You said;
“You ARE conservative. That’s the compass, and since you know which way to go – you ask guys like me how to get there fast.”
Am I correct is assuming that people rarely accuse you of lacking self-confidence?
Salem You asked:
“I too am interested in the view that 5% NGDP level targeting is good independent of RGDP. If all the extra NGDP growth was just inflation, how does that help?”
In other posts I argue that the problems many people associate with inflation instability are actually due to NGDP growth instability.
You said;
“Does the sluggish performance of the UK economy diminish your belief in the effectiveness of NGDP targeting as a way of improving real economic outcomes?”
It does slightly for the UK, but not really for the US. There is massive evidence that NGDP affects RGDP, going back for hundreds of years. But it may be that Britain has some structural problems–I am not an expert on their situation. Oddly, most of my critics make the opposite argument–they say I’m wrong about Britain because it needs more NGDP, via fiscal stimulus.
You asked:
“If the BOE raised interest rates and returned inflation to its legally-mandated target, what do you think would happen to the UK economy?”
If they tightened monetary policy (not necessarily the same as raising rates) unemployment would surely rise. However inflation might well return to the mandate level without any tightening, as much of the recent rise was oil and VAT, both temporary.
Left Outside, I read that but I don’t follow their argument.
Ken I’ll try to do a post of links in a week or so, when my big NGDP article comes out.
I don’t much care what the Fed buys, it’s what they sell that matters. I’d prefer they buy something fairly safe, like T-bonds or German government bonds. But it wouldn’t upset me if they bought a few Italian bonds–the EMH protects us from foolish behavior.
flow5, You may be right about RGDP responding faster.
Meegs, You said;
“It seems to me that the best the current FED can achieve is a 2% memory-less inflation target.”
That’s about the worst they can achieve. Price level targeting (with memory) would be better. So would NGDP, which better fits their dual mandate. Inflation targeting violates the dual mandate.
TylerG, Actually that’s a pretty good analogy, and as you may know the punting strategy is often the wrong one (according to statistics.)
14. September 2011 at 17:08
Two things:
1. conservative does not equal Republican. I’m conservative and the only Republican running for President right now that I’m considering supporting is Paul, and I have many reservations about him.
2. my aphorism: Two half-measures doesn’t equal a full-measure. In monetary policy, it isn’t even much more than nothing.
14. September 2011 at 17:16
Scott,
“Banks are hoarding trillions of dollars in reserves precisely because with low NGDP it’s the best investment out there (plus the IOR issue).”
Uhm, Scott this where you step out off the cliff into thin air.
this is noise.
What you mean is WITH THE CURRENT HORRID GOVT. POLICY PROPPING UP LABOR AND REAL ESTATE PRICES, the best investment is bonds.
No one is HAPPY investing in bonds they are HIDING from other bad investments.
Other investments are bad because of govt. policy.
15. September 2011 at 09:05
@Morgan Warstler
In blunt terms, poor folk rich enough to be fat with 500 channels on a wall sized tv… don’t rise up ans topple the rich the same way starving dirty desperate people do.
You get that right?
Bread and circuses. I get that.
More seriously. I’m not talking revolution. I’m talking 90%+ marginal tax rates. I’m talking a european-style, socialist welfare state. Make no mistake: I don’t endorse these views; but I can envision them.
15. September 2011 at 09:13
@W. Peden
I’m not pretending to know or be able to predict the future; I was countering Mr. Warstler’s confident prediction of a more liberatian future with a different possible outcome.
Secondly, in the long-run, greater automation will greatly benefit society as a whole. In the interim, it may be very painful for specific affected individuals. Many of the immigrants who built this nation accepted this bargain so that their grandchildren would reap ever-greater rewards. Evidence of the behavior of our current voting populace suggests that they may not be so willing. In the long-run, after all, we are all dead.
15. September 2011 at 15:15
“You may be right about RGDP responding faster”
Given low levels of inflation – it always has. If it didn’t that would violate MVt=PT. The graphs in the rates-of-change in whatever proxies you might use are persuading.
15. September 2011 at 18:47
Blunt instrument, You said;
“More seriously. I’m not talking revolution. I’m talking 90%+ marginal tax rates. I’m talking a european-style, socialist welfare state.”
You can have 90% rates or a Euro-style welfare state–but not both.
flow5, You said;
“If it didn’t that would violate MVt=PT.”
I have no idea what that equation means, but nothing violates MV=PY.
16. September 2011 at 11:16
“I have no idea what that equation means, but nothing violates MV=PY”
The transactions concept of money velocity (Vt) has its roots in Irving Fisher’s equation of exchange (PT = MV), where (1) M equals the volume of means-of-payment money; (2) Vt, the transactions rate of turnover of this money; (3) T, the volume of transactions units; and (4) P, the average price of all transactions units. Unlike MV=PY, the equation is a truism -to sell 100 bushels of wheat (T) at $4 a bushel (P) requires the exchange of $400 (M) once (V), or $200 twice, etc.
Friedman’s equation doesn’t balance…for one, Vi = income velocity & it is a contrived figure.
People don’t just spend their income once. Vt is a function of three factors: (1) the number of transactions; (2) the prices of goods and services; (3) the volume of M, etc.
17. September 2011 at 09:34
flow5, That’s a pretty useless equation. Most transactions are in places like the forex market, transactions for goods and services are so tiny in relative terms that they can be ignored. But goods and services are very important for the business cycle. Which is why MV=PY is much better. It’s a tautology, as V is defined as PY/M.