Krugman on NGDP targeting

Here’s part of a Paul Krugman interview that Britmouse sent me, all quite interesting:

On the fiscal vs monetary policy debate, there’s a lot of pressure on the Bank of England to do more money printing. Do you think the evidence is there to say that if you do X amount you get X amount of return, so that’s what we should do?

The evidence is really thin. The evidence that just expanding the central bank balance sheet or even expanding it into unconventional assets has a big effect on the economy is pretty thin. It’s very iffy, it’s weak, there’s probably something there, but it’s not something you really want to count on – which doesn’t mean don’t do it, but it’s not a guaranteed solution. What you do seem to see is that when major QE programmes are announced there’s a pretty big effect on expectations, especially inflation expectations, which is, after all what, in simple models, the way you get leverage in this kind of situation. You can see when the fed began its QE2 programme, there’s not that much evidence of a significant change in the term structure of interest rates, but inflation expectations had plunged and they bounced back. QE serves a signal that perhaps the central bank won’t be so keen to pull the trigger and start raising rates. It’s not working through its ostensible channel of influence, but through the expectations channel. But again – you take what you can get. I still think the prudent policy would be to rely on fiscal stimulus as the primary tool, but backed up by monetary. And if you can’t get the fiscal stimulus by all means let’s do the QE and cross our fingers.

What about Nominal GDP targeting? Would you support a change in the Bank’s mandate?

I have a possibly minor worry that in the longer run that if you do have an NGDP target, what if you have an acceleration of the rate of potential output growth, that’s automatically lowering your implicit inflation target. Do you really want to do that? So it’s not clear that that’s a good long run framework. The argument that people are using for it now is that it’s a way of creating that credible commitment to future inflation without actually saying so in so many words. I guess my thought would be that if you think that’s going to fool anybody – if you think you can slide that past [hard money/libertarian US Senator] Ron Paul – you’re kidding yourself. I don’t have a strong feeling about NGDP one way or the other – I think the idea that it’s a magic bullet is wrong, but if that helps sell more aggressive monetary policy, sure.

What about simply raising the Bank of England’s policy rate?

I’m all for that. The micro costs of 4% instead of 2% inflation are as far as we can tell trivial. We had 4% inflation during Ronald Reagan’s second term and it did not seem like a big problem. Where did the 2 per cent norm come from? People weren’t aware of the zero lower bound problem [where rates can’t go any lower and the economy still needs stimulus]. And there were a number of studies that were done by the fed and elsewhere in 2001/2002 suggesting that as long as you had a 2% target it was extremely unlikely that you’d find yourself up against the zero lower bound. We just learned about that. It now turns out that 4% makes a lot more sense. It now makes sense as a prospective thing, since it would at least somewhat raise expectations of inflation and then as a deeper cushion against the kind of mess we’re in now in the longer run – I’ve been pushing that line since 1998. But it’s one of those things that we have a situation in which the wild and crazy people are the ones who believe in standard textbook economics and the sensible people are the ones who invent all these reasons why you shouldn’t do what the textbook says you should do.

And should the Bank of England should have an employment mandate like the Federal Reserve?

The idea [took hold] that stable inflation rate means that you’re also going to be at sustainable full employment, which relies on the belief that the long-run Phillips Curve is vertical. We’re now getting very strong evidence that it’s not – that you can have stable inflation with persistently depressed employment. I worry that we may get into a position where central banks say “well inflation is stable, we’ve done our job” when the economy is in fact sitting far, far below capacity .

I agree with his analysis of QE2, the main effect worked through inflation expectations (obviously NGDP expectations in my view) not the term structure of rates.  As far as his “Do you really want that?” comment regarding lower inflation when trend growth rises, the answer is YES!!!!!!  That helps stabilize the economy.  Not sure why he’s concerned.  Krugman definitely focuses on inflation rather than NGDP as the key nominal variable, so perhaps he worries that lower inflation would lead to lower interest rates, making future liquidity traps more likely.  But of course the higher real growth puts upward pressure on rates; indeed I think rates would still be procyclical, even with NGDP targeting.  And of course it’s the low growth periods where you really need the higher inflation, and NGDP targeting does that.

Also notice that the problem he worries about in the final answer would be eliminated by NGDPLT.  They couldn’t be complacent because if the economy was in the toilet but inflation was on track, then NGDP would be below the level target trajectory.  Oddly, I don’t recall Krugman talking about level targeting.  And yet it’s an issue emphasized by other Keynesians like Christy Romer and Michael Woodford.  Does anyone know his views?

I’m an inflation hawk who long favored reducing inflation from 4% to 2%.  I now realize I was wrong.  It’s still true that 2% inflation is better for capital formation in the long run, but the gain is small compared to the cost of this policy fiasco, which could have been avoided with 4% trend inflation.  Of course if we do NGDPLT we can have the best of both worlds; low inflation and macro stability.

PS.  People often defend using inflation rather than NGDP in expectations models by arguing that people care about inflation, but pay no attention to NGDP.  Just the reverse is true.  Suppose you had a crystal ball and told someone about to buy a house; “Just letting you know that my crystal ball says your cost of living is going to start soaring upward at 8% per year.”  The inflation model people claim the average Joe would be thrilled by this news, and be much more likely to rush out and buy that house.  Now suppose you told that guy “My crystal ball says your income will rise at 8% a year over the next 30 years.”  The NGDP people say this guy would be thrilled by this news and would be more likely to buy the house.  Which seems more plausible to you?


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61 Responses to “Krugman on NGDP targeting”

  1. Gravatar of Kevin Donoghue Kevin Donoghue
    7. June 2012 at 05:56

    PK: if you have an acceleration of the rate of potential output growth, that’s automatically lowering your implicit inflation target. Do you really want to do that?

    SS: As far as his “Do you really want that?” comment regarding lower inflation when trend growth rises, the answer is YES!!!!!! That helps stabilize the economy.

    Seriously? If the growth-rate of potential GDP rises, a lower inflation target is stabilizing? Why?

  2. Gravatar of John hall John hall
    7. June 2012 at 06:25

    Krugman’s argument also implies is that if trend growth falls, then it will lead to higher long-run inflation, which is one of my main concerns about NGDP targeting. I think your reply is a good one to Krugman’s point about trend growth rising, but it isn’t so easily applied to trend growth falling.

  3. Gravatar of johnleemk johnleemk
    7. June 2012 at 06:26

    Kevin, I think it’s a natural implication of the AS-AD model. If the AS curve shifts out, output rises and the price level falls. A central bank with an inflation target would respond by printing more money and driving up AD because it sees the inflation rate falling, even though there is no demand crisis necessitating demand stimulus. Letting the inflation rate fall when AS goes up is the stabilising policy.

  4. Gravatar of johnleemk johnleemk
    7. June 2012 at 06:32

    John hall,

    I think the Market Monetarist insight here is that demand management policy should have nothing to do with the supply-side. Demand policy is all about the nominal economy. It doesn’t matter what the rate of growth of real output is; that has little to do with what the rate of growth of nominal spending should be. Demand policy is for addressing crises of demand. If AS shifts out or shifts in, demand policy should not concern itself with the impact, because there’s nothing demand policy can do.

    The problem with inflation targeting is it does not sufficiently distinguish between real and nominal. If a real supply shock takes place and affects inflation, inflation targeting demands a demand policy response, even though demand policy cannot change what the NAIRU is . That is one of the key points of failure with New Keynesianism that Market Monetarism addresses.

  5. Gravatar of Mike Sax Mike Sax
    7. June 2012 at 06:37

    Are we entering the era of not so uneasy money?

    http://diaryofarepublicanhater.blogspot.com/2012/06/are-we-entering-era-of-not-so-uneasy.html

  6. Gravatar of johnleemk johnleemk
    7. June 2012 at 06:44

    Sorry, clarifying this: “It doesn’t matter what the rate of growth of real output is; that has little to do with what the rate of growth of nominal spending should be.”

    What this means is that it doesn’t matter what happens to AS, NGDP should just keep on chugging as before. That is the stabilising policy. Responding to an AS shock with a policy that only moves AD makes no sense. It’s like holding a hammer (demand policy) and only seeing nails. Destabilising AD is not a sensible policy, but that is what inflation targeting would have us do.

  7. Gravatar of ssumner ssumner
    7. June 2012 at 06:50

    Kevin. If you target inflation when growth rates are changing, the NGDP growth will be procyclcial. That means bubbles are more likely to form during periods of high NGDP growth (like the 1990s), and AD will slow during periods of slow growth, making recessions more likely. Indeed under stable inflation you’d be most likely to hit the zero rate bound during periods when growth is slow, just when you need to avoid the zero rate bound!

    John, The argument is symmetrical. It’s logically impossible to have one without the other. If you favor lower inflation during fast growth, then ipso facto you MUST favor higher inflation during slow growth.

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. June 2012 at 06:51

    John Hall,
    You wrote:
    “Krugman’s argument also implies is that if trend growth falls, then it will lead to higher long-run inflation, which is one of my main concerns about NGDP targeting.”

    But as Krugman points out (and Scott appears to agree):

    “The micro costs of 4% instead of 2% inflation are as far as we can tell trivial.”

  9. Gravatar of Morgan Warstler Morgan Warstler
    7. June 2012 at 06:57

    Laet’s take this apart correctly… note I posted on this days ago:

    “I have a possibly minor worry that in the longer run that if you do have an NGDP target, what if you have an acceleration of the rate of potential output growth, that’s automatically lowering your implicit inflation target.”

    Besides the OBVIOUS benefit of pissing on booms….

    Then you will have great political pressure to choose deflationary policies like making public sector productivity gains or deregulating commodity creation / extraction INSTEAD OF RAISING RATES.

    “Do you really want to do that?”

    YES.

    “The argument that people are using for it now is that it’s a way of creating that credible commitment to future inflation without actually saying so in so many words”

    WRONG. And you DeKrugman KNOW IT. The unspoken truth is the very OPPOSITE of why all MM followers think you like Fiscal.

    “I guess my thought would be that if you think that’s going to fool anybody – if you think you can slide that past [hard money/libertarian US Senator] Ron Paul – you’re kidding yourself.”

    NGDPLT sneaks shrinking the govt and King Dollar past your team and Rand Paul and Larry “King Dollar” Kudlow will endorse it.

    —–

    It took Evan Solitas all of what 20 posts to look at what NGDPLT would have done historically.

    Under 4.5% NGDPLT 78% of the time the NGDP futures market would call for TIGHTENING.

    That is the ONLY thing conservatives need to know. Shrinking the govt. is just icing on the cake.

  10. Gravatar of o. nate o. nate
    7. June 2012 at 07:49

    I think it’s harder to have an intuition about what the “right” rate of NGDP growth is, than about what the “right” inflation rate is. It seems like people come up with their NGDP target growth rate by first estimating the “right” rate of RGDP growth and then tacking on their preferred inflation cushion. It seems easier just to target the inflation cushion directly. If 2% has shown itself to be too small, then go to 4%. That may still not be a one-size-fits-all solution, but it seems less likely to go far astray than a one-size-fits-all NGDP growth target. At the very least there should be some kind of mechanism in place for deciding when to revise the target under certain kinds of structural changes.

  11. Gravatar of Mike Sax Mike Sax
    7. June 2012 at 08:05

    “NGDPLT sneaks shrinking the govt and King Dollar past your team and Rand Paul and Larry “King Dollar” Kudlow will endorse it.”

    Morgan you just did a good job of expressing exactly what it is that has always been my reservations about NGDPT

  12. Gravatar of Jfield Jfield
    7. June 2012 at 08:32

    o. nate has a good point, how do you determine when you need to change the target. For example, lets say you’re doing 5% ngdplt and cyclical rgdp growth is 3% so you have average inflation of 2%/year. Now consider what happens if you have a large shift in cyclical rgdp growth: if it falls to 0% then inflation rises to 5%/year – I can live with that (of course govt needs to figure out how to fix the 0% rgdp but in the mean time monetary policy is ok). Now if rgdp goes to 6% then you have deflation at 1%. Given nominal downward rigidities, is this going to be a problem?

  13. Gravatar of Jfield Jfield
    7. June 2012 at 08:37

    Just to clarify my last post:

    I am not thinking of intracyclical potential rgdp growth changes but rather regime changes that lead to changes in average full cycle rgdp growth over multi-decade time frames.

  14. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    7. June 2012 at 08:49

    ‘…if you think you can slide that past [hard money/libertarian US Senator] Ron Paul – you’re kidding yourself.’

    Just how many divisions does [Congressman] Paul have?

  15. Gravatar of johnleemk johnleemk
    7. June 2012 at 08:50

    Jfield, I think deflation is only a problem when on the demand-side. Deflation on the supply-side is a manifestly good thing.

    Deflation on the demand-side is a symptom of weak demand. Deflation on the supply-side is a symptom of strong supply; in some sense (a very loose illustrative sense, because there cannot be a general glut), we are able to produce more things every year than we know what to do with.

    This confusion between demand-side and supply-side changes in the price level is I think why Scott once joked about banning the term “inflation” from this blog. Adopting an inflationary monetary policy when the economy is booming and deflationary monetary policy when the economy is weakening is pro-cyclical and insensible.

    It’s obvious that tightening the money supply when AS is shifting out is going to reduce real economic growth via wage rigidity, and loosening it when AS is shifting in is going to support real economic growth, again via money illusion; the point is to be counter-cyclical, providing nominal stability, such that people’s nominal incomes and spending rise at a stable rate.

  16. Gravatar of Kevin Donoghue Kevin Donoghue
    7. June 2012 at 08:53

    Scott/johnleemk,

    Like the above commenters, I think you’re not seeing Krugman’s point. Suppose potential GDP has been growing at a steady 2% for decades and NGDP grows at 4% giving you 2% inflation, on average. Now a huge number of highly talented immigrants arrive in your country fleeing persecution. Not only are they highly productive but they have a high birth-rate. So now you expect potential GDP to grow at a steady 5% forever. You’re going to want to your NGDP growth-rate to increase. A 7% target would now be quite sensible.

    What this is meant to show is that your NGDP target is derived from your perception of long-run growth-potential and some roughly optimal inflation rate.

  17. Gravatar of Gabe Gabe
    7. June 2012 at 08:53

    Krugman makes it sound like Ron Paul is running the country. What an odd perspective.

  18. Gravatar of GMC GMC
    7. June 2012 at 08:55

    Possibly the most misguided P Krugman ever:

    “I have a possibly minor worry that in the longer run that if you do have an NGDP target, what if you have an acceleration of the rate of potential output growth, that’s automatically lowering your implicit inflation target.”

    Is he really concerned that with an aging population, massive public and private debt overhangs, and an apparent innovation desert stretching into the foreseeable future, that an NGPLT will result in deflation? At 4.5%? And if it did, so what?

    The reason we dislike deflation is that it nominal deflation has retardant effects on real growth. What on earth is he doing complaining that under inflation targeting, there is a terrifying possibility that instead of a combination of real growth and inflation, we’ll get too much real growth and not enough inflation… What, Paul, 4.5% real growth isn’t good enough for you?

  19. Gravatar of Greg Ransom Greg Ransom
    7. June 2012 at 09:02

    Exactly.

    “As far as his “Do you really want that?” comment regarding lower inflation when trend growth rises, the answer is YES!!!!!!  That helps stabilize the economy.  Not sure why he’s concerned.”

    Because he doesn’t understand the economics?

    No need for the ‘?’ actually.

  20. Gravatar of GMC GMC
    7. June 2012 at 09:18

    This discussion gives us an interesting way to compare inflation targeting and NGDPLT. Johnleemk said: “What this means is that it doesn’t matter what happens to AS, NGDP should just keep on chugging as before. That is the stabilising policy.”

    What he is saying, and what Paul missed in the quoted portion above, is that inflation targeting is NGDPLT at one level of abstraction. Inflation targeting is intended to provide a stable basis for real growth by preventing deflation and excess inflation. But instead of using the actually relevant variable (NGDP), the inflation targeting regime picks one part of it and tries to hold that constant on the assumption that it will result in the other staying constant.

    The problems are (partial list):

    (1) Targeting inflation at a low number reduces inflation expectations and results in low policy interest rates (because all interest rates will be low because of the reduced inflation component); the Central Bank has less conventional policy “room to operate” to increase liquidity relative to the baseline case;
    (1a) Likewise, deflation is never that far away;
    (2) By targeting the rate, rather than the level, the policy has an inherent path dependency; it is unable to permit catch-up growth.
    (3) It does not correct for external shocks;
    (4) It targets a variable (Price) that is subject to exogenous shocks having nothing to do with monetary conditions;
    (5) It targets a trailing indicator, since price itself is set in response to market conditions;
    (5a) There is no good data on price available within the time needed for Central Bank action;
    (6) In the United States, it ignores the dual mandate.

    Note that these are the problems with an honest, competent, and accurate inflation targeting regime. The problems that would exist if 2% inflation was actually attempted, a la Lars Svensson’s presentations.

  21. Gravatar of Justin Justin
    7. June 2012 at 09:30

    –“Like the above commenters, I think you’re not seeing Krugman’s point. Suppose potential GDP has been growing at a steady 2% for decades and NGDP grows at 4% giving you 2% inflation, on average. Now a huge number of highly talented immigrants arrive in your country fleeing persecution. Not only are they highly productive but they have a high birth-rate. So now you expect potential GDP to grow at a steady 5% forever. You’re going to want to your NGDP growth-rate to increase. A 7% target would now be quite sensible.”–

    The NGDP growth target isn’t set in stone – in the (quite unlikely) scenario that the long run RGDP trend jumps to 5% and RGDP of 3% manages to create recessionary conditions in the job market because inflation is too low, the target can be lifted to 6% or 7%. Most likely though, 5% level targeting should be sufficient to avoid any serious demand problems going forward. If businesses in aggregate expect sales to grow 5% every year, then it’s hard to see why demand would ever be a problem, regardless of the real GDP growth trend.

    Hopefully a future President Romney nominates Scott for Fed chair and we can all find out how well 5% works!

  22. Gravatar of Saturos Saturos
    7. June 2012 at 09:30

    “Oddly, I don’t recall Krugman talking about level targeting.”

    Scott, I think this is actually your fault. You always go on about NGDP, and any casual reader is going to think that that’s the main thrust of your advocacy, switching to NGDP as the target variable (as in ReTargeting the Fed). But in fact you’ve admitted occasionally that level-targeting is even more important to you than NGDP targeting. The gap in effectiveness between price-level targeting and inflation targeting is far greater than the gap between price-level targeting and NGDP level targeting. (And also the gap between inflation targeting and whatever the hell it is we’ve been doing since ’08). Consequently a random reporter who gets inspired by your blog to ask Krugman a couple pointed questions is going to use up his time pressing him on the desirability of NGDP as a variable, missing the larger points on level path targeting and establishing greater credibility to restore AD to the desired level, getting the Fed to coherently decide what level of AD it wants and announce that it intends to get there, the rest be damned. Indeed I would have liked to have seen him asked about the O’Brien article – what in NK thinking prevents him from accepting the point of view laid out therein? And does he accept the Sumner critique? Does he acknowledge that the level of AD in America is always set by where markets guess the Fed implicitly wants it to be?

    But I have some sympathy for his final point. He says he is beginning to doubt that the long-run Phillips curve is vertical – which of course is the same as doubting that the LRAS is vertical. This lines up with my objections about how long it’s taking AS to shift rightwards back onto the long-run equilibrium. You agree that stable inflation with high unemployment is perfectly predictable given that spending follows a level path far beneath the level path of aggregate supply set by rigid nominal contracts. But Krugman sees this as contradicting the natural rate hypothesis. Indeed so long as the central bank doesn’t allow repeated negative shocks the economy should return to its natural rate on its own. Do you think he’s just doubting the usefulness of the natural rate hypothesis, going back to the “in the long run we’re all dead” view – or does he think that allowing demand to slip is permanently ruinous?

  23. Gravatar of Saturos Saturos
    7. June 2012 at 09:32

    Justin, Scott wants 4.5% these days, as he thinks trend growth has slowed.

  24. Gravatar of Major_Freedom Major_Freedom
    7. June 2012 at 09:32

    “The argument that people are using for it now is that it’s a way of creating that credible commitment to future inflation without actually saying so in so many words. I guess my thought would be that if you think that’s going to fool anybody – if you think you can slide that past [hard money/libertarian US Senator] Ron Paul – you’re kidding yourself.”

    You see that folks? Krugman respects his intellectual superiors.

  25. Gravatar of Saturos Saturos
    7. June 2012 at 09:34

    johnleemk, AS only slopes up in the short run. If trend growth rises we could raise the NGDP growth rate without unsustainable booms.

  26. Gravatar of Saturos Saturos
    7. June 2012 at 09:35

    MF, don’t let Paul catch you saying that.

  27. Gravatar of Major_Freedom Major_Freedom
    7. June 2012 at 09:47

    ssumner:

    As far as his “Do you really want that?” comment regarding lower inflation when trend growth rises, the answer is YES!!!!!! That helps stabilize the economy. Not sure why he’s concerned. Krugman definitely focuses on inflation rather than NGDP as the key nominal variable, so perhaps he worries that lower inflation would lead to lower interest rates, making future liquidity traps more likely. But of course the higher real growth puts upward pressure on rates; indeed I think rates would still be procyclical, even with NGDP targeting. And of course it’s the low growth periods where you really need the higher inflation, and NGDP targeting does that.

    This is a classic example of a Sumner argument where I agree, then disagree.

    Yes, lower prices result when productivity goes up, all else equal. In a free market with sound money, prices would gradually fall, as they did in the latter half of the 20th century. This is healthy deflation. Money gains in value, and money prices fall.

    But you’re wrong to claim that increases in productivity put upward pressure on interest rates. Interest rates are independent of productivity. Interest rates are a function of money flows, not how many widgets are churned out. Interest rates are determined by the difference between demand for factors of production, and the demand for output of production, i.e. profits. If this demand difference expands, profits rise, and thus interest rates tend to rise, and when this demand difference contracts, profits fall, and thus interest rates tend to fall.

    What you’re invoking is the productivity theory of interest, which isn’t correct.

    If a business earns 20% profit on its total costs, then it won’t borrow at higher than 20%, or else it will lose money, and it won’t lend money for anything less than 20%, because it can make a higher return investing the money in its own business. This is the case regardless if the business churns out N goods, or 2N goods.

    An upward pressure on interest rates occurs when the difference between the demand for input factors of production, and output of production, widens. This can occur with inflation of the money supply (since it immediately adds to aggregate demand and hence demand for output of production, but it affects costs only with a time lag), and it can occur when the rate of saving falls (since less investment spending relative to aggregate spending will eventually make costs fall relative to revenues).

  28. Gravatar of Major_Freedom Major_Freedom
    7. June 2012 at 09:48

    Saturos:

    MF, don’t let Paul catch you saying that.

    Which Paul, and why not?

    It’s too late now anyway.

  29. Gravatar of Major_Freedom Major_Freedom
    7. June 2012 at 09:49

    Oops…

    “as they did in the latter half of the 19th century.”

  30. Gravatar of Negation of Ideology Negation of Ideology
    7. June 2012 at 10:14

    To be fair, Krugman did describe it as a “possibly minor worry.” I agree that if real growth exceeded 5% for an extended period because of productivity growth and you had deflation it wouldn’t be a bad thing. But what if it was because of population growth? In any case, Scott has said in the past that NGDP per person would be the better target.

    The key is that people can understand what income per person they can expect to occur so they can plan accordingly. It doesn’t have to be fixed for all time, you could have a commitment for levels for the next 3 years or so and then every year set(and publish) the 3 year out target based on whether the a rolling GDP deflator average. (This is similar to an idea Scott floated to use the average real GDP growth over 20 years.) It depends on whether people prefer to take long term productivity gains as higher nominal incomes or lower nominal prices. It’s more of a psychological thing than an economic thing.

    As for Krugman acting as if Ron Paul runs the country, that’s the partisan Krugman. He wants to associate the Republican party with Ron Paul so he can portray the whole party as being nuts.

  31. Gravatar of ssumner ssumner
    7. June 2012 at 10:38

    Mark, I would put it differently. What are widely regarded as the welfare costs of inflation, are actually the welfare costs of excessively high NGDP growth.

    Morgan, Yup, Evan Soltas is on a roll, and you still aren’t spelling his name correctly.

    o. nate, You said;

    “I think it’s harder to have an intuition about what the “right” rate of NGDP growth is, than about what the “right” inflation rate is. It seems like people come up with their NGDP target growth rate by first estimating the “right” rate of RGDP growth and then tacking on their preferred inflation cushion. It seems easier just to target the inflation cushion directly.”

    This is the wrong way to think about the issue. Inflation simply doesn’t matter, the government shouldn’t even bother measuring inflation. See my answer to Mark.

    JField, You said;

    “Now if rgdp goes to 6% then you have deflation at 1%. Given nominal downward rigidities, is this going to be a problem?”

    Not at all, because inflation simply doesn’t matter, NGDP grwoth is what matters (see my previous answers.)

    Kevin, You said;

    “What this is meant to show is that your NGDP target is derived from your perception of long-run growth-potential and some roughly optimal inflation rate.”

    No, inflation simply doesn’t matter in macroeconomics, NGDP growth is what matters. As long as NGDP growth is stable, inflation doesn’t matter. I’ll grant you one point–it might be better to target NGDP per capita, but I don’t even want the government to measure inflation, it just causes confusion. In addition, real world measures of inflation are nearly worthless. The BLS says housing prices have risen 8% in 5 years, whereas they’ve actually fallen 35%.

    GMC, Exactly! Others should read your comment.

    Saturos, You said;

    “But I have some sympathy for his final point. He says he is beginning to doubt that the long-run Phillips curve is vertical – which of course is the same as doubting that the LRAS is vertical. This lines up with my objections about how long it’s taking AS to shift rightwards back onto the long-run equilibrium.”

    This is partly because textbook models assume that supply and demand shocks are independent. I argue they are “entangled” and hence lower AD causes government policies (UI, minimum wage) that reduce AS. That’s one reason for the slow adjustment. The other is that we didn’t just have a negative shock in 2008-09, like most recessions, we had a series of negative demand shocks, one after the other.

    No, I don’t want 4.5% NGDP growth because trend has slowed, that was Romer’s argument. I don’t think the NGDP line should ever be adjusted, except perhaps for changes in population growth.

    Negation, Good comment.

  32. Gravatar of Saturos Saturos
    7. June 2012 at 10:55

    Scott, so you aren’t still arguing for going 1/3 way back up to June ’08 NGDP and then 4.5% growth path thereafter?

  33. Gravatar of Morgan Warstler Morgan Warstler
    7. June 2012 at 11:06

    Evan Soltas, got it

  34. Gravatar of Kevin Donoghue Kevin Donoghue
    7. June 2012 at 11:16

    Scott: “inflation simply doesn’t matter in macroeconomics, NGDP growth is what matters.”

    Since NGDP = RGDP x GDP deflator I take it you’re saying real growth is what matters. Leaving aside quibbles about the difference between RGDP and welfare (all of which you know better than I do), I’d say that you, Krugman and I are all on the same page. The argument is about how to get steady RGDP growth. From that point of view inflation certainly can matter. A policy which requires inflation to go negative (for example) is unlikely to deliver good results.

    I’ll leave it at that because I think we’re drifting away from the point Krugman was making. My reading is that he doesn’t much care what the Fed targets: “End This Depression Now!” That’s all he asks.

  35. Gravatar of Saturos Saturos
    7. June 2012 at 11:35

    Kevin, not quite: https://www.themoneyillusion.com/?p=2018

  36. Gravatar of Justin Justin
    7. June 2012 at 12:00

    Saturos, good color. Haven’t made to The Money Illusion as often as I would have liked the past few months!

    Not sure 50bps in either direction would make much of a difference. 4.5% or 5.0% should both be fine if the overall concept is sound.

  37. Gravatar of Nick Rowe Nick Rowe
    7. June 2012 at 12:28

    Scott: “But of course the higher real growth puts upward pressure on rates; indeed I think rates would still be procyclical, even with NGDP targeting. And of course it’s the low growth periods where you really need the higher inflation, and NGDP targeting does that.”

    You have made that same point before, IIRC, but it’s an important point that needs repeating. If people like Paul Krugman are (not altogether unreasonably) scared of hitting the ZLB, then targeting NGD provides the higher implicit inflation target exactly at those times when it’s most likely to be needed — times of low potential RGDP growth when the natural rate of interest is also likely to be low.

    The level-path aspect of the target (whether price level of NGDP) provides additional insurance against hitting the ZLB.

  38. Gravatar of o. nate o. nate
    7. June 2012 at 13:09

    I think inflation does matter – at least in terms of allowing financial markets to clear. If one thinks of the “right” real interest rate as being the one that matches borrowers and lenders, then the problem with a low inflation target is that the nominal interest rate can’t fall below zero (and it only gets close to zero for AAA-borrowers, for most of us it’s still considerably north of zero), so at times when there is an AD shortfall, the real interest rate can’t get low enough to allow markets to clear, so you have banks sitting on huge mounds of cash instead of lending it out (and leading to shenanigans like JPMorgan’s derivatives gamble). That’s why you need a higher inflation target. I don’t see how an NGDP target solves this problem, except indirectly through the inflation channel, unless you’re saying that NGDP targeting would prevent the AD shortfall in the first place.

  39. Gravatar of o. nate o. nate
    7. June 2012 at 13:34

    Reading the post that Saturos linked to above, I guess one response might be that the “real” interest rate that matters is the one deflated by wage inflation rather than by price inflation, and NGDP is a proxy for wage inflation. I suppose that might be not a terrible assumption, esp. if one looks at NGDP per capita, but at that point, it seems to me the question becomes increasingly technical, a matter of the best tool for measurement, rather than a disagreement in principle. There are lots of difficulties in measuring inflation, but aren’t there just as many difficulties in measuring NGDP, especially if it’s required to be a proxy for wage inflation? What about the shadow economy for instance, or the effect of asset bubbles on these statistics?

  40. Gravatar of RebelEconomist RebelEconomist
    7. June 2012 at 14:36

    Scott, Krugman has similar concerns about NGDP targeting to me – in particular the problem of the need to implicitly assume a long-term trend growth rate of potential output (as well as an acceptable average level of inflation) in the NGDP target. Bearing in mind our discussion of a few days ago, in which you agreed that (apart from the possibility of hysteresis effects) monetary policy had no long run effect on real variables, but that short run costs from output variability are important, wouldn’t a more appropriate target than NGDP be some combination of inflation plus the RATE OF CHANGE of (forecast if you like) output (employment if you like). That way, if the assumed trend growth rate turns out to be, for example, unrealistically high, and real GDP (employment) hits a ceiling lower than hoped, the central bank is not holding inflation at an undesirably high rate.

  41. Gravatar of dwb dwb
    7. June 2012 at 14:40

    I think Krugman’s concern about ngdp targeting is that it demolishes his worldview that we are in a liquidity trap.

  42. Gravatar of Mike Sax Mike Sax
    7. June 2012 at 15:04

    Evan Soltas looked at a 5% NGDP target not 4.5.

    dwb I don’t think Krugman has some nefarious attachment to the idea of a liquidity trap, I think he worries that in the long run an NGDP target would give us inflation that is too low.

    And Evan Soltas seems to give some credence to that owrry by his ideea that since 1948 72% of the time NGDP targeting would have called for tighter policy.

  43. Gravatar of GMC GMC
    7. June 2012 at 15:26

    Scott: This may be just slightly off topic, but it was my earlier thinking in this thread that prompted it. I said that inflation targeting was vulnerable to external shocks. My question is: to what extent is this also true of NGDPLT?

    Let’s take the classic case of a rise in the market price of oil. Under inflation targeting, exogenous price shocks affect real output because the central bank is unable to correct for them; indeed, will take action to avoid permitting the market to correct for them. Real output falls, not because oil is more expensive, but because the central bank reduces demand; we buy less of other things.

    Under NGDPLT, (I think), the central bank would do nothing. An exogenous price shock to one input would not affect NDGP, but only the composition of NGDP. There would be a slowing in the real growth rate of output, because the oil price increase would “eat” some NGDP otherwise devoted to expansion.

    Is this right?

    And if it is, is this the result we want?

  44. Gravatar of Justin Justin
    7. June 2012 at 16:17

    I’m not sure why you would need to pick the ‘right’ NGDP level target (as opposed to avoiding the ‘wrong’ target, such +17% or -9%).

    Suppose the NGDPLT is 5% and then RGDP trend jumps to 5%. In that world, there is no inflation trend, so expectations for annual pay increases just to keep up with the cost of living go away. If RGDP winds up at zero for a year, that generates a sudden 5% inflation in a world with no COLA increases, reducing real wages by close to 5% and reducing real debt burdens made for a world that generally didn’t experience inflation. If there was a slump like 2007-2009, it would generate around 10% inflation for a year.

    I think a better question would be why did real production slump despite a constant increase in AD? The answer would be a supply shock and there isn’t anything monetary policy can do to fix that. If the supply of oil to the US suddenly falls 20%, for example, that really does limit our ability to create wealth.

  45. Gravatar of dwb dwb
    7. June 2012 at 16:46

    I don’t think Krugman has some nefarious attachment to the idea of a liquidity trap, I think he worries that in the long run an NGDP target would give us inflation that is too low.

    And Evan Soltas seems to give some credence to that owrry by his ideea that since 1948 72% of the time NGDP targeting would have called for tighter policy.

    72% is a little misleading. if we had been ngdp targeting in the 70s, inflation would have definitely been lower- and appropriately so. real gdp growth has been about 3.3% since 1948 so 4.5% leaves room for about 1.2% inflation. I am fine with that.

    right now, i think mainly Krugman has a nefarious attachment to his book and the election. I cant understand what “liquidity trap” means if we have 4+% nominal growth while the govt is cutting back. maybe he believes in some magic x-factor that’s running the economy right now. i like his, blog, he’s obviously smarter than me, i just dont get his argument sometimes.

  46. Gravatar of Morgan Warstler Morgan Warstler
    7. June 2012 at 17:42

    Sax, I asked him to run it at 4.5% – it was 78%.

    —-

    The point is that the highs and lows can be neutralized, and doing so is a good thing.

    And yes the number has to be low enough, to make us SEEK productivity gains and deregulation just to keep rates low.

    Or we aren’t doing it.

  47. Gravatar of RebelEconomist RebelEconomist
    8. June 2012 at 01:14

    For those who are discussing what growth rate an NGDP target should be based on, I would urge them to err on the low side. There is a danger that NGDP targeting gets adopted now because it offers politicians and populist economists an intellectually respectable way of immediately promoting higher inflation. Even if you disagree with my objection to an inflationary solution to present economic problems, you should not ignore the cost of being seen to introduce a new monetary policy regime out of desperation to ease. In the case of NGDP targeting, the outcome would probably be that inflation would account for more of the composition of NGDP in the early years of the regime. Learn from Britain’s experience of ERM entry: http://reservedplace.blogspot.co.uk/2011/11/easing-in.html

  48. Gravatar of Saturos Saturos
    8. June 2012 at 01:16

    Scott, regarding aggregate supply, what do you think about Evan Soltas’ contribution to business-cycle theory here: http://esoltas.blogspot.com.au/2012/03/potential-insights.html

  49. Gravatar of ssumner ssumner
    8. June 2012 at 06:29

    Saturos, Yes.

    Kevin, You said;

    “Since NGDP = RGDP x GDP deflator I take it you’re saying real growth is what matters.”

    No, if inflation is a figment of the imagination of Washington bureaucrats, then ipso facto RGDP is equally an illusion. Hence the big (and fruitless) debate about whether US RGDP/person has been increasing over recent decades.

    Thanks Nick,

    O. nate, You are mistaken in assuming that low inflation means low nominal interest rates. Nominal interest rates are more strongly influenced by NGDP growth. As long as NGDP growth is high, rates won’t fall to zero no matter how low the inflation rate.

    You said;

    “but aren’t there just as many difficulties in measuring NGDP”

    Not at all, no judgments are required about quality changes with NGDP.

    rebeleconomist, You said;

    “Scott, Krugman has similar concerns about NGDP targeting to me – in particular the problem of the need to implicitly assume a long-term trend growth rate of potential output (as well as an acceptable average level of inflation) in the NGDP target.”

    No! No such trend growth rate estimate is required, even implicitly. Inflation simply doesn’t matter at all. The government shouldn’t even be measuring inflation. It’s a useless variable. It’s not even clear what it is supposed to mean. The term has never been defined by economists.

    GMC, If you assume an adverse supply shock then you want to see some slowdown in growth, and some rise in inflation. That’s optimal. You want steady wage inflation.

    Keep in mind that imported oil is not a part of GDP. So inflation in oil imports doesn’t boost US inflation in terms of the deflator. However we also produce lots of oil domestically, so there is an effect that way.

    Justin, I agree.

    Saturos, I’m not sure why he thinks a positive supply shock would reduce output–or did I misread the post?

  50. Gravatar of Saturos Saturos
    8. June 2012 at 06:39

    Scott,

    Arrrgh! You sound like my college math prof (“Should I take this unit or not?” “Yes.”) What level path are you advocating these days, then?

    I think Evan was talking about an increase in productivity during recession throwing more workers out of work (since total production is fixed by demand) who then atrophy human capital and then hysteresis reduces long run potential output. But he’s also flirting with palaeo-Keynesianism – the notion that aggregate supply never returns to equilibrium, only demand can stabilize the economy.

  51. Gravatar of RebelEconomist RebelEconomist
    8. June 2012 at 06:48

    Scott, you are impossible! You may not think inflation matters and that it cannot be defined, but the vast majority of people think that it does matter and that the concept can be at least narrowed down to something like the increase in the transaction-weighted average price level. Now, if you can accept that monetary policy ought to at least take account of what concerns most people, what do you think of my suggestion for a monetary policy objective that addresses Krugman’s point?

  52. Gravatar of Major_Freedom Major_Freedom
    8. June 2012 at 06:59

    ssumner:

    rebeleconomist, You said;

    “Scott, Krugman has similar concerns about NGDP targeting to me – in particular the problem of the need to implicitly assume a long-term trend growth rate of potential output (as well as an acceptable average level of inflation) in the NGDP target.”

    No! No such trend growth rate estimate is required, even implicitly. Inflation simply doesn’t matter at all. The government shouldn’t even be measuring inflation. It’s a useless variable. It’s not even clear what it is supposed to mean. The term has never been defined by economists.

    You defined it: NGDP = RGDP + inflation, which means you define inflation = NGDP – RGDP.

    The reason why you have pulled 5% NGDP out of where the sun don’t shine, is because you think of 3% real growth and 2% price inflation.

    If not, why 5% rather than 15%? Because price inflation would be NGDP – RGDP = 15% – 3% = 12%, which is “too high”, of course.

    NGDP targeting implicitly requires an estimate of inflation in order to come up with a non-inflation statistic of 5% NGDPLT.

    Why are you misleading RebelEconomist like that? Bad form.

  53. Gravatar of TallDave TallDave
    8. June 2012 at 07:34

    –As far as his “Do you really want that?” comment regarding lower inflation when trend growth rises, the answer is YES!!!!!! That helps stabilize the economy. Not sure why he’s concerned. —

    Because in his AD-centric world, the only thing that matters is whether AD is increasing. Unsustainable? Not important. Debt bubble? Doesn’t matter. Misallocation? No such thing.

  54. Gravatar of TallDave TallDave
    8. June 2012 at 07:40

    — Hence the big (and fruitless) debate about whether US RGDP/person has been increasing over recent decades. —

    I tend to agree with this pretty strongly. There was actually a fascinating Harvard paper on this I should dig up and link, in which they looked at this question and sort of threw up their hands because observed living standards don’t seem to match what RGDP is saying happened. This is another situation where Austrian skepticism of econometric precision seems warranted.

  55. Gravatar of GMC GMC
    8. June 2012 at 07:42

    “If you assume an adverse supply shock then you want to see some slowdown in growth, and some rise in inflation. That’s optimal. You want steady wage inflation.”

    Makes sense. Thanks, Scott.

  56. Gravatar of Saturos Saturos
    8. June 2012 at 07:47

    Funny how the whole of optimal macro is geared around making sure that there is as little disruption as possible to the precious conceits of workers (their money illusion).

  57. Gravatar of GMC GMC
    8. June 2012 at 07:47

    @Talldave:

    “Because in his AD-centric world, the only thing that matters is whether AD is increasing. Unsustainable? Not important. Debt bubble? Doesn’t matter. Misallocation? No such thing.”

    This is a bit unfair. The point is not that Scott’s world is AD-centric, but that Monetary Policy (the topic of this conversation) is AD-centric. So more accurately:

    Unsustainable? Then it won’t be sustained.
    Debt bubble? Not my problem, I’ll just keep NGDP moving and do the best I can to prevent it harming the broader economy.
    Misallocation? Not my problem, in the long run it will be fixed.

    The central bank isn’t responsible for allocating resources, or pricking bubbles. It’s responsible for keeping the nominal economy growing at a rate which prevents monetary policy from making these problems worse.

  58. Gravatar of TallDave TallDave
    8. June 2012 at 07:52

    GMC,

    Sorry, should have been more clear, I was answering Scott’s question re Krugman. I think that explains why Krugman favors massive fiscal deficits and maybe a little monetary stimulus while Scott has argued for surpluses + lots of monetary stimulus.

    Also have to agree with Scott your comment above was excellent — and same answer to your question, 4.5% real growth is NOT good enough for Krugman, virtually anything that reduces AD is bad in his world.

  59. Gravatar of ssumner ssumner
    10. June 2012 at 05:58

    Saturos, You might be right about Evan, but I don’t see that as being much of a problem in the real world.

    Rebeleconomist, You said;

    “Now, if you can accept that monetary policy ought to at least take account of what concerns most people,”

    Most people don’t have a clue as to what inflation is, and the BLS certainly doesn’t compute it the way you suggest. Every year I ask my students “If all prices rose 10% and all incomes rose 10% would the cost of living have actually increased.” And each year roughly 100% get the question wrong. They think the cost of living would not have changed in that case, whereas it would obviously rise by 10%. The problem is that most people implicitly hold income constant when thinking about inflation, WHICH IS WHY THEY DON’T LIKE INFLATION. They think it hurts consumers. But inflation doesn’t hurt consumers. That’s why it’s a very misleading concept. The extra money you pay shows up equally as extra income for those receiving the payment.

    And it also can’t be measured. The government does not look at the change in transactions prices, if they did the estimated rate of inflation would be far higher.

    My goal in the blog is not to reinforce stupid prejudices about inflation, but to get people to think in terms of NGDP growth, not inflation. NGDP growth is what matters.

    Regarding Krugman’s idea, changes in long run trend growth are so small, and so difficult to measure, that I see no advantage to the proposal. On the other hand I’ve suggested it myself as a possible compromise in an earlier post, if we really must pander to the prejudices of the ill-informed.

    MF, You are so much fun!

    “You defined it: NGDP = RGDP + inflation, which means you define inflation = NGDP – RGDP.”

    Where do I start. The equation is false. And if you used rates of change consistently to make it true, it would merely be a definition. But if inflation is ill-defined, the RGDP is equally ill-defined!

    TallDave, You said;

    “Because in his AD-centric world, the only thing that matters is whether AD is increasing. Unsustainable? Not important. Debt bubble? Doesn’t matter. Misallocation? No such thing.”

    That can’t be the reason, because with a stable NGDP growth path there are (by definition) no demand shocks.

    Saturos, In fairness, prices are also sticky.

  60. Gravatar of Major_Freedom Major_Freedom
    11. June 2012 at 11:53

    ssumner:

    MF, You are so much fun!

    I know!

    “You defined it: NGDP = RGDP + inflation, which means you define inflation = NGDP – RGDP.”

    Where do I start. The equation is false.

    The equation is false? Then why did you you use it? You say I am so much fun? Here I am looking at someone who defines a concept using an equation, and they say the equation is false!

    And if you used rates of change consistently to make it true, it would merely be a definition. But if inflation is ill-defined, the RGDP is equally ill-defined!

    So when you say things like this, and this, and this?

    In all three articles, which were recent to the last few months, you are speaking of RGDP as if it were defined, and you were talking about inflation as if it were defined.

    Really, I am flabbergasted at how anyone can seriously consider themselves to be consistent thinkers. You’re all over the place.

  61. Gravatar of Mike Sax Mike Sax
    11. June 2012 at 12:02

    Morgan:

    “the number has to be low enough, to make us SEEK productivity gains and deregulation just to keep rates low.”

    “Or we aren’t doing it.”

    Ok Morgan then lets not make the number so low and let’s not do it. That’s my proposal.

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