Level Target Now!
For 6 years market monetarists (and occasionally Keynesians like Paul Krugman) have been warning that ECB policy was much too tight. During most of that period the ECB was not at the zero bound, and indeed it occasionally raised interest rates. Now the eurozone has slipped into a Japanese style deflation (i.e. mild deflation, accompanied by near-zero medium term bond yields.) Those German savers who hoped the ECB’s 2011 rate increase would help them out are in for a bitter disappointment. Here’s Paul Krugman:
How is this supposed to end? I like and admire Mario Draghi, and believe that he’s doing his best. But it’s really hard to see how the ECB could gain enough traction here to solve the problem even if it didn’t face internal dissent from the hard-money types.
Krugman supports QE but is pessimistic about its effects. I think that’s right. Rumors of eurozone QE have already depressed the euro, but that modest depreciation is nowhere near enough to get the job done. QE would work if done “a outrance” (a term used by Keynes in 1930, when he recommended massive QE), but obviously the actual ECB program will fall far short of what’s needed.
It’s clear the ECB (and BOJ) need to switch from IT to price level targeting. The ECB should set a price level target rising along a 1.9% trend line, to avoid any loss of “credibility.” This is what moderate Ben Bernanke recommended for Japan under similar circumstances, this is what New Keynesians like Michael Woodford recommends, and market monetarists also like level targeting. The policy has always been superior to IT, but now in 2015 the advantages of PLT over IT in Europe are so massive that it’s hard to see how anyone could oppose the shift. (Of course NGDPLT would be better still, but would involve a loss of credibility, making it less politically feasible.)
And yet I predict the pundit class will entirely ignore this option, and go on wringing their hands that QE is just not enough, so it’s not the ECB’s fault.
The dark age of macroeconomics continues.
Update: I have a related post over at Econlog, also a new post on currency and the underground economy.
Update #2: Britonomist asks a good question:
Does the ECB have the political capital to make a switch like that? Wouldn’t it require approval from the European council first?
The ECB’s mandate is for price stability, but leaves it up to the ECB to provide a more precise definition. Obviously, price level targeting is more likely to guarantee price stability that inflation targeting. So yes, a 1.8% or 1.9%/year increasing price level target is well within their mandate, more so than inflation targeting.
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7. January 2015 at 11:16
IF the ECB just hit there inflation target — something greater than 0 — they would be doing a better job than they are currently doing.
7. January 2015 at 11:31
Does the ECB have the political to make a switch like that? Wouldn’t it require approval from the European council first?
7. January 2015 at 11:32
Political capital*
7. January 2015 at 12:21
Britonomist, I added an update.
7. January 2015 at 12:21
Egads. Tight money just does not work, as a pragmatic, practical matter. 0% inflation is an economy-wrecking honey-trap for entranced central bankers.
We need central bankers who say, “When the economy is burning white-hot and they are crying about pandemic labor shortages, then we will know in a few years it will be time to tighten up.”
I may be understating the case.
7. January 2015 at 12:22
Test. Tight money just does not work, as a pragmatic, practical matter. 0% inflation is an economy-wrecking honey-trap for entranced central bankers.
We need central bankers who say, “When the economy is burning white-hot and they are crying about pandemic labor shortages, then we will know in a few years it will be time to tighten up.”
I may be understating the case.
7. January 2015 at 12:48
Unrelated question, here, but I’m missing a vital piece of the economic puzzle.
If the interest rates aren’t a good way of judging monetary policy, how is it the Fed is so able to manipulate the interest rate when it wants to? Considering they’re operating on a basis of manipulating the money supply in order to do that?
7. January 2015 at 13:49
if they can’t hit their inflation target why should they be able to hit any other target?
7. January 2015 at 14:11
Some observations about price level targeting:
1. In October 2007, the ECB published a working paper “Is Time Ripe for Price Level Path Stability?”
2. May 2009 ECB Monthly Bulletin had an interesting discussion of price level targeting and history-dependent monetary policy in Box 2 – see pages 83-86 in http://www.ecb.europa.eu/pub/pdf/mobu/mb200905en.pdf
3. ECB officials frequently refer to average inflation since the inception of the euro. For example, two months ago the vice-president of the ECB said “The average inflation rate in the euro area over the 15 years from 1999 to date is 1.96% – a level fully consistent with the ECB’s definition of price stability. We are proud of our track record…”. Such communication is a signal that the policy of the ECB has a degree of history-dependence. In addition, the definition of ECB’s monetary pillar contains elements of history dependence too.
4. Until recently, Eurozone price level was above an implicit PLT. For this reason, in 2013 the ECB could not have included a reference to PLT when formulating the forward guidance.
5. Elements of history-dependence in ECB’s policy framework contributed to the decision to raise the interest rates in 2011.
6. Six months ago the vice-president of the ECB said: “By far the most visible innovation since the beginning of the Great Recession however, has been the increase in the array of instruments used for monetary policy purposes, particularly forward guidance about interest rates and most notably the use of central banks’ balance sheets through Large Scale Assets Purchases (LSAP, i.e. Quantitative Easing or QE).
In theoretical debates, other proposals were made namely, to change the targets of monetary policy to price level targeting or to nominal GDP or simply, to increase the established objective of 2% in inflation targeting regimes to 3% or 4%. For practical reasons, these proposals were not retained and forward guidance and QE were the new instruments of choice for many central banks.”
7. January 2015 at 14:19
Dear Commenters,
This year’s FOMC membership is more dovish than the membership described below, correct?
http://www.usatoday.com/story/money/business/2015/01/07/federal-reserve-minutes-december-meeting/21390449
“Fed officials sparred over interest rate guidance”
7. January 2015 at 15:18
It maybe hard to convince many that level targeting increases stability because you’d have to argue using second order expectations effect son overall economic stability (unless I’m missing something?), otherwise people will just interpret it as a large downturn in prices being accompanied by a larger upswing, which is more volatile.
7. January 2015 at 15:27
Ashton, You said:
“If the interest rates aren’t a good way of judging monetary policy, how is it the Fed is so able to manipulate the interest rate when it wants to?”
This is exactly why people have the wrong impression about interest rates, they can manipulate them in the short run. But rates also change for other reasons. For instance, between July 2007 and May 2008 market interest rates fell sharply, without the Fed doing anything. Rather rates fell because the demand for money declined as the economy weakened. People wrongly thought the Fed had injected more money into the economy.
Yes, an injection of new money usually does reduce short term rates, but most interest rate changes reflect other forces.
Vaidas, You said:
“In October 2007, the ECB published a working paper “Is Time Ripe for Price Level Path Stability?””
There’s your answer—in 2007 they said they were not engaged in PLT, but were thinking about the wisdom of going that way. They have never officially adopted PLT. If they are doing it secretly then they are extraordinarily incompetent, as no one in the market thinks the ECB is committed to the PL being 19% higher in 10 years. Nobody. Nobody thinks the price level in 1999 plays any role in their decision-making. Nobody.
7. January 2015 at 15:37
Just heard on NPR (Marketplace) now, Rogoff said “Oil prices are stimulus to the Euro economy which is part of the deflation, but the ECB has been struuuuugling to get one percent or ideally two percent inflation.” It really pissed me off, because I was yelling the ECB wasn’t even at the zero-bound.
7. January 2015 at 15:46
Robert Shiller: This Doesn’t Look Like A Bond Bubble
http://www.businessinsider.com/robert-shiller-doesnt-think-bonds-are-in-a-bubble-2015-1
7. January 2015 at 15:51
It should also be 4% inflation level target, not just 2% level target. If we’re talking about inflation and not NGDP targets, a slightly higher inflation target seems pretty close to a free lunch. That’s for a long-term, steady inflation rate of, say 4% vs. 2%. I’m not talking about a hyperinflationary spiral of >10% which starts creating real inefficiencies. I’m also talking about monetary inflation, not inflation through seignorage.
The classic argument is that higher inflation devalues savings. But EXPECTED inflation does not, as interest rates adjust to inflation. Where there is a danger is going from a long-period of low inflation to high inflation. Banks and insurers felt confident enough making long-dated fixed loans in the 60’s and then subsequently had big losses in the 70’s. The S&L crisis was in some ways not due to bad loans, but due to unrecognized losses from the 70’s that already made the bank’s insolvent.
Now, in Europe, Germany wields the power and they have a clear incentive as a creditor. Wealth transfers of unexpected changes in inflation can go from debtors to creditors as well. The ECB has been laughably bad at meeting even a 2% inflation target, but given the incentives of German savers, the low inflation is very good for them as long as the debtors somehow still pay.
As far as why a long-term 4% inflation rate could be a “free lunch?” Well, it reduces the number of people who see their nominal market-clearing pay go down. The “jobless recovery” stating in 2001 in America directly correlates with when lower inflation rates became the norm.
7. January 2015 at 16:07
With a level targeting regime would the trend growth rate of MB be higher than pre 2009? Is it the case that the demand for money has also permanently increased since the last crisis?
7. January 2015 at 16:30
Dudes and anyone from the ECB: Now is not the time for niceties, theorizing, modeling, or minuscule changes in targets.
The ECB should send a clear signal that the pedal is going to the metal for many years, they are going for a full-scale blowout, a rampaging economy. They will start buying €100 billion a month in government bonds, the amount rising monthly until labor shortages are chronic and pervasive. This tweety-birding around will accomplish nothing but more economic gloom.
7. January 2015 at 16:37
“They will start buying €100 billion a month in government bonds”
So you’re saying the ECB should call for permanent government deficits over the long term? Only permanent increases in the monetary base matter, after all.
7. January 2015 at 16:38
“They will start buying €100 billion a month in government bonds”
So you’re saying the ECB should call for permanent government deficits over the long term? Only permanent increases in the monetary base matter, after all.
7. January 2015 at 16:44
Waaay OT, but for Scott Sumner: The Shanghai Stock Exchange Composite is up 60% in last half-year or so…the Hang Seng flat for years…?????
7. January 2015 at 16:52
Benjamin Cole,
I’ve also found that disconnect between the Shanghai Composite and the Hang Seng to be extremely perplexing. Perhaps driven by the fact that the Shanghai Composite has been opened up to foreign investors.
The fact that Shanghai Composite prices have been increasing gradually rather than instantly indicates to me that something’s wrong with the Efficient Market Hypothesis…..
7. January 2015 at 18:44
ECB’s QE policies are unlikely to work because they provide additional financing to governments that because of misguided fiscal policy reasons will not increase investment in projects that have positive net present value at the new lower rates. ECB QE will lower rates on private sector bonds and so may have some effect.
Agree about price level targeting even if not as good as NGDPLT.
8. January 2015 at 03:36
Scott,
let’s wait a couple of years until the vice-president will say “The average inflation rate in the euro area over the 15 years from 1999 to date is 1.66% – a level slightly below the ECB’s definition of price stability….”
8. January 2015 at 04:46
Well Sumner has a flexible mind it seems. He is now advocating price level targeting, which has a richer history than targeting NGDP, and by his own admission in another thread it’s completely different from targeting NGDP. OK, noted. Maybe the idea is to get the Fed to slow adopt different frameworks, then drop the target NGDP Trojan Horse on them? Clever if so.
8. January 2015 at 05:09
Ray,
Prof summer has been pretty clear for years in terms of ranking his preference for different targets. The argument for level instead of rate targeting is indeed seperate from preferring a certain price index, ngdp, or something like total labor compensation. But there’s no secret plan or evolution of agenda. I never see prof sumner write anything in favor of ‘heighten the contradictions’ policy … He’s always willing to support a central bank doing something less bad, even if it’s not his #1 choice.
8. January 2015 at 05:36
@Nick–OK, thanks for that. If you, as a long time reader, have any insight as to what “peg” means in Sumner’s target NGDP framework, please post here or in the other thread.
8. January 2015 at 06:05
I go back to Britonomist’s question. Is the ECB not constrained as to the type of actions it can take. For example, I thought the treaty explicitly outlawed the purchase of national government bonds. I am prepared to be corrected on this. If, however, I am correct, wouldn’t this mean that the ECB’s credibility is fundamentally undermined, because it cannot do whatever it takes to implement the target?
Unlike the BoJ or the Fed or the BoE, the ECB can’t simply buy everything up until prices start to rise.
8. January 2015 at 06:38
Ray,
There are so many little permutations or wrinkles one could include. The basic idea on a non discretionary peg from prof sumner is:
“Another approach “” which would be more radical, but perhaps also more effective “” would limit the Fed’s role to setting the NGDP target, and would leave the markets to determine the money supply and interest rates. This would mitigate the “central planning” aspect of the Federal Reserve’s current role, which has rightly come under criticism from many conservatives. To give a simplified overview, the Fed would create NGDP futures contracts and peg them at a price that would rise at 5% per year. If investors expected NGDP growth above 5%, they would buy these contracts from the Fed. This would be an “open market sale,” which would automatically tighten the money supply and raise interest rates. The Fed’s role would be passive, merely offering to buy or sell the contracts at the specified target price, and settling the contracts a year later. Market participants would buy and sell these contracts until they no longer saw profit opportunities, i.e., until the money supply and interest rates adjusted to the point where NGDP was expected by the market to grow at the target rate.”
I think in reality you’d want to offer a variety of ngdp products over a variety bit of a spread of time, not just the one year forward contract.
8. January 2015 at 07:51
Ray, You said:
“Well Sumner has a flexible mind it seems. He is now advocating price level targeting,”
I’ve always said PLT is better than IT. Where have you been?
Matt, That’s possible, but I don’t think it’s needed.
CMA, I doubt it would have much affect on the trend rate, in the very long run.
Vaidas, Yes, I think it quite likely they say something irrelevant like that. Reminds me of the line in Dr Strangelove: “What’s the point of the Doomsday Machine if you don’t announce it to the public when it is first put in place?”
8. January 2015 at 08:20
Unfortunately the credibility of ECB’s Machine is much higher when the threat to price stability is coming from the inflationary side. EURUSD exchange rate in 2007 and first half of 2008 is a good illustration how it works.
8. January 2015 at 08:53
Benjamin Cole,
Re: your post above, you might be interested in this new story on the seemingly irrational premium the Shanghai Composite is selling at relative to the Hang Seng:
http://seekingalpha.com/news/2212745-alarm-bells-ring-on-china-a-shares
8. January 2015 at 10:39
I found the paper, and it’s one of the most bizarre proposals I have read. No less than a half dozen or more different proposals are discussed, but what caught my eye, even more than ‘pegging’ (which is not defined) is a proposal where NGDP futures traders are betting vs the Fed as a counterparty. Seriously? Is this really Sumner’s main proposal? @Nick–I do not believe your interpretation of Sumner’s Target NGDP framework is accurate. After reading this paper I see Sumner’s proposal(s) (there are a half dozen variants) include the Fed as an active counterparty to NGDP futures traders–wow!–see below. RL
http://mercatus.org/publication/market-driven-nominal-gdp-targeting-regime
(my comments in CAPS. Apologies for the long post but there’s no other way to show you guys the Kool-Aid)
To summarize, one way to transition from current FOMC policy to NGDP futures targeting would involve the following four steps: 1. Have each FOMC member vote on the optimal policy-instrument setting, and then set the policy at the median vote. [THIS IS SO DISCRETIONARY] 2. Reward or fine each FOMC member based on the accuracy of his or her implied NGDP forecast. [LOL!] 3. Open up the FOMC to anyone who wishes to participate.{COMEDY!! AM I READING ‘THE ONION’ NOW?] 4. Shift from a one-man, one-vote system to a one-dollar, one-vote system. [OK FINALLY, SANITY, BUT IT’S NOT AS BENIGN AS IT APPEARS, READ ON] I will call this approach NGDP futures targeting. Before considering objections to this proposal, it will be helpful to discuss three other methods by which market expectations could guide monetary policy.
SO THAT IS SEVEN (7 = 4+3) DIFFERENT PROPOSALS BY SUMNER. WHICH ONE INVOLVES PEGGING?
In a paper published in 1997, I suggested that futures markets could be used to predict the optimal policy instrument setting. The meaning of the term “policy instrument” is actually a bit vague.
I AGREE. VAGUE INDEED. AS IS “PEGGING”.
NGDP futures targeting could help clarify the real issues that occur when nomi- nal rates hit zero. When this situation occurs, policymakers have three choices: 1. Expand the balance sheet as needed to peg [HOW?] the NGDP futures price. If the central bank purchased the entire national debt … 2. Raise the long-run target-growth path for NGDP. A higher growth path will lead to higher inflation expectations and a lower demand for base money. … 3. Accept the fact that policy will fall short and NGDP will grow by less than the target.
I AM SORRY, BUT YOUR PAPER DOES NOT CLEARLY EXPLAIN HOW THE FED IS “PEGGING”. I FOUND THIS PASSAGE AND IT DOES LITTLE TO EXPLAIN PEGGING BUT MAKES EVEN MORE ASTONISHING CLAIMS:
In most futures markets, a change in investor sentiment affects the price of the futures contract. This proposed market would be very different. The Fed would peg the price of NGDP futures at $1.0365, but only during the period where it was the target of monetary policy [ONLY? WHAT DOES THIS MEAN? VERY CONFUSING]. During this period, changes in investor sentiment would affect the quantity of money, not the price of NGDP futures [WHY NOT? WHAT ARE YOU TALKING ABOUT SUMNER? THIS IS CRAZY CONFUSING AND AMBIGUOUS?! WHAAAT?] For market expectations to determine monetary policy, there must be a link between NGDP futures purchases and sales, and the quantity of money. This link can be achieved by requiring parallel open-market operations for each NGDP contract purchase or sale. [OK, SO FAR SO GOOD. THE FED WILL TRY AND MAKE OPEN-MARKET OPERATIONS BASED ON NGDP FUTURES, RIGHT?] Because investors buying NGDP futures are expecting above-target growth in NGDP, the Fed should automatically reduce the monetary base each time an investor buys an NGDP futures contract, and it should automatically expand the base each time an investor sells an NGDP contract short. … In that case, investors would be effec- tively determining the size of the monetary base. [I AM SORRY, BUT THIS IS NUTS. HERE YOU SEEM TO IMPLY NGDP FUTURES PRICES ARE MERE GUIDANCE TO THE FED. BUT, LATER IN THE PAPER, YOU MAKE THE PROPOSAL THAT EACH NGDP FUTURES INVESTOR IS BETTING AGAINST THE FED, AND COLLECTING OR GIVING MONEY TO THE FED (“However, this system would expose the Fed to default risk, as the Fed is the counterparty in all transactions” pp.11-12). WHICH IS IT? OR WAS THE FED AS COUNTERPARTY A STRAWMAN ARGUMENT? I COULD NOT TELL.]
PAGING MAJOR FREEDOM””HAVE YOU READ THIS GOOFY PAPER? CAN YOU MAKE SENSE OF IT? PLEASE SUMMARIZE. AND I BEG THE OTHER LOYAL READERS OF THIS BLOG TO PLEASE, PLEASE EDUCATE ME. I HAVE A DOCTORATE DEGREE AND i CANNOT MAKE HEADS OR TAILS OF THIS, IT’S SO VAGUE AND IMPRECISE. WOW NO WONDER NOBODY IS TAKING SUMNER SERIOUSLY.-rl
8. January 2015 at 16:03
@Ray Lopez: “GOOFY PAPER … VAGUE AND IMPRECISE”
Is it possible that you’re not the intended audience? Sumner is proposing and arguing for something, which is essentially new, not just to professional economists, but even to Nobel prize winners like Krugman and macroeconomic experts like Cochrane. He’s trying to convince them that he has a better framework than they do.
It’s no surprise that he doesn’t write a technical paper like this, pitched to someone (like you?) who may need to start with a basic tutorial to the standard framework of economics in general.
Sumner is trying to affect change, among people who already well understand the current monetary framework of modern nations. His pitch needs to take them from where they are, to where he wants them to be.
I’m not surprised that you find it a bit hard to follow, given where your understanding seems to be starting from.
8. January 2015 at 20:04
@Don Geddis – no, Sumner is clearly writing for a lay audience, from his informal prose, which includes jokes like “open up the FOMC to anyone who wishes to participate”. I just think he is doing a lot of hand-waiving.
8. January 2015 at 22:12
Ray,
For concreteness, let’s think only about 5 year NGDP futures. So a contract is defined in, say June of 2015 that will be paid off in June of 2020 and the payoff amount will be 0.00000005 percent of the Commerce Departments then-current (in June 2020) estimate of 2019 US NGDP. If I did my math correctly and put the right number of zeroes to the right of the decimal place, 2019 NGDP of $20 trillion would mean a payoff of $10 thousand per contract.
Let’s suppose that $20 trillion is, in fact, the level of NGDP that the Fed wants to see in 2019, as is $21 trillion in 2020, $22.05 trillion in 2021, and so on, growing at 5 percent per year. If, in 2015, people expect 2019 NGDP to be $20 trillion, the futures contract will trade for $10 thousand in 2015. If 2019 NGDP is expected to be less than $20 trillion, the contract will, in 2015, be worth a bit less than $10 thousand, and the reverse is true if expected NGDP rises.
So from the futures price, you can infer the market’s expectation of 2019 NGDP. During the year 2015, the Fed can use the futures price to guide it’s monetary policy. When the futures price is less than $10K, the Fed buys T-bills, thus increasing the monetary base. When the base increases, market participants revise upward their expectations of NGDP, and the Fed can stop printing money when the futures price hits the $10 K target. Similary, if the futures price is too high, the Fed sells T-bills and thus lowers the monetary base.
In January of 2016, the Fed switches from targeting expected 2019 NGDP to targeting expected 2020 NGDP. It no longer cares what happens to the 2019 contract, which eventually gets settled in June 2020. By then the Fed is focused on the 2024 NGDP contract.
9. January 2015 at 04:33
@Jeff–I find your explanation easy to follow; it’s the same as what I thought was Sumner’s proposal before I read his paper and his comments. But unfortunately that’s not what Sumner is proposing. Two things: Sumner is talking about a “peg” to Fed policy, so that the Fed will not have to increase the money supply if expectations ‘go wild’. I am asking Sumner to clarify what “peg” this is, but his paper is no help. Perhaps he means the Fed will arbitrarily announce some target, like 5% growth a year for X years, but it’s not clear. Second, Sumner’s paper in one variant of his target NGDP proposal talks about the Fed being the counterpart to many NGDP futures traders. Normally this is not a problem if buyers and sellers of futures ‘cancel out’, but I can see a problem developing if the entire market is against the Fed. See the comment by Nick upstream, apparently a quote from Sumner: “If investors expected NGDP growth above 5%, they would buy these contracts from the Fed.” Does the Fed have any business making a market in NGDP futures, especially when the Fed itself would be doing open market operations? The entire idea sounds absurd. What investor would bet against the Fed? Only those that don’t think the Fed has any power. To use a commodities futures analogy: Cargill the grain company speculates in commodity futures like wheat futures, but they don’t make a market but rely on the Chicago Mercantile Exchange.
9. January 2015 at 05:28
Ray,
I don’t know what “peg” you’re referring to, but when economists use the term, they generally mean fixing the price of one thing in terms of another thing. The most common usage is in “pegging” an exchange rate, e.g., the Chinese central bank stands ready to exchange dollars for yuan in either direction at a particular exchange rate. They have “pegged” the yuan to the dollar.
In Scott’s case I think he must be referring to the idea that, if you define a sequence of NGDP futures contracts such that their prices are all $10,000 when the expected NGDP follows exactly a target path set by the central bank, then when the Fed takes actions to keep expected NGDP on that path, you could say that it is “pegging” the prices of those futures contracts.
As for the Fed itself trading the contracts, I think this is just a way to show how it could be done. Like you, I don’t really think it is practical. If buying and selling futures contracts were the sole means of implementing monetary policy, the market for them would have to be really enormous and the Fed would in principle have to hold contracts with a market value approximately equal to the monetary base, which is currently around $3 trillion. As you say, having the central bank take that much risk out of the markets and onto it’s own balance sheet could have consequences we can’t begin to fathom. I don’t even want to think about how clever Wall Street derivatives writers would game that system.
But a small subsidy to get an NGDP futures market going would give the FOMC a good measure of expected NGDP, and I think we could count on pressure from Congress and the financial press to do the rest. If the Fed chair were confronted several times a year by a congressional panel asking him or her why expected NGDP is being allowed to diverge significantly from a reasonable path, particularly if that path were one the Congress itself had approved, that might focus the Fed’s attention wonderfully.
9. January 2015 at 08:37
@Jeff – I agree with you on both points. But I don’t think Sumner agrees with you on either point, especially the first point on pegging. He is strangely silent as to details. The reason I am hounding him on ‘pegging’ is that futures markets are notoriously fickle, as graphs of implied volatility show. So essentially, as I stated, a target NGDP money supply would be much more volatile than a gold-standard based money supply, which depends on new discoveries of gold. It’s hard to find new gold (pace South Africa in the late 19th C), so supplies are fixed or change slowly. By contrast, the futures market for NGDP could swing radically 100s of basis points in a couple of days. What then becomes the Fed target? Does the Fed announce something out of the blue? And what if this prediction is at odds with the future market? Does the Fed then do massive Open Market operations to bring the Fed’s target in line with the wildly fluctuating futures market? Or just wait for the market to come back to the Fed’s target? Sumner says ‘don’t worry, it’s pegged’ but what does that mean? Pegged to what? It’s Sumner’s responsibility to explain, but I’m not holding my breath. Professors are notorious for hand-waving, and this is a clear example of such.
9. January 2015 at 09:37
@Ray Lopez: “jokes like “open up the FOMC to anyone who wishes to participate”” You continue to misunderstand. That was not a joke.
““peg” to Fed policy, so that the Fed will not have to increase the money supply if expectations ‘go wild’” No. Sumner wants to set a target (“peg”) NGDP (level!) growth. That’s the opposite of stabilizing the money supply. Instead, the money supply will vary (perhaps wildly), in order to meet the (NGDP) target. Your idea to “not have to increase the money supply” is in fact the opposite of what Sumner is proposing.
“NGDP money supply would be much more volatile than a gold-standard based money supply, which depends on new discoveries of gold.” Agreed. But you seem to be viewing that as a bug. You’ve got it completely backwards. It’s a feature.
The point, in fact, is to vary the money supply, so that the value of the unit of account is stable (more precisely: changing very predictably). What you have identified with gold, is in fact the exact problem with gold: supplies don’t change with changing demand for money, and thus money demand changes (in a gold-standard monetary system) cause wild fluctuations in the value of money.
It’s the value of money that is being stabilized, not the supply of money.
“the futures market for NGDP could swing radically 100s of basis points in a couple of days. What then becomes the Fed target?” The Fed target (in Sumner’s proposal) is NGDP levels. Not the money supply. So nothing at all happens to the target.
“And what if this prediction is at odds with the future market? Does the Fed then do massive Open Market operations to bring the Fed’s target in line with the wildly fluctuating futures market?” Yes! Exactly. That’s, in fact, the whole point. It’s a feedback loop, so when market expectations suggest that actual NGDP will be different than the target, the whole point of the design is that it would then cause the Fed to change the money supply, in order to bring NGDP back to target.
9. January 2015 at 10:14
Ray, You said:
“I BEG THE OTHER LOYAL READERS OF THIS BLOG TO PLEASE, PLEASE EDUCATE ME. I HAVE A DOCTORATE DEGREE AND i CANNOT MAKE HEADS OR TAILS OF THIS”
There are some tasks beyond the ability of any mortal. Educating you is one.
You said:
“@Don Geddis – no, Sumner is clearly writing for a lay audience, from his informal prose, which includes jokes like “open up the FOMC to anyone who wishes to participate”. I just think he is doing a lot of hand-waiving.”
I’m not sure what’s funnier, the fact that you don’t know that academic papers often include jokes, or that you think this was a joke.
Don and Jeff, Thanks for trying, but it’s hopeless. He’s a clown.
9. January 2015 at 11:29
Since Ray mentioned the gold standard, I will take this opportunity to point out to all the gold bugs out there that there is a version of it that isn’t too bad. Irving Fisher proposed targeting the level of a broadly-measured price index by varying the amount of gold in a dollar, i.e., by having the official price of gold rise when the price level was below target, and fall when the price level was above target. If the gold price is adjusted often enough, this gets around the historical problem of wild swings in the money supply due to new gold discoveries or changes in the demand for gold.
Of course, it would be even better if the target were NGDP. Even Scott could get behind a compensated dollar gold standard if it targeted a path for the level of NGDP.
But if Scott is right, and I’m afraid he probably is, Ray will come with some objection to this as well.
Oh well, at least maybe someone read this stuff who did find it useful.
9. January 2015 at 14:13
@Don Geddis – thanks for that explanation, but I find it hard to believe that Sumner is proposing such a radical notion. If so, he’s arguably more crazy than I thought. If you have any links to support your claims, pls post them, Sumner’s paper was vague. If your interpretation is correct, Sumner will have the Fed doing Open Market operations like a weather vane in a hurricane, expanding one day, contracting the next, and only making the primary dealers happy with all the volume churned.
@Sumner – so you propose opening the FOMC (http://en.wikipedia.org/wiki/Federal_Open_Market_Committee) to anybody? Is this your version of free banking? I heard you corrupted George Selgin and now he believes in NGDP targeting, but it seems he may have also corrupted you.
@Jeff–thanks; Richard Cooper (anti-gold bug Harvard economist) mentioned what you say Fisher proposed, in his 1982 gold standard paper I’ve cited and found online, but unfairly dismissed it with a comment along the lines of ‘you might as well use the Statue of Liberty as the backing for the money supply, and say the value of the statue fluctuates accordingly’. But I like Fisher’s idea.
9. January 2015 at 16:34
Ray,
I think that for its time, Fisher’s idea was great. Had it been adopted, most of the Great Depression and its awful consequences like WW2 probably would not have happened. Remember, the price level fell by 25 percent, and none of that would have happened with Fisher’s compensated dollar scheme. There probably still would have been a recession, but nothing like what actually happened.
If you Google “compensated dollar” and “Fisher”, I’m sure you’ll be able to find a lot of stuff about it. It’s mostly been forgotten except by those of us who are interested in economic history and the history of economic thought. None of this stuff is in graduate school curriculum any more, and the field is poorer for it. Most of the mistakes made in policy today have been made before, but nobody remembers.
9. January 2015 at 23:11
@Ray Lopez: “If you have any links to support your claims, pls post them”
Sure! Try Sumner’s Re-Targeting the Fed.
I can’t wait to see your wacky, unique interpretations of yet another seminal paper.
10. January 2015 at 01:08
The fear of inflation is still irrationally strong in Europe. Everyone should realize by now that an implicit 0% inflation rate is suboptimal.
Doug M’s point is spot on. Just like the Fed, they see missing low as a win.
10. January 2015 at 01:09
*target, not rate
10. January 2015 at 03:16
@Don Geddis — I read Sumner’s op-ed, and it’s not persuasive. Sumner drinks the Kool-Aid that monetary policy can affect long-term AD/AS–simply not true. He does, as a sop, add one sentence below to try and remedy this but it’s just one sentence is a wall of bad words. – RL
Sumner speaking truthfully here: “This does not mean, of course, that NGDP targeting can address our broader economic predicament. Monetary policy is not an answer to structural policy problems. It cannot make up for a failure to control the growth of public spending or the explosion of entitlement costs. But it can do a great deal to help create a stable environment of consistent growth, and thus make the difficult structural reforms ahead both more effective and easier to tolerate”
In short, if today’s economy underperformance is simply a ‘temporary’ response to the crisis of 2008, rather than a balance sheet recession as advocated by Koo or even more seriously, a structural recession, then you have to ask yourself why eight (8) years after a shock is still considered ‘temporary’? Are we measuring time based on long-term geological time?
BTW, note that Sumner is biased against ‘public spending’ separate and distinct from ‘entitlement costs’ (he lists them separately). So the question for Sumner is whether he feels basic research as done by the government is a useful public good? He seems to think not. Ditto for national defense, public roads, public schools, and the like.
10. January 2015 at 05:30
Ray, you are the dumbest internet commenter I have ever come across
10. January 2015 at 08:11
Jeff, I like Fisher’s idea, although it’s probably best not to view it as a version of the gold standard, as the price of gold is no longer constant.
Ray, You said:
“I heard you corrupted George Selgin and now he believes in NGDP targeting, but it seems he may have also corrupted you.”
Cute. If Selgin reads this he’ll be ROFL. Yes, I persuaded George to support NGDPLT, just as I persuaded Milton Friedman to favor M2 targeting.
Tall Dave, I’d say they are far worse than the Fed.
Ray, You said:
“I read Sumner’s op-ed, and it’s not persuasive. Sumner drinks the Kool-Aid that monetary policy can affect long-term AD/AS”
Like Charlie, you spew out words that have no coherent meaning, and assume you’ve said something intelligible. There is no such thing in economics as “long term AS-AD.” You are like a drunk in a bar, confident that he is saying something profound, but no one else knows what you are talking about.
Ben, I think you just might be correct. Even MF wasn’t this bad, at least back when I read him.
10. January 2015 at 12:10
Au contraire, Scott. MF really is as bad, maybe worse. You’re just repressing the unpleasant memories.
10. January 2015 at 20:02
@Sumner – I meant–and you should have understood–long-RUN AS-AD, not long-term. You’re dishonest if you fail to see this.
11. January 2015 at 09:21
Ray, Nice try, but still gibberish.