Nick Rowe puts it all in perspective

The world is full of brilliant macroeconomists who fail to see the big picture.  Very few of them are able to step back and ask the sort of basic questions that Nick Rowe likes to pose:

Is the macroeconomic importance of finance, likewise, merely an artefact of a particular monetary policy?

What lesson should we learn from the recent recession? Is it that macroeconomists should pay more attention to finance? Or is it that we should change monetary policy?

In the past, the lesson we learned is that we should change monetary policy. When fluctuations in the demand and supply of gold became macroeconomically important, we dropped the gold standard. When fluctuations in the trade balance became macroeconomically important, we dropped fixed exchange rates. When fluctuations in the demand for money became macroeconomically important, we dropped money growth targeting. When fluctuations in finance became macroeconomically important, what should we do? Why should this time be different?

Now, the analogy is not exact. The Bank of Canada does not peg a nominal interest rate, except for 6-week periods. It adjusts that nominal interest rate peg eight times a year, as needed, to try to peg the CPI inflation rate. But interest rates, in particular the gap between market rates of interest and their corresponding “natural” rates of interest, play a key role in monetary policy tactics. And the monetary policy strategy, targeting 2% inflation, can be seen as pegging the real rate of interest on currency at minus 2%, which is the interest rate differential between holding currency and holding the CPI basket of goods. Current monetary policy uses one interest rate differential as an instrument to target a second interest rate differential.Current monetary policy, in both tactics and strategy, is all about interest rate differentials. And the theory of interest rate differentials is finance. A financial crisis is a big sudden change in interest rate differentials.

It doesn’t have to be this way.

In the past, we changed monetary policy to make the demand for gold, the trade balance, and the demand for money, macroeconomically unimportant.

We should now change monetary policy to make interest rate differentials macroeconomically unimportant.

Excellent.  I’d like to propose NGDP futures targeting as an alternative to the failed interest rate targeting regime.

PS.  In the comment section Vaidas raises some interesting objections to futures targeting, but I doubt any of them would be of economic significance. However it’s hard to be sure, as we have no empirical evidence for this sort of system, at least that I know of. Which is why we need to create the market!! Andy Harless says a NGDPLT target of central bank internal forecasts could do about as well, and I suspect he’s right.

PPS.  I started teaching today (after being on sabbatical last year) and thus am suddenly much busier. Blogging will probably be slower, but if it seems to dry up you can always check over at Econlog, where I will continue to guest blog.



37 Responses to “Nick Rowe puts it all in perspective”

  1. Gravatar of Benjamin Cole Benjamin Cole
    22. January 2014 at 20:01

    Amen, amen, a thousand amens.

    It ain’t the 1970s anymore.

    The devil going forward is probably sluggish growth and ZLB, not inflation.

    And if interest rates go to zero, what do you do?

    QE to the moon, targeting NGDP. And shoot on the high side, dudes, shoot on the high side. Some boom times would be nice.

  2. Gravatar of Geoff Geoff
    22. January 2014 at 20:28

    “Which is why we need to create the market!!”

    Yeah, you can’t create a market by pointing guns at people. It’s going to have to be valued voluntarily for a market to take place.

    Which leads to the question of why no investor is offering NGDP futures and why no investor is buying NGDP futures.


    Benjamin sounds like a crackhead I once saw on Cops.

  3. Gravatar of Ben J Ben J
    22. January 2014 at 20:29


    See if Bentley would be happy to let you release recordings of your teaching. I’m obviously not sure what classes you’re taking, but if for example you were teaching a stream of intermediate macro, I’d love to see your treatment of AS/AD.

    If it’s first year PhD students, your macro stuff would be even more interesting.

  4. Gravatar of Saturos Saturos
    22. January 2014 at 20:51

    Just noticed: According to the ECB’s Twitter bio, “Its main task is to maintain the euro’s purchasing power.” in case anyone was wondering why tens of millions of Europeans are still unemployed.

  5. Gravatar of Tom Brown Tom Brown
    22. January 2014 at 20:54

    Scott, my comment to Nick over there was that the structure of his story went something like this: “We tried X(n) and that failed because of Y(n) so then we tried X(n+1) and that failed because of Y(n+1) so then we tried X(n+2) … ”

    So I asked him to identify both the next thing we’ll try and to take a stab at why it’ll fail, and to then guess what we’ll try after that. He replied: “Tom: that’s the right question to ask. But it’s going to need another post to answer.”

    I think the “next solution” is pretty obvious, but identifying possibilities for the next resulting failure it will lead to and the next possible solution after that take some creative thinking. Any ideas?

  6. Gravatar of Saturos Saturos
    22. January 2014 at 20:55

    Also, “The Reserve Bank of Australia conducts monetary policy… and issues the nation’s currency”, as if those were unrelated.

  7. Gravatar of Tom Brown Tom Brown
    22. January 2014 at 21:04

    Scott, re: my above comment, yes I’m asking you to get creative and try to fairly identify the most likely way your own baby will die (which of course presumes it will die), and what the new baby after that might look like. Not a pleasant thought perhaps, but that’s where the creativity comes in.

  8. Gravatar of Garrett M Garrett M
    22. January 2014 at 21:12

    Tom, my murky crystal ball says that the main risk to NGDP targeting is it being abandoned the moment a real shock leads to stagflation. Imaging the uproar if we had a 4% NGDP target and an energy shock led to -1% growth and 5% inflation. It could lead to policy tightening and another huge recession.

  9. Gravatar of William Luther William Luther
    22. January 2014 at 21:17

    “When fluctuations in the demand and supply of gold became macroeconomically important, we dropped the gold standard.”

    Wait. What? I’m not sure that is historically accurate.

  10. Gravatar of Tom Brown Tom Brown
    22. January 2014 at 21:41

    Garret M, thanks for taking a stab at that. Now what “improvements” to NGDPLT do you imagine would be proposed to address such a problem.

    William Luther, it sounds like you share Vincent Cate’s skepticism on this (in Nick’s comments). Here’s one of Nick’s replies to Vincent:

  11. Gravatar of Nick Rowe Nick Rowe
    23. January 2014 at 02:52

    Thanks Scott!

    So, you have been on sabbatical. That makes me feel better. I wondered how you could possibly manage to write so much good stuff every week.

    Geoff: if the government issued part of the national debt in bonds indexed to NGDP (trills), which would be a good idea anyway, that market would trade those bonds just like other bonds. And the yield differential between NGDP-indexed bonds and regular bonds would mimic an NGDP futures market.

    William: other people (like Scott) are better at monetary history than me, but I think the Bank of France hoarding gold (an increased demand for gold) was important in ending the gold standard.

  12. Gravatar of ssumner ssumner
    23. January 2014 at 05:33

    Ben J. My classes aren’t taped.

    Saturos, That’s depressing.

    Tom, NGDPLT futures targeting is the next idea.

    Garrett, I don’t agree, with -1% RGDP growth I think there would be very little pressure to tighten policy.

    William, I think it’s reasonably accurate. The US devalued the dollar sharply in 1933, after a big increase in the demand for gold.

    Thanks Nick.

  13. Gravatar of Saturos Saturos
    23. January 2014 at 05:33

    Only just saw this – the Adam Smith Institute has betting markets on UK unemployment and inflation!

  14. Gravatar of Dan S Dan S
    23. January 2014 at 05:46

    So, does this mean your book is on the way?

  15. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    23. January 2014 at 06:58

    ‘We should now change monetary policy to make interest rate differentials macroeconomically unimportant.’

    Am I too big to say, ‘I told you so.”?

  16. Gravatar of Randomize Randomize
    23. January 2014 at 08:17

    Dr. Sumner,

    Skip the NGDP futures market and have the treasury start issuing NGDP-adjusted bonds so the Fed can target the spreads vs. regular bonds.

  17. Gravatar of W. Peden W. Peden
    23. January 2014 at 08:17

    Garrett M,

    We had something quite similar to that in the UK recently (5% CPI inflation with a flexible 2% CPI inflation target) and the Bank of England was able to weather the storm until inflation dropped back down to 2% recently.

  18. Gravatar of Tom Brown Tom Brown
    23. January 2014 at 08:18

    Scott, I know NGDPLT is the next thing: I was asking you to imagine that an unforeseen problem arose to kill it… I realize you don’t think that will happen, but imagine it follows Nick’s pattern and just like every other idea, it fails. What do you imagine would be the likely cause of that failure?

  19. Gravatar of Garrett M Garrett M
    23. January 2014 at 09:35

    W. Peden,

    That’s a good point. Though I recall them receiving a good amount of criticism for it at the time, even though it ended up being the right decision.

  20. Gravatar of W. Peden W. Peden
    23. January 2014 at 10:17

    Garrett M,

    Yes, and it probably stopped them from doing more QE in that period to get NGDP up. I think that stagflatory situations would be easier to handle under NGDP targeting than under inflation targeting, even if that inflation targeting was very flexible.

  21. Gravatar of ssumner ssumner
    23. January 2014 at 12:35

    Dan, I’m told it will be released this year. But then I was told it would be released last year. It’s up to the publisher.

  22. Gravatar of ssumner ssumner
    23. January 2014 at 12:37

    Tom, It would be some factor that caused wages to be unstable even as NGDP growth was stable. Perhaps a huge discovery of oil, or something like that.

  23. Gravatar of Morgan Warstler Morgan Warstler
    23. January 2014 at 13:30


    Have you ever said why NGDPLT shouldn’t be the actual transmission mechanism, the way money enters and leaves economy?

  24. Gravatar of Morgan Warstler Morgan Warstler
    23. January 2014 at 15:39

    Er, NGDP futures.

  25. Gravatar of ssumner ssumner
    24. January 2014 at 06:38

    Morgan, You want parallel OMOs in Treasuries so that most of the Fed balance sheet is Treasuries, not GDP futures.

  26. Gravatar of Morgan Warstler Morgan Warstler
    24. January 2014 at 07:25

    Why does there need to be a balance sheet? Why even assume there will be treasuries to buy? Why encourage government borrowing?

    Why not just put money into hands of hedgers/winners when economy shrinks and take money out when hedgers/losers hands when it grows to fast?

  27. Gravatar of ssumner ssumner
    25. January 2014 at 10:30

    Morgan, It’s an artifical market whoich few people want to trade. You’d have to have a trillion dollar short position to get the money supply on target for 4.5% NGDP. That’s not efficient.

  28. Gravatar of Major_Freedom Major_Freedom
    25. January 2014 at 10:32

    That’s not efficient.

    Not efficient according to what metrics?

  29. Gravatar of Morgan Warstler Morgan Warstler
    25. January 2014 at 12:04

    Scott, at runtime (meaning we’re at and have been on the NGPDLT for say 1 year) it doesn’t have to be $1 TRILLION, right?

    That’s just the lift you are seeking to get there right?

    At runtime, we’d need to add about / subtract less than $33B on most all months right?

    Meaning we’re supposed to be adding $66B a month in 2014 to stay on 4.5%, so month by month we’d hardly ever be over / under by more than 50%, I’m assuming 80% of the time we hit within 20% of the target, and since we do LT, the dice roll means we’re going to sooner than later hit the target the next month.

    Now look at this:

    So, if SMBs are 46% of GDP and we open my NGDPLT futures market where the odds are tilted slightly in favor of betters vs. the house. If you don’t remember it, I’ll give you a link…

    It seems like we’d quickly get $20-$50B in bets made monthly.

    What am I missing?

  30. Gravatar of ssumner ssumner
    26. January 2014 at 07:32

    Morgan, You can start with zero, but after a few decades when the base is up to 2 trillion the public would have to have a one trillion short position in those futures.

    I was looking at it as a long run proposition.

  31. Gravatar of Morgan Warstler Morgan Warstler
    26. January 2014 at 11:49

    You just blew past my knowledge level.

    I get that in theory in money supply has to grow so that the current loans can be paid off with interest.

    Is this what you are referencing?

    I never really think about that, frankly, bc I expect the loan demand to continue to fall as:

    1. more people live without debt.

    2. each new business to kill the incumbent costs less than the one it replaces (digital take over)

    But, if we can get off that for a second.

    Imagine we’re running perfectly level at 4.5% and for March 2014 GDP is supposed to be $64B to hit $17.175B and then $17.240B in April.

    And it comes in $4B light ($60B ) at $17.171B, so we need $4B in catch up next month, so we need $69B in April.

    The economy came in weak so Fed is paying off bets making sure enough new cash in in system to goose us up to $69B, from the expected $60B.

    How much new cash has to be paid out to the 46% of GDP (SMB) so that they cheer and go buy some new stuff in the casino gift shop?

    The Fed doesn’t have to hand out a full $9B (the expected make up), its some part of that.

    Please humor me here, assuming the Fed was using this as the transmission mechanism, how much?

    Can you give me a different example if mine is wrong.

  32. Gravatar of Major_Freedom Major_Freedom
    26. January 2014 at 12:38


    I get that in theory in money supply has to grow so that the current loans can be paid off with interest.

    Is this what you are referencing?

    That isn’t actually true. That notion confuses stocks with flows. See here:

  33. Gravatar of ssumner ssumner
    27. January 2014 at 18:25

    Morgan, You make things so complicated it makes my brain hurt. It’s this simple:

    1. The base grows at the same rate as the economy in the long run.

    2. NGDP doubles every 20 years or so.

    3. Therefore the base doubles every 20 years or so.

    4. If that extra base money were injected via futures contracts, and only futures contracts, the short position of the public would have to be huge. The Fed would have a massive position in futures.

    Better to use futures as signals and hold a portfolio of boring T-bonds. The futures expire each period, and you run the “prediction market” again for the next period. But all that money is balanced by the Fed’s big T-bond holdings. Futures are just a signaling device.

  34. Gravatar of Morgan Warstler Morgan Warstler
    28. January 2014 at 11:17


    I’d say the same thing to you!

    “1. The base grows at the same rate as the economy in the long run.

    2. NGDP doubles every 20 years or so.

    3. Therefore the base doubles every 20 years or so.”

    Oh really?

    Ok, but let’s get past that….

    “4. If that extra base money were injected via futures contracts, and only futures contracts, the short position of the public would have to be huge. The Fed would have a massive position in futures.”

    The Fed would not ever have a massive position in futures.

    “Here’s how it would work:

    1. An SMB owner would deposit money into a Fed account.

    2. He’d only be able to bet that NGDP was going to come in soft, but the odds / payoff would slightly favor the players, and not the house.

    3. If NGDP comes in too soft (the economy is slowing down) the Fed prints the new money and pays off the SMB owners.

    4. If NGDP comes in too strong (the economy is overheating) the Fed takes some money out of SMB accounts.

    Generally, the odds are slightly in SMB owners favor, so much so, that being an SMB owner becomes the thing that the best and brightest want to do.

    So not only does NGDPLT end crazy booms and busts, it helps out SMB owners exactly when things start to slow down.

    At EXACTLY THE RIGHT MOMENT, when prices are just about fall, and small bear market opportunities avail themselves….

    The SMB owners are FLUSH! They can take their windfall winnings and go buy up something cheap, being sold off (hopefully by a Fortune 1000 as the economy cools down).

    And when things are running a bit too hot, the Fed take a bit of the cash out of each SMB owner’s account…

    And the SMB owners are AWARE! Since, they get the first real taste that things are about to cool down, they are first movers to batten down the hatches.

    There may be some arguments from economists that this may not be enough injection and removal from the economy to move the ball.

    This is impossible.

    When I say the odds slightly favor the SMB owners in the betting, I mean they will be pay whatever odds are necessary to get the majority of SMBs to use this system.

    If after God’s chosen people have been serviced, the Fed has to buy /sell a few Treasury Bills from Goldman, who cares?

    The new money goes to SMB Owners first, and that’s all that matters.


    Ok, so right now the base is $2.5T.

    We’d need it to be $5.0T by 2033.

    So that’s 2.5T over 360 months or about $7B a month right?

    So if the Fed generally on average pays out $7B at the betting window to SMB owners that make up 46% of gdp…

    They are the kind to drive velocity right?

    Are my numbers off?

    I’m not an economist.

  35. Gravatar of ssumner ssumner
    28. January 2014 at 12:16

    Morgan, What does the Fed get in return for the $7 billion it gives SMB owners?

  36. Gravatar of Morgan Warstler Morgan Warstler
    28. January 2014 at 12:45

    The Fed gets:

    1. NGDPLT stays on target. Dead solid perfect.

    2. it does away with fraud that the Fed contributes profits to USG. Increasing the cost of USG borrowing, reducing spending.

    3. it does away with moral hazard of Goldman Sachs and bankers in general – it says that not only are the not TBTF, they aren’t even the best kind of people in our society.

    It VALORIZES God’s chosen people.

    4. And some months, to cool things off, to get back to level target, the bettors lose, the money leaves their account.

    But, we’re talking about a couple million SMB employers, and since on average $7B in payouts will occur OVER the bets…

    What’s the effect?


    Now think about this Scott, really noodle it, I know you don’t like mechanized thinking… but give it a shot:

    The only players are employer SMBs – the guys with 2-500 employees.

    If too few play at first,t eh windfalls are legendary, so more play.

    If too many play too much, the payout makes it barely worth doing.

    But certainly at $7B on average, a good percentage of them, we’re talking MILLIONS OF VESTED INTEREST PLAYERS are hedging month to month.

    Each guy is looking at his own biz, and essentially reporting back on the state of the economy with the bet he’s making.

    That’s real economic feedback. Coming and going no?

    It seems to me, the thing is really no different than a “skill based” lottery, the payout can grow and shrink as need be, but the same way the Chicago Pits normalized the commodities market…

    The Fed could operate to stabilize and valorize the SMB market.

    It’d be more fun to be a SMB owner. They’d become the “rent seeker” on the Monetary side of the realm.

  37. Gravatar of ssumner ssumner
    29. January 2014 at 17:27

    So you’re saying they’d just give $7 billion away each month? I don’t think so.

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