Reply to Greg Ip

Again I’m way behind with everything, but a quick comment on my “ban” of the term ‘inflation’.  I’m way too lazy to go through and censor every comment, what I really meant was “not respond to comments that don’t clearly express the concept they are discussing.” Inflation doesn’t clearly express any meaningful economic concept.   (I erred in using the term “ban.”)  And even that was done half jokingly–just to be provocative.  Knowing my lack of self-control, I’ll probably be back responding to “inflation” comments within weeks.  So stop worrying about 1984.

Greg Ip has a very long piece discussing all sorts of potential problems with NGDP targeting.  Since I don’t see any major faults in the idea, it’s not surprising that I don’t agree with Ip.  But I’ll focus on one passage for the moment, and perhaps consider the other objections in a later post:

So why doesn’t it? The Fed now finds itself in the odd position of being blasted from one side for doing too much and the other for doing too little. There is far more substance to the latter arguments than the former, but NGDP advocates base their arguments on a flawed premise: that with a different framework the Fed would have been less concerned about inflation and more about output, and would have thus eased more aggressively.

That was true for only for a narrow window: the summer of 2008 when oil prices spiked; at the time, the Fed, worried that high headline inflation could find its way into higher expected inflation, paused in its easing, although at least, unlike the ECB, it did not tighten. But for most of 2008, the Fed was easing. Scott Sumner and other NGDP advocates claim that had the Fed been targeting NGDP, it would have responded sooner and far more aggressively.

This fundamentally misinterprets the Fed’s behavior. The Fed’s failure to act sooner and more aggressively was down not to its policy framework but its forecast. As late as October, 2008, it thought unemployment would peak around 7.5% in 2009 and GDP would grow slightly. It also thought inflation would fall to around 1.5%, below its long-term objective. This forecast led it to lower short-term interest rates over the next two months to zero and initiate its first round of quantitative easing. A more pessimistic, and accurate, forecast would have resulted in a more aggressive policy.

If money was easy in the US during 2008, then it was easy during the US during the 1930s and Japan during the late 1990s and 2000s.  Is that really Ip’s view?

More importantly, this episode is a perfect example of the trouble central banks get into when they use their own judgment, and don’t rely on market forecasts.  The Fed had no business (in October 2008) forecasting 1.5% inflation for 2009.  All the market indicators were screaming deflation and deep recession.  So they need to start targeting market forecasts.

But it’s even worse than that.  Even if I’m wrong, and if the Fed should ignore markets and use its own internal forecasts, Ip’s data shows that Fed policy was disastrously off course in October 2008. Indeed I started my crusade for easier money that very month because it was obvious to me (and others I talked to in late 2008 like Greg Mankiw) that demand growth in 2009 was likely to come in at levels below what the Fed wanted.  They weren’t even expecting to hit their own policy goals.

Think about the Fed’s dual mandate; low inflation and high employment.  In October 2008 they forecast inflation of 1.5%; below their 2% implicit target for “stable prices.”  And they forecast a sharp rise in unemployment.  The Fed should never make that sort of forecast, as it implies their policy is far too tight.  That’s the sort of policy that would make Lars Svensson roll over in his grave.  (Actually he’s still alive—it would give him a fatal heart attack, and then he’d roll over.)  Why was the fed funds target set at 2% in early October, and 1.5% in mid-October?  Why initiate the interest on reserve program in October, a policy the Fed admits had a contractionary intent?  This policy stance makes no sense if you anticipate 1.5% inflation, and 7.5% unemployment.  The Fed should always set policy so that either both variables are on target, or if one variable calls for easier money, the other variable calls for tighter money.  And yet both the inflation and unemployment forecasts called for easier money.  (I really wish I’d had a blog then, as I wasn’t reading this critique from most other bloggers–who were obsessed with bank bailouts at that time.)

If Greg Ip thinks I’m wrong, then he should do this thought experiment.  Imagine Bernanke can go back in time to September or October 2008, and ask whether he would have cut rates much more aggressively, and started QE much sooner.  I think we all know what the answer is, after all, by early 2009 he was favoring fiscal stimulus.  Coming from a central banker, a call for fiscal stimulus is basically an admission that as far as AD is concerned “we blew it.”  But what’s most dismaying is that the Fed had all the justification it needed for easier money in its own forecasts, hopelessly flawed as they were.  And yet the Fed ignored those signals.

Greg Ip’s long post touches on three distinct issues, which are not always easy to disentangle:

1.  Can the Fed control AD at the zero bound?  Bernanke says yes.

2.  Would an explicit NGDP target, level targeting, lead to faster NGDP growth?  We don’t know what Bernanke thinks, but everything in his academic writings suggests the answer is yes, and he hinted as much for a price level target in a 2010 speech.  (And the correct answer is yes)

3.  Is stable NGDP growth a good idea, or is there some other superior central bank objective?  You can’t beat something with nothing.  If there’s some combination of price and output combinations that NGDP critics like better, say so and explain why.  I might even agree.

HT:  Dilip,  Bill Woolsey.

PS.  Here’s the Financial Post, no time to comment now.



18 Responses to “Reply to Greg Ip”

  1. Gravatar of Benjamin Cole Benjamin Cole
    1. November 2011 at 12:34

    Greg Ip is a terrific journalist, but perhaps out of his depth discussing NGDP targeting. Think Kelley Evans.

    NGDP targeting is still new to a lot of people. Think how long Krugman snorted and scoffed, before relenting that NGDP might be a good idea.

    And the ink is still fresh of Romer’s recent NYT piece. Market Monetarism has gone from obscure (and then better-known) bloggers, to mainstream media rapidly (except for those carrying the lonely torch for many a moon).

    Anyway, I contend the battle ground has shifted from the blogs (Market Monetarists won) to the media (Market Monetarists are winning), to the last assault, on the Fed and policymakers.

    Market Monetarists, keep up the fight!

  2. Gravatar of Joseph Joseph
    1. November 2011 at 13:26

    >All the market indicators were screaming deflation and deep recession.
    Hmm, if you want people to stop using the word “inflation” here should not you stop using “deflation” as well? 😉

  3. Gravatar of JimP JimP
    1. November 2011 at 13:31

    Here is the inflation argument. The guy implies that QE3 is coming, that it is all inflation and that it will doom us.

  4. Gravatar of JimP JimP
    1. November 2011 at 13:35

    This guy says the Fed already does NGDP targeting – just not successfully.

  5. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2011 at 13:45

    “If Greg Ip thinks I’m wrong, then he should do this thought experiment. Imagine Bernanke can go back in time to September or October 2008, and ask whether he would have cut rates much more aggressively, and started QE much sooner.”


    Well at least NOW you are thinking about what should have happened BEFORE Sept. 2008.

    And finally, there is no way not to do the what should have the Fed done differently before 2008.

    You can’t get a little bit pregnant.

    So now that you are having my baby, howzabout a nice thoughtful reflection on how a level target of 4% (fine you can use 4.5%) would have stopped the the crisis to begin with.

  6. Gravatar of David Pearson David Pearson
    1. November 2011 at 15:32

    Your ban got me thinking: much of what is negative about an NGDP overshoot we normally associate with the unmentionable becoming unanchored. Since we can’t mention it, how do we tell a negative story about an NGDP overshoot?

    Brazil apparently suffered from too much NGDP growth in the early 90’s. What was the impact of all this growth? Maybe if you gave us a Brazil NGDP narrative, we wouldn’t have to try so hard to stop mentioning inf… I mean, that other word.

  7. Gravatar of ssumner ssumner
    1. November 2011 at 16:43

    Ben, You have given me new hope.

    Joseph, I knew I wouldn’t be able to adhere to the rule, but I still expect my commenters to. 🙂

    JimP, I linked to the Oregon guy in the previous post. We’ll see about QE3, I have no opinion.

    Morgan, For the millionth time, 6% NGDP doesn’t cause the mother of all housing bubbles–bad regulation does.

    David, People need to take my reasoning more seriously. Unexpected NGDP growth in Brazil redistributes NGDP from lenders to borrowers. It increases the tax on capital (assuming no tax indexation–not sure about Brazil. It increases the distortions in labor markets.

    But it doesn’t hurt consumers as a class, as incomes rise just as fast as prices.

  8. Gravatar of thruth thruth
    1. November 2011 at 17:06

    You’ve been doing very well of late Scott!

    One reply to your number 3 is apparently creditism, Eichengreen and Rajan style :

    (I’m personally skeptical but they’re big names so worth taking seriously)

  9. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2011 at 17:10

    The Fed RAISING RATES to force NGDP down to below 4% in 2005-2006 (to make up for 2003-2004) keeps the Housing Crisis from happening.

    It is just another example of the Fed NEUTERING Fiscal policy.

    Look, you can’t get around it Scott, at 4%, the Fed is essentially VETOING Fannie / Freddie.

  10. Gravatar of Doc Merlin Doc Merlin
    1. November 2011 at 18:14

    @ Morgan Warstler

    I am in agreement here. If rates get too low bubbles will emerge for a variety of reasons. I also agree with Scott though in that regulation is what made it happen in housing (I think it was mostly micro-level regulation, like zoning).

  11. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2011 at 22:29

    Doc, again it is IRRATIONAL to make the argument the Fed can ALWAYS act, and then say “it was bad fiscal.”

    OF COURSE it was bad fiscal.

    But the logic of saying “the Fed can always act” morally leads us to: the Fed SHOULD and OUGHT act in ways that force the government to behave.

    Meaning, the Fed should be neutered, so it can’t act – so the current government suffers its mistakes. Putting off suffering, confuses what is good and bad fiscal policy.

    Scott’s mistake is presuming that “vote to get free shit” should be forgiven, fudged over by the Fed.

    The totality of human suffering is weighed against the behavior of its government, so a Fed that dishes out righteous medicine, reduces suffering over the long term.

    I carry the utility argument.

  12. Gravatar of Morgan Warstler Morgan Warstler
    1. November 2011 at 22:34

    Anything Doc Merlin is in agreement with me on, that Scott hasn’t written a full length post explaining himself on – is proof Scott is hiding.

    C’mon Sumner, try and swing at the fastballs. It makes you a better batter.

  13. Gravatar of Lorenzo from Oz Lorenzo from Oz
    1. November 2011 at 23:47

    Folks, give up on the asset bubbles issue. If you have macroeconomic stability in a growing economy you will get asset bubbles as confidence in the future increases, estimates of risk fall and there is more money to invest in credit and assets. This is not a “problem” for monetary policy. There are certainly issues about prudential regulation, moral hazard/risk suppression effects and such things as land rationing, but not monetary policy. Monetary policy needs to worry about achieving macroeconomic stability in a growing economy: that is enough, really it is.

  14. Gravatar of Lorenzo from Oz Lorenzo from Oz
    2. November 2011 at 04:07

    Australia had more intense bubbles in commercial land in the late 1980s, than it has since it adopted an explicit monetary regime (1993 [pdf]). Conversely, it has had amazing increases in housing land values since (though this is flattening out a bit recently). While land rationing attracts credit to housing. Asset bubbles are not a monetary policy issue.

    The real issue is that the Reserve Bank tells you what it is targeting up front on its website. Australia has an explicit monetary regime. The US Fed has no such thing. Which leaves commentary on the Fed being like doing old-style Kremlinology, which is truly pathetic.

  15. Gravatar of Paul Andrews Paul Andrews
    2. November 2011 at 04:33

    “Is stable NGDP growth a good idea, or is there some other superior central bank objective?”

    Stable RGDP growth.

  16. Gravatar of flow5 flow5
    2. November 2011 at 05:40

    IP “extreme argument that the recession could have been avoided altogether had the Fed pursued an NGDP target”

    IP “claim that had the Fed been targeting NGDP, it would have responded sooner and far more aggressively”

    I was taught in 1972 that one should eschew all gov’t forecasts. Given that one of the prerequisites for employment at the FED is an ability to deceive provides a sufficient reason to develop a ngDp futures market.

    But that’s not the problem. The nuances in the economy are revealed not by its metrics, but by the correct measurement of its metrics. Monetary lags are not “long & variable”. From the 2nd qtr of 2006 until the 2nd qtr of 2009 the rate-of-change in nominal gDp fell a phenomenal 14 percentage points. It fell 2 in 2006, 2 in 2007, 6 in 2008, & 4 in 2009. But the crystal ball extends out 2 years.

    Forecasts about nominal gDp are as predictable as the bottom in prices was this January 2011. I.e., you already knew about 2009 in 2007, etc. Therefore to say that “That was true for only for a narrow window” is very serious and narrow minded mis-statement.

    The FED should change the monetary transmission channel (interest rates) & target nominal gDp using conventional monetary operations.

  17. Gravatar of flow5 flow5
    2. November 2011 at 05:53

    But you had more advanced notice than just a single prediction. You knew about the excesses in housing for years.

  18. Gravatar of ssumner ssumner
    3. November 2011 at 18:42

    thruth, I hate to see Eichengreen get involved with Rajan, who has very odd views of central banking.

    Morgan, I’m not hiding, there is no plausible argument that the Fed created the housing bubble.

    Lorenzo, I wish I still lived in Australia.

    Paul, But the Fed can only control RGDP by controlling NGDP.

    flow5, Ip also ignores the role of level targeting in reducing the downside risk in the first place.

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