Roger Farmer on NGDP targeting

Marcus Nunes directed me to a very interesting post by Roger Farmer (written right after the Brexit vote.) Farmer suggests that the Bank of England needs to do whatever it takes to prevent uncertainty from depressing aggregate demand. Indeed it should consider buying shares in an index fund, if necessary.  He then provides a comment from Thomas Hutcheson:

“This is fine so far as it goes, but we should deal as well with the policy response of the ECB and the Fed, as well. Whatever long term damage may occur from slightly less free trade (including investment to trade) cannot be prevented by central banks, but they can prevent the damage that comes from uncertainty about the future course of NGDP. It is expectations about that they should seek to stabilize.”

Farmer replies to Hutcheson as follows:

I am in broad agreement with the proposal to stabilize expectations of future NGDP growth and, in the simple models that guide my thinking, stabilizing asset price growth and stabilizing expectations of NGDP growth amount to the same thing. The question is: how to achieve that goal?

If central banks simply substitute NGDP targeting for inflation targeting, and if they continue to try to achieve their objective by adjusting short term interest rates, not much will have been achieved. Scott Sumner has proposed instead, that central banks should trade NGDP futures. Robert Shiller goes further and advocates that national governments finance their borrowing requirements by issuing equity-like instruments that pay a trillionth of GDP: Shiller calls these ‘trills‘. I wholeheartedly endorse both of these proposals. Creating a market for nominal GDP futures, and actively trading trills for Tbills would have much the same effect as stabilizing asset price growth.

Needless to say, I’m very pleased to see that Farmer is receptive to NGDP futures targeting.  We both have a longstanding interest in the relationship between asset prices and macroeconomic stability, which perhaps puts us a bit on the fringe of the mainstream.  But Farmer is much better known than I am (he teaches at UCLA) so any support from him is very welcome.

I did find the next paragraph a bit confusing:

I differ from Scott in one important respect. Whereas Scott sees NGDP targeting as a substitute for inflation targeting, for me, it is a complement. Central banks should set interest rates to target inflation, and they should set the growth rate of some other object, be it asset prices, NGDP futures, or the price path for trills, to target the unemployment rate.

I’d need to know more, but here’s my initial reaction.  Normally economists think that you need two independent tools to hit two distinct policy targets.  Farmer would probably say that his plan contemplates two tools (interest rates and NGDP futures.)  But I see basically only one tool.  The Fed would presumably use standard monetary policies (open market operations, interest on reserves, etc.) to affect both interest rates and NGDP futures.  Can slightly different monetary tools have two independent impacts?  Buying T-bonds and stocks, for instance?  Maybe, but I’m an old school monetarist in the sense that I believe it’s the liability side of the balance sheet that really matters, not the asset side.  So unless I’m missing something, I’m skeptical of Farmer’s claim.

I should add that I am assuming this is a sort of business cycle argument.  I take it as a given that monetary policy doesn’t affect the long run trend rate of unemployment, and hence you cannot choose independent long run targets for inflation and unemployment.  (At least without other tools, beyonds monetary policy.)

PS.  Off topic, I greatly enjoyed Tyler Cowen’s recent interview at the IEA.  There was virtually nothing with which I disagree.  That’s not to say I could make the same arguments; he’s a much better social scientist than I am.  I just point this out because I have a habit of mostly responding to posts I disagree with, and so if you want to see where our views agree, that interview is a great example.  (Covers the Great Stagnation, Brexit, negative rates, education, a bit on Trump, and a few other topics.)

PPS.  Zachary David responded to my recent post on NGDP futures:

In true Sumnerian fashion, he begins with an off-hand remark about how I ignored/didn’t read his proposal. Any long time follower of his, like me, knows that this is Sumner’s standard opening move for responding to all criticisms of NGDP targeting. I’ve read it all; it’s still goofy. (though not as goofy as the time he called Arctic Monkeys a one-hit wonder)

I was giving him the benefit of the doubt.  If he actually read that paper, and then still wrote his deeply misleading post, then that’s much worse.

Let’s start here:

He wonders why NGDP futures would be such a good idea, given that the private sector hasn’t already created such a market. Perhaps that’s because the private sector is not legally allowed to do monetary policy.

Oof. This is embarrassing. Sumner attempts to imply that we haven’t seen a private sector futures contract linked to NGDP because it would necessarily “do monetary policy” which the private sector cannot. It’s a gross non sequitur and completely ignores my point. In the main piece, you’ll see that there are no fundamental or market structure issues preventing the creation of an NGDP futures contract. I use the unpopularity of the former unemployment-linked contracts as an analogous example of why his market might have problems gaining traction. Dressing up a futures contract as “monetary policy” does not make it any less of a futures contract.

The only thing embarrassing is David’s failure to understand what I wrote.  I never said an NGDP futures market would necessarily do monetary policy, I said that would be the logical motivation for creating such a contract.  If the private sector is not doing monetary policy, why would it want to create such a market?  Yes, there are no barriers to creating such a market.  Indeed I created one.  So what’s the point?

As far as not gaining traction, why would I care?  If monetary policy stabilizes the price of NGDP futures, it really doesn’t matter whether there is any trading at all.  I explained all this in the paper that he insists he read, but somehow didn’t understand.  If David’s too lazy to read the entire paper, he can try the section entitled “What if No One Trades”, which begins on page 18 and goes all the way through page 21.  Don’t you think it’s a bit silly to read that entire section, and then whine that Sumner doesn’t realize that no one might trade his contracts?

The rest of his response is more of the same.  He quotes me, and then misrepresents what I said.  Perhaps the funniest example is where he claims I was advocating a gold price peg:

. . . did an economist really just extol the virtues of gold standard pegging?

Um, no.  Why do you ask?

HT:  Dilip,  James Elizondo



37 Responses to “Roger Farmer on NGDP targeting”

  1. Gravatar of Effem Effem
    20. July 2016 at 08:31

    So fight political volatility using the very methods that helped create the political volatility (i.e., pushing up financial assets relative to incomes, thus widening wealth inequality)?

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    20. July 2016 at 08:44

    Well, I’ve jumped in at Zachary David’s site;

    Patrick Sullivan • a few seconds ago
    I’d like to see you actually confront Sumner’s (and Shiller’s) ideas, rather than a questionable paraphrase of them. So, let’s start with this from Scott’s Mercatus paper of 2013;

    Monetary policy could be greatly improved by a regime of “targeting the forecast,” or setting policy so that the expected growth in nominal GDP is equal to the central bank’s target growth rate. The central bank could accomplish this goal by setting up a nominal GDP futures market and then adjusting the monetary base to stabilize nominal GDP futures prices. The market, not the central bank, would set both the level of the monetary base and short-term interest rates under this sort of policy regime.

    For example, if the central bank’s goal were 5 percent nominal GDP growth, then it would adjust its policy instruments until the futures market also forecast 5 percent nominal GDP growth. In most cases, its policy instruments would be buying and selling government bonds on the open market.

    Eventually, the buying and selling of government bonds could even be automated, with every “long” or “short” purchase on the futures market triggering a corresponding open-market operation. For instance, each $1 purchase of a long position in a nominal GDP futures contract might trigger a $1,000 open-market sale by the Fed, while a $1 purchase of a short position would trigger a $1,000 open-market purchase by the Fed. Investors would effectively be determining the size of the monetary base.

    Could you address the specifics in the above?

    We’ll see what develops.

  3. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    20. July 2016 at 09:33

    And now Noah’s arc;

  4. Gravatar of marcus nunes marcus nunes
    20. July 2016 at 09:57

    A few years ago, Farmer wrote the GR was caused by the stockmarket crash!

  5. Gravatar of Peter Peter
    20. July 2016 at 10:11

    For NGDP futures targeting, it seems like the important piece is not the actual trading that would occur in an NGDP futures market, it’s the committment to buy and sell unlimited base-linked quantities of futures at that specified price that matters, right? Maybe NGDP futures could be thought of as a sort of credibility or committment device for keeping NGDP expectations anchored?

    Take the brexit shock. US Markets fell after the brexit results because participants did not think the Fed would keep NGDP growth stable by offsetting the increase in money demand created by brexit, right? This dynamic would not have occured under NGDP futures targeting. If people did think that NGDP would fall after Brexit, they could have made money by selling NGDP futures. But, as long as the Fed is willing to buy and sell those contracts in unlimited amounts, then the base would automatically be expected to rise and offset the increase in money demand. Knowing that this possibility exists will keep participants NGDP expectations from falling in the first place. No trading would happen, but the simple possibility that trading could take place anchors NGDP expectations.

    Is that right, or am I completely off base?

  6. Gravatar of Chris Chris
    20. July 2016 at 10:41


    I read the section in your paper about the market if there is no trading, but I’m still a bit confused.

    Let’s say at the beginning of the quarter I think NGDP growth will come in at 3% if nothing changes. I see two possibilities

    1. NGDP futures targeting is successful and on average the Fed hits the 5% target every quarter

    2. It is not successful and it is likely that NGDP will come in below target.

    Obviously you believe that 1 is closer to the truth. But under case 1, what incentive do I have to ever trade? My expected return is 0. If everybody uses this logic then nobody trades. The only reason I can see for people to trade would be if case 2 is actually true, but then its not a very successful policy.

    So the problem to me is not that nobody trades, it’s that nobody trades even when they think NGDP is off target. By acting on this belief, they prompt policy to restore the target and in doing so make their belief incorrect. I can’t think of any situation where a person can make money in an NGDP futures market by pushing the market in the correct direction. If I buy a stock I think is undervalued, I make a profit after the market corrects the price, whereas if I buy an NGDP future, I make exactly 0 if the market works.

  7. Gravatar of Brian Donohue Brian Donohue
    20. July 2016 at 11:05


    I thought this article from Tim Duy was very good. The business press seems to be getting the hang of things:

    Interested in your reaction…

  8. Gravatar of John Hall John Hall
    20. July 2016 at 11:35

    What if you complemented a nominal GDP target with a rule that adjusts the NGDP target growth rate based on long-term inflation expectations?

    So for instance, if you have a 5% NGDP level target and then long-term inflation expectations rise to 2.5%, then you bump down the NGDP target by 25bps to 4.75% and wait a year and see what happens.

  9. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    20. July 2016 at 12:15

    What developed with Zachary David was DeLongism. He deleted my post rather than responding to it.

  10. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    20. July 2016 at 12:23

    As for Noah Smith, it’s been 4 hours since I started posting excerpts from Scott’s 2013 paper for specific responses by him, to no avail…so far.

    Both Zachary David and Noah seem to be more comfortable confronting their strawmen rather than what Scott’s argument actually was.

  11. Gravatar of Major.Freedom Major.Freedom
    20. July 2016 at 15:05

    This is fine so far as it goes, but we should deal as well with the policy response of the ECB and the Fed, as well. Whatever long term damage may occur from slightly less free trade (including investment to trade) cannot be prevented by [government], but they can prevent the damage that comes from uncertainty about the future course of [fill in the socialist demand here]. It is expectations about that they should seek to stabilize.

    This is the consistent principle underlying these socialist demands for less freedom.

  12. Gravatar of Major.Freedom Major.Freedom
    20. July 2016 at 15:10

    We both have a longstanding interest in the relationship between asset prices and macroeconomic stability

    Please explain how your not caring a lick about asset prices, and focusing entirely on NGDP, and from time to time paying lip service to “fiscal reform” and vague “supply side problems”, constitutes a ” long standing interest in the relationship between asset prices and macro-economic stability”.

  13. Gravatar of Major.Freedom Major.Freedom
    20. July 2016 at 15:10

    Now we’re back to reasoning from a price change being a good thing.

  14. Gravatar of Benjamin Cole Benjamin Cole
    20. July 2016 at 15:32

    Central banks should set interest rates to target inflation, and they should set the growth rate of some other object, be it asset prices, NGDP futures, —Farmer.

    I dunno….Japan? Will even deeper negative rates budge inflation?

    Are not interest rates, QE, helicopter drops, trills, IOER all mixed together in their results?

    BTW Japan has chronic tight labor markets and deflation….

  15. Gravatar of Ray Lopez Ray Lopez
    20. July 2016 at 21:07

    The simpleton Farmer says: “I am in broad agreement with the proposal to stabilize expectations of future NGDP growth and, in the simple models that guide my thinking, stabilizing asset price growth and stabilizing expectations of NGDP growth amount to the same thing. The question is: how to achieve that goal?”

    No, Farmer Fred, the question is: why should a complex, chaotic, non-linear economy be guided by a simple first-order differential equation such as posited by you, which you could have pulled out of a first year diff. eq. book like M. Braun? It should not. Happily for you and Sumner, however, money is neutral so it really doesn’t matter what you do to the money supply, short of creating hyperinflation.

  16. Gravatar of James Alexander James Alexander
    21. July 2016 at 01:00

    Maybe think of the Fed fining itself if it doesn’t hit the target.

    If you buy at 3% and the Fed moves NGDP expectations to 5% you win 2%.

    Those who buy later as the forecast moves to 5% win less.

    If the Fed doesn’t move NGDP to 5% and you bought at 3% you still win 2%.

    The incentive is for the Fed to lose less by moving NGDP to 5%.

    You still win if NGDP growth goes to 2% just not as much as if you’d bought at 2%. The Fed loses even more.

    The Fed can never win, it is subsidising the market in the interests of macro-stability. It gets penalised if its projections are wrong, if it hasn’t done enough.

  17. Gravatar of Grant Gould Grant Gould
    21. July 2016 at 05:08

    Prof. Sumner —

    I have read here and half a dozen other places variations on your remark, “you need two independent tools to hit two distinct policy targets,” and I am a bit confused by it. Is this an empirical or a theoretical result?

    I work in robotics, where we routinely move “underactuated” systems (systems with more unconstrained degrees of freedom than degrees of actuation) into arbitrary states. Different parts of the system might respond to different modes of the control input, for instance, or to different derivatives or frequencies. Thus I’m slightly surprised the same principles might not be true in economics.

    Is this just a simplifying assumption, or is there an underlying theory that makes this true of economics in particular?

  18. Gravatar of Gary Anderson Gary Anderson
    21. July 2016 at 05:11

    Monetarism was formulated prior to the dramatic rise in demand for bonds as collateral in the derivatives markets. We are talking about trillions upon trillions of dollars of bonds that are being squirreled away for this collateral.

    Monetarism does not speak to this collateral and this new normal at all. It needs to to be relevant.

  19. Gravatar of John Hall John Hall
    21. July 2016 at 05:15

    Arctic Monkeys are not really even a one-hit wonder in the U.S. Maybe the U.K.? Their highest charting song (in the U.S.) barely broke the top 100 of the charts.

  20. Gravatar of ssumner ssumner
    21. July 2016 at 05:33

    Marcus, I don’t agree with him on the stock market. Consider the 1987 crash, unemployment fell afterwards.

    Peter, That’s right. The central bank is not going to intentionally lose zillions of dollars, and hence they need to keep monetary policy on course to avoid massive losses.

    Chris, Your argument proves too much, as there would be no arbitrage in any market (your claim implies) if people thought arbitrage would successfully move asset prices to equilibrium.

    In any case, people have diverse views, and those who think the Fed is too loose or too tight will trade.

    John, I’d rather adjust if for population growth changes. But I do think your proposal is still better than the status quo, although not not preferred option.

    The Arctic Monkeys were just a throwaway joke, I know almost nothing about them.

    Grant, It’s theory, but also common sense. Suppose you set the (single ) instrument at a level expected to produce 2% inflation. Then you instruct them to also hit 5% NGDP growth. As soon as you adjust the instrument for 5% NGDP growth, it’s no longer the right setting for 2% inflation.

  21. Gravatar of Gary Anderson Gary Anderson
    21. July 2016 at 09:01

    So, Scott, at least mention whether you are thinking about making monetarism more relevant in this age of bonds as collateral? I would wait an entire year for your solution. Just throw down some understanding yields cannot go up much, because of this collateral. The system is addicted to this collateral. The system is prisoner to this collateral.

    And that means bond yields must stay low and banks must not lend much to the real economy in order to keep inflation way down.

  22. Gravatar of Chris Chris
    21. July 2016 at 09:08

    James, I thought the plan was that the Fed buys and sells unlimited quantities at 5%. Nobody is selling at 3%, so if I want to bet on 3% I short sell the 5% from the Fed, which is supposed to then pull money into the economy and raise NGDP. But if it raises NGDP to 5% when I buy back my shares they cost exactly the same as I sold them for and my profit is 0, not 2%. Maybe I am missing something?

    Scott, I don’t think so. As I said, with stocks I can easily make money through arbitrage. If I think the correct price of Apple is 105 and it’s currently at 100, I buy at 100. If I am right and the equilibrium price is 105, I make 5% profit on my trade. On the other hand, trading on NGDP futures pushes the market in exactly the opposite direction I want it to go. If I make profit when NGDP is too low, why would I take an action that pushes it higher? Again, maybe I am misunderstanding the policy. I am assuming that the Fed buys and sells unlimited quantities at 5%, so my only options are to buy or sell at 5%. Then if NGDP targeting works, my expected profit is always 0 even if I was initially right that policy was too tight at the time I traded.

  23. Gravatar of ssumner ssumner
    21. July 2016 at 11:37

    Chris, The answer is simple. Your don’t think your individual purchase of NGDP futures will affect future NGDP very much. You are just one trader.

    In any case, I really don’t care if no one else buys NGDP contracts . I will, and if I’m the only one then I’ll be able to have all the profits for myself. I’ll buy some, but not enough to bring expected future NGDP all the way back to target. Free money!!

    See my new Econlog post.

  24. Gravatar of ssumner ssumner
    21. July 2016 at 11:39

    Gary, You might want to try reading a different type of blog, perhaps one focusing on cute cat videos.

  25. Gravatar of Roger Farmer Roger Farmer
    21. July 2016 at 12:23

    I’m happy to endorse the idea of trading NDGP futures. I do think the point that the market is currently thin is something to be concerned about. That’s why I like the Shiller idea of financing government deficits with Trills. (The Bank of England has a working group currently thinking about this.) An alternative, that I have advocated, is trading an ETF defined over the whole market.

    The reason I see NGDP targeting and inflation targeting as complements is because I do not believe that the real economy homes in on the natural rate of unemployment. The reason has nothing to do with sticky prices; it has to do with missing markets and is explained in a series of research papers that are linked on my blog and in a forthcoming book, Prosperity for All.

    The 1987 crash was different because the Fed still had room to lower rates. That was not true in 1931 and it was not true in 2009.

  26. Gravatar of James Alexander James Alexander
    21. July 2016 at 12:44

    You are correct in that you do need to be rewarded for getting it right. I think it helps to separate two models here.

    I think there is a basic model whereby the Fed has discretion over how it gets NGDP back up or down to target. And the Fed has to pay out for missing the target. That is what I was thinking in my reply.

    In a more advanced model the Fed has no discretion and has to issue more money until NGDP is on target. Why not see yourself as betting on how much money the Fed is obliged to create (or destroy)? If you expect nominal growth is going to slow then you’d bet on the Fed issuing $100bn and you win if you get it right. If nominal growth expectations pick up to target with only $50bn them you lose.

  27. Gravatar of Mike sankowski Mike sankowski
    21. July 2016 at 14:26


  28. Gravatar of ssumner ssumner
    21. July 2016 at 18:11

    Roger, Thanks for the comment. I need to look at your new book when it comes out. I do now recall your view on the natural rate, which is different from my own–I look forward to finding out more about your theory.

    Regarding NGDP futures, I believe that many people overthink this issue. You don’t need any trading at all. The Fed can still do its own thing, using discretion if it wishes. All you need is for the Fed to commit to take the other side of trades, at least where traders expect the outcome to be outside some range, say 3% to 5%. The Fed must take a short position at 5% with anyone wanting to go long, and vice versa. That sets “guardrails” on policy and prevents disasters such as 2008, when they let NGDP expectations slip into negative territory.

    I could have gotten rich in late 2008 at the Fed’s expense, with their existing policy. They would have seen that risk and been much more aggressive with stimulus, to avoid losing a fortune to people like me—who clearly saw NGDP expectations slipping badly. That’s all you need, market guardrails on Fed behavior. Let them have discretion within those guardrails.

  29. Gravatar of Chris Chris
    21. July 2016 at 20:56

    James, betting on how much money the Fed seems to at least put the incentives in the right direction (at least I can still win if I am right and the policy works). I would need to think a bit more on how to actually implement that kind of market, but I think it’s a step in the right direction.

    Scott, I still don’t see it. I know individual traders can make profit when the Fed fails. What I don’t see is how they can make profit when it succeeds. I posted a bunch of comments on your Econlog post. There’s still a high chance I’m misunderstanding something, but you haven’t convinced me yet.

  30. Gravatar of Gary Anderson Gary Anderson
    21. July 2016 at 21:46

    Scott, you might want to get your head out of the sand and realize that bonds aren’t going up in yield because everybody wants them and depends on them. You can insult all you want but you just show your ignorance of this issue. Derivatives collateral is growing leaps and bounds. If you discount it, you will never get your answer as to why the Fed ignores you and your NGDP targeting.

    And by the way, I enjoy cute dog videos more than cute cat videos. I need to find a blog where people aren’t afraid to talk about bond demand. Do you read the FT Scott?

    Clearinghouses are supposed to limit systemic risk. But Scott, they have not, precisely because the collateral is becoming scarce. Got that Scott? Want you know why prices for bonds are up? They are fricken SCARCE you dolt.

  31. Gravatar of Gary Anderson Gary Anderson
    22. July 2016 at 05:57

    You aren’t a dolt, sorry, just stubborn. You have a system. It should take into account demand for bonds and lack of supply.

  32. Gravatar of flow5 flow5
    22. July 2016 at 06:25

    “We believe policymakers are so scarred by the events of 2008 that they live in constant fear of anything resembling a recurrence,” say the Bank’s Global Markets economists. “The simplest way to prevent one has little to do with achieving 2 percent inflation and much to do with minimizing the variance of nominal growth, preferably while maintaining full employment.”

    “You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time.” – Abraham Lincoln

    Targeting N-gDp caps real-output. And targeting R-gDp is easier to do.

  33. Gravatar of flow5 flow5
    22. July 2016 at 06:28

    Interest rates are low because Vt is low. Vt has been trending down c. 1981 and this accelerated after the remuneration of reserves. Bottling up existing savings within the commercial banking system retards economic growth. This is the cause of the decline in Vt. I.e., the deregulation of Reg. Q ceilings for the CBs was a theoretical mistake. CBs do not loan out existing deposits, saved or otherwise. $9 trillion dollars of savings are lost to investment, to consumption, indeed to any type of payment. This is what will flat-line gDp.

  34. Gravatar of ssumner ssumner
    22. July 2016 at 07:22

    Gary, You said:

    “You can insult all you want”

    Are you really this dense? Do you really not see what’s going on here? Seriously?

    OK, I’ll spell it out one more time. I initially responded very politely to your inquiries, spending hours trying to educate you. Eventually I realized that you were simply not smart enough to understand this stuff. No shame in that, I’m not smart enough to understand relativity.

    Then I politely told you to stop commenting here. You acted like a jerk and kept commenting over and over again. And now you talk about my “insults”?

    I suppose if you broke into someone’s house and they told you to get the hell out you’d view that as an “insult”.

  35. Gravatar of Gary Anderson Gary Anderson
    22. July 2016 at 08:07

    Fair enough Scott, sorry I broke into your house. But in those hours of instruction, you have never commented about bond demand exceeding supply and why that is. That is all I want to know more about. That is happening, and it isn’t going to stop. It probably will affect yields for many, many years. What could stop it? The banks and the financial system are prisoners to bond yields. They are weak.

    I understand, by the way, how NGDP cratered prior to inflation cratering in 2008, and have defended you in articles speaking to this revelation you have given the world. So I have learned something along the way, Scott.

  36. Gravatar of James Alexander James Alexander
    22. July 2016 at 23:17

    Mike Sankowski

  37. Gravatar of NGDP Futures Targeting Is A Pretty Goofy Idea | Zachary David's NGDP Futures Targeting Is A Pretty Goofy Idea | Zachary David's
    26. July 2016 at 23:22

    […] objected to my […]

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