Supply shocks and NGDP targeting

Sorry, still no time for comments–I’ll try to get to them gradually over the next week.

Meanwhile I wanted to link to this excellent discussion of NGDP targeting by Ryan Avent:

Now, in a situation in which a central bank has credibly established an NGDP target, recessions would by definition be due to real shocks. In those cases, maintaining the target would mean higher inflation to go with lower real growth. So if the American economy is hit by a real shock, an NGDP target might mean inflation at 5% and zero real growth, rather than what we might observe today””inflation around 3% and a drop in real growth of perhaps 2%. I’m happy to have a debate about which Americans are likely to prefer, provided that we stipulate that in the meantime, the NGDP target is also preventing major episodes of cyclical unemployment. It’s worth mentioning that given a positive productivity shock, an NGDP target would imply real growth above normal levels and inflation below normal levels. An inflation-targeting central bank, by contrast, might respond by adding more stimulus to an economy, potentially inflating bubbles.

This is a good response to Kevin Drum, but I’d like to add a footnote.  Supply shocks aren’t bad because they cause “inflation,” they are bad because they reduce resources available to our society (often oil and food) and hence reduce real GDP, real living standards.  Let’s start with a perfectly flexible wage price model, then add sticky prices.  With complete flexibility, a supply shock that reduces real output by 3% might lead to 5% inflation and 0% RGDP growth (assuming a 5% NGDP target.)  That’s unpleasant.  But exactly the same reduction in real output and living standards would occur with any inflation rate, including the normal 2%, or even 0%.  With perfect wage and price flexibility, the supply shock will immediately reduce real wages, so whatever the inflation rate is, wage growth will be even lower (relative to trend.)  It makes no sense (in that case) to talk about supply shocks being bad because the cause “inflation;” they are bad because the are real shocks, they reduce real output.

Now consider the more realistic sticky wage/price case.  If the Fed keeps inflation at 2% during the supply shock, then the adjustment in real living standards must occur via nominal wage reductions.  We know that nominal wages are sticky, the evidence is overwhelming.  Thus an inflation targeting regime will lead to a situation where supply shocks push actual nominal wages above equilibrium, until they have fully adjusted.  This will lead to needless cyclical unemployment, above and beyond the direct effect of the real shock.  America will suffer from less food and oil, and in addition a wave of involuntary “vacations” due to nominal wage stickiness.  Real GDP and hence real living standards will fall by even more than in the flexible price case.  Yet when most people are told that a downside of NGDP targeting is that it will allow higher inflation during recessions, they form a mental picture of Americans suffering a loss of living standards due to the inflation the Fed is allowing during the supply shock.  In fact, just the opposite is true–any inflation allowed by the Fed raises living standards (i.e. makes the reduction smaller.)

In contrast, NGDP targeting allows just enough inflation during supply shocks so that workers don’t need to take nominal wage cuts.  The necessary loss in living standards occurs via prices rising faster than wages, but there is no unnecessary cyclical unemployment to add to our woes.  It allows the price of the two problem goods (food and energy) to rise to reflect their scarcity, but doesn’t impose all sorts of other wage and price changes on the economy.  Because wages are sticky, forcing all sorts of other wages and prices to adjust adds needless “misallocation” to the economy.  That’s why Austrians like Friedrich Hayek favored NGDP targeting.

[I love the fact that my more Rothbardian Austrian readers get enraged every time I mention Hayek.]

HT:  Marcus Nunes


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56 Responses to “Supply shocks and NGDP targeting”

  1. Gravatar of Morgan Warstler Morgan Warstler
    26. October 2011 at 05:17

    Hayek: It is scummy to do, because you write the whole post HIDING from the growth ceiling side, whereas as Avent at least mentions it:

    “It’s worth mentioning that given a positive productivity shock, an NGDP target would imply real growth above normal levels and inflation below normal levels. An inflation-targeting central bank, by contrast, might respond by adding more stimulus to an economy, potentially inflating bubbles.”

    You idiots need to say Hayek would really like to see the booms pissed on, and the downward force on public and upward force on private consumption brought about by a LOW NGDP target.

    Hayek would favor no more than 4% NGDP level. Probably 3%.

    Not focusing on the pieces that he’d actually care about the most makes you seem squirrelly.

  2. Gravatar of StatsGuy StatsGuy
    26. October 2011 at 05:35

    “Hayek would favor no more than 4% NGDP level. Probably 3%.”

    Leaving money illusion aside, the issue isn’t the actual level of NGDP growth targeted. The issue is the level of growth RELATIVE TO PRIOR EXPECTATIONS of the level of growth.

    If the Fed says they’re going to initiative a 5% NGDP level target, and beginning in 30 years (the longest dated bonds held by large segments of the population) we’re going to begin reducing the level target to 4% over the course of the subsequent 10 years, that should not cause a problem.

    Cutting it IMMEDIATELY to 3%, given historical expectations of 5% built into the asset markets, is nothing short of government-enforced redistribution of wealth from productive asset holders to bond/cash holders.

  3. Gravatar of JimP JimP
    26. October 2011 at 05:50

    http://www.businessinsider.com/again-goldman-calls-for-the-fed-to-use-unconventional-unconventional-policies-2011-10

    Goldman says it again. They are really on this – which is wonderful.

    Scott once said – long ago – that he could not understand why there are people like Kudlow (my use of that vile name – not his) – people who claim to want a good stock market but who hate even a hint of an active Fed – people who love deflation, falling wages and a strong dollar.

    Clearly Goldman is not in that camp.

  4. Gravatar of Nick Rowe Nick Rowe
    26. October 2011 at 05:53

    To add to Statsguy’s point, my guess is that if Scott were transported back in time and across the Atlantic, so that he and Hayek were both living in an economy that had previously gotten used to 3% or 4% NGDP growth on average, the numbers they both picked would be roughly that same 3% or 4%.

  5. Gravatar of TGGP TGGP
    26. October 2011 at 06:06

    Doesn’t inflation (even a constant low rate) have real costs all its own? Otherwise one might just as well pick a 100% NGDP growth target rather than 5%.

  6. Gravatar of Dan Kervick Dan Kervick
    26. October 2011 at 06:15

    Can’t you have a kind of supply shock that doesn’t reduce the amount of some essential input that our society purchases, and doesn’t suppress output, but just increases the cost of production and the price of the output?

  7. Gravatar of bill woolsey bill woolsey
    26. October 2011 at 07:07

    Kervik:

    A supply shock where the supply of some good or other doesn’t shift to the left or “up?” What are you talking about, exactly?

  8. Gravatar of johnleemk johnleemk
    26. October 2011 at 07:09

    “Can’t you have a kind of supply shock that doesn’t reduce the amount of some essential input that our society purchases, and doesn’t suppress output, but just increases the cost of production and the price of the output?”

    Can you give an example of a supply shock that wouldn’t affect quantity or quality of factors of production, but would affect their prices? I can’t think of anything. The whole point of a supply shock is that it costs more to make stuff because there is less stuff to begin with.

  9. Gravatar of Nick Rowe Nick Rowe
    26. October 2011 at 07:14

    TGGP: yes. But probably not very big, as long as it’s fairly low, and we’re all used to it.

    Dan: Yes. One example. A few years back, Canada replaced an inefficient tax with a VAT. The net effect, given sticky nominal input prices, was a small jump in the price level. But it either had no effect on the productive capacity of the economy, or even increased it very slightly, since it was a better tax.

    The Bank of Canada’s response (because it knew this shock was coming) was to say “OK, we will allow a one-time temporary jump in inflation, but will stamp out any second-round spiral effects”.

    It’s an interesting case, because they knowingly fudged their inflation target, but everybody agreed it was the right thing to do.

  10. Gravatar of Nick Rowe Nick Rowe
    26. October 2011 at 07:20

    Course, if Bill and john say that wasn’t really a supply shock, OK. But it wasn’t really a demand shock either. Some people call that sort of shock a “price shock”, but that’s not an ideal terminology either.

  11. Gravatar of Rob Rob
    26. October 2011 at 07:29

    I think Hayek favored a stable NGDP (in effect a NGDP target of 0%, with at most some variation to reflect growth in the work force)

    To achieve this we would need to reduce inflation expectations to zero and have prices reduce to reflect productivity increase (and increase to reflect supply-shocks).

    Other than the issue of inflation-expectations I do not think that Hayek would have disagreed with Scott’s post though.

  12. Gravatar of Richard A. Richard A.
    26. October 2011 at 07:30

    IOWs, a smooth growing nominal GDP stabilizes the demand for labor.

    The dynamic AD-AS model that Tyler Cowen and Alex Tabarrok use in Ch. 12 in their macro textbook can easily be modified for labor. Let the vertical axis represent wage inflation and the horizontal axis the growth rate of the available labor supply. The long run growth rate supply curve for labor would be vertical (at about 2% or so for the US) while the short run supply curve would be sloping. Such a model would show that a changing rate of growth for GDPn would destabilize the demand for labor.

  13. Gravatar of Dan Kervick Dan Kervick
    26. October 2011 at 07:41

    “A supply shock where the supply of some good or other doesn’t shift to the left or “up?” What are you talking about, exactly?”

    Bill Woolsey, maybe this is just a semantic issue, but I thought a supply shock was anything that increases the price of some factor input due to a diminished supply of that input. In some cases, the reduced supply might mean less is purchased by particular buyers of the input, and their output goes down. But in other cases, the same amount is purchased but at a higher price, the same output is produced and the increase is just passed to the next customer in the chain. Doesn’t that sometimes happen when the demand for the good is relatively inflexible?

  14. Gravatar of johnleemk johnleemk
    26. October 2011 at 07:50

    Dan,

    That’s plausible in microeconomics but not macro. If consumers purchase more of one product, they must by necessity purchase less of another. It does not make sense for the cost of factors of production to increase without a fall in aggregate supply.

    Nick,

    That’s a supply shock I think. But the way I would think about it is in two steps:

    1. Getting rid of an inefficient tax increases potential output
    2. Adding a new VAT reduces potential output

    #1 and #2 can cancel each other out, but that doesn’t mean that as individual shocks they didn’t affect potential output.

  15. Gravatar of Benjamin Cole Benjamin Cole
    26. October 2011 at 07:54

    Excellent post by both Ryan Avent and Scott Sumner.

    Go Market Monetarists!

  16. Gravatar of John John
    26. October 2011 at 08:03

    I still laugh when you say that “Austrians like Friedrich Hayek favored NGDP targeting.” If Hayek ever said anything like that, it was well after the period when he was an economist and no other Austrians backed him on it. The two most important works in the “Austrian” economic canon are “Human Action” by Mises and “Man, Economy, and State” by Rothbard. Neither book mentions anything about NGDP targeting, advocates a central bank, or recommends anything other than market chosen commodity money.

    Back in the days when Hayek was actually an economist, he was a political scientist later, he wrote “Prices and Production” and “The Pure Theory of Capital.” Neither one has any mention of NGDP targeting.

    The point I’m trying to make is that NGDP targeting is not something favored by Austrian economists and not a part of Austrian thought. It doesn’t flow from the Mises-Hayek-Rothbard view of money. Scott is just saying that to try to convince free market people that NGDP targeting is a good idea.

  17. Gravatar of Nick Rowe Nick Rowe
    26. October 2011 at 08:28

    johnleemk:

    Let me take a different example. Suppose you replace a tax on wage income with a VAT. Assume the two taxes are equally efficient, so there’s no effect on LRAS (potential output). But if nominal wages are sticky in the sort run, the SRAS curve shifts up/left.

    Even simpler: switch an employment tax away from workers onto employers. This will have zero effect on anything, if wages are flexible. But if wages are sticky, the SRAS shifts up/left.

  18. Gravatar of David Pearson David Pearson
    26. October 2011 at 08:47

    Is the idea of an NGDP gravitating towards a trend a valid construct? Nominal spending should rise with incomes over time. Disaggregated income trends in the U.S. show extreme variation: corporate profits have spiked, as have incomes of the top 10%. Meanwhile, incomes for the bottom 90% of households have stagnated.

    So which is the trend that the Fed should “sustain”? Should it rely on continued gains in share of national income (already at peak) by corporations and wealthy households? Or expect a reversal in the trend towards middle class income stagnation? I would argue that reducing real wages through (headline-led) inflation is not likely to achieve that second goal.

    This is not a value judgement, but an observation that if your hair is on fire and your feet are on ice, the “average” temperature of your body tells you little. The NGDP trend, translated into nominal income, suffers from the same type of variation.

  19. Gravatar of bill woolsey bill woolsey
    26. October 2011 at 08:47

    If the supply of the input decreases (shifts left,) then this also shifts the supply of the output (shifts left.)

    If you assume perfectly inelastic demand (not somewhat inflexible,) then a decrease in supply has no impact on the equilibrium quantity. It just raises the price.

    Of course, economists generally don’t go for perfectly inelastic demand.

    Anyway, I just did a post on supply shocks.

    http://monetaryfreedom-billwoolsey.blogspot.com/2011/10/bennett-mccallum-has-written-short.html

    I discuss what Nick calls “price shocks,” as well as the opposite, which would be “output shocks,” I suppose.

    But I think that in reality there is no such thing as either, but rather micro supply shocks that generate both price and output effects together.

    But the way, just as the “price” shock seems to imply perfectly inelastic demand for some particular good, I would think that the pure output effecdt would require perfectly elastic demand for the goods with the shock.

    And while I agree with Sumner’s analysis more or less, I think that it works exactly when the particular good with the supply shock is unit elastic. Otherwise, stabilizing aggregate nominal expenditure involves changing in nominal expenditure on and nominal incomes earned from everthing else.

    It really comes down to nominal GDP targeting being better than price level targeting when there is a supply shock unless the demand for the good with the shock is very elastic. Then maybe a price level target is better.

  20. Gravatar of Dan Kervick Dan Kervick
    26. October 2011 at 08:48

    That’s plausible in microeconomics but not macro. If consumers purchase more of one product, they must by necessity purchase less of another. It does not make sense for the cost of factors of production to increase without a fall in aggregate supply.

    What about savings? Can’t they maintain their current level of purchases by depleting savings?

  21. Gravatar of bill woolsey bill woolsey
    26. October 2011 at 08:52

    John:

    According to the Rothbardians, Austrian economics is Murray-Rothbard thought.

    Hayek argued that the “ideal” for equilibrium was a stable flow of expenditure on output.

    The “theory” that the optimum is whatever happens to nominal expenditure, prices, and output given a 100% reserve gold standard was Rothbard’s ideology. A position taken now by all of his dogmatic followers. For odd historic reasons they choose to call it “Austrian” economics or maybe “Misean” economics, when really it is “Murray Rothbard Thought.”

  22. Gravatar of Fed Up Fed Up
    26. October 2011 at 08:55

    “But exactly the same reduction in real output and living standards would occur with any inflation rate, including the normal 2%, or even 0%. With perfect wage and price flexibility, the supply shock will immediately reduce real wages, so whatever the inflation rate is, wage growth will be even lower (relative to trend.)”

    Are you going to reduce the “real corporate income” too so that the “living standard” of corporations goes down also?

    And, “The necessary loss in living standards occurs via prices rising faster than wages, but there is no unnecessary cyclical unemployment to add to our woes.”

    How is that going to affect debt levels?

  23. Gravatar of Fed Up Fed Up
    26. October 2011 at 09:07

    “With complete flexibility, a supply shock that reduces real output by 3% might lead to 5% inflation and 0% RGDP growth (assuming a 5% NGDP target.)”

    Let’s say there is a medium of exchange “shock” (like a Minsky Moment) that reduces real AD of final demand so that real GDP is 1.5% and price inflation goes to 3.5% with productivity of 2% or higher. With 1.5% real GDP and productivity of 2% or higher, employment falls. I assume you will want wages below 3.5%. It seems to me that in both cases debt defaults are more likely causing another medium of exchange “shock”. How does it end?

  24. Gravatar of Fed Up Fed Up
    26. October 2011 at 09:10

    About our ongoing discussion about real aggregate demand (AD) NOT being UNLIMITED:

    http://econlog.econlib.org/archives/2011/10/for_the_myth_of.html

    “For the Myth of the Macroeconomy File”

    “Physical jobs are disappearing into the second economy, and I believe this effect is dwarfing the much more publicized effect of jobs disappearing to places like India and China.

    the main challenge of the economy is shifting from producing prosperity to distributing prosperity. The second economy will produce wealth no matter what we do; distributing that wealth has become the main problem. For centuries, wealth has traditionally been apportioned in the West through jobs, and jobs have always been forthcoming. When farm jobs disappeared, we still had manufacturing jobs, and when these disappeared we migrated to service jobs. With this digital transformation, this last repository of jobs is shrinking-fewer of us in the future may have white-collar business process jobs-and we face a problem.”

    “The standard view in economics is that wants are unlimited, so that in the long run as old jobs are destroyed new jobs are created. ***But will reality conform to this theory?*** Brian Arthur is suggesting that it might not. I have an article coming out in about a month at American.com that speculates along very similar lines.

    What if there are many people whose marginal product is so low that there is little social cost to their engaging in leisure rather than in work? How do we adapt to that? As Arthur puts it,

    Perhaps some new part of the economy will come forward and generate a whole new set of jobs. Perhaps we will have short workweeks and long vacations so there will be more jobs to go around. Perhaps we will have to subsidize job creation. Perhaps the very idea of a job and of being productive will change over the next two or three decades.

    I file these pieces under “Myth of the Macroeconomy” because they stress the importance of economic transformation, not aggregate demand and sticky nominal wages.”

    I believe they have left out more retirement.

  25. Gravatar of Morgan Warstler Morgan Warstler
    26. October 2011 at 09:56

    Stats, I’m not an idiot, I use 3-4% because that’s our historical RGDP.

    Stop dreaming Nick.

    Hayek would look at RGDP that is historically 3.25% and say .25%-.75% inflation sounds good to me going forward.

    1. Because after all hawks favor opportunistic disinflation.
    2. As things have been slowing down on the RDGP side, better to be conservative.
    3. Because, as Scott admits, when you routinely bang into the top side of your level target – it puts pressure to reduce public spending in favor or private spending – and Hayek would LOVE THAT, so would Friedman, and secretly so does Scott.

    Look boys, let’s just admit 3% NGDP is HARD MONEY.

    5% would have proven more conservative than our past the years and likely would have averted the financial crisis.

    And we’re going to come in under 5%, in order to win over conservatives.

  26. Gravatar of Morgan Warstler Morgan Warstler
    26. October 2011 at 10:08

    Fed Up,

    “the main challenge of the economy is shifting from producing prosperity to distributing prosperity. The second economy will produce wealth no matter what we do; distributing that wealth has become the main problem. For centuries, wealth has traditionally been apportioned in the West through jobs, and jobs have always been forthcoming. When farm jobs disappeared, we still had manufacturing jobs, and when these disappeared we migrated to service jobs. With this digital transformation, this last repository of jobs is shrinking-fewer of us in the future may have white-collar business process jobs-and we face a problem.”

    The MAIN CHALLENGE is to force liberals to accept that:

    1. ALL people will be forced to work 40 per week.
    2. They WILL ALL have a boss.
    3. Someone will earn profit on their labor.

    Once you accept those conditions as fact, and then read the above paragraph you will invent my Guaranteed Income plan.

    1. The Unemployed are Guaranteed an income.
    2. The Unemployed are auctioned.

    The questions isn’t if there are jobs for people to do – of course there are, the question is simply who will bid the most to buy their labor.

    Demand in service sector is as infinite as human want. People want massages, personal chefs, their nails and hair done, they want babysitters, they want call center operators who speak English as a first language, and they want their yard and neighborhood clean and tidy.

    All people want these things, and fortunately we have 25M unemployed to provide them at rates that would make Groupon envious.

  27. Gravatar of Jeff Jeff
    26. October 2011 at 10:08

    As an impartial observers of the economy it might be clear that inflation during recessions helps, but how do you convince the 90% with jobs that we need to lower their real wage in order to make the economy better?

  28. Gravatar of Liberal Roman Liberal Roman
    26. October 2011 at 11:00

    Isn’t this the essential political problem of an NGDP targeting regime. People have an instinct-like aversion to inflation.

    I remember a survey where people were asked would you rather have unemployment rise by 10%, but prices to remain stable or have unemployment not rise but prices to rise 10%. Overwhelmingly people chose to have unemployment rise and prices to stay the same.

  29. Gravatar of Becky Hargrove Becky Hargrove
    26. October 2011 at 11:12

    Fed Up,
    The primary resource that is growing in our time is that of human skills in connection to knowledge. Plus, skills/knowledge growth has become exponential, as other growth indicators gradually slow down. Have patience, the wealth potential inherent in humanity will eventually be recognized for what it is. Morgan, before you disagree check my comment to you on the last blogpost.

  30. Gravatar of Morgan Warstler Morgan Warstler
    26. October 2011 at 11:15

    Liberal Roman / Jeff,

    That is WHY it is sooooo crucial these people stop talking about the thing they care about and instead sell what the audience cares about.

    If you sell it as a jobs plan for the marginally least productive, no one cares about them enough to pay the inflation tax.

    The other side of the coin to “print now” to get to 4% NGDP:

    1. we don’t have future boom / bust crisis.
    2. the Fed is weakened, has less say – so banks are weakened.
    3. private investment crowds out the public sector.

    These are ALL GUARANTEED effects of a 4% level targeted NGDP, and all of those things would make the 90% with jobs, the Tea Party, etc. LIKE the plan.

  31. Gravatar of W. Peden W. Peden
    26. October 2011 at 12:22

    John,

    Along with Hayek, George Selgin is another example of an Austrian who would prefer NGDP targeting to the existing system. Along with both thinkers, I would prefer the denationalisation of money to NGDP targeting.

  32. Gravatar of John John
    26. October 2011 at 13:47

    Bill,

    I’m more of a fan of Mises than Rothbard. Among Mises, Hayek, and Rothbard, I like all their economic writings in different ways but pretty much equally. I have a soft spot for Mises I suppose since I love his writing style. The point is that it definitely isn’t all about Rothbard.

    W. Peden,

    I’d prefer NGDP targeting to the current system because it at least holds the most powerful, unsupervised person (the Fed chairman) in the country accountable. That doesn’t mean that me or George Selgin, whose writings I’m not that familiar with, think it’s a great idea. Just a slight improvement over the current system which is one of the worst setups possible. It’s like preferring black liquorice jellybeans over those horrible egg jellybeans. They’re both completely nasty.

  33. Gravatar of John John
    26. October 2011 at 13:51

    Morgan,

    You’re dead on right in that first post. Scott is leaching off of Hayek’s name to convince free-market readers but their fundamental approach to problems is completely different. Hayek several times supported the gold standard and thought it was a good thing that prices didn’t rise in England from 1814-1914 (In the “Constitution of Liberty”). I doubt Scott would ever say anything nice about 100 years of stagnant prices. That’s one of the main reasons I feel like Scott mentioning Hayek is “squirrelly”

  34. Gravatar of John John
    26. October 2011 at 14:04

    I think I’ll spell out some of the major differences between Sumner and Hayek so that people can see why he shouldn’t use Hayek’s name; their approaches couldn’t be more different.

    1. Scott follows an empirical approach while Hayek slammed that approach in his Nobel Prize Speech “The Pretense of Knowledge.”

    2. Hayek believed in preventing bubbles, Scott believes in using monetary policy to prevent their collapse (that is assuming Scott admits that bubbles exist).

    3. Hayek believed in letting relative prices adjust to end a recession, Scott believes in pumping in more money

    4. Hayek spoke favorably of the gold standard, Scott pisses on it

    5. Scott wants prices to continually rise, Hayek doesn’t

    6. Scott thinks that economic prosperity is related to the total volume of spending, Hayek doesn’t

    Some of these overlap, but anyone can see that these are huge FUNDAMENTAL differences in methodolgy, outlook, and policy recommendations. Scott has about as much in common with Hayek as Krugman does with Murray Rothbard.

  35. Gravatar of ssumner ssumner
    26. October 2011 at 14:15

    Morgan, I prefer “provocative” to “squirrelly.”

    JimP, Thanks, I put Goldman in the “realist” camp. I like Kudlow more than you, but he’s a bit of an ideologue.

    Nick, That’s right.

    TGGP, Good point. The costs of inflation are due to the excess tax on capital. The costs of disinflation are a less flexible labor market, due to the effective zero lower bound on most wage increases. In my view a very low but positive inflation rate is best, but of course I use NGDP, so the rate would be higher than for inflation.

    Dan, I think that’s right, like with certain types of taxes. There again I think NGDP targeting prevents the higher taxes from causing unneeded unemployment. So it’s still better. But there is no direct effect on output (except any disincentive effects of taxes.)

    Edit: Later Nick pointed out even that doesn’t occur if you switch from VAT to payroll taxes.

    Bill, I think Dan is right. (Perhaps it’s a terminology issue, but on substance he’s right.)

    Nick, Good point about VAT. I’ll need to think a bit more about price shocks.

    Rob, That’s right.

    Richard A. Good observation.

    Thanks Ben.

    John, You are wrong, he favored NGDP targeting during the interwar period, when he was in his prime.

    There are others in the modern Austrian tradition who are sympathetic to the general NGDP approach.

    David, You said;

    “Nominal spending should rise with incomes over time.”

    Actually, nominal spending IS national income. But you are correct about types of income. I’ve always insisted that a nominal wage target is theoretically superior, but politically and technically difficult to implement.

    Bill, I agree that my example relied on a unit elastic assumption, but was just trying to give an easy to see example of why it might be superior to inflation targeting–I agree it wouldn’t work as perfectly as I suggested.

    Fed up, Regarding income redistribution, I’d guess that monetary stimulus would redistribute toward the poor and toward capital, and away from middle class low savers. But it’s not zero sum, so gains are much bigger than losses.

    Debt will be less of a problem.

    I don’t follow the Minsky moment part.

    I don’t worry about lack of “wants” or ZMP workers. Our society would love bigger houses, more vacations, more restaurant meals, etc. Stuff low skilled workers can do. It’s demand we lack.

    Jeff, You said;

    “As an impartial observers of the economy it might be clear that inflation during recessions helps, but how do you convince the 90% with jobs that we need to lower their real wage in order to make the economy better?”

    I have a job, and I think stimulus will help me. It will lower real wages and raise real incomes. That’s politically popular, if you look at history. It’s when total incomes fall that Presidents get really unpopular.

    Liberal Roman, No, inflation is no higher (on average) under NGDP targeting than inflation targeting. And people only think they care about inflation. They actually care about real income.

    W. Peden, Good point. What about Steven Horwitz?

  36. Gravatar of dwb dwb
    26. October 2011 at 14:19

    good post!

  37. Gravatar of Morgan Warstler Morgan Warstler
    26. October 2011 at 14:48

    John, while I agree with your points, let me point out:

    IF we followed 3% level targeting of NGDP from 1999 on:

    1. prices would be far lower…. like zero inflation.
    2. we wouldn’t have had a financial crisis.
    3. we wouldn’t be bummed about stagnating wages.

    AND Scott WILL accept a 3% level target if that’s all he can get. Woolsey, according to Scott, still wants it.

    Yes, yes, I know that it’s not a gold standard, but it’s about as close as you can get without radical change to our Monetary system.

    1. Interest rates would go up.
    2. There would be IMMENSE pressure on the government to cut fiscal spending.
    3. It’s be almost impossible to have a Fed fueled boom.

    If Scott would just dummy up, and shrug off the current “missing” NDGP (and all the liberal moaners) and just say, let’s use my policy to keep the bad shit from happening in the future!

    He’d get immediate support from the folks that matter – the Tea Party.

    For all intents and purposes 3% level targeted NGDP is basically the Gold Standard.

  38. Gravatar of Jeff Jeff
    26. October 2011 at 15:13

    Scott,
    That may be how you think about stimulus, but that’s not how (even very smart) non-economists think about it. They think fiscal stimulus is great for unemployed people because the government is stepping in and doing some hiring when firms won’t, but this won’t affect them because they have a job. They think monetary stimulus lowers interest rates to encourage people and firms to spend more. This might lower their mortgage payment a bit, which is nice, but ultimately won’t affect them either.
    As soon as you say “we need inflation” people think, woah-woah-woah! I’m supposed to pay higher prices for gas and groceries to fix someone else’s mess?
    Indeed, I agree that all politicians should jump on board if they want to get re-elected. Maybe all you really need to do is convince them and you’re done, but NGDP targeting doesn’t have (will ever have?) the same populist appeal as “keep inflation low and do what you can for unemployment”.

  39. Gravatar of Bob Murphy Bob Murphy
    26. October 2011 at 19:06

    Does anyone else find it ironic that Morgan Warstler’s chief goal on this blog is to convince Scott that he is an expert on persuading people?

  40. Gravatar of Bob Murphy Bob Murphy
    26. October 2011 at 19:13

    OK Scott if you have time try this one: Let’s say we get a new Fed policy function. Every January 2, a computer randomly picks a number x, between 1 and 5. Then, the Fed raises NGDP that year by a factor of 2^x. (So some years NGDP doubles, some years it quadruples, etc.)

    I claim that real GDP growth over a 25-year period will be lower for that economy, than under (say) a Taylor Rule. Now my questions:

    (1) Do you agree?

    (2) Would you say that technically, even here the problem wouldn’t be due to inflation or monetary shocks, but (by definition) the problem would be the lower standard of living implied by stagnant RGDP growth, which in turn was caused by shorter-term business planning etc.?

    (3) If you answered “yes” to the above two questions, can you understand why I now want to take a hostage?

  41. Gravatar of John John
    26. October 2011 at 19:42

    Morgan,

    I remember Scott blogging at some point how low NGDP growth looked in Japan. He used that example to show why he favored a 5% target.

    I agree with your point on bubbles but remember, Scott’s from the ratex school that doesn’t believe in them. In any case, he doesn’t think bubbles directly cause problems, low NGDP growth does. I just really don’t think you two see eye to eye on the 3% target.

    More importantly, I just think GDP is a silly measure and I wish people would give up on the idea of steering an economy all together.

    I actually think going back on gold would be easier than people think. Mises lays out a great plan in “The Theory of Money and Credit.” All you gotta do is stop issuing further currency (electronic stuff counts obviously). When you think the gold price has turned the corner where it’s going to continue to fall indefinitely, you peg that price. From then on, any new money issues have to be backed by gold at 100%. This is a simple plan that allows a central bank without a lot of gold to get back on the standard fairly painlessly.

  42. Gravatar of Morgan Warstler Morgan Warstler
    26. October 2011 at 21:10

    John,

    I’ll stand on this:

    If Scott was only able to have 3% level target starting Q1 2011 OR what we have now…

    He’d TAKE IT and stop blogging.

    On our discussion… you have to use your noodle here dude.

    3% is actually LESS than we have averaged for decades.

    Under such a plan from 1999 your $.75 cents would be worth $1.

    Let me say this again: it’s OK if wages stagnate IF prices do to.

    See this is where we flip the stick wages argument on the liberals.

    NOW, we are saying SINCE wages are sticky, we should AIM for sticky prices.

    That’s a Fed saying,”well anytime RDGP is 3%, we MUST have zero inflation.”

    Don’t let the perfect be the enemy of something that strips the bark off liberals and chews their sweet meat to pulp.

  43. Gravatar of W. Peden W. Peden
    26. October 2011 at 22:43

    Scott Sumner,

    I haven’t read anything by Steve Horowitz.

    John,

    Sure, we live in an era of least-bad-choices (like every era). Having a central bank may stink, but I’ve rather have a system that prevents that central bank from stoking inflation during a boom and where its monopoly power over base money isn’t abused in such a way to choke the private sector during a downturn.

  44. Gravatar of John John
    27. October 2011 at 08:50

    Morgan,

    I’ll agree a 3% target would be nice. It would lessen the risk of a severe boom bust cycle and would stop people from looking at wild inflationary ventures as recession cures. I’d be in favor of them locking in a 3% NGDP target if they worked on fixing the recession through radical supply side measures like freeing up oil drilling, gutting the EPA, dramatically simplifying the tax code, and eliminating vast chunks of business regulation.

    Where I have a beef with Scott is the idea that money is the solution to our current situation. I think if Scott had his way he’d destabilize our entire economy with crazy monetary hijinks in the name of making up for lost ground. The Fed created our current disaster and more expansionary measures will lead to more of the same instability. We need to stablize monetary policy by any means necessary and liberate the market system.

    People forget that our last great recovery in 1983 was preceded by years of regulatory overhaul.

  45. Gravatar of How Are Sujatha Reddy and Scott Sumner Alike? How Are Sujatha Reddy and Scott Sumner Alike?
    27. October 2011 at 19:16

    […] about how Scott says that inflation poses no problem at all (or words to that effect). In a recent post he gave a hint as to what he could possibly mean: Supply shocks aren’t bad because they cause […]

  46. Gravatar of ssumner ssumner
    28. October 2011 at 18:34

    Thanks dwb,

    Morgan; You said;

    “For all intents and purposes 3% level targeted NGDP is basically the Gold Standard.”

    No, it’s 10 times better, but still not good enough for me.

    Jeff, I agree with you that the average person doesn’t have a clue about monetary and fiscal policy, and that the average person doesn’t want to hear on the radio that Bernanke is trying to raise their cost of living.

    What he does want to hear on the radio is the reporter telling him Bernanke is trying to raise the income of Americans.

    Bob, I think growth would be lower because high inflation is a tax on capital. It’s hard to say how it would affect business planning, as I don’t know if the public would respond by indexing contracts.

    Not sure where you are going with this. I favor stable growth in NGDP, which makes business planning much easier.

    John, You said;

    “I actually think going back on gold would be easier than people think. Mises lays out a great plan in “The Theory of Money and Credit.” All you gotta do is stop issuing further currency (electronic stuff counts obviously). When you think the gold price has turned the corner where it’s going to continue to fall indefinitely, you peg that price. From then on, any new money issues have to be backed by gold at 100%. This is a simple plan that allows a central bank without a lot of gold to get back on the standard fairly painlessly.”

    There are two holes in this argument big enough to drive a dump truck through.

    1. You can’t predict gold prices.
    2. Even if you could, falling world gold prices would lead to inflation for any country on a gold standard. Of course since prices can’t be predicted, you could just as easily have deflation. If Switzerland had been on the gold standard since the early 2000s, they would have had massive deflation by now.

  47. Gravatar of John John
    29. October 2011 at 01:02

    Scott,

    I think there’s a pretty big whole in your argument too. Why have gold prices been so upwardly volatile? The investors who are buying gold seem a little concerned about unprecedented central bank policies. If central banks hadn’t been pumping so much money into the system in the first place, the gold price wouldn’t have moved so much.

    I’m aware that the gold standard isn’t a utopian money system that offers perfect fairness and stability, but it is a practical way of limiting increases in supply and taking control of money out of the hands of politicians and central bankers who always seem to wanna inflate, inflate, inflate.

  48. Gravatar of Scott Sumner Scott Sumner
    29. October 2011 at 06:12

    John, Why would gold prices no longer be volatile just because one country adopted the gold standard? What about the other 199 countries?

    The real world gold standard did not take money out of the hands of politicians, that’s a myth.

  49. Gravatar of Fed Up Fed Up
    2. November 2011 at 19:30

    “Fed up, Regarding income redistribution, I’d guess that monetary stimulus would redistribute toward the poor and toward capital, and away from middle class low savers. But it’s not zero sum, so gains are much bigger than losses.

    Debt will be less of a problem.

    I don’t follow the Minsky moment part.

    I don’t worry about lack of “wants” or ZMP workers. Our society would love bigger houses, more vacations, more restaurant meals, etc. Stuff low skilled workers can do. It’s demand we lack.”

    I’d say “monetary stimulus” is about getting people off unemployment so the gov’t can attempt to get the gov’t debt to GDP ratio back to “near normal”. It is NOT about redistributing towards the poor and middle class. It is about going towards capital (mostly the rich). If nominal wages get too high or if there are attempts at real wage growth for the lower and middle class, then the fed raises interest rates to cut off spending and has the gov’t cut spending if necessary too.

    Debt still remains a problem because the fed does not want the amount of medium of exchange to fall.

    http://www.interfluidity.com/v2/2392.html

    “Stabilizing expenditure requires continual easing. Any sort of lower bound provokes a “Minsky moment”, as expenditures that can no longer be sustained unexpectedly contract, rendering maxed-out spenders unable to service their debts.”

    Debt defaults can lead to the amount of medium of exchange going down. Next, there could other effects. People won’t go into debt. People attempt to pay down debt. Real GDP and asset prices can fall.

    Bigger houses: how did that whole housing bubble work out? If people finally assume that housing does not outperform, will they want bigger houses? I doubt it. I don’t because it means a bigger monthly mortgage payment, more taxes, more monthly expenses, and bigger upkeep expenses.

    More vacations: will businesses just complain about being uncompetitive and/or becoming European?

    More restaurant meals: I’m not really interested in eating out more. I read one story of a lady who had to stop eating out so much because of the recession. She lost 30 pounds. Hopefully, she did not go back to eating out more.

    “I have a job, and I think stimulus will help me. It will lower real wages and raise real incomes. That’s politically popular, if you look at history. It’s when total incomes fall that Presidents get really unpopular.”

    Once again, ignoring wealth/income inequality. What you are hoping for is that lowering real wages for the lower and middle class can raise “real wages” for corporations and the rich leading to real AS growth and then real GDP growth. You are assuming supply constraints. The 0% fed funds rate should be telling just the opposite. You won’t even consider the idea that real AD is not unlimited and what an economy would look like if real AD is NOT unlimited.

  50. Gravatar of Fed Up Fed Up
    2. November 2011 at 19:38

    Morgan Warstler, I don’t believe it has anything to do with liberal vs. conservative.

    I don’t agree people will be forced to 40 hours per week. Also, productivity gains and other things should be distributed evenly between profit and wages. The unemployed being auctioned sounds more like slavery to me.

    I don’t agree service sector demand is unlimited. As Mish likes to say, there are already enough nail salons around.

  51. Gravatar of Fed Up Fed Up
    2. November 2011 at 19:39

    Becky Hargrove, I’m not sure that will help people with their monthly budgets.

  52. Gravatar of Scott Sumner Scott Sumner
    5. November 2011 at 12:53

    Fed Up,, Money is neutral in the long run, it doesn’t affect inequality in any important way.

    I don’t understand the problem with steady 5% NGDP growth–so what if it required a continual increase in M?

    Ask the averge guy making $20,000 if they’d prefer the lifestyle of someone making $200,000. Believe me, there are and always will be plenty of unmet wants. We heard the same argument in the Great Depresison, which later looked silly.

  53. Gravatar of Fed Up Fed Up
    6. November 2011 at 22:45

    “Fed Up,, Money is neutral in the long run, it doesn’t affect inequality in any important way.”

    I’ll need some more explanation there, but at first glance, I don’t believe that is going to be right. Some of it will come down to the definition of “money”, a term I would like to see done away with because there are too many definitions of it.

    And, “I don’t understand the problem with steady 5% NGDP growth-so what if it required a continual increase in M?”

    That is an excellent question, and one I was going to basically ask in another way. First, I’m going to consider M to be medium of exchange because I have bought things with currency and/or demand deposits and sold things for currency and/or demand deposits out in the real economy. I have never bought or sold for central bank reserves although they may “go along for the ride” with a demand deposit if it ends up at another bank.

    There is nothing wrong with a continual increase in medium of exchange per se. It depends on how that happens, specifically if it is coming from more and more demand deposits from loans (making it debt). If it is, you now have to consider the possibility that the amount of medium of exchange can fall from debt repayments (principal) and debt defaults when the economy needs it to be at least flat if not rising. I believe that also means wealth/income inequality is more likely. You get accounting wise:

    savings of the rich = dissavings of the gov’t (preferably with debt) + dissavings of the lower and middle class (preferably with debt)

    You get budget wise:

    the rich have positive real earnings growth, the gov’t and the lower and middle class have negative real earnings growth, which they make up for with more debt

    I’m also going to make a Minsky like argument. You get periods of stable NGDP growth, but in reality the debt is making the situation more and more unstable eventually. In other words, if more and more debt does not cause price inflation or is being used to prevent price deflation, there is an imbalance in “someone’s” budget somewhere (negative real earnings growth and more debt).

    Next, if you create more medium of exchange from currency/demand deposits with no bond/loan attached, you eliminate the possibility of debt repayments and debt defaults. I believe that also means wealth/income inequality is less likely. You get accounting wise:

    savings of the rich + savings of the lower and middle class = the balanced budget(s) of gov’t + dissavings of the currency printing entity with currency/demand deposits and no loan/bond attached

    You get budget wise:

    the rich have positive real earnings growth, the lower and middle class have positive real earnings growth, the gov’t has balanced budgets, and the currency printing entity has negative real earnings growth, which is makes up for with currency/demand deposits and no loan/bond attached

    It seems to me the Minsky argument goes away because there are no imbalances in anybody’s budget somewhere.

    More later!

  54. Gravatar of Fed Up Fed Up
    10. November 2011 at 19:33

    More on “I don’t understand the problem with steady 5% NGDP growth-so what if it required a continual increase in M?”

    If I’m stating your argument correctly, you basically believe the period from about 1990 to 2007 or 2008 was a stable NGDP growth path. Then something went wrong or was not handled correctly in 2007 or 2008. My argument is that the period from about 1990 to 2007 or 2008 was an UNstable NGDP growth path. It all comes down to whether someone believes that too much debt can cause medium of exchange problems that build up over the years.

    To do that, you would need to take a step down from macroeconomics to microeconomics and budgeting. The budgets of these three(3) entities all are big enough to affect the macroeconomy. The three(3) entities are the gov’t, the rich, and the lower and middle class. The gov’t is one(1) entity so it acts the same way, and the rich basically act as one(1) entity because they are trying to get richer. If enough of the lower and middle class act the same way, it can be considered one(1) entity. If the budget of the entity is big enough and enough of the entities act the same way, then the entity can affect the macroeconomy. So since about 1982, it has been negative real earnings growth for the lower and middle class and more debt. Eventually, that entity goes bankrupt.

    Lastly, a problem that was caused by negative real earnings growth can’t be solved by more negative real earnings growth.

    “Ask the averge guy making $20,000 if they’d prefer the lifestyle of someone making $200,000. Believe me, there are and always will be plenty of unmet wants. We heard the same argument in the Great Depresison, which later looked silly.”

    Although it is different for different people, there is some point ($75,000, $150,000, $200,000) where people have enough. Warren Buffett is a good example. Your policy seems to be to affect the workers indirectly by making the rich richer. When the economy goes from mostly supply constrained to mostly demand constrained, that is probably not going to work. You are probably going to need to affect the labor market directly.

    “Believe me, there are and always will be plenty of unmet wants.”

    Then why do people voluntarily retire (meaning I don’t believe you)?

  55. Gravatar of Fed Up Fed Up
    10. November 2011 at 19:37

    I’m going to move this over to Statsguy’s game theory post so it is easier to find for me in the future.

    Anyone can reply there.

    https://www.themoneyillusion.com/?p=11705

  56. Gravatar of Scott Sumner Scott Sumner
    12. November 2011 at 14:22

    Fed up, So what’s the bad thing that would have happened if the Fed kept NGDP growing at 5%.

    Warren Buffett is a lousy example, the people who live in Beverly Hills are much more typical. I could easily spend more income if I had it.

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