Three options
The central bank has three options if the economy is at the zero bound, and is also likely to stay there if the central bank maintains its current inflation target:
1. The Chuck Norris approach; buy up as many assets as it takes to hit the expected inflation target. They can also reduce IOR if they don’t want to buy so many assets.
2. Set a higher inflation target, or switch to price level targeting, or switch to NGDP level targeting. All of these options effectively raise the short term inflation target, but they don’t necessarily affect the long run rate of inflation. This will allow the central bank to boost NGDP and simultaneously reduce the base.
Most modern central banks say options one and two are out of the question. One is too risky and two would lead to a loss of policy credibility. That leaves option three:
3. Abject failure.
Note that option 3 is actually far more costly and risky than option one, and entails an even greater loss of credibility than option two.
I’ve recently read dozens of articles attached to student essays, written by both economists and journalists. The vast majority can be boiled down to the claim that if the Fed follows policy option three, abject failure, it is unlikely to succeed. You don’t say!
BTW, Readers may have assumed that this post applies to the current situation in the US. That’s not at all clear to me. It might apply, but I’m not certain. The Fed has a dual mandate; it’s not a pure inflation targeter. Thus it’s not obvious that the zero bound is actually what’s inhibiting Fed policy, one could argue that it is a reluctance to take the employment half of the mandate seriously. After all, on several occasions they backed off of QE because inflation was too high. Thus it’s not clear that the Fed would have to buy more assets to hit its Congressionally-given mandate. It might merely need to announce that it intends to do so.
On the other hand it’s certainly possible that it would have to buy more assets.
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21. October 2012 at 06:53
No! Chuck Norris was a metaphor for threats, not brute force! (Chuck Norris doesn’t read books; he stares them down until they divulge their information)
21. October 2012 at 07:22
“All of these options effectively raise the short term inflation target, but they don’t necessarily affect the long run rate of inflation.”
This is why it is logical to set the rate low enough (<4.5%) that pressure is always there to force govt. to be productive.
It lets you say "less inflation in long run" not say "they don’t necessarily affect the long run rate of inflation."
NGDPLT is a conservative policy that leads to conservative govt. outcomes.
It starts with the death of Keynesian.
And then extends to rewarding private sector immediately whenever public sector is made to run leaner.
In the long term we get less economic swings, which further strengthens hands of conservatives.
21. October 2012 at 07:48
God Morgan, NGDPLT is supply shock neutral, rates only fall if the natural rate falls, what part of this don’t you get? Scott has NOT devised a plan to destroy the public sector. You’re on your own for that one, mate.
21. October 2012 at 07:55
The Fed ought to be looked at as an institution whose sole purpose is to benefit the banks at the expense of everyone else, but at the same time maintain its dollar hegemony worldwide.
It is the legalized headquarters of a banking cartel.
This observation makes it obvious which one of the three options listed the Fed will tend to choose:
4. If unemployment is too low, then the banking cartel would make fewer interest based profits, ceteris paribus. Hence, it would seek to inflate to goose the labor market. However, doing so goes against their dollar hegemony, because the more they inflate, the less willing other nations will agree to use dollars as reserve, and the less able will the banking cartel in the US be to get their dollars out into the world to earn interest. Therefore, the rate at which the Fed inflates will be a function of maximization of profits subject to the constraint of nations dropping the dollar as reserve.
The rate of monetary inflation you observe today is to benefit the banks and to maintain the hegemony.
All the prattle on NGDP targeting, price inflation targeting, employment, all of this will continue to be rejected unless and until the world’s nations accept a higher rate of dollar debasement for the benefit of US banks.
The problem for market monetarists is that the rest of the world is not as dependent on the US economy as they once were. They don’t need the dollar as much as they used to in order to have viable economies using other currencies. The Fed is on a shorter leash than they were in the past.
Market monetarists are intellectually stuck in the past. They believe that if something worked well 10 or 20 or 30 or 40 or 50 years ago, it should work well again. But this presumes the ultimate fallacy in all of economics: that humans act according to constant causal operative factors.
The Fed will only be able to inflate more dollars (which is required to get a level NGDP target) if the rest of the world (and less so US citizens, since they are legally obligated to keep using dollars, unlike the world, although the US military is used to enforce dollar hegemony abroad for those nations who don’t play ball, but that is very costly) are willing to pay for it through dollar debasement.
Europe and Asia are still using dollars as reserve and will continue to do so for the foreseeable future, so they are treated well by the US military industrial congressional banking complex. But there are countries in the middle east that despise US military presence, so they are doing the only thing they can do, which is seek to sell their oil in something other than dollars. Hence, they are invaded, coerced and threatened by the complex. Human rights is but a smokescreen. Saudi Arabia and China have egregious rights violations, but they are not threatened, because they are two major players in the dollar hegemony. Oil and consumer goods…for dollars, so let them continue to kill children.
21. October 2012 at 07:55
Wealth creators and producers come in all shapes and sizes, public and private. Sometimes the public/private designation is little more than a matter of social convenience.
21. October 2012 at 08:10
Saturos, I’ve seen Norris get violent.
21. October 2012 at 08:25
Might be time for another Pot, Kettle, Black Award for the same guy;
http://delong.typepad.com/sdj/2012/10/failure-to-understand-basic-macroeconomics.html
———-quote———
If China were to decide to spend less of its earnings from exports to the U.S. buying our debt and more buying our goods, interest rates would not go up–remember, the Federal Reserve is pegging short-term safe nominal interest rates at zero–but production and employment would.
Paging Rob Portman to the white courtesy phone, please.
The fact that Republican High Politicians do not get briefings teaching them basic income-expenditure macroeconomics is one of many, many, many reasons not to vote Republican. And it is a reason to ask senior Republican economists–I’m looking at you, Glenn Hubbard, Greg Mankiw, John Taylor, Marty Feldstein, Eddie Lazear–what the f*&$ they think they are doing.
———–endquote———-
So, Prof. DeLong thinks that interest rates would not rise from their now abnormally low levels if the economy picked up steam?
21. October 2012 at 09:14
Scott – Are you not marginally more bullish w open-ended QE and a soft version of the Evans Rule vs the sterilized Twist/low rates only if the economy is on its arce nonsense of last year? Five year breakevens have rallied nicely over the last four months…..
21. October 2012 at 09:22
Patrick, the Fed can always keep rates pressed down even as the natural rate rises – but wouldn’t that lead to really overshooting the inflation target?
Scott, how awesome was Way of the Dragon!
(No that wasn’t a question)
21. October 2012 at 12:29
Scott: I think 1 and 2 are the same. Chuck threatens to do 1 unless 2 happens.
What you say about 3 though seems right to me.
21. October 2012 at 12:30
OK. Maybe I misunderstood. 2 involves setting a different target to 1.
21. October 2012 at 12:44
Becky Hargrove:
Wealth creators and producers come in all shapes and sizes, public and private.
There are no wealth generating, productive public agents. All government activity is consumptive activity, even if the form the consumption takes are large, sophisticated projects like dams and bridges. They depend entirely on actual wealth generating, productive agents in business activity.
21. October 2012 at 13:17
Scott,
What an unimaginative list. I would add.
4. Convert to electronic currency and set a negative interest rate on it.
5. Set minimum asset to equity ratios for banks (i.e. force bank lending)
I agree with Nick that 1) and 2) are the same.
21. October 2012 at 14:57
dtoh, How can you agree with Nick when Nick doesn’t agree with Nick. They aren’t the same.
Case one is where the equilibrium involves zero interest rates. Case two does not.
Tommy, Marginally, but I’m still not bullish.
21. October 2012 at 16:28
“NGDPLT is supply shock neutral, rates only fall if the natural rate falls, what part of this don’t you get?”
the natural rate is made up of two things mate, real growth and inflation.
real growth comes from productivity gains (in crass terms people being fired – as in only 3% now work in agriculture, fewer and fewer are needed for manufacturing while output increases.)
firing public employees AND getting the same amount of govt services is a productivity gain, and historically the Keynesian left has argued it would slow down the economy.
NOW that argument doesn’t exist.
Saturos, don’t convince yourself that Keynesian Economics dies and government doesn’t shrink.
Think on that a bit.
If you need to ask Scott, he’ll admit to my logic above.
21. October 2012 at 16:34
Pat, DeKrugman is buying into the fiction that the Fed will keep rates low even as inflation goes up.
Won’t happen under Romney, and DeKrugman knows it, so he’s lying.
22. October 2012 at 08:28
‘Patrick, the Fed can always keep rates pressed down even as the natural rate rises – but wouldn’t that lead to really overshooting the inflation target?’
Which would lead to higher interest rates. Which DeLong clearly knows. Politics makes strange, Berkeley Fellows.
22. October 2012 at 08:58
Saturos,
Seriously! Ask Scott!
22. October 2012 at 09:26
Morgan, real interest rates don’t rise one-for-one with real growth (else the Dow wouldn’t rise on good news for the economy). And why do you think a rise in public sector productivity would lead to more borrowing? Higher expected private real growth leads to more private planned investment and borrowing, but the public sector is another kettle of fish…
The Keynesians have argued many absurdities. Many, many absurdities…
22. October 2012 at 09:27
Did you want me to ask Scott about Way of the Dragon? There’s no need, he knows it’s awesome.
22. October 2012 at 10:15
“And why do you think a rise in public sector productivity would lead to more borrowing?”
Dude, productivity = savings = investment
Money currently wasted on a fat lazy unproductive public sector goes to new more productive places.
The public sector is no different than Agriculture or Manufacturing, it just hasn’t been put through the wringer of invention yet.
—-
Look Scott has ADMITTED I’m right on this. He acknowledges he thinks NDGPLT shrinks govt.
He doesn’t like saying it.
So ASK HIM. See what happens.
22. October 2012 at 10:30
Look, a one off productivity shock to the public sector might send resources to the private sector, but it’s not going to permanently raise the real growth rate, and it won’t permanently lower the natural rate of interest. That would require ongoing innovation in the public sector, i.e. the public sector would have to become the private sector.
Scott, Morgan is wrong, isn’t he?
22. October 2012 at 10:31
Permanently change the natural rate, I mean.
22. October 2012 at 12:38
Saturos,
Scott won’t answer, no matter who many times you ask, and he won’t really flesh it out.
Let’s talk about REAL growth for a second.
You do get that Agriculture and Manufacturing din’t go through one time “shocks” they went through steady YOY productivity gains that steadily increased output value while decreasing the the number of people employed in those sectors.
And this was the REAL growth the economy experienced over the long term.
This is the nuts and bolts of how an economy grows: Some asshole figures out a way to do the same thing differently, the old method and its practitioners die off – the price of thing goes down, and the new saved money on both capital and consumer side is freed up to have new improved things.
Pssstt… the entire US public sector could indeed run with 5M public employees, not 23M of them, without ANY fall of in public goods provided.
And when Suddenly we have compensation of $700B instead of $1.7B (and growing) EVERY SINGLE YEAR… that is not a “one time shock.”
You get this right?
22. October 2012 at 15:52
Saturos, Sorry, never even heard of “Way of the Dragon.”
Morgan, NGDPLT makes fiscal stimulus and auto bailouts go away. Other than that, not much effect on size of government. But it’s a good start.
22. October 2012 at 17:30
ssumner:
Other than increasing the size of state activity via buying government debt every time anyone anywhere at any time decides to decrease their spending and increase their cash balances, thus reducing “aggregate spending”, it’s true, it won’t increase the size of the state any faster than inflation is generating now.
23. October 2012 at 10:49
“Morgan, NGDPLT makes fiscal stimulus and auto bailouts go away. Other than that, not much effect on size of government. But it’s a good start.”
We now have a shift in Sumner policy!
Scott, before I got digging, are you sure you didn’t grant that the feedback loop when running at target (when banging our heads at 5%), is shorter…
Meaning, I think I can go find where you admitte:
1. that with a low single econ metric NGDP, we’d routinely bump into it. You want it higher for just that reason.
2. if we are bumping into it, I think you’ve admitted that it becomes more obvious to public how GOVT SPENDING increases NGDP.
Are you sure you haven’t said these things?