Why liberals should support NGDP targeting
A commenter named Richard A. asked me why there don’t appear to be any liberal economists who support NGDP targeting. For a moment I was stunned. I am so used to NGDP targeting be attacked from the right that I forget that it has no supporters on the left. Recall that conservatives usually support inflation or price level targeting, and think that NGDP targeting is soft on inflation. So why no liberal support?
Not knowing any liberal macroeconomists, I can only guess:
1. Maybe they somehow associate the idea with the infamous MV=PY equation.
2. Maybe they think price stickiness is a much bigger problem than wage stickiness.
3. Maybe they think it too crude, as it seems to put equal weight on P and Y fluctuations, and pays no attention to the output gap.
I suppose some right-wingers might have arrived at NGDP targeting via the equation of exchange. Once people started criticizing Milton Friedman’s “4% rule” by pointing out that velocity fluctuates, then it is natural to think about monetary rules that offset changes in velocity.
But of course this is no reason for a Keynesian to oppose NGDP targeting. After all, it is equally true that price level targeting can be explained in terms of this tautology:
P = M/m
Where P is the price level, M is the supply of base money, and m is the real demand for base money. And yet I doubt whether any economist has ever rejected inflation targeting because they found that tautology offensive.
Regarding price stickiness, I think the Keynesians are wrong about it being more important than wage stickiness. As I recall this view is partly based on post-war studies that showed real wages to be procylical. But (in a 1989 JPE article) Steve Silver and I showed these studies are flawed and that real wage cyclicality is consistent with sticky-wage business cycle theories.
I think the third objection is the most important (and is also mentioned by Bill Woolsey in a recent comment to this post.) How likely is it that the optimal coefficients on price level and output fluctuations are exactly the same? And why not take into account the output gap, rather than merely the change in real GDP?
I would give several answers. First, we aren’t even close to developing a macro model capable of showing which coefficients would be best, and which is also generally accepted by policymakers and economists. Indeed I’d go further and argue that even new Keynesian policymakers and economists don’t agree on these issues.
Second, we don’t know how to measure the output gap. All we know is that when output falls sharply, there is usually an output gap. This means we don’t know enough to make a Taylor Rule produce dependably better results than a NGDP target.
Furthermore (as Woodford recently pointed out), we really need level targeting, not growth rate targeting. Level targeting is obviously really easy to do with an NGDP target. There are ways to do it with a Taylor Rule, but you have to rework the model, and there is already great disagreement about which Taylor Rule is best.
Most importantly, you can’t fight something simple and appealing with something complicated and unappealing. Americans are conservative people. What sounds more appealing:
1. Stable prices
or
2. Maximize some complicated social welfare function involving inflation and output gaps.
NGDP targeting is a sort of focal point that liberals and (some) conservatives could rally around. It also appeals to pragmatic moderates like Bennett McCallum.
Until liberals realize this they will continue to lose out to the Plosser’s of the world, who have a simple and appealing message. We need a similarly simple message, such as “The Fed must provide enough money to keep America’s nominal income rising at 4% per year.”
I just picked 4% at random, but in principle it isn’t random, it’s the sum of the current forecast of long run RGDP growth (say 2.5%) and the current policy goal for inflation (say 1.5%.) So it’s not an entirely new goal, but rather a better way of achieving goals we already have, whether we admit it or not.
Here’s my fallback position. Let’s suppose liberal macroeconomists don’t think NGDP targeting is good enough, because of issues like the output gap. OK, then call it “flexible NGDP targeting.” After all, many liberal macroeconomists say they support flexible inflation targeting, where the term ‘flexible’ indicates that they don’t look solely at inflation. The problem with this is that inflation still lies at the center of their policy; it is still the variable everyone sees. But inflation didn’t provide anywhere near as unambiguous a signal in 2008-09 as did NGDP. If we had been talking about NGDP, it would have been obvious to everyone that money was far too tight. But when you looked at variables like core inflation (horribly distorted by its failure to detect the fall in housing prices) you got much more ambiguous signals. It gave the inflation hawks a leg to stand on, something they wouldn’t have had if everyone viewed policy in NGDP terms (even flexible NGDP terms.) Again, flexible NGDP targeting is hardly my first choice (too much chance for mischief) but it is still light years ahead of the vague flexible inflation targeting regime we are currently operating under.
Don’t let the perfect be the enemy of the good enough. Forget about the policy goals embedded in Taylor Rules. It’s going to be NGDP targeting, level targeting, or we will continue to have monetary screw-ups because we have hopelessly vague inflation targets that allow policymakers to oppose monetary stimulus after a deep fall in NGDP. (And for you Austrians, recall that inflation targeting allows the Fed to have easy money when NGDP is rising too fast. They just point to core inflation.)
Tags: conservatism, liberalism
13. January 2010 at 12:43
I will hazard a guess or two at why liberal macroeconomists don’t like NGDP targeting –
1) They are suspicious of using a market to set a policy instrument. Which means some real effort needs to go into showing how this targeting regime would avoid being gamed – and this requires more than citing a paper or fifteen about Wisdom of the Crowds. It requires showing exactly how the system will work, and wargaming scenarios about possible attempts to exploit the system. Not long ago, I inquired about manipulation of thin markets, Scott indicated it was a low risk, but Bill W disagreed. We should at least be able to build a system where most of the experts agree that manipulating/gaming it would be nearly impossible.
2) Liberals do not like using monetary policy as the primary instrument because they do not trust the mechanism by which money is injected into the economy – namely, that in a recession (when asset prices are depressed), money is injected by giving preferential credit to institutions (banks, hedge funds, etc) that allow them to increase their liquidity position at a time when non-financial-institutions are liquidity constrained. Technically, the money is “borrowed”, but it’s borrowed at a time when the relative price of money is very very high (as measured by the relative value of other asset classes) and repaid when the price of money is lower. Which would be fine if it were borrowed fairly at a market price and secured only by private collateral. But it’s not.
This is a distributional issue, and it really depends on the empirical evidence (which seems mixed). But reality over the last year has failed to give the lie to this deeply held suspicion of financial institutions as the chief intermediaries in monetary policy. How is it that Goldman Sachs can make such huge profits by investing borrowed money (using govt supplied liquidity, or liquidity that is borrowed cheaply due to the implied backing of govt) in distressed assets, when it was damn near broke?
The method of money injection is hugely important to liberals because of political/economic implications; Scott might call that an obsession with distributional issues, but it’s idealistic to think distributional issues don’t matter. (Note how quickly certain folks move from arguments about “optimality” to arguments about “fairness” when the optimal policy requires them to make the sacrifices.)
I think there are two things that would help convince liberals:
1) Show that monetary policy would be MORE stable, not less stable, in an NGDP targeting regime (if it could be built securely). This would decrease volatility, which would decrease the (potentially) wealth-concentrating dynamics that we observed this past year. (Have not yet seen wealth distribution data for 2009, so I don’t know how it compares to 2006, for example.)
I don’t think we have a true appreciation for just how harmful volatility is in an economy where innovation is dependent on long term investments.
To show how bad it is, Bob Lutz just endorsed a gas tax just to create stability in the market…
http://money.cnn.com/2010/01/11/news/companies/lutz_gastax/index.htm
2) Build a monetary policy system that does not advantage banks. This, however, implies that monetary policy was conducted in a manner that did not (in practice) hugely advantage certain financial players – and in this regard the Fed failed rather miserably in 2008.
The Fed’s directed purchases of MBS, on the other hand, really should be widely appreciated by liberals. The net effect has been to increase cash flow to indebted mortgage owners – a large portion of the population. It is not surprising that many hard money folks particularly hate the MBS program – not only does it loosen monetary policy, but it does so in a directed way that decreases the value of existing (high priced) bonds while the benefits of those cheap rates are given to (oh my gosh) consumers.
The the upshot is that Liberals potentially have a lot to like in an NGDP targeting system, but the implementation details matter a whole lot.
13. January 2010 at 13:12
Scott:
You left out the free banking perspective, which is that bankers shouldn’t target NGDP any more than wheat farmers should. Bankers, like wheat farmers, should mind their own profits. Government officials who think they can improve on the market will be just as wrong about money as they are about wheat.
13. January 2010 at 18:47
statsguy, You said;
“Not long ago, I inquired about manipulation of thin markets, Scott indicated it was a low risk, but Bill W disagreed. We should at least be able to build a system where most of the experts agree that manipulating/gaming it would be nearly impossible.”
You jumped the gun here, the post wasn’t about futures targeting it was about NGDP targeting. So the issue you raised is not a problem at all. But I’ll answer it as if it is.
I don’t know whether Bill is an expert on market manipulation, but those who study prediction markets suggest that it is not a problem. I have suggested a number of ways to prevent manipulation, such as letting the central bank trade large quantities of futures if they think the market is being manipulated. I have no problem with that. As long as I can go short in October 2008 when it is obvious NGDP is crashing, then they can take whatever actions they want to limit the ability of the big boys to manipulate the market.
You said;
“2) Liberals do not like using monetary policy as the primary instrument because they do not trust the mechanism by which money is injected into the economy – namely, that in a recession (when asset prices are depressed), money is injected by giving preferential credit to institutions (banks, hedge funds, etc) that allow them to increase their liquidity position at a time when non-financial-institutions are liquidity constrained.”
I don’t follow this at all. Most liberal economists I read favor some form of flexible inflation targeting like the Taylor Rule. So that can’t be the reason. The question is why they prefer inflation targeting, even flexible inflation targeting, to a flexible NGDP rule.
You said;
“The method of money injection is hugely important to liberals because of political/economic implications; Scott might call that an obsession with distributional issues, but it’s idealistic to think distributional issues don’t matter.”
In my entire life I don’t recall reading a single liberal economist raise this issue. And even if it was an issue, how would that affect the desirability of doing NGDP targeting? It’s not like there is a choice between “using” monetary policy and not using it. We are always doing monetary policy. The question is what variable do we target.
I don’t think our monetary policy favors banks, it’s our regulatory policy that favors banks. Banks were hurt very badly by the tight money of late 2008. Or the tight money of the Great Depression, for that matter.
I find your reply very interesting because it suggests that there is a whole universe of discussion out there that I am completely oblivious to. I have never even heard the issues you discussed being raised. I guess I have spent too much time reading highly technical papers by liberal economists at salt water universities. They never discuss those populist issues. It’s all about price level and output volatility. Very technical.
Mike Sproul, If money is to be like wheat can I produce it in my backyard legally? Seriously, I assume you have some sort of monetary system in mind (gold standard?) but without knowing what it is I can’t comment on whether anyone should be controlling it in any way. A gold standard doesn’t need to be controlled, but will not deliver price stability. Fiat money systems do need to be “regulated” otherwise money becomes worthless.
13. January 2010 at 19:26
Scott,
What do you mean by price stability? Surely a gold standard plus free banking can provide better macroeoncomic stability than a fiat system. And they are consistent with morality, unlike the current setup. No hectoring Fedhead lecturing us that “sorry, Milton, we did it but we won’t do it again thanks to you,” then doing “it” or at least a variant of “it” (where is Bubba when we need him?), and finally blaming lax regulation instead of his State monetary planning.
13. January 2010 at 19:40
ssumner:
I’m not trying to represent why Liberals _say_ they don’t like NGDP targeting. No sane macroeconomist would ever write that they are deeply suspicious of markets, if they wanted to keep their job. Nor do liberals favor pure inflation targeting – they favor a group of technocrats who try to balance two objectives (employment and inflation) in the best interests of society.
As to Liberals and monetary policy, observe the odd spectacle of many liberals seizing on fiscal stimulus and proving very willing to give up on monetary stimulus without much of an effort. Remember this…
http://krugman.blogs.nytimes.com/2009/09/30/does-unconventional-monetary-policy-solve-the-zero-bound-problem/
Friedmanomics never actually defeated the Liberals; it just beat them into submission for a time. I don’t think many liberals have consciously stated that they instinctively distrust monetary stimulus – that’s not something one says in polite company. Yet it underlies their preference for fiscal action over monetary action in spite of prior work (of their own). Liberals somehow believe that when money itself is the vehicle for stimulating demand, someone somewhere is making an illicit profit. And certainly, the last year has given them plenty of fodder (particularly in the context of banks and bonuses).
An old quote, can’t find author – “A Liberal is afraid that somewhere someone is making money. A conservative is afraid that somewhere someone is having fun.”
Please treat my comments above as nothing more than purely speculative psychology.
13. January 2010 at 20:15
Scott:
“If money is to be like wheat can I produce it in my backyard legally?”
Yes. You should be able to print up paper dollars provided that you put your name on those dollars, recognize them as your liability, and hold enough assets to buy them back at par (i.e., you have enough assets to buy back all of your Scott dollars with federal reserve notes). Otherwise you’d be counterfeiting. Of course, people will only value them according to their opinion of your ability to buy them back.
“Seriously, I assume you have some sort of monetary system in mind (gold standard?) but without knowing what it is I can’t comment on whether anyone should be controlling it in any way.”
Here’s one possibility: Every year I collect 50 oz. of silver in rent on some land I own. At a 5% interest rate, that makes my land worth 5/.05=1000 oz. When I buy groceries, I write out a piece of paper saying “good for 1 oz. of Mike’s land rent”. People accept these Mike dollars because they know I accept them for rent. In principle, I could issue up to 1000 of these Mike dollars, but prudence would prevent me from issuing more than maybe 400. So far, no government control is necessary. People only accept Mike dollars if they have a well-founded belief in my solvency.
(Note that some misguided individuals might think Mike dollars are fiat money, since they are seldom, if ever, redeemed for actual silver. But of course Mike dollars are backed by my assets, and are not a true fiat money. In the same way, federal reserve dollars are backed by US bonds, which are backed by US taxes, so US dollars aren’t fiat money either.)
“A gold standard doesn’t need to be controlled, but will not deliver price stability.”
That’s easily overcome by using a basket of goods as the standard, rather than just gold.
“Fiat money systems do need to be “regulated” otherwise money becomes worthless.”
Mike dollars don’t need to be regulated because they are backed by my land. As I asserted in one of my papers, There’s No Such Thing as Fiat Money, so there is no need to regulate money.
13. January 2010 at 22:00
When not merely something not considered, I think it may be more a matter of conservatism. We have a fair amount of experience at inflation targeting and a feel for how to do it and what to expect even if it falls flat. We don’t have any at ngdp targeting and we don’t know its sensitivity or how slow or fast we may end up altering it, whether we may over or under react or whether we might end up destabilizing rather than stabilizing the system. The trick is probably to introduce it as a factor in flexible inflation targeting, and then shift the weighting towards it instead.
14. January 2010 at 06:33
The case for nominal GNP targets was made, with some reservations, by James Tobin in 1983 (PDF file). AFAICT his view is fairly typical of liberal thinking on the matter.
14. January 2010 at 08:16
Liberals supporting NGDP targeting? Not a chance.
To support an NGDP target would be to accept that monetary policy can be highly effective, even with short-term rates a the zero lower bound, which, in turn, dramatically weakens the case for fiscal stimulus. Liberals love fiscal stimulus because the government gets to decide how and where to allocate resources. It gives them a chance to advocate spending projects and government intervention that would otherwise not be given consideration. Think how quick liberal economists (Delong, Krugman) were to claim that monetary policy was impotent in the fall of 2008.
Furthermore, accepting an NGDP target would undermine their longstanding argument that it was fiscal stimulus, rather than delinking from gold, that was the key to ending the Great Depression. As you pointed out Scott, the F&S thesis that tight money was the cause of the Great Depression was fundamentally a defense of free markets. Similarly, denying that tight money is the foremost cause of recessions is, at its core, an attack on the free enterprise system.
14. January 2010 at 17:50
If you mean by Krugman, DeLong, Thoma and Chinn, then I’m probably fairly familiar with liberal economist views (being ABD PhD I probably almost qualify as being both myself). I think there is an additional factor that so far has not been mentioned.
Ironically, perhaps, there seems to be a respect for perceived authority and bureaucratic expertise in the liberal economics community that sometimes trumps healthy rational debate. For example my sense is that liberal economists truly believe that the Fed must be doing all it can already.
I don’t share that belief. Part of the reason is perhaps monetary economics is part of my sphere of greatest competence (not that I am necessarily all that competent). The other is that I am aware of the role that politics plays in the FOMC. In short I spent some time with the Devil himself (Charles Plosser).
@Gregor Bush
Actually both Krugman and Delong have alluded to the devaluation of the dollar as a (if not the) major factor in the recovery from the Great Depression. For some unknown reason both don’t seem to see how terribly relevant that is to our current situation.
14. January 2010 at 23:46
Mike, free bankers will end up targeting NGDP or something like it but better as they do business. During times of high money demand (deflationary busts) they will have to create more money in times of high credit demand (inflationary booms) they will have to create more credit.
This means as they target their own profits collectively through the magic of the invisible hand they end up targeting the aggregate nominal level of the economy.
15. January 2010 at 14:03
Bill Stepp. The Great Depression occurred under the gold standard. If you don’t trust the Fed to run a fiat system, how can we trust them to aviod meddling in the gold market. And even if they don’t, an increase in gold demand in China and India could cause a Great Depression by raising the value of gold.
Statsguy, As with Keynes, there is a Krugman quotation to prove any point of view. Your guess is as good as mine.
Mike Sproul, If you want Woolsey-type index futures convertiblity combined with free banking (which is how I read your comment) then I’m on board.
Lord, I suppose the gradualism idea makes sense.
Kevin, Thanks, I’ll take a look tonight. But what other liberal economists favor this. You mentioned his views were pretty common. McCallum was often cited as one of the only well known economists to still advocate NGDP. Have the others drifted toward Tayor Rule–type approaches?
Gregor, Ideology may play a role. But I notice that as the Dems approach the midterms with 10% unemployment, attitudes are shifting.
Mark, Those are good points.
Doc merlin, Realistically, the government probably needs to determine a medium of account. You don’t want shifting exchange rates between GS dollar and BOA dollars. But then get out of the way and let the market provide the right amount of money.
15. January 2010 at 18:41
Scott:
“If you want Woolsey-type index futures convertiblity combined with free banking (which is how I read your comment) then I’m on board.”
Cool. Now I just have to try to convince you that fiat money is a figment of economists’ imaginations–no more real than phlogiston, ether, and caloric.
17. January 2010 at 11:24
Mike, Does that mean I should throw away the money in my wallet? Just kidding, I know you think it’s backed by bonds.