Why we need 5% NGDPLT

Morgan Warstler sent me the following story by Matthew Boesler:

The consensus on Wall Street is that U.S. economic growth finally takes off in 2014, which will give the Fed the opportunity to taper.

But what if it doesn’t? Consider this: some believe the U.S. economy is actually entering a “late-cycle stage” “” in other words, the upward acceleration may not be coming.

“A growing number of indicators are showing late-cycle dynamics, and while this need not imply a recession it might well indicate a shift into a period of slower growth and lower inflation,” says Deutsche Bank global head of rates research Dominic Konstam.

“So much for animal spirits,” he writes in a recent note to clients:

.  .  .

Labor input is high relative to productivity, which typically predicts a sharply slower labor market 2 years ahead. In fact, simply conditioning on the relative gaps of labor input to productivity when it is negative predicts an almost stagnant labor market. In the absence of further fiscal or monetary stimulus, a lower household savings rate, or some combination of these, the implication is lower, not higher, rates.

“This is hardly a recipe for above trend growth,” says Konstam. “We note that recent trend real growth is less than 2%, so if inflation is stuck in the 1-1.5% range, then nominal growth is stuck closer to 3%, not 4%. In that environment, nominal yields become restrictive over 3% and become inhibitive to growth.”

There’s a reason NGDP growth slows “late-cycle.”  The Fed tightens monetary policy to cool an overheated economy.  Falling NGDP growth is tight money.  Tight money is falling NGDP growth.

But the economy is not overheated today.

As I said a few days ago, MOAR.



25 Responses to “Why we need 5% NGDPLT”

  1. Gravatar of dtoh dtoh
    28. October 2013 at 17:31

    Spot on. Since expectations play such a major role, it is not at all surprising that talk of tighter money (tapering) results in lower expected and actual NGDP growth. If the Fed announced a real and credible target (ideally) NGDP, they would not even need to talk about the timing or amount of OMP.

    It amazes me how incompetently monetary policy is being managed by the Fed.

  2. Gravatar of Morgan Warstler Morgan Warstler
    28. October 2013 at 17:53

    I keep telling Scott to make this argument.

    Frankly, I think Yellen is going to have to make it.

    The only way to to truly shock the system is to say:

    1. we’re doing NGDPLT
    2. so we’re doing one BIG CHUG of inflation all at once and then raising rates EVERYTIME govt. spends more money, and lower rates EVERYTIME govt. spend less money.

    Read 3 yr old email exchange with Scott today, NGDPLT is very much like saying “we’ll do $150B of QE if Govt. cuts spending $100B”

    The #’s might be wrong, but the shock to the system, is the EXPECTED GROWTH that comes from:

    1. rule based
    2. small govt.
    3. free market

    favored MP.

  3. Gravatar of Scott H. Scott H.
    28. October 2013 at 18:14

    Ladies and Gentlemen,

    It’s not even about tapering anymore. For crying out loud, how big does the monetary base need to get? It’s already plenty large enough to expand NGDP by more than quadruple of what we need.

    The issue now is that the banks must finish the job. They need to get money supply and velocity up by making loans. In this case tapering QE should be expansionary. Stopping QE will increase the spread between long term and short term interest rates — thus increasing the incentives to loan money. Can’t we point to England to see how growth took off AFTER a good period of QE AND a tapering off of purchases?

  4. Gravatar of Dustin Dustin
    28. October 2013 at 19:09

    Emerging from behind my veil of ignorance, I must ask the stupid question(s)… ^^ How, exactly? Simply stopping QE to steepen the yield curve and thereby increase supply of loans? Is IOER a part of the solution, as well? Is there not also a ‘demand for loans’ component? A reliable commitment to 5% NGDPLT does the trick?

    I read this blog a lot, and observe, and consume, and digest, yet the answers to these questions seem always to evade me. In fact, the moar I read the moar questions I have! Is there a resource, a Scott Sumner paper, whatever, where I can find such info?

    If RGDP is at 1.5%, implicit inflation target is 3.5% to hit the 5% NGDPLT in a current period. Granted, with the MB growth we’ve had that 3.5% could be hit easily if credit expands, but it hasn’t yet, so I am very curious as to how it could.

  5. Gravatar of Geoff Geoff
    28. October 2013 at 19:09

    “Falling NGDP growth is tight money. Tight money is falling NGDP growth.”

    Slightly falling NGDP growth from a recent 100% growth per year is still “tight”?

    Slightly rising NGDP growth from a recent -100% growth per year is still “loose”?

    Never reason from a spending change. Spending changes are outcomes only. Outcomes from what? That “what” is where we must look.

    The only economically legitimate meanings for “tight” and “loose” money are certinaly not what the Fed says they are, nor what Sumner and his magical 5% say they are, nor what the Fed’s non-market, arbitrary target implies they are.

    The only useful definition of “tight” money is: an increase in the money supply, from a central bank, that is less than what a free market in money would have otherwise generated.

    By the same token, the only useful definition of “loose” money is an increase in the money supply, from a central bank, that is more than what a free market in money would have generated.

    If this year a free market would have generated a 1% increase in the money supply, and a -2% increase in NGDP, then money is neither loose nor tight, it is what it is supposed to be.

    Nobody has any knowledge of what the money supply should be, based on sitting on their armchair and coming up with a number out of their arses, like 5% NGDPLT. Such protestations are what priests convince the rabble to believe are divinely inspired and not subject to the value judgments of any other individual in the real world action sense (as opposed to the purely verbal sense such as “advocacy”, or “voice”, or “opinion”.

    Each individual must be free, using his own property, to produce any money he wants, and, just as importantly, must be free to choose not to use any money he doesn’t want to use, which includes US dollars, without being threatened with violence. The money generated in this context is the money we identify as “tight”, or “loose”, or “just right.”

    Unfortunately, the individual in our society is treatened with violence by the state if he doesn’t pay taxes in US dollars regardless of the form of the individual’s income, which of course means he is threatened by violence into using money he might otherwise not want to use. And market monetarists want this. They want violence in our society, so that they can get what they want, which a peaceful free market will not provide them with.

    Market monetarists are enemies of civilized society.

  6. Gravatar of Benjamin Cole Benjamin Cole
    29. October 2013 at 00:35

    Love this post. But maybe the title should be “Why We Need 7 Percent NGDPLT.”

    Would it kill us to shoot a little high, and have a few moons of “excessive” labor demand? A bottleneck here or there? Some of the North Dakota feeling in other states?

    Even Sumner, my hero, sometimes tends to hint, “It is okay to shoot a little low, but not a little high.”

    Dang it, dudes. Shoot a little high. Blow the Fed doors open, and bring on some boom-times.

  7. Gravatar of Zac Zac
    29. October 2013 at 01:46

    A non-economist friend recently asked for recommendations on good popular economics books to read. I could think of plenty of books on microeconomics (ie Freakonomics) and several Keynesian macro books (ie Krugman and Stiglitz), but no market monetarist books came to mind. Do you have any recommendations?

    What is the best laymans guide to a MM approach to macro outside the blogosphere?

  8. Gravatar of Geoff Geoff
    29. October 2013 at 02:28

    Benjamin Cole:

    Because 10% unemployment wasn’t enough.

  9. Gravatar of Daniel Daniel
    29. October 2013 at 04:03

    Market monetarists are enemies of civilized society.

    Austrian economics is the enemy of logical thinking.

  10. Gravatar of Dan W. Dan W.
    29. October 2013 at 05:19

    Austrian economics is rational as the framework is based on understanding and explaining personal motivations and incentives for action. Theories that presume outcomes will follow inputs, without ever explaining how, are of the sort of the scientist who writes a bunch of formulas and then adds “a miracle happens” to conclude the proof.

    Science demands more than the assumption of miracles. The invitation to Monetarists like Sumner and Keynesians like Krugman is to follow the money and explain how the change in x will actually result in a change in y. Outcomes are the consequence of individual decisions. It is lazy, if not outright dishonest to presume that individuals will response the way one wants just because that is what one wants!

    No matter what one thinks of “Supply Side Economics” the theory makes the case that changes at the macro level will change individual incentives and that it is individual actions that will change macro-economic conditions. In other words, the theory provides justification for action along every link of the economic chain.

    My challenge to monetarists is to consider the full chain and provide a justification for how and WHY inputs at one end will transfer to the other. Otherwise, in my view one is simply begging for a miracle.

  11. Gravatar of rbl rbl
    29. October 2013 at 06:26

    Dan W,
    That’s not exactly how science works. Establishing a mechanism of causation is desireable, but not necessary or sufficient for a theory to be good. For example, evolution via natural selection was theorized well before anyone understood that genes were transmitted via DNA, but it was still good science. Conversely, Aristotle made very convincing arguments that the natural state of motion was for bodies to be at rest, but it was still nonsense.
    What makes science science is the ability to make falsifiable predictions that are then tested. The reason economics sometimes has trouble being a science is that it is really hard to test hypothesies without controlled experiments. Recent monetarist predictions about things like the devaluation of the Swiss Franc or the creation of inflation expectations in Japan have been more or less supported by the results, and that is what should give credibility to the theories, not whether they have an aestetically appealing model of transmission mechanisms.

  12. Gravatar of Daniel Daniel
    29. October 2013 at 06:26

    Does austrian “logic” make you say nonsense like “deflation helps everyone except the over-leveraged lender” ?

  13. Gravatar of ssumner ssumner
    29. October 2013 at 06:33

    Morgan, Yellen is not on your wavelength.

    Scott, It’s about whatever the market’s think it’s about. And right now they think it’s about tapering. I certainly agree that QE is far from the optimal tool. Higher velocity would be much preferred.

    Dustin, NGDPLT is the main tool. BTW, if NGDP grew 5%, then RGDP would grow much more than 1.5%, probably 3% for a few years. If we are really committed to 2% inflation (God knows why) then I’d scale back the NGDPLT target to 4% after a few years of catchup.

    Ben, Given how often they’d undershot it would be better to aim high for once, as you say.

    Zac, Marcus Nunes and Benjamin Cole have an excellent book on MM. I’d also refer you to some of my articles on NGDP targeting, and NGDP futures targeting, in the right column.

    Dan, We’ve done that, you just haven’t been paying attention.

  14. Gravatar of Michael Michael
    29. October 2013 at 06:46

    Dan W. wrote:

    “My challenge to monetarists is to consider the full chain and provide a justification for how and WHY inputs at one end will transfer to the other. Otherwise, in my view one is simply begging for a miracle.”

    Individuals can make a rational decisions to accumulate more money (by selling assets or foregoing purchases) or to hold less money (by buying assets or making purchases). Note I am referring only about *money* here, not about wealth, which includes money and assets that are not money.

    An economy, as a whole, cannot accumulate more money or hold less money. Every dollar I hold is a dollar that is not available to anyone else. Every dollar I spend is a dollar that someone else is forced to hold. It’s zero sum.

    In our current system, then, if the Fed provides money in excess of the demand for money, people will spend more and prices will rise. In contrast, if the Fed provides insufficient money to meet this demond, people will spend less and you get a recession (as prices/wages fail to adjust in the short run).

    Beyond that, deviation from the expected price level trend is inequitable. If the price level rises above expectations, this transfers wealth from lenders to borrowers. If the price level falls below expectations, this transfers wealth from borrowers to lenders (or, perhaps, from borrowers who pay the increased real costs of the loan to borrowers who default, if enough borrowers default to offset the increased real return to lenders).

  15. Gravatar of Doug M Doug M
    29. October 2013 at 07:45


    “That’s not exactly how science works.”

    This is economics, this is not science.
    There are no controlled experiments.
    Even when an economist will point what passes for experiment, to states taking different prescriptions for the same illness, different economists see the results entirely differently depending upon their philosophy.

  16. Gravatar of TravisV TravisV
    29. October 2013 at 08:25

    On TV last night, Greenspan discussed NGDP targeting with Kudlow……..


  17. Gravatar of rbl rbl
    29. October 2013 at 08:32

    Doug M,
    Sure, economics isn’t a pure science like physics but astronomy, geology, and ecology also have trouble with controlled experiments as well. The fact that interpretation of reults is hard is irrelevant. Some economists certainly don’t do science but ISLM, RBC, the EMH, and much of the rest of the stuff in macro are empirical theories subject to falsifiability. It may be hard to disprove the real business cycle framework, for example, but in principle most of this stuff can be disproved. If some economists refuse to modify their frameworks in response to new information, then oh well. Even Einstein didn’t accept quantum mechanics.

  18. Gravatar of Edward Edward
    29. October 2013 at 09:05

    “And market monetarists want this. They want violence in our society, so that they can get what they want, which a peaceful free market will not provide them with.

    Market monetarists are enemies of civilized society.”

    The ravings of our resident lunatic, gentlemen

  19. Gravatar of Edward Edward
    29. October 2013 at 09:12

    How does this Austrian bimbo even know that the free market wouldn’t generate a higher nominal money supply and higher nominal incomes than what the Fed is generating now? If no one can discover what the free market will provide, he is contradicting himself by saying that NGDPLT is too “loose” relative to that standard.

  20. Gravatar of TravisV TravisV
    29. October 2013 at 10:14

    Fascinating video where Eugene Fama discusses the Fed with Rick Santelli:


    Efficient markets!

  21. Gravatar of ssumner ssumner
    29. October 2013 at 15:22

    Everyone, Economists do lots of controlled experiments, probably more than climate scientists or cosmologists. (“Let’s try another Big Bang with different parameters.”)

    Edward, Given that the stock market currently loves easy money, I think you raise a very good question–what makes conservatives think the free market wouldn’t provide easier money?

  22. Gravatar of W. Peden W. Peden
    29. October 2013 at 15:31

    I see US markets are hitting new heights in a lagged reaction to the improved budget-negotiations situation.

  23. Gravatar of Geoff Geoff
    29. October 2013 at 17:01

    It’s funny how Sumner tells me what I need, without even asking me, as if he knows more about me, than me.

    Pompous true believer.

  24. Gravatar of Peter Drake Peter Drake
    29. October 2013 at 17:19

    Experiments are not required for a science. Hypothesis, prediction, observation, that’s it. If you make predictions that follow logically from the hypothesis, and they can be proven right or wrong, but are proven right, then you have a hypothesis that has some predictive value and you’ve done some science.

    Cosmologists don’t make new universes, but they may make predictions about what new instruments should detect, and when those results are in agreement with their predictions then they’ve proven their hypothesis has some value.

  25. Gravatar of ssumner ssumner
    30. October 2013 at 06:30

    Peter, That’s right.

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