Wrong question, wrong answer

John Cochrane has a new piece in the WSJ, criticizing the widespread concern over deflation risks, especially in Europe. I have mixed feelings about this whole enterprise.  I’ve repeatedly argued that inflation doesn’t matter, and that economists should just stop talking about inflation (and deflation.)  But they obviously won’t stop, and hence I guess I can’t blame Cochrane for responding to the often incoherent discussion. He lists 4 reasons to be skeptical about deflation fears:

1) Sticky wages. A common story is that employers are loath to cut wages, so deflation can make labor artificially expensive. With product prices falling and wages too high, employers will cut back or close down.

Sticky wages would be a problem for a sharp 20% deflation. But not for steady 2% deflation. A typical worker’s earnings rise around 2% a year as he or she gains experience, and another 1%””hopefully more””from aggregate productivity growth. So there could be 3% deflation before a typical worker would have to take a wage cut. And the typical worker also changes jobs, and wages, every 4½ years. Moreover, “typical” is the middle of a highly volatile distribution of wage changes among a churning job market. Ultimately very few additional workers would have to take nominal wage cuts to accommodate 2% deflation.

Curiously, if sticky wages are the central problem, why do we not hear any loud cries to unstick wages: lower minimum wages, less unionization, less judicial meddling in wages such as comparable worth and disparate-impact discrimination suits, fewer occupational licenses and so forth?

2) Monetary policy headroom. The Federal Reserve wants a 2% inflation rate. That’s because with “normal” 4% interest rates, the Fed will have some room to lower interest rates when it wants to stimulate the economy. This is like the argument that you should wear shoes two sizes too small, because it feels so good to take them off at night.

The weight you put on this argument depends on how much good rather than mischief you think the Fed has achieved by raising and lowering interest rates, and to what extent other measures like quantitative easing can substitute when rates are stuck at zero. In any case, establishing some headroom for stimulation in the next recession is not a big problem today.

3) Debt payments. The story here is that deflation will push debtors, and indebted governments especially, to default, causing financial crises. When prices fall unexpectedly, profits and tax revenues fall. Costs also fall, but required debt payments do not fall.

Again, a sudden, unexpected 20% deflation is one thing, but a slow slide to 2% deflation is quite another. A 100% debt-to-GDP ratio is, after a year of unexpected 2% deflation, a 102% debt-to-GDP ratio. You’d have to go decades like this before deflation causes a debt crisis.

Strangely, in the next breath deflation worriers tell governments to deliberately borrow lots of money and spend it on stimulus. This was the centerpiece of the IMF’s October World Economic Outlook antideflation advice. The IMF at least seemed to realize this apparent inconsistency, claiming that spending would be so immensely stimulative that it would pay for itself.

4) Deflation spiral. Keynesians have been warning of a “deflation spiral” since Japanese interest rates hit zero two decades ago. Here’s the story: Deflation with zero interest is the same thing as a high interest rate with moderate inflation: holding either money or zero-interest rate bonds, you can buy more next year. This incentive stymies “demand,” as people postpone consumption. Falling demand causes output to fall, more deflation, and the economy spirals downward.

It never happened. Nowhere, ever, has an economy such as ours or Europe’s, with fiat money, an interest-rate target, massive excess bank reserves and outstanding government debt, experienced the dreaded deflation spiral. Not even Japan, though it has had near-zero inflation for two decades, experienced the predicted spiral.

He’s right about point 4, there’s very little risk of a deflationary spiral.  And of course he’s right about the insanity of borrowing money to try to overcome deflation. Point 2 is a lousy metaphor, which doesn’t capture the logic of higher inflation as a way of avoiding a liquidity trap.  If Cochrane insists on shoe metaphors, here’s the right one:

Suppose you occasionally have to go out and shovel snow when it’s 40 below.  You should have one set of shoes that is 2 sizes too large, so that you can wear 4 pairs of socks with it.

Points one and three are examples how conservatives (except for the great Milton Friedman) have an unfortunately tendency to minimize the impact of demand shocks.  It’s true that inflation itself doesn’t matter, and that almost all Phillips Curve models perform really poorly.  But that’s a side issue.  When economists worry about deflation they are actually worried about falling NGDP, they just don’t realize it.  Obvious lower prices, ceteris paribus, are perfectly fine.  But when NGDP growth comes in 10% or 20% lower than workers or borrowers expected when they signed labor and debt contracts, then you have big problems.  Conservatives tend to have a blind spot for that problem (except for Milton Friedman, obviously.)

PS.  I hereby issue “loud cries to unstick wages.

PPS.  Notice to my international readers.  Keep in mind that 40 below zero fahrenheit is equivalent to 40 below zero centigrade.  

HT:  Ramesh Ponnuru


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41 Responses to “Wrong question, wrong answer”

  1. Gravatar of CMA (@CMAMonetary) CMA (@CMAMonetary)
    14. November 2014 at 19:01

    “It’s true that inflation itself doesn’t matter”

    I think it matters to a degree. For example it is prefferable to have a relatively stable and predictable increase in prices rather than wild swinging or excessive increase in prices. I dont think it matters much though whether you have 1% deflation or 1% inflation though.

  2. Gravatar of Major.Freedom Major.Freedom
    14. November 2014 at 19:52

    “But when NGDP growth comes in 10% or 20% lower than workers or borrowers expected when they signed labor and debt contracts, then you have big problems.”

    If a firm’s or industry’s revenues comes in 10% or 20% lower than the workers or borrowers expected when they signed labor and debt contracts, then those workers and debt holders will have big problems.

    So why doesn’t MM advocate for central banks to make sure every firm’s or industry’s spending rises 5% every year?

    Clearly it isn’t workers or debt holders that MM is concerned about. It is actually how to perpetuate the central bank for its own sake.

    It is similar to the welfare advocates. They don’t call for poor but not impoverished Americans to be taxed to finance the much poorer in Africa. They are not concerned with poverty per se. They are concerned about how their domestic goverment can loot the domestic rich. The “poor” is just an excuse.

    MM is concerned about how to best entrench the central bank without causing political revolution. “Think of the workers” is a fake, pandering, appeasing deceit designed solely to give one’s actual intentions the appearance of “the public good”.

  3. Gravatar of Benoit Essiambre Benoit Essiambre
    14. November 2014 at 20:08

    I feel there is a semantic issue here. When you say inflation doesn’t matter but ngdp does, it feels almost contradictory as inflation can be seen as an arithmetic component of ngdp. I wonder if there wouldn’t be a better way to use words to convey the message less ambiguously.

    It is not unreasonable to interpret arguments about inflation as less precise arguments about ngdp. It is likely that a lot of economists are thinking about something like ngdp despite putting emphasis on the inflation component possibly because it can be seen as more purely monetary. Even if it is the wrong emphasis in practice, it seems difficult to reconcile the semantics of it being all about ngdp and inflation not mattering.

  4. Gravatar of Benoit Essiambre Benoit Essiambre
    14. November 2014 at 20:34

    “But when NGDP growth comes in 10% or 20% lower than workers or borrowers expected when they signed labor and debt contracts, then you have big problems.”

    I’m also curious of what you think would happen if NGDP was predicted to trend down? Wouldn’t the economy still face zero lower bound type problems? I’m not trying to make an argument here. I am genuinely curious as I am not an economist and this stuff is mostly over my head.

    Wouldn’t cash keep value better than private investments (at least for a while until the economy resets) and thus inhibit private investments or at least create huge amounts of volatility as people play musical chair with cash alternating hoarding it until suddenly deciding to spend it in an environment now deficient of production and spiking inflation or forcing central banks to use corrective or even punitively high interest rates?

    Or would the expectation of the music eventually stopping be enough itself to prevent this volatility (Is that what is preventing deflationary spirals?). Are people smart enough for that? Cash is far from exclusive to sophisticated investors who can predict these things.

  5. Gravatar of Kenneth Duda Kenneth Duda
    14. November 2014 at 21:07

    Scott, a bit off topic, but I was curious about your reaction to this lovely article:

    http://www.chicagotribune.com/sns-wp-blm-news-bc-treasuries14-20141114-story.html

    which basically says, since inflation expectations are as low as they’ve ever been, now would be a great time for the Fed to tighten:

    > reports suggested the economy is growing with little risk of inflation,
    > allowing the Federal Reserve to proceed with plans to increase borrowing
    > costs next year.

    ….

    > “The FOMC has indicated that the policy rate is likely to rise next
    > year, with the exact timing dependent on macroeconomic data in coming
    > quarters,” Bullard said in St. Louis. “While a low inflation rate may
    > suggest a somewhat lower-than-normal policy rate, that effect is not
    > large enough to justify remaining at the zero lower bound.”

    Translation: “Undershooting our inflation target over and over does not justify aiming higher.”

    -Ken

    Kenneth Duda
    Menlo Park, CA

  6. Gravatar of Cameron Cameron
    14. November 2014 at 21:50

    “He’s right about point 4, there’s very little risk of a deflationary spiral.”

    This is a strong argument against the mechanical “Interest rate and fiscal policy in–> AD out” view that many economists seem to hold.

    Are we really to believe Japan has achieved a combination of monetary+fiscal policy just expansionary enough to avoid such a spiral but contractionary enough to lead to 0% NGDP growth for 15 years? The world just makes more sense from a MM perspective.

  7. Gravatar of Don Geddis Don Geddis
    14. November 2014 at 22:50

    @Benoit Essiambre: “When you say inflation doesn’t matter but ngdp does, it feels almost contradictory as inflation can be seen as an arithmetic component of ngdp.

    You’re confusing yourself with simple math. Central banks are capable of targeting any nominal aggregate. If they keep NGDP growth steady, then business cycles (recessions) will be moderated, regardless of how volatile inflation happens to get. On the other hand, if they stabilize annual inflation, but allow NGDP to be volatile, then the severity of business cycle crises is a function of how far NGDP is off of expectation.

    The fact that you can arithmetically view NGDP as = RGDP + inflation, really isn’t relevant. Because that doesn’t imply any necessary connection between the volatility of NGDP, vs. the volatility of inflation. Sumner is saying that the volatility of inflation doesn’t matter (for business cycles), but the volatility of NGDP matters a lot.

  8. Gravatar of TallDave TallDave
    14. November 2014 at 23:43

    Sorry if this double posts.

    Isn’t the main point of fiat money to avoid deflationary spirals?

    You’re absolutely correct, conservatives drive me crazy on this topic. It really seems that at some level they see a certain immorality to avoiding the consequences of shocks, or at least an efficiency gain in recessions.

    I don’t know it it’s fair to call Friedman a conservative, though, he was for legalization (we’re getting there Milt!) which puts him pretty firmly in the libertarian camp.

  9. Gravatar of Benjamin Cole Benjamin Cole
    15. November 2014 at 04:35

    So, who would lend on real estate in a deflationary environment?

    What happened to Japan equity and property values in the island’s deflationary period ? 1992-2012. They fell 75%.

    Even is Cochrane is “right,” there is a practical matter of stock and property markets falling in nominal terms for the next 20 years or so.

    Moreover, Cochrane says there is no cost to 2% deflation (other than cratering stock and property markets, perhaps). But what are the costs of 2%-3% inflation?

    In fact the US economy performed well from 1982 to 2007, through a wide variety of moderate inflationary periods. That’s recent history, and not debatable. Inflation ranged from 2-6%, in general.

    Why now this obsession with either 0% inflation, or even deflation?

    Give unto me the USA 1982 to 2007 period again.

    Meanwhile, Japan did poorly in their 20-year bout with deflation.

    I don’t understand what Cochrane is driving at, unless it is simple belief that 0% inflation is good, and deflation even better. But why?

  10. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. November 2014 at 05:14

    The conservative obsession with inflation seems to just assume income (keeps flowing).

    Also, the compulsion to think in terms of the “real” economy with inflation as add-on smacks of a barter-deluson; as if money is just some transparent “thing” that performs no “real” function. Curious that there is so much of it about, then. And used so often.

    My house, it’s worth 20 Volkswagens Yes, people think like that all the time …

    So, with a certain breed of conservative economic commentary, we operate in a “barter” economy where income just keeps coming but inflation is still really bad.

    I so get why you don’t like talking about inflation.

  11. Gravatar of ssumner ssumner
    15. November 2014 at 06:08

    CMA, With NGDPLT, the inflation rate is unlikely to swing sharply, and if it did that would be desirable.

    Benoit, I’m trying to shake people up with strong claims, make them look at the picture in a different way. You could say inflation matters only to the extent it is correlated with NGDP (demand side), but then why not focus on NGDP?

    If NGDP trended down, as in Japan, then you’d have the problem of the equilibrium rate falling below zero.

    Ken, That doesn’t sound very logical to me. Unfortunately Bullard has been all over the map. He changes his mind faster than conditions call for a change.

    Cameron, Yes. Just to be clear, a deflationary spiral is technically possible, but as a practical matter even the BOJ did enough QE to avoid that outcome.

    TallDave, Good point, but then I’m pretty sure that most other “conservatives” like Cochrane (and myself) are also more libertarian than conservative.

    Lorenzo, Yes, it makes no sense to worry about inflation but not deflation.

  12. Gravatar of Michael Byrnes Michael Byrnes
    15. November 2014 at 06:52

    Is it fair to think of NGDP as purely a measure of demand, whereas inflation and real output are dependent on both supply and demand?

  13. Gravatar of Benoit Essiambre Benoit Essiambre
    15. November 2014 at 07:01

    I think I understand the argument, but to me it would feel less contradictory and thus more convincing to say something like “inflation only matters indirectly”.

    Otherwise you are setting up others as straw men that talk about completely the wrong thing which doesn’t make for super convincing arguments.

    I think I get that for the markets, it is NGDP that matters most to allow aggregate contracts to add up. But sometimes, people may be thinking about a short term where real supply and output is mostly external to monetary policy and where it is easier to see inflation as the most direct result of central bank actions, even if it is not what matters in the end. It is not illegitimate to talk about inflation even if it is only an intermediate goal to dealing with ngdp. Maybe this is not true of real economist, but dismissing this confuses me.

    To put it another way, I guess it is not clear to me that you can best draw the causal chain that start at central bank action as central-bank-action -> ngdp -> real-ouput instead of central bank action -> inflation -> real-output. Even if ngdp is the best target in both case, it seems legitimate to talk using the later case’s language.

  14. Gravatar of Benoit Essiambre Benoit Essiambre
    15. November 2014 at 07:26

    Another way to put it is that ngdp targeting to a level that is consistently rising sufficiently may be optimal but not _that_ much better than just an inflation level target that is rising sufficiently, the key thing being that the target line should be rising sufficiently to avoid the zero lower bound issues.

    Arguing the finer details of the actual target variable may be premature until we can at least agree to not let money act as a market distorting barrier to private investment at the zero lower bound.

  15. Gravatar of Don Geddis Don Geddis
    15. November 2014 at 07:48

    @Benoit Essiambre: “ngdp targeting … may be optimal but not _that_ much better than just an inflation level target

    In many economic conditions, the two kinds of targets have very similar effects. So yes, they’re closely related policies.

    The problem is, when they differ, then NGDPLT is superior.

    Arguing the finer details of the actual target variable may be premature/i>”

    But the global financial crisis in 2008, which has lasted years now, turns out to be exactly a case when the difference between NGDPLT and inflation targeting is highly relevant. Hence it’s the opposite of “premature”: this debate on the correct target should have been resolved a decade ago, so that millions of people wouldn’t have needed to suffer unnecessary unemployment.

    key thing being that the target line should be rising sufficiently to avoid the zero lower bound issues

    No, there is no actual ZLB issue. (That’s not the main factor i choosing an NGDPLT growth rate target.) ZLB is a self-imposed illusionary barrier, from those who focus inappropriately on interest rates as the primary monetary policy tool. (Which is generally highly correlated with those who focus on an inflation target.)

    You should try it. Switch from inflation targeting to NGDPLT. Switch from interest rates as a tool, to managing the money supply instead. All the (demand-side) economic crises will magically evaporate!

  16. Gravatar of Steven Kopits Steven Kopits
    15. November 2014 at 09:20

    Actually, I wanted to put this here:

    Latest from me:

    US labor markets may be signaling wage growth-which may or may not lead to inflation. In any event, the statistics say labor markets are hot.

    http://www.prienga.com/blog/2014/11/14/oil-and-labor

    My take on the Euro zone: Oil is helping, Russia is hurting. Russia is knocking about 1 percentage point off the growth rate of countries with exposure to Russia (eg, Germany, Poland, Hungary, Finland)
    http://www.prienga.com/blog/2014/11/14/q3-euro-gdp-stagnation-russia-or-oil

    Finally, we should keep in mind the oil exporters are going to see a massive drop in savings, leading to a potentially significant drop in global funds available for investment. This may lead to increased interest rates.

  17. Gravatar of Benoit Essiambre Benoit Essiambre
    15. November 2014 at 09:56

    Don, I don’t get how NGDPLT gets you around ZLB unless your target level is a path rising fast enough (Another place where semantics is a barrier as the “level” is not level at all but a tilted rising path).

    How does it prevent cash from having a real return above risk adjusted private return on investment. How does it prevent it from jamming the private markets?

    It is easy to see that if your NGDP level is actually a level (0% nominal growth), we stay in deflation most of the time and returns on a lot of investments get to natural levels that are deeply negative nominally. It becomes better for investors to keep their wealth in intrinsically valueless cash than in those investments which clearly results in low economic output, velocity dropping and people accumulating intrinsically valueless cash instead of creating real wealth. Or am I missing something?

  18. Gravatar of Major.Freedom Major.Freedom
    15. November 2014 at 10:44

    One can argue that the contarction in the money supply during the early 1930s turned a bad situation worse, without presupposing the solution of a central bank going forward.

    This is because central banks cannot know how much more money to issue, nor where to issue it, nor what to exchange it with, that will prevent the same sudden deflationary choices of individuals throughout society in the future. Central banks necessarily chase their own tails. They have no access to the information revealed by, nor are they constrained to, private market forces in money production and distribution. But it is this and only this information that investors in a division of labor require in order to coordinate their behavior. Rigid aggregate spending as an outcome of central bank activity cannot do this. Investors need market prices, market interest rates, and market spending. There is no market prices or interest rates or spending when there is a central bank.

    Even if they don’t target a variable, it does not imply that variable would then be determined by the market.

    If a person prints money in their basement, and they spend at a rate of which they intend to make the price of oil rise at a constant rate, this does not suddenly imply that every other price is market determined. The prices of the things I buy would obviously be affected. So would the things that are bought by the people I buy from. And so on. Prices throughput the economy would all be hampered prices not free market ones.

    It is not true that not intending to affect something, prevents you from affecting that something necessarily.

    Sumner is lying – or at least seriously confused, but I am going to go with lying due to his recent non-surprising admission that he purposefully lies to people if he believes he can get away with it – by claiming that he wants interest rates and prices to be market determined. No, he cannot possibly want that as long as he wants a non-market institution of legalized counterfeiting to print money. It is ridiculous to believe that merely turning attention away from prices and interest rates somehow results in one never affecting them by one’s non-market monetary activity.

    Price inflation is claimed as not mattering. As long as spending grows at a constant rate, then poor people can be priced out of necessary goods solely because of the money printing. Assume the fallacy that the only thing that matters is average wages rising. Ignore the individual victims. Believe in one’s mind that they are the necessary “collateral damage” who should suffer for the sake of Sumner’s ideology, imposed by government guns. The world is apparently so incomprehensible that we cannot even think of an ethic that would identify individual victims, and to at least identify the aggressors as acting immorally. We cannot do this because we’re supposed to pretend to be so incredibly intelligent that we can discern the dirty secrets of human life to learn the super secret knowledge that violence and misery are not only inevitable, but serve a useful function. Useful to whom you ask? Useful to those who wish to rule.

  19. Gravatar of Don Geddis Don Geddis
    15. November 2014 at 15:48

    @Benoit Essiambre: “I don’t get how NGDPLT gets you around ZLB

    Well, just NGDPLT by itself is not relevant to ZLB, that’s true. But the NGDPLT proposal by the MMs comes out of a monetary framework where the ZLB just disappears.

    First of all, I’m a little unclear whether by ZLB you’re referring to 0% inflation, or the more usual 0% interest rates. The Krugman-style ZLB concern is that the central bank wants to provide monetary stimulus, but they’ve already dropped interest rates to zero, and “you can’t have negative interest rates”, so they’re stuck with 0% nominal rates (and thus real rates that are too high).

    The “solution” to that is easy: focus on the money supply and the value of the unit of account, and ignore (i.e., let the market determine) whatever happens to interest rates. Even if interest rates are at 0%, nothing prevents the CB from issuing more currency, and thus debasing the value of the unit of account (which is how a central bank provides monetary stimulus, when needed). And there’s obviously no ZLB on the value of a dollar, or the total amount of currency that you print.

    (If you’re somehow concerned about 0% inflation instead, that topic would require a different answer.)

  20. Gravatar of Don Geddis Don Geddis
    15. November 2014 at 15:57

    @Benoit Essiambre: As for your final paragraph, “0% nominal growth … we stay in deflation most of the time“, most MMs are advocating about 5% nominal NGDP (level target) growth for the US, which would probably come out as about 2% productivity increases, 1% population increases, and 2% inflation. I’ve seen some proposals for 3% nominal growth / 0% inflation. Your suggestion, of 0% nominal growth and regular annual deflation, probably would have negative effects, as you suggest. I haven’t heard any MM advocate for such a policy, and MM macroeconomics regularly discusses the economic damage from deflation in any case. Your scenario sounds like a strawman that would be, at most, of only hypothetical / theoretical interest.

  21. Gravatar of ThomasH ThomasH
    15. November 2014 at 18:26

    “Curiously, if sticky wages are the central problem, why do we not hear any loud cries to unstick wages: lower minimum wages, less unionization, less judicial meddling in wages such as comparable worth and disparate-impact discrimination suits, fewer occupational licenses and so forth.”

    But we do hear these suggestions [particularly from the ECB] and some of them MIGHT even have something to do with average wage levels and not just relative wage levels But one can well think that even in Libertarian wage utopia that wages and prices are still likely to be asymmetrically sticky downward.

    “worriers tell governments to deliberately borrow lots of money and spend it on stimulus.” But that is because the borrowed money is to be spent on be spent on projects with positive net present values so borrowing now lowers the future debt/gdp ratio.

    “But when NGDP growth comes in 10% or 20% lower than workers or borrowers expected when they signed labor and debt contracts, then you have big problems.” [bigger problems than if it comes in 20% higher than expected.]

    This is another way of saying that wages and prices are asymmetrically sticky downward.

  22. Gravatar of Benoit Essiambre Benoit Essiambre
    15. November 2014 at 19:14

    I guess I am not so much worried about the ZLB preventing the target to be reached as I am worried about a target path for either inflation or ngdp being not steep enough to allow the economy to reach full output. It seems to me we should first agree that we need to allow cash to devalue fast enough to let the private investment market clear and then we can argue the finer point of which exact variable to target. As long as money or central bank interest rates are not blocking private investments by having higher risk adjusted return than private stores of value, the economy should be somewhat able to adjust. Though I agree it might well adjust best under an NGDPLT regime.

  23. Gravatar of Don Geddis Don Geddis
    15. November 2014 at 21:43

    @Benoit Essiambre: usually the concern, for “the economy to reach full output”, is unemployment (above NAIRU). Which generally comes down to clearing the labor market without requiring nominal wage cuts. I’m not sure how that relates to your suggestion of devaluing cash “fast enough to let the private investment market clear”, but perhaps it’s about the same.

    In any case, it seems pretty easy: the US economy is unlikely to grow more than about 3% annually, so pick some NGDP growth target above that (3%,4%,5%), and you’re sure to get at least a little inflation each year, even in the best years. Inflation is your sign that cash is being devalued sufficiently quickly (during normal economic times) for full output.

  24. Gravatar of Benoit Essiambre Benoit Essiambre
    16. November 2014 at 04:57

    Don, I think you are correct and thank you for clearing that up, ideas were mixed up in my head.

    I guess my issue is that I don’t understand why the emphasis is being put on choosing ngdplt instead of inflation as a target when it should be first about choosing a sufficiently rising target path regardless of the exact target variable to allow for the market to clear since this will give you the most gains and then as a second optimization choosing the exact optimal path to target.

    Even if we can’t agree on ngdp or inflation as the specific variable to target can’t we all agree that whichever one it is, at least for places like europe and japan we clearly need it rising faster?

  25. Gravatar of Benoit Essiambre Benoit Essiambre
    16. November 2014 at 05:46

    “Which generally comes down to clearing the labor market without requiring nominal wage cuts. I’m not sure how that relates to your suggestion of devaluing cash “fast enough to let the private investment market clear”, but perhaps it’s about the same.”

    I think it is equivalent (but I am not sure). To me it makes more sense to see it in terms of not letting money be a store of value that artificially keeps its value at a risk adjusted rate above private investments.

    When central banks allow money to maintain too high a value over time and let people have too much faith into this paper as a store of value compared to private market alternatives, intrinsically valueless money displaces private intrinsically valuable stores of value. When real economic activity is replaced by government paper, we have a gridlock in the private markets, unemployment and sub potential investment and production.

    The point is to get money out of the way as a store of value to let the private savings markets function. Make it lose value fast enough so that people can’t use it as an artificially propped up store of value. If the private markets for stores of value offer short term risk adjusted returns that are worst than -2% than inflation *must* be higher than 2%!

  26. Gravatar of ssumner ssumner
    16. November 2014 at 06:20

    Michael, Yes.

    Benoit, The problem with inflation is that it can change for either AS or AD reasons. Thus a change in inflation does not have any predictable impact on RGDP.

    Steven, I think you linked to eurozone GDP data for the wrong year.

    Thomas, Good point.

    Benoit, The zero bound is only a problem for investment and the business cycle if it leads to a more unstable path of NGDP. And NGDPLT can help make the path more stable. Any plausible path for NGDP in the US would be high enough to clear the labor market.

  27. Gravatar of Benoit Essiambre Benoit Essiambre
    16. November 2014 at 06:48

    “The problem with inflation is that it can change for either AS or AD reasons. Thus a change in inflation does not have any predictable impact on RGDP.”

    I understand that NGDPLT is superior, but isn’t there a rising enough price level target that would do at least the trick of allowing the labor market to clear even if not in the most optimal way (if I understand correctly, it might sometimes result in more inflation than really needed). Shouldn’t economists at least be able to agree on that?

    “Any plausible path for NGDP in the US would be high enough to clear the labor market”

    This is interesting, what does it mean? Would the 0% level “level” I mentioned before work?

  28. Gravatar of Alex Alex
    16. November 2014 at 06:57

    The negative number is negative, the 2 diagram is at -40F low and there is an equality!
    However reduced oil taxes (hide negative externalities) in a depressed economy drove people to substitute oil heating with wood and industries cut production due to smog -the negative externalities are offseting. In cigarettes the externalities are more obvious for health.

  29. Gravatar of TravisV TravisV
    16. November 2014 at 07:41

    Yglesias: “The NAIRU, explained: why economists don’t want unemployment to drop too low”

    http://www.vox.com/2014/11/14/7027823/nairu-natural-rate-unemployment

  30. Gravatar of W. Peden W. Peden
    16. November 2014 at 08:53

    I think that Milton Friedman would agree with the saying, “The best way to do justice to the Friedmanite natural rate hypothesis is to stop trying to think what the natural rate is.”

    The experience of the late 1990s in the US should tell us that trying to use the NAIRU as an ersatz Keynesian output-gap is not a reliable approach to monetary policy. Similarly, in the UK right now, our natural rate seems to have fallen to 4% (or even lower) but there’s an element of a lag (dare I say ‘hysteresis’?) in monetary policymakers ESTIMATES of the natural rate.

  31. Gravatar of Steven Kopits Steven Kopits
    16. November 2014 at 08:54

    Yes, thanks Scott. Fixed it.

    Whenever I do these charts, I inevitably find that I am missing one piece of data which should be readily available, but isn’t. In this case, the missing data is quarterly GDP for Greece, which seems to have been not reported for much of the last few years.

    As a consequence, I was trying to piece the data for the associated graph together from various sources, and linked the wrong news release in the process.

    As a practical matter, I am always concerned about whether the presentation fairly represents the data, and whether the data actually says what I am contending. There is an element of unavoidable sausage-making in all this. It’s a struggle to let the data speak.

  32. Gravatar of W. Peden W. Peden
    16. November 2014 at 08:55

    Also, the natural rate and the NAIRU are defined differently, and Friedman was a bit snooty about the NAIRU concept.

  33. Gravatar of W. Peden W. Peden
    16. November 2014 at 09:45

    “Either way, Greenspan aimed for a level of unemployment that was lower than conventional estimates of the NAIRU, and society benefitted from it.”

    As far as I know, that’s just false. Greenspan was focusing on inflation, and just disregarded (correctly) those who were claiming that the US economy was overheated in the late 1990s. He was not targeting an unemployment rate.

  34. Gravatar of Don Geddis Don Geddis
    16. November 2014 at 12:00

    @Benoit Essiambre: “why the emphasis is being put on choosing ngdplt instead of inflation as a target” Mostly because, in our very recent and painful example of the recession that started in 2008, inflation targeting was “the dog that didn’t bark“, as Nick Rowe put it. In particular: “The Bank of Canada kept inflation on target, almost exactly as it was supposed to. But keeping inflation on target wasn’t good enough to prevent the 2008 recession.

    You are right, that in most cases they wind up in approximately the same place. And indeed, inflation targeting was far more successful than previous monetary policies, e.g. from ~1982-2007 “The Great Moderation”. So it’s very close to the right thing (and a higher inflation target would cause it to fail less often, as you suggest).

    But the question is relevant, because of the last years of recession and millions of workers unnecessarily unemployed. Whose fault is this recent economic pain? If you believe in inflation targeting, then the central banks did “what they should have done”, and the “fault” is subprime mortgages, or lack of regulation, or some Austrian babble about “unsustainability” and “corrections”. But if you look from an NGDP(LT) perspective, then the fault and blame and responsibility lies solely with the central banks. It was a completely unnecessary, self-inflicted Great Recession, causing lots of economic damage for no benefit. And the root cause was: the CBs erroneously chose an inflation target, instead of an NGDP target.

  35. Gravatar of Benoit Essiambre Benoit Essiambre
    16. November 2014 at 18:00

    Don I understand that ngdplt is superior but why couldn’t we get say 80% of the benefit from a faster rising price path target. Also are you sure even ngdplt would be effective if the target path rising rate wasn’t fast enough? What I mean is that in both cases, getting the rate rising fast enough so that the labor market can clear might be what gives you most of the benefits, ngdplt allowing you to optimize yet a bit further. Or am I missing something?

  36. Gravatar of Benoit Essiambre Benoit Essiambre
    16. November 2014 at 18:25

    Also, I am no economist but I feel this is no time to debate the finer points of which exact path should the value of currencies take. Can’t we all agree that money needs to devalue enough for labor and investment markets to clear? Unemployment in the eurozone is in the double digits for god sakes. Proper health care and government services are much scarcer than they need to be in some areas. This is not some academic exercise to see who’s more right. People are dying! Can’t the economic profession get its shit together and at least agree on the basics and loosen the noose around europe’s neck so she can breath a little?

  37. Gravatar of ssumner ssumner
    16. November 2014 at 19:20

    Benoit, No, 0% is not enough, but it’s also not a plausible target for the Fed.

    And yes, price level targeting would be considerably better than current policy.

  38. Gravatar of Steven Kopits Steven Kopits
    17. November 2014 at 06:31

    Kevin –

    According to the IMF Oct WEO, Japan central govt expenditure is 40% of GDP. This is not a low number, expect maybe compared to France.

  39. Gravatar of Charlie Jamieson Charlie Jamieson
    17. November 2014 at 10:40

    With all the talk about deflation fears, it makes you wonder who is squealing?
    The working class has suffered deflation for the past 25 years at least, as it has lost jobs and seen its real income fall (stick wages, hah!).
    Since the Financial Crash in 08, now the middle class is suffering deflation, as now college graduates are losing jobs and seeing their income stagnate.
    But I don’t think economists or financial types are worried about this type of deflation. They must be worried about the values of their financial assets, or perhaps they see defaults coming?

  40. Gravatar of Dawson Dawson
    17. November 2014 at 22:29

    Scott, if the Fed could set the visa quota, could we have loose money for a longer time?

  41. Gravatar of David de los Ángeles Buendía David de los Ángeles Buendía
    19. November 2014 at 08:40

    Dr. Sumner,

    You wrote:”Keynesians have been warning of a ‘deflation spiral’ since Japanese interest rates hit zero two decades ago…It never happened.”

    This is exactly because the Federal Reserve Bank (FRB)(and the Federal Open Market Committee in particular) and the Federal Deposit Insurance Corporation have been effective at combating deflation. The Quantitative Easing Policy (QEP)is in no small part an anti-deflation policy.

    The FRB increased the supply currency and the monetary base. The supply of M1 Currency (Federal Reserve Notes (FRNs) and coins) increase from 800 BUSD to 1200 BUSD between 2008 and 2012 [1], a 50% increase, which quite significant. During the same period the size of the M2 Money Stock increased dramatically as well, from 7,600 BUSD to 11.500 BUSD, a 40% increase. Of course the size of the Monetary Base rose by a staggering 400% [3] in the same period. Increasing the size of the money stock does indeed create inflationary pressures.

    During the same period monetary velocity was falling, also quite dramatically, as was industrial utilization capacity, and rates of capital formation[4][5]. These represented deflationary pressures. The inflationary pressures created by the monetary policy of the FRB countered the deflationary pressures of the US economy, producing a small amount price increase.

    So the reason that Dr. Fisher’s Deflationary Spiral never occurred was because of the action of the FRB.

    [1] https://research.stlouisfed.org/fred2/series/CURRENCY

    [2] https://research.stlouisfed.org/fred2/series/M2

    [3] https://research.stlouisfed.org/fred2/series/BASE

    [4] http://cpi-u-m2v.tumblr.com/

    [5] http://capitalformation19552014.tumblr.com/

    People who imagine that deflation is not a problem are like the people who lived below a dam and wondered why everyone used to be so worried about floods in the old days.

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