Zinc price targeting, and beyond

Now that the multiple universe hypothesis is gaining increasing scientific acceptance, it’s time to soar beyond our own tiny universe and consider monetary policy in alternative worlds.  Consider a universe very similar to our own, but where central banks target zinc prices, not interest rates.

1.  They started with a “zinc standard,” maintained through open market operations.  It provided a sort of nominal anchor.

2.  Then an economist named Irwin Fisher noticed that the relative price of zinc is unstable, and hence the price level fluctuates even when nominal zinc price are constant.  Even worse, price level fluctuations seem to trigger fluctuations in output and employment.  He suggested lowering the price of zinc by 1% each time the price level rose by 1%, and vice versa.

3.  A few decades later a more sophisticated macroeconomist named Johan Tailor devised a more complex monetary rule, which tried to stabilize NGDP growth by adjusting zinc prices in response to both inflation and output deviations, according to an optimal rule estimated using state-of-the-art econometric techniques.  The zinc price that will stabilize NGDP was called the “Wicksellian equilibrium zinc price.”  The central bank was instructed to do OMOs until the actual free market price of zinc was equal to its Wicksellian equilibrium value.  It no longer even needed to hold stocks of zinc.  It bought and sold Treasury securities until the free market price of zinc moved to the right level.

4.   Then they decided to set up a NGDP futures market.  Now the central bank was instructed to adjust the monetary base until the price of zinc moved to a value that generated a NGDP futures price equal to the NGDP target.

5.  Eventually zinc price targeting started to wither away.  Zinc was increasingly viewed as a barbarous relic.  It played no important role in the monetary transmission mechanism, and the central bank began to directly target NGDP futures, without even bothering to use the intermediate step of zinc price targeting.  This brought about “the end of macroeconomics” as a separate field of study.  All “macro” analysis now had micro foundations.

In other universes other elements were used; cobalt, lead, chromium, etc.  Some used valuable compounds like H20, or NaCl.  In one universe zirconium was quite rare, and was the medium of account.  Diamonds were common, and used for small coins.   Oddly, the “zero lower bound issue” never arose in any of these universes.  Zinc prices can go as high as infinity (and also as low as you want in log terms, which is what matters.)  But in one poor benighted universe central banks adopted interest rates as an intermediate target.  Whenever the Wicksellian equilibrium nominal interest rate fell below zero, the central bankers didn’t know what to do—they ran around like chickens with their heads cut off.  Fortunately they too passed through that stage, and eventually moved to a system where OMOs were used to directly target NGDP futures prices (in the year 2037.)  But during the intermediate targeting period things sure were messy!


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36 Responses to “Zinc price targeting, and beyond”

  1. Gravatar of Jon Jon
    14. August 2011 at 10:47

    Scott, you always lose me at #4. Whatever nominal anchor you pick, one attribute it must have is being widely traded to minimize the risk of a speculative run or decoupling between the nominal anchor and the broader economy.

    Gold had that feature among other things because it had industrial uses, retail uses and, most importantly was a medium of exchange.

    You just cannot make a market using something that has no expected return and no use in trade. You have to subsidize the administrative costs somehow. Unless our ngdp futures contracts become the currency, it just won’t work.

  2. Gravatar of Benjamin Cole Benjamin Cole
    14. August 2011 at 11:21

    Excellent blogging!

    The right-wing has developed a dangerous obsession with minute rates of inflation, and a perverted fetish for gold and related symbols of wealth, such as currency.

    The currency must not be debased! Next you end up with gay brothels in the Fed, or even occupying a landlocked Asian nation to establish an Islamic narco-state where Marines protect opium fields of warlords loyal to central authority, and they hand citizens who convert to Christianity (oh wait, we already did that).

    Gold has an industrial value to be sure, although I suspect that use has been phased out wherever possible. As jewelry or an “investment” gold is worth whatever people think it is worth (those people are now largely in India and China, where the price of gold is set).

    Milton Friedman said the gold standard was for fools. It is remarkable how often that guy is right.

  3. Gravatar of JP Koning JP Koning
    14. August 2011 at 11:27

    “But in one poor benighted universe central banks adopted interest rates as an intermediate target. Whenever the Wicksellian equilibrium nominal interest rate fell below zero, the central bankers didn’t know what to do””they ran around like chickens with their heads cut off.”

    What if they central bank in this benighted universe targets short term treasury bills? These bills typically trade at a discount to their par value, creating a positive yield to maturity. Say par value is $1000. Can’t the central bank target any price greater than $1001 for bills, thereby creating a negative interest rate, and thereby avoid the zero bound? Like zinc, the bill’s premium over par can go as high as infinity.

  4. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    14. August 2011 at 11:35

    Let me re-word my question from one of the earlier threads, since I completely agree that thinking about monetary policy in interest rate terms is worse than useless. Is the explanation for the peaceful co-existence of abnormally low NGDP growth with a (very)abnormally high gold price simply that the gold bugs are making a huge mistake? That one day the gold bubble will pop and they will be sorry?

    I guess that is possible, but it makes me uneasy.

  5. Gravatar of Morgan Warstler Morgan Warstler
    14. August 2011 at 11:39

    Benji, please explain to me WHY deep down in his heart of hearts, Milton Friedman wasn’t comfy with the Gold Standard.

    Scott, I’ll take you “alt.universe” thing seriously when you get serious abut HONESTLY arguing about my it’s public employees fault.

    Since Obama took office we have ADDED 150K Federal Employees.

    That you refuse to discuss FIRST cutting $500B in public employee pay BEFORE we print money, makes you seem like you don’t rally want to print money.

    It makes you seem like you want to saving public employee jobs, like you want to lock in Obama gains.

  6. Gravatar of Scott Sumner Scott Sumner
    14. August 2011 at 11:46

    Jon, You have it exactly backward. You want something that’s never been traded, for which their is no hedging demand. Then you subsidize trading to assure a liquid and deep market. It’s easy to do, and I outline various methods in my published papers. If my policy failed, it would be easy for all of us to get rich. I could have sold NGDP contracts short in October 2008. How likely does it seem that it will be easy for us all to get rich?

    Thanks Ben.

    JP, No, investors would never accept strongly negative rates on T-bills. They’d prefer cash. That’s why some economists (not me) worry about liquidity traps.

    Patrick, I’m reluctant to second guess markets. I certainly think many individual gold bugs expect more inflation than we are likely to get, but I don’t know that the price is “wrong.” Supply grows slowly and Asian demand is rising fast. But I don’t personally own gold.

  7. Gravatar of Scott Sumner Scott Sumner
    14. August 2011 at 11:47

    Morgan, Read any of my previous replies.

  8. Gravatar of Morgan Warstler Morgan Warstler
    14. August 2011 at 12:04

    Scott, I could add up all you previous replies and it wouldn’t be worth a warm bucket of spit.

    You either think I’m some econ student who can be put off with glib bromides, or you don’t take the time to consider what I’m saying at all.

    PLEASE since you feel you have given me an answer, EXPLAIN what my point is… what do I mean by:

    1. Cut public employee pay 25%.
    2. Use savings to pay 16M unemployed $25K per year.
    3. That’s NO AD increase in the short term.
    4. And apparently solves for the Fed’s dual mandate.

    Please EXPLAIN what I’m saying… say WHY you think it is wrong. Would the Fed rejoice? Would it be moral? Is it realistic politically? If not, WHY? What coalitions do you think will stop it?

  9. Gravatar of Martin Martin
    14. August 2011 at 12:26

    Scott, what about a universe where there is free banking? Wouldn’t deposit contracts, denominated in the currency of the bank, work pretty much the same as NGDP-futures?

  10. Gravatar of Marcel Marcel
    14. August 2011 at 12:33

    I can’t think why you didn’t title this “On Beyond Zinc.”

  11. Gravatar of marcus nunes marcus nunes
    14. August 2011 at 13:42

    Scott
    And for at least 12 years “they” have been discussing the “profound” question: How to run MP in a low inflation environment! “When will they ever learn”?

  12. Gravatar of Felix Felix
    14. August 2011 at 14:52

    What would happen if the stabilization of the price level in your alternative universe required that the zinc price evolve in time in a way that would imply that zinc is worth more (in real terms) tomorrow than it is today by more than the real interest rate? Then everybody would want to hold zinc, because it’s a riskless investment that offers more than the real interest rate, right? Then, no matter how much zinc the central bank sold, it could never be able to hold down the zinc price in order to avoid deflation! That’s the liquidity trap in the zinc economy!

  13. Gravatar of JP Koning JP Koning
    14. August 2011 at 16:15

    Scott: “They’d prefer cash.”

    Institute a Gesell stamp tax and a negative IOR, no?

    Or, since we’re talking about alternate universes, imagine that paper money is now a very thin plastic sheet with a microchip that credits or debits you some % amount each period.

    In other words, there’s got to be an alternate universe in which rates are being targeted and the zero bound rule is not a problem.

  14. Gravatar of JP Koning JP Koning
    14. August 2011 at 16:20

    Or nix Gesell’s stamp tax and imagine that the Fed decides to begin canceling all $20s, $50s and $100s, only issuing $1s and $5s to anyone demanding redemption into paper. The inconvenience of holding cash and transacting with it dramatically increases, effectively imposing a negative return on it.

  15. Gravatar of Bob Knaus Bob Knaus
    14. August 2011 at 16:38

    Morgan,

    I am a high school dropout, not an economist. Nonetheless, I will undertake to answer where Scott has ignored. Rudyard Kipling pretty much covered your proposal in 1886:
    http://www.kipling.org.uk/rg_rupaiyat1.htm

    If you don’t get this, I can’t think of much else to say.

  16. Gravatar of Morgan Warstler Morgan Warstler
    14. August 2011 at 17:32

    “I can’t think of much else to say.”

    no worries.

    Eventually Scott runs into the buzz saw of what I’m saying – after all, I’m right. Politics will force this entire discussion my way.

    Remember, three years ago I was advocating the liquidation of houses by the government, and that is now what Matty at Think Progress supports.

    Mark my words, soon the only kind of “forgiveness” anyone will be speaking of is helping the already evicted clean up their credit report AFTER they lose the house.

    p.s. Degrees, like 19th century poetry, are over-rated. Hopefully, you get that.

  17. Gravatar of marcus nunes marcus nunes
    14. August 2011 at 18:59

    Hot Hot Hot From the FT Press:

    Please respect FT.com’s ts&cs and copyright policy which allow you to: share links; copy content for personal use; & redistribute limited extracts. Email ftsales.support@ft.com to buy additional rights or use this link to reference the article – http://www.ft.com/cms/s/0/ac5804a6-c413-11e0-b302-00144feabdc0.html#ixzz1V3wvXbqf

    To make the case for new stimulus, the Fed needs better arguments. The past few weeks have settled, to my satisfaction at least, a long-running debate on this very topic. Rather than targeting inflation, central banks should keep nominal incomes growing on a pre-announced path: say 5 per cent a year. Nominal gross domestic product is the sum of inflation and growth in real output – and is the variable that monetary stimulus directly drives.
    Samuel Brittan made the case for this approach decades ago on this page. The crucial point – how an increase in nominal GDP breaks down between output and inflation – is not something the Fed can determine, or should have to explain. There are pros and cons to this approach, but that is the decisive political virtue of casting the target this way.
    When nominal GDP falls below track, monetary stimulus pushes it back. If inflation rises temporarily during catch-up, that is tolerated. In current conditions, this makes all the difference. The new GDP figures showed demand has fallen much further below trend than had been appreciated. With a nominal GDP target, that announcement would have led investors to expect new monetary stimulus. With the implicit inflation target that the Fed is assumed to use, it did not.
    http://www.ft.com/intl/cms/s/0/ac5804a6-c413-11e0-b302-00144feabdc0.html#axzz1V3wdI2MD

  18. Gravatar of marcus nunes marcus nunes
    14. August 2011 at 19:23

    And the semi official “birth of QM”. Hot of the FT:
    To make the case for new stimulus, the Fed needs better arguments. The past few weeks have settled, to my satisfaction at least, a long-running debate on this very topic. Rather than targeting inflation, central banks should keep nominal incomes growing on a pre-announced path: say 5 per cent a year. Nominal gross domestic product is the sum of inflation and growth in real output – and is the variable that monetary stimulus directly drives.
    And there´s much, much more:
    http://www.ft.com/intl/cms/s/0/ac5804a6-c413-11e0-b302-00144feabdc0.html#axzz1V3wdI2MD

  19. Gravatar of Andy Harless Andy Harless
    14. August 2011 at 19:51

    The central bank was instructed to do OMOs until the actual free market price of zinc was equal to its Wicksellian equilibrium value. It bought and sold Treasury securities until the free market price of zinc moved to the right level.

    What particular Treasury securities did it buy and sell?

    The interest rate is a natural instrument for a central bank that does OMO’s because it’s closely related to the price of Treasury securities. And in particular, the short-term interest rate is closely related to the price of short-term Treasury securities. It seems to me that once you get away from T-bills as the primary vehicle for OMO’s, any central bank will begin to acquire a decapitated chicken quality, whether it’s targeting zinc prices or interest rates, unless it has a rule to tell it what to buy.

  20. Gravatar of Jon Jon
    14. August 2011 at 22:44

    T-bills as the primary vehicle for OMO

    T-bills are not the primary vehicle for OMO in the United States–neither now nor immediately before the crisis. It’s an academic fantasy to say otherwise, and one which shows a very strange disconnect between academics and practice.

  21. Gravatar of Jon Jon
    14. August 2011 at 22:48

    Scott,

    Jon, You have it exactly backward. You want something that’s never been traded, for which their is no hedging demand.

    You know better. Surely the mechanism with the fewest conceptual parts is the one where the CB changes the nominal value of currency: opens up its window and offers to replace every series XXX federal reserve note with a series XXX+1 note with a high nominal denomination.

    That approach is has the fewest conceptual parts precisely because money already touches all markets.

  22. Gravatar of Alejandro Alejandro
    15. August 2011 at 03:38

    Morgan Warstler

    Proof by contradiction:

    1. Assume you are in office.
    2. Announce that you will Cut public employee pay by 25%.
    3. You are no longer in office.

    QED

  23. Gravatar of Morgan Warstler Morgan Warstler
    15. August 2011 at 03:39

    marucs,

    Note CC says:

    “Cut payroll taxes, subsidise low-wage employment, increase temporary aid to the states, broaden the tax base, cut long-term defence spending and raise the retirement age.”

    Communications wise, this is ALMOST EXACTLY the approach Scott should / must use in every post:

    1. Crook FIRST mentions a stack of Fiscal changes that the Tea Party would support – even AID tot he states could be done IF the AID was tied to ending Davis-Bacon and came with strings that required privatization of services.

    2. Crook admits Monetary is a political problem.

    3. Crook makes two small mistaeks: we’re only going to be doing maybe 4% NGDP. ALso, the right needs to be reminded what they get in return – in the near future when NGDP is at running at 4%, up go rates to keep things from going gaga.

  24. Gravatar of Bob Dobalina Bob Dobalina
    15. August 2011 at 03:55

    Scott/Marcus–

    Didja notce, on that FT link, that the estimable Paul Kasriel is now on the team?

    http://www.ft.com/intl/cms/s/0/ac5804a6-c413-11e0-b302-00144feabdc0.html#comment-1216515

    Maybe he’s always been there, dunno, but I bet Kasriel and Sumner probably share 90% of their worldviews– Right-wing(ish) economists who understand that most Right-wing economists are way off base at the present time.

  25. Gravatar of Browsing Catharsis – 08.15.11 « Increasing Marginal Utility Browsing Catharsis – 08.15.11 « Increasing Marginal Utility
    15. August 2011 at 04:11

    […] I know I’ve been linking to Sumner a lot lately, but this is my favorite post of his in a while: why interest rates and the zero bound are so irrelevant for macroeconomic policy. […]

  26. Gravatar of FT Alphaville » The price of JGB-isation FT Alphaville » The price of JGB-isation
    15. August 2011 at 04:49

    […] link: Zinc price targeting, and beyond – The Money […]

  27. Gravatar of Doc Merlin Doc Merlin
    15. August 2011 at 07:16

    Zinc is primarily an industrial metal and as such would make a bad target. For a commodity target you either want a basket or you want something that isn’t as sensitive to industrial demand side fluctuations.

    NGDP futures would work, but once the government starts targeting NGDP futures they will lose a lot of their value, as targets always do. E.G.: In an NGDP futures targeting regiem I expect to see a lot more assets and wages tied to some sort of price index.

  28. Gravatar of Silas Barta Silas Barta
    15. August 2011 at 07:59

    What about the universes that used bitcoins, which doesn’t have any use other than as money?

  29. Gravatar of Scott Sumner Scott Sumner
    15. August 2011 at 08:48

    Morgan, You said;

    “Cut public employee pay 25%. . . . Is it realistic politically?”

    Is this some kind of joke? I thought you were supposed to be the realistic one, and I had my head in the clouds.

    Martin, No, because it wouldn’t stabilize NGDP.

    Marcel, Even better.

    Marcus. I hope they learn soon.

    Felix, No, because there is no upper bound on zinc prices–there is always a price high enough so that future zinc appreciation is not expected.

    JP Koning, Yes, everyone agrees that with negative interest on cash there is no liquidity trap. But none of the proposals seem realistic.

    Marcus, Thanks, I did a post on that this morning.

    Andy, It makes little difference what the Fed buys. OMPs caused a liquidity effect on short term interest rates even back when the Fed bought gold, not T-bills. The effect occurs because of more cash (plus sticky prices) not because of what the Fed bought. (The amount of purchases is tiny in normal times.) I have the central bank buy bonds because it’s convenient, but they could buy foreign debt, AAA corporate bonds, stocks, silver, copper, whatever.

    Jon, That seems very cumbersome to me–it seems simpler to just issue more currency. Especially if changes were made frequently. Are you going to have currency reforms every few weeks?

    Bob, Thanks for the Kasriel link.

    Doc Merlin, That’s why the Fisher and Tailor reforms were needed.

    Silas, They also adjust the supply of bitcoins to stabilize NGDP.

  30. Gravatar of Morgan Warstler Morgan Warstler
    15. August 2011 at 09:59

    “Is this some kind of joke? I thought you were supposed to be the realistic one, and I had my head in the clouds.”

    LOL. you do have you head in the clouds, that is why you don’t think it is politically possible.

    EXPLAIN why you don’t think it is. We just saw public employees in Wisconsin forced to take 12-15% pay cuts and the public come out in not one but TWO special elections to enforce it.

    So step up Scott, explain your assumption.

  31. Gravatar of Morgan Warstler Morgan Warstler
    15. August 2011 at 10:00

    Alejandro, see above.

  32. Gravatar of Steve Steve
    15. August 2011 at 11:28

    Patrick Sullivan wrote:

    “Is the explanation for the peaceful co-existence of abnormally low NGDP growth with a (very)abnormally high gold price simply that the gold bugs are making a huge mistake? That one day the gold bubble will pop and they will be sorry?”

    Patrick,

    The rise in gold is understandably discomfiting, but one has to remember that gold fell from ~$400 in 1990 to ~$300 in 200, or about -3% per annum. This leads to two possible conclusions:
    1) Alan Greenspan ran a ridiculously tight, deflationary monetary policy for the entire decade of the 1990s (and the irrational exuberance and internet bubble happened DESPITE this incredible deflation)
    OR
    2) Gold is a very, very poor indicator of monetary conditions.

    I vote for #2. The barbarous relic crowd made a huge mistake during the 1990s, and the gold buggers are making an equally huge mistake today.

  33. Gravatar of Scott Sumner Scott Sumner
    16. August 2011 at 06:39

    Morgan, Provide a citation for Wisconsin, I don’t believe you.

  34. Gravatar of Jon Jon
    16. August 2011 at 08:23

    Scott, yes what I describe is cumbersome to implement. If you read the sentence closely, I emphasized it’s conceptual simplicity–which referred to it being easy to understand as a matter of theory.

    So you haven’t touched my core arguement: you want an instrument of policy that touches as many markets as possible. That will always be the conceptually simplest policy instrument. Gold once had that property because gold coin was also a medium of exchange as well as being an asset with a price unrelated to it’s speculative yield.

    It seems to me that a ngdp futures contract is missing some properties. It does not touch every market. It has value only from it’s speculative component–it produces a nominal good only (money). That makes it not so much like an asset whose price can become arbitrarily big or small (no zero bound) and more like a bond (there will be no market unless it can be profitably traded).

    Maybe your papers explain this, but call me lazy, You’re going to need to do more to sell me on reading them. Perhaps a few posts highlighting which ones you think are important along with a syllabus outlining their main points.

  35. Gravatar of ssumner ssumner
    16. August 2011 at 19:55

    Jon, Google my post “spot the flaw in NGDP targeting” I explain how the Fed can easily make it profitable to trade. But the real point is that it becomes profitable to trade if policy is failing. Suppose I let my 12 year old daughter steer the boat. I hover over her shoulder, ready to grap the wheel if the boat goes in the wrong direction. It’s no problem for this procedure if I never once touch the wheel. It means she’s doing a good job. And it’s no problem if not one share of NGDP futues is ever traded–it means the Fed’s doing a good job.

    I have no idea why an instrument must “touch as many markets as possible.” You want an instrument closely connected to the policy goal.

  36. Gravatar of Jon Jon
    16. August 2011 at 22:45

    Scott,

    With a policy goal of moving NGDP stabilization, don’t you want to an instrument that impacts all markets uniformly. Any thing less will eventually move some market by a more complex (and dubious) causal chain.

    Its not that it “must”; its just preferable. Obviously OMOs conducted via treasuries don’t touch every market but they are effective–through a causal chain. Surely though, you agree that if the Fed directly devalued the dollar by issuing new dollars with a higher nominal par in exchange for every old dollar, that this would be more powerful that the OMOs are today.

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