Update: When I am talking about nominal and real effects, insert the word ‘reliable’ as appropriate. My point was that MMs hold the distribution between RGDP/inflation to be impossible to determine, rather than that there can be no real effects.
At the centre of arguments for NGDP targeting is the implicit assumption that macroeconomic policy can only have nominal impacts. I believe this to be false.
‘Market Monetarists’ (MMs) hold that macroeconomic policy can only have nominal or ‘cash’ effects, and the effect on the actual production of goods and services is uncertain. To put it intuitively, they are saying (or believe they are saying) that the amount of cash we inject into the economy can only affect the amount of cash flowing around the economy. There are two reasons this is flawed.
Firstly, MMs use a standard AD/AS framework for their analysis. When you respond that fiscal stimulus can be spent on roads and the like, which benefits the economy in more ways than one, they suggest that you are confusing the AD side of the equation with the AS one. However, this is a problem for MMs: fiscal stimulus can simultaneously boost AD and AS (not to mention LRAS), which means that even if the CB offsets the increase in spending, fiscal policy can ensure that a higher percentage of the spending is a real increase in production. In other words, fiscal policy can impact RGDP better than monetary stimulus, at least in certain circumstances.
My second point, however, is more important and applies universally. MMs neglect of the role of the RoI in determining not only the rate but the type of macroeconomic activity that takes place (New Keynesians are also guilty of this; at least, I’ve never seen them mention it).
In a capitalist economy, the rate of interest not only determines the amount of investment, but also the nature of that investment. Here’s Adam Smith, whom I can never resist quoting on the subject:
If the legal rate of interest in Great Britain, for example, was fixed so high as eight or ten per cent, the greater part of the money which was to be lent, would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people, who will give for the use of money no more than a part of what they are likely to make by the use of it, would not venture into the competition. A great part of the capital of the country would thus be kept out of the hands which were most likely to make a profitable and advantageous use of it, and thrown into the those which were most likely to waste and destroy it.
High interest rates mean that there is less investment and also that the investment that does take place is less sustainable. Speculative investment causes bubbles and price inflation, reducing the CB’s control over both the nominal and real economy. By keeping long term rates low, the CB is hence able to impact the real activity in the economy.
For an example, see this poorly taken photograph of long-term corporate bond yields from Geoff Tily’s excellent book Keynes Betrayed:
High interest rates are correlated with downturns, whilst steady low interest rates are correlated with the ‘Golden Age’. Rates weren’t massive in the recent crisis, though there were plenty of ‘hidden’ sources of funding such as the repo and Eurodollar markets, and expectations were not anchored downwards.
Of course this evidence is far from exhaustive but Tily’s book has much more, and I don’t want to flood this post with too many poorly taken photographs.
If macroeconomic policy can have real effects, that blows a significant hole in the arsenal of NGDP target advocates. For whilst most critiques of NGDP targeting focus on how it isn’t feasible, particularly at the ZLB, this one is compatible with its feasibility, but questions its efficacy.