Pieria Article Against NGDP Targeting

I’ve got a new article in Pieria, arguing against NGDPT:

However, I believe – as in the bottom right section of the table – that NGDPT would actually be completely ineffective. It is tautologically true that a given level of nominal income will correspond to a certain stock of money M, turned over at a rate V, and therefore MV = PY. However, much like the Savings = Investment confusion, it does not follow that there is an arrow from the left hand side of the equation to the right hand side. It may simply not be the case that an increase in the ‘available’ stock of money translates into an increase in income at all.

I also note that the empirical evidence suggests RGDP moved first in the recent crisis, before NGDP and before NGDP expectations. I don’t really know how market monetarists can square that fact with their framework.

I temper my criticisms of market monetarism in the piece, but to be honest I find the whole thing pretty worthless. Market monetarists continually evade pertinent criticisms from MMTers and endogenous money theorists, who point out that things simply do not work the way they think they do. Any attempt at a serious discussion of transmission mechanisms is met with ‘expectations!‘ as if expectations are a magic wand and not simply a reflection of the actual behaviour of the economy. Scott Sumner in particular refuses to discuss transmission mechanisms or engage the Lucas Critique, and seems to be more concerned with making out he is an oppressed minority than actual arguments.

Anyway, I’ll end my rant here – the actual piece has the important points.


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  1. #1 by Ramanan on August 9, 2013 - 12:14 pm

    Very direct and pin-pointy of the errors of Market Monetarists. Nice precise and complete piece.

    Joan Robinson once said – think you have quoted it somewhere –

    If the quantity equation had been read in the usual way, with the dependent variable on the left and the independent variable on the right, though rather vague,it would not have been silly

    in “Quantity Theories Old and New, A Comment.”, 1970.

    • #2 by Unlearningecon on August 9, 2013 - 12:25 pm

      I am not familiar with my quote, though I am happy that Robinson came to the same conclusion as me.

  2. #3 by sumnerbentley on August 9, 2013 - 2:01 pm

    The fundamental transmission mechanism is not expectations, it’s the hot potato effect. But expectations are very important in any sensible model, including NK models. Still everyone agrees that in the end expectations must be about something. It’s absurd to say I don’t talk about transmission mechanisms. And no, RGDP did not move ahead of NGDP in the recent crisis. Both collapsed between June and December 2008, using monthly estimates from Macroeconomics Advisers. So your facts are wrong. Is that all you’ve got?

    • #4 by Unlearningecon on August 9, 2013 - 2:19 pm

      I link to a piece where you suggest we should”abandon” attempts to talk about transmission mechanisms, so I think it was a fair characterisation. I also responded directly to the hot potato idea, and linked to Fulwiller who goes over it in far more depth.

      According to MMers, expectations drive future NGDP, right? I have previously seen you say that in 1929 the markets crashed because they realised we were heading into recession; I can only assume you apply similar thinking to 2008. Yet everything seems to move at roughly the same time, possibly with RGDP slightly ahead, which suggests to me that the ‘fundamentals’ of the economy are what drives changes.

      • #5 by Luis Enrique on August 9, 2013 - 3:21 pm

        if the person in question says they do discuss something, just because you’ve found a quote that you think implies otherwise, it might be wise to think twice rather than just reassure yourself you’ve fairly characterized them. Your textual exegesis does not trump Scott’s, presumably honestly reported, testimony.

      • #6 by Unlearningecon on August 9, 2013 - 3:30 pm

        What I am suggesting is that it was fair to infer that from what Scott has said in the past, and certainly far from ‘ridiculous’. His attempt at showing he discusses transmission mechanisms was the ever-vague ‘hot potato’ effect, which I and others have addressed directly.

        If Scott wants to make a post with a comprehensive discussion of how CB operations could translate directly into higher nominal income, I’d be happy to discuss it. I have not seen any market monetarist attempt to do this.

      • #7 by Luis Enrique on August 9, 2013 - 3:50 pm

        you wrote: “Scott Sumner in particular refuses to discuss transmission mechanisms”

        do you still think that claim is correct?

      • #8 by Unlearningecon on August 9, 2013 - 3:57 pm

        Yes, the hot potato effect is not a true transmission mechanism that deals with the causality from monetary policy to nominal income. It is a theoretical idea that is, in my experience, is illustrated using simplified thought experiments rather than real world examples.

        I wouldn’t just make the claim if I thought it was unfair. I have searched in vain for adequate discussion, and direct responses to people like Fulwiller. I have even asked market monetarists directly. I have found nothing.

      • #9 by Luis Enrique on August 9, 2013 - 4:25 pm

        “his discussions do not satisfy me” != “refuses to discuss”

      • #10 by Unlearningecon on August 9, 2013 - 5:48 pm

        He did explicitly say we should abandon attempts to find a transmission mechanism, though.

  3. #11 by Rob Rawlings on August 9, 2013 - 3:18 pm

    The hot-potato effect says that there is a correlation between the quantity of base money and the price level. Even supporters of endogenous money presumably believe that the fed can control the base? They just apparently believe that in the current situation no matter how much the base is increased it will just accumulate as additional bank reserves and never affect NGDP. The logical conclusion of this, as has been pointed out, is that a central bank could buy up all the assets in the world in exchange for newly printed money with no effect on the price level or NGDP. As this conclusion seems absurd I believe it reasonable to assume that the CB can affect NGDP by QE-type activities.

    In any case even if asset-buying didn’t work the govt could increase the money supply by helicopter-drop style activities, I assume that no-one would deny that this would have a direct effect on NGDP ?

    So I think we are always on the left-hand side of your grid where NGDP can always be increased by CB/govt policy. I think it is then an excellent question as to how this increase in NGDP will translate into RGDP increases v inflation. At full employment one would predict we would get more inflation and no RGDP-increase. At less than full-employment , and in a world with sticky (and possibly administered) prices, where firms make adjustment in quantity rather than price when demand changes it seems reasonable that increases in NGDP will translate into RGDP increases rather than inflation. This will be especially true if expectations can be set so that NGDP targeting is used to stabilize the expected growth path of AD over time.

    • #12 by Unlearningecon on August 9, 2013 - 6:44 pm

      The logical conclusion of this, as has been pointed out, is that a central bank could buy up all the assets in the world in exchange for newly printed money with no effect on the price level or NGDP.

      Well, I’m not so sure. It seems to me that giving money to individuals, however it is done, will not necessarily generate a ‘hot potato’ effect by making them buy goods, but will result in them depositing their money into interest-bearing bank accounts. There is no limit to the deposits a bank can hold so we are simply left with more bank reserves again.

      • #13 by Rob Rawlings on August 9, 2013 - 7:03 pm

        So you think that the fed could literally buy up everything in the world with new money and NGDP would remain unchanged ?

        What about helicopter drops? If the fed gave everyone $1M would they all just pay that in into the bank and it would just become unused reserves ?

      • #14 by Unlearningecon on August 9, 2013 - 7:06 pm

        I think the fed buying up everything would have some highly destabilising effects and people would lose trust in be value of money.

      • #15 by Rob Rawlings on August 9, 2013 - 7:09 pm

        Well, possibly – but you are changing the line of argument now

      • #16 by Unlearningecon on August 9, 2013 - 7:48 pm

        Sort of true, but what I am arguing is that within ‘traditional’, legal monetary measures, I doubt NGDP could be targeted at all times. You then argued the CB could take other measures, but I am pointing out that perhaps many of these limits exist for a fundamental reason, rather than being simply arbitrary.

      • #17 by Rob Rawlings on August 9, 2013 - 8:00 pm

        I agree.

        If the NGDPT can only be hit thru unnatural acts then one does need to be concerned about unforeseen side-effects , for sure.

        But I think the point made my many market monetarists is that QE is working as expected , it just hasn’t been taken far enough to actually get NGDP back to trend , and has not been used within a context where it is used to set expectations about future NGDP growth path.

  4. #18 by JP Koning on August 9, 2013 - 5:30 pm

    I’m going to have to come down with Scott Sumner on this one — an unconstrained central bank should have no problem driving up NGDP. I do sympathize with Unlearning though since Sumner’s posts are often quite clumsy and the point he is trying to convey gets lost. He himself admits to not being a natural blogger.

    “The idea at the heart of NGDPT is that if you load up the financial system with enough money, banks will ‘lend out’ at least some of this money.”

    The idea isn’t necessarily linked to lending. A central bank can always promise to degrade, or lower the return, on the dollar liabilities it issues, say via QE or lower rates. Any degradation in central bank liabilities must ignite a “hot-potato” effect as individuals holding these now inferior liabilities seek to sell them. Their value will fall to a lower level (ie the price level will rise) until the market is once again satisfied with the expected return from holding central bank liabilities… at least until the central bank degrades them once again. Voila, we have higher NGDP.

    Endogenous instruments like private bank deposits are essentially options on central bank liabilities, so a degradation of the latter is implicitly a degradation of the former.

    The hot potato effect can happen almost instantaneously or slowly over time. It might only affect prices, or if prices are sticky may have a buoyant effect on quantities as well. (NGDP is made up of both quantities and prices).

    To doubt that a central bank can drive up NGDP is to doubt that the central bank can degrade its own liabilities. Certain laws might prevent degradation, like the requirement to only buy assets at market prices. Man-made constraints like the zero-lower bound also get in the way. But once these impediments are removed (see Miles Kimball on negative rates as a way to get around the ZLB, for instance), then nothing can prevent degradation from occurring, with the concomitant effect on NGDP.

    • #19 by Unlearningecon on August 9, 2013 - 6:12 pm

      Thanks for your comment.

      A central bank can always promise to degrade, or lower the return, on the dollar liabilities it issues, say via QE or lower rates.

      But if rates are zero, how does the CB “degrade” its assets?

      But once these impediments are removed (see Miles Kimball on negative rates as a way to get around the ZLB, for instance)

      So say the CB charges negative interest on reserves. Banks will not want to hold reserves, and cannot pass it on, as people will simply hold cash. So where does the increase in income come from?

      • #20 by JP Koning on August 9, 2013 - 6:39 pm

        “But if rates are zero, how does the CB “degrade” its assets?”

        It has to drop the rate paid on central bank deposits into negative territory. In order to forestall a mass conversion of negative-yielding central bank deposits into 0% yielding cash, the CB then needs to cease par conversion between deposits and dollar notes. The introduction of a floating rate allows the CB to set a penalty on cash conversion such that cash now yields the same negative return as deposits. This removes the incentive for people to “simply hold cash”. Put differently, thanks to the floating conversion rate, cash has been rendered just as unsavory as negative-yielding deposits.

        Once the mechanism is in place, any interest rate degradation will push up prices, and therefore NGDP.

        Alternatively, I suppose a CB could degrade via massive asset purchases at silly prices, but that’s a different story.

      • #21 by Unlearningecon on August 10, 2013 - 12:25 pm

        See, as I’ve said here and elsewhere, these kinds of ‘unorthodox’ measures just strike me as things that would create widespread mistrust, instability and political opposition. Legality does not always tell us what’s ‘right’, but it does seem to me there are reasons for the institutional constraints on central banks. We are possibly coming up against some of the fundamental realities of what money means, and what creates its value, when we start tampering with basics like par conversion, or buying up various financial assets beyond government bonds.

  5. #22 by srini on August 9, 2013 - 6:47 pm

    What exactly does an “unconstrained” central bank mean? They can conduct helicopter drop? Buy junk bonds? Cars, homes, furniture? Needless to say, if central banks buy up all kinds of assets, thereby justifying the original financial decision of private parties, then there will be no financial crisis. Presently, central banks do not have this type of power (thankfully!). Under extraordinary conditions, the Fed can indirectly do all of the above–even then only through backdoor methods. So, if NGDP targeting depends on credible threats of doing something that the Fed does not have power to do, then I presume NGDP targeting will not be particularly successful over long periods of time.

    The idea of negative interest rates and forcing people out of hoarding “money” is a classic case of treating the symptoms. The desire to hoard money reflects the desire to hold an “asset” that is uncorrelated with the economy’s performance because investors are worried about the economy. If money fails to satisfy that desire (because the Fed is charging negative interest rates), then people will find something else–gold, swiss franc, whatever–sooner or later. You will only end up undermining a powerful tool, fiat money.

    By the same token, successful NGDP targeting will also undermine fiat money (an government debt). If there is no “aggregate” risk of large system-wide losses, then risk premiums will go to zero. You will not need money (the transaction demand for money is irrelevant in my opinion) nor pay a premium for government bonds.

    Money and government paper have to be seen in the portfolio and balance sheet context, then itthe problems with NGDP targeting become clear.

    • #23 by Unlearningecon on August 10, 2013 - 5:22 pm

      Completely agree – I had the exact same thoughts, as my new post shows.

  6. #24 by Blue Aurora on August 10, 2013 - 11:16 am

    Out of curiosity Unlearningecon, in the future, will you point to more specific posts by those who consider themselves Market Monetarists (to use two examples, I have nothing personal against them) like Evan Soltas or Yi-Chuan Wang?

    • #25 by Unlearningecon on August 10, 2013 - 11:36 am

      Quite possibly, yes. The responses I’ve seen about transmission mechanisms (here and elsewhere) have been quite good.

  7. #26 by gbgasser on August 11, 2013 - 5:47 pm

    To Rob Rawlings at#13

    I think if the Fed bought up everything in the USA (I wont go with world, lets stick with the currency area of the US dollar), by definition the price it paid for everything would be the GDP. Also, by definition, if it bought everything off the shelves of Costco, Wal Mart, Target….. then real GDP would increase as well as those stores rarely sell everything. And if it continued this process ad infinitum, buying everything, the prices it paid would be defacto GDP so it would determine the change in GDP with each change in price it paid. So of course GDP would change to whereevr they wanted it. That shouldnt be controversial. The question is when they stopped, and we had to resume using the money we received from the fed for our goods or services we provided, where would GDP go?

  8. #27 by freundchen on August 15, 2013 - 12:46 pm

    Just as a sidenote: you do know that MV=PY never holds, right? If you said MV=PT with T standing for all transactions, it would be correct (ignoring the usual problem of intermediate goods transactions, thereby assuming this part changes sufficiently slowly for practical/empirical purposes). But since, according to the system of National Accounts, financial transactions are not part of GDP, MV=PT ignores a significant (seriously, significant! look at the numbers…) share of all transactions M is used for… I would say get the equation right first, then start worrying about the direction of the arrow 😉

    • #28 by Unlearningecon on August 16, 2013 - 2:09 pm

      But financial transactions sum to zero, right?

      In any case, MV = PY is defined as holding, where V is tautologically whichever variable balances the equation. So I don’t think there’s a problem with what I say; only one with the nature of V itself.

      • #29 by freundchen on August 26, 2013 - 10:21 am

        no, why would financial transactions sum to zero?

      • #30 by Unlearningecon on August 28, 2013 - 2:12 pm

        Not sure what I was talking about, I was thinking of the returns on financial assets (eg one party in the exchange always ‘loses’). Anyway, the point about V still applies.

  9. #31 by Nick Rowe on August 21, 2013 - 7:33 pm

    Unlearning: “Any attempt at a serious discussion of transmission mechanisms is met with ‘expectations!‘ as if expectations are a magic wand and not simply a reflection of the actual behaviour of the economy.”

    You gotta be very careful there, because that sounds awfully like something you would say if you were advocating rational expectations!

    A couple of points:

    1. There are models with multiple equilibria, and (in my opinion) these are not stupid models. If people expect recession we get recession, and if people don’t expect recession we don’t get recession. “We have nothing to fear except fear itself”. (Just like if everyone expects everyone else to drive on the right/left they will drive on the right/left too, so we get two equilibria.) In these sorts of models, expectations can be self-fulfilling. There is no “actual behaviour” of such an economy that can be divorced from expectations; it is more true to say that the actual behaviour of such an economy reflects expectations than vice versa. The conductor of an orchestra, where everyone is trying to keep time with everyone else, holds a magic wand. The cox in a racing eight has a magic voice.

    2. Even leaving such models aside, people’s expectations of *future* monetary policy can matter a lot, and can matter a lot more than current monetary policy. (Since “monetary policy” includes the idea of some sort of commitment or signal about what policy will be not just this minute, can we even talk about “*current* monetary policy” while ignoring expected future monetary policy?). Even if you believe the US economy is in a liquidity trap and that therefore “current” monetary policy can do nothing, is everybody certain that the US economy will always be in a liquidity trap for ever and ever? If not, then expected future monetary policy matters today, and the central bank’s commitments and signals can matter today.

    3. Suppose we add more water to one side of a bucket. We know this will raise the level of water right across the bucket, but we can argue about lots of different transmission mechanisms. Maybe the new water will flow across the previous surface, so the new water is all on top? Or maybe the new water will flow down and force old water to the surface? Arguments about different monetary transmission mechanisms (hot potato vs interest rates vs expected inflation vs expected future NGDP) are a bit like that.

    4. As soon as you talk about any “transmission mechanism”, and the causal chain from the central bank’s actions to economic variables, it is impossible to keep expectations out of the story unless you assume the central bank operates in total secrecy and people are really stupid and didn’t figure out the central bank was doing something and that this would affect economic variables. Which is a really bad assumption. And you are forced to recognise that those changing expectations will matter, and usually matter more than the “mechanism” itself minus those expectations would matter. Because the economy is not like a car’s transmission, where you pull a lever and one cog turns another cog. It’s like an auto transmission, only one that can anticipate your future moves and changes gear even before you get to the hill, and even anticipate what you would counterfactually do if it didn’t anticipate your moves. Chuck Norris drives a car like that.

    5. Empirically: Roosevelt in the 1930’s; Switzerland and the exchange rate; maybe now Japan too (though I wish they had been clearer on the communications strategy). They said it couldn’t be done.

    • #32 by Unlearningecon on August 22, 2013 - 2:09 pm

      You gotta be very careful there, because that sounds awfully like something you would say if you were advocating rational expectations!

      I’m more of the position that expectations depend on past behaviour. Among certain segments of society – particularly the investor class – expectations are a function of monetary policy. However, they are also dependent on previously observed variables, and hence I think you really must have some oomph behind your policy for it to have lasting, far reaching effects.

      1. Yeah, I know there are perfectly acceptable (for the purposes of this debate) models with multiple equilibria, including my pal John Maynard Keynes’ model. However, your quote was about the actual economy, which may or may not be in equilibrium.

      2. I think we are getting into the realm of irreducible uncertainty when we talk about the economy that far into the future. I’d again go with Keynes and suggest that expectations of that kind of thing are vague and based more on rules of thumb than anything. Actually, I believe one of Keynes’ prime examples of irreducible uncertainty was interest rates 20 years into the future.

      3. But the economy is a bucket with a leak into another bucket (the banking system). If there is no way to ensure the money ‘stays’ in the ‘real economy’, we just can’t manage to keep pumping up income.

      4. I agree expectations matter but I think they are secondary. If we are discussing a good monetary policy, it has to be good on its own merits, before we invoke expectations. Expectations can then either work for or against it (think of the Lucas Critique). But I’d just first like a concrete discussion transmission mechanisms (which some have given me, though they seem crazy like suspending par conversion of deposits).

      5. As I’ve said, the first two were not at the ZLB. Japan is, but as you imply that’s unfinished business. We’ll see.

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