Posts Tagged NGDP Targeting

Market Monetarism Jumps the Shark

Seriously, what does this mean?

The US economy is currently in equilibrium. It’s not a market-clearing equilibrium. It’s not a very good equilibrium. But it is an equilibrium. If it wasn’t an equilibrium, it would be somewhere else. But it isn’t somewhere else, so it must be.

Nick Rowe

I find this incomprehensibly circular. The beetle is red because if it weren’t red it would be something else, but it isn’t something else, so it’s red. Nick, we must first prove that the bloody beetle is red! Furthermore, ‘proving’ something does not entail making analogies to driving rules or how we manage time, which are both 100% arbitrary, maneuverable human constructs.

Also note that the entire post is about how people who want to know what market monetarists are talking about are somehow crazy for asking. Imagine if engineers had this type of attitude: “heh, so you want to know what we’re making the bridge out of? Doesn’t matter, just believe that it will stand up. God, stop being so concrete! (No pun intended)”.

I’ll give some credit to Rowe – he goes on to try and list some transmission mechanisms, but doesn’t get very far:

1. The Fed clearly announces its target path for NGDP. That’s by far the most important bit. Everything else is secondary. And if the Fed had credibility, that would be enough.

Irrelevant, as credibility depends on transmission mechanisms; expectations can only ever work if there is something to anchor them to. So this one is a no-go, as it depends on the actual transmission mechanisms below:

2. The Fed makes a threat. On the first day the Fed will print $1 billion and use it to buy assets. On the second day the Fed will print $2 billion and use it to buy assets. On the third day the Fed will print $4 billion and use it to buy assets. And the Fed will keep on doubling the amount it prints and buys daily, forever and ever, until E(NGDP) rises to the target path. (And will go into reverse and sells assets if E(NGDP) rises above the target path).

And, if my calculations are correct, just over half way through the month the fed will own every asset in the US economy. Then what? But don’t worry, this won’t materialise because:

3. The Fed puts on its best James Dean (oops, Marlon Brando, thanks Andy) voice and replies: “What have you got?”

There are two rooms at a party. The first room is nearly empty. The second room is nearly full. Because everyone wants to be where everyone else is. Then Chuck Norris enters the second room. He threatens to beat up 1 person at random in the first minute, 2 people in the second minute, 4 people in the third minute, and so on, until the room is empty. This is no longer an equilibrium.

More analogies. But as somebody, somewhere in the blogosphere, once said: if Chuck Norris has no arms or legs, nobody will listen to him.

Why will buying assets actually have an effect on the economy? What if people just hold the money, or put it into banks? What if they don’t want to sell their assets? Do you wonder if people/banks/firms are not spending right now because of the the fact that they are in bad financial positions and facing a lack of demand, and buying their assets (presumably at market prices) wouldn’t change this? Finally, are there any examples of this ever working, on the scale and in the ‘rule-based’ way you outline, in similar conditions to the one the US/UK/EZ economies are in now?

Market monetarists: please tell everyone what you mean, and without using any analogies, either. Because right now your school of thought doesn’t sound like a serious attempt at economics, but an article of faith.

Edit: I’m aware I used analogies here, but there’s a difference. Think of analogies as a First, analogies where you only replace one or two words are more useful than those that attempt to model complex systems by another complex system. Second, I regard my analogies as tools of communication, rather than a means of proof.

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Monetarists Versus Money

In my article on NGDP Targeting, I  argued  – among other things – that traditional monetary policy transmission mechanisms are now ineffective, and the banking system stops any ‘hot potato’ effect in its tracks. I felt the nature of which alternative monetary transmission mechanisms we might use to target NGDP was not always made clear by market monetarists; however, they proved me wrong with responses that discussed just that.

But I am still not satisfied.

The problem here is that their suggestions, which imply transcending ‘traditional’ monetary policy, may simply undermine the role of money in the economy. Market monetarists sometimes display a tendency to believe that those who conduct monetary policy simply don’t ‘get it‘, or are just constrained by petty politics. I’d instead suggest that policymakers just realise they’ve come up against some fundamental, inescapable constraints, implied by the nature of monetary policy itself.

One unconventional monetary policy tool was suggested by commenter J P Koning: negative interest rates on reserves. When I said that this would simply induce people to hold cash, he suggested that the central bank could stop 1:1 conversion of cash to deposits, making cash just as unattractive as deposits as the ‘price’ between cash and deposits adjusted to reflect the negative rates. Yet one of money’s fundamental roles is a store of value, and you undermine that by charging people to hold it. If you charge people to hold money, they will no longer see it as a desirable asset and will simply reject it. It is also worth noting that ‘floating’ deposit conversion rates could potentially play havoc with the value of bank’s balance sheets (bubble in deposits anyone?), as if these didn’t need more disruption.

Another suggestion, which I’ve seen before, is that the central bank could buy other assets than government bonds. First, I don’t really see why this would result in actual spending rather than people simply depositing or (assuming J P’s idea is not in play) holding cash. Second, this seems to undermine what it means to have somebody invest in your business – why bother having a business plan if the central bank will just buy up your bonds? I could set up ‘Unlearning Economics PLC’ and sell millions of pounds worth of bonds to the central bank – free money! Obviously this would quickly undermine the scarcity of, and trust in, money.

I suppose the central bank could screen who it invests in, but that just makes it another bank. This might help somewhat if the central bank were more willing to lend than private banks, but it doesn’t change the fact that banks aren’t lending for a reason: there’s just not much demand for goods and services in the economy, and businesses will have limited success.

Obviously, even the proposed introduction of such changes would likely meet widespread political opposition. However, if they were implemented I simply see it undermining the value of money and the workings of the financial sector, possibly resulting in widespread instability. I’m not talking about ‘the money is coming!!!’ gold bug style instability; more ‘what is going on, why is the central bank buying my house and the local branch of KFC?’ or ‘why am I not allowed to save money safely any more?’ type instability.

My basic view is that that monetary policy can primarily alter the costs in the economy, but not the demand conditions. This is why it can often effect changes in NGDP and other variables, albeit indirectly. However, when those costs go as low as they can go (0), beginning to tamper with the fundamentals only risks completely undermining the term ‘monetary policy’ and how it should ensure that money retains its traditional roles, including that as a reliable store of value.

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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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The ‘Sumner Critique’, or Why Not to Ignore Keynes

I thought I’d offer a brief note on Scott Sumner’s latest offering to the field of economics – the ‘Sumner Critique.’ Sumner offers an apt example of why macroeconomists who ignore TGT are basically wasting their time – virtually every macroeconomic insight is already in The General Theory. Sumner says he has ‘never been able to take the book seriously.’ Maybe he just needs to read it properly.

The ‘Sumner Critique’ states that if the path of NGDP is stable, all macroeconomic effects become classical in nature. Sumner and others appear to think this is new and original, but, unfortunately for them, it was stated 76 years ago by Keynes:

Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the classical theory comes into its own again from this point onwards. If we suppose the volume of output to be given, i.e. to be determined by forces outside the classical scheme of thought, then there is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed between them. Again, if we have dealt otherwise with the problem of thrift, there is no objection to be raised against the modern classical theory as to the degree of consilience between private and public advantage in conditions of perfect and imperfect competition respectively. Thus, apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest, there is no more reason to socialise economic life than there was before.

There you go. Replace ‘NGDP’ with full employment, and Keynes said it a long time ago. Keynes’ primary policy prescription of long term interest rates also has the benefit of being tried, and of working, after WW2. Conversely, NGDP targeting relies on expectations fairies and continually pumping up the value of asset prices. In other words: Keynes said it, but better.

Addendum: The riposte the NGDP and full employment are sufficiently different to make my criticism void does not hold. As Jonathan Catalan points out, for Keynes, ‘full employment’ was synonymous with ‘maximum effective demand, given potential output constraints.’ It’s hard to deny that Sumner uses something very similar.

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More on NGDP Targeting (and Bubbles)

Left Outside has responded to my post on NGDP targeting, in which my major claim was that nominal income doesn’t drive the real economy. They note:

In 2007/8 asset prices fell because expectations of future NGDP fell which was priced into current asset prices. This lead to a fall in real GDP contemporaneous with a fall in NGDP, but both were caused by fall in expectations of future NGDP as is argued by adherents (cultists?) of NGDP targeting. Asset prices are forward looking and money is an asset, hence you have to look at expectations of future NGDP rather than looking at which moved first by a few months, RGDP or NGDP.

I’m not sure this is the full story. A bubble bursts when people realise that there is no real production underlying the growth of nominal income. If this sounds too economisty, I’ll phrase it in a different way: a bubble bursts when people realise that income is only rising because everyone expects it to rise. Ultimately, NGDP targeting relies on a claim that bubbles are not an important phenomenon for the macroeconomy.

The CB can continue buying assets – even housing – and so spur nominal income, by definition. But does pushing nominal income actually help the real economy? Take a look at this, via Bubbles and Busts:

During the 1970’s the US was plagued by high inflation that at times drifted into the double digits. This led to a brief stint of monetarism at the end of the decade into the early 1980’s. Monetarism, at the time, attempted to target a quantity of money rather than price. As can clearly be seen in this chart, the relationship between NGDP and RGDP is least correlated in the post-WWII period during this time of high inflation and quantity targeting.

For those convinced that NGDP targeting will be successful, the task is to explain why changing policy to promote higher inflation today will not cause a breakdown in the correlation of the past 30 years, similar to the 1970’s. Otherwise it seems perfectly reasonable to expect that NGDP targets will be met with increasing inflation, not real growth.

What’s the point in turning recessions into stagflation?

Left Outside asks what NGDP targeting failure would look like. My answer is either number 1:

NGDP does not reach trend because the bank lacks credibility and the policy is abandoned.

or number 3:

NGDP reaches trend but nominal growth consists (almost) entirely of price changes.

with the possibility that ‘price changes’ are predominantly in various assets, real production is marginally affected, and once the CB runs out of assets to buy we face the mother of all crashes.


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On the Lousy Reasoning Behind NGDP Targeting

NGDP targeting has been catching on across the blogosphere, and, to a more limited extent, in the mainstream. So far, it appears to be the best response to the crisis that mainstream economists can come up with. However, I remain unconvinced – the whole thing, to me, appears to beg a lot of questions.

The rationale for NGDP targeting is roughly as follows: macroeconomic policy can only reliably influence the nominal; the distribution between real income and inflation is determined partly by long run supply-side factors and is partially out of our control. Hence, if we keep nominal spending constant then we will know there is never an AD deficiency – any problems lie elsewhere.

Firstly, I have to agree with Rogue Economist:

Wow. Imagine, business planners and executives will have no more compunctions about claiming to their investors that they will attain at least 5% nominal revenue growth year in year out.  If they don’t achieve it via additional sales volume, the Fed is going to make sure they achieve their targets via inflation. Recessions will be a thing of the past.  Woohoo!

To believe that we can magically promise stable income growth, no matter the state of anything else in the economy, is to hand wave away the problem of macroeconomics in its entirety. How can it be so easy? Why hasn’t this been adopted before – after all, it’s not a new idea?

The fact is that no rigorous theoretical case has been made that supports NGDP targeting. As evidence, advocates of NGDP targeting offer no more than a graph showing that NGDP declined during the recession, with the implicit assertion that nominal income is what drives the macroeconomy. But is this true? Left Outside’s endorsement of NGDP targeting included this graph, showing that low NGDP is correlated with low RGDP:

This is a clear example of confusing correlation and causation. When looking at two correlated variables, a good question to ask is which one moves first – here, the drop in RGDP clearly precedes the drop in NGDP. This suggests that the decline in RGDP is not a result of the decline in NGDP; rather, its the opposite.

So what happened in 2008? Obviously, the conventional story is true: a large drop in asset prices made many households and firms realise they were less wealthy than they thought; this caused firms to lay off workers; real production decreased; nominal income followed; expectations dropped; this created a spiral. The NGDP-driven story doesn’t withstand scrutiny, else we’d expect the NGDP drop to come first.

Another example of the lack of concrete justification for NGDP targeting is its proponents completely refusal to discuss transmission mechanisms at the zero bound. As we know, government bond yields across the world are about as low as they’re going to get, so ‘traditional’ monetary policy measures are exhausted. What to do?

The CB could begin buying other assets, but that leads us to the  question of what happens when these reach the zero bound, or worse, when there are no more assets left to buy. This is at least theoretically possible. Furthermore, there is the obvious observation that merely purchasing assets will not do anything for the real economy. What if NGDP is 5% and RGDP is -5%?

Expectations are often touted as highly important to NGDP targeting, but if expectations are relied on as a transmission mechanism when all other transmission mechanisms become impotent, this undermines itself. For if the CB wishes to make a ‘credible commitment’ to a certain outcome, and this ‘credible commitment’ is vital to the outcome materialising, then that suggests the CB does not have any other way to create the outcome, and hence undermines the credibility of the commitment. To put it another way: the CB can only change things by making people think it will, if it is able to change those things without relying on people thinking it will. Expectations are a product of very real phenomenon, rather than something that can be magically manipulated to produce any desired outcome. Furthermore, even if they could be, evidence suggests that they don’t have that much of an impact.

So the foundation of NGDP targeting – that the CB controls NGDP so they should control NGDP – is completely circular; evidence suggests that nominal spending does not drive the real economy; it is not at all clear exactly how the CB would go about controlling NGDP, and it’s also not clear that targeting NGDP is a particularly desirable policy. Bearing all of this in mind, I’m inclined to agree with Winterspeak – NGDP is just the latest in a long line of mainstream stupidities.

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Post-Keynesians, Interest Rates & Monetary Policy

Steve Randy Waldman has a good post on Interfluidity in which he attempts to form a synthesis between New Keynesians (NKs), post-Keynesians (PKs) and Market Monetarists (MMs).

Waldman actually exposes a bit of a fault with post-Keynesianism: what exactly are the policy prescriptions? Or, more specifically: how should monetary policy be conducted? PKs generally want to channel bank’s lending to the right people; we’re generally in favour of fiscal stimulus during downturns; Steve Keen has a policy prescription for redefining shares that I’m not entirely sure I understand the implications of, but it would be hard to say anything about a shared stance on monetary policy.

Waldman fills this gap by assuming that PKs don’t have a problem with NGDP targeting in principle, though they may doubt its practicality at the zero bound. However, I have spoken before about how NGDP targeting ignores the role of interest rates in determining not only the rate but the type of investment that takes place – instead assuming that macroeconomic policy can only reliably influence nominal variables. Scott Sumner, in fact, appears to believe that under NGDP targeting, the interest rate would be irrelevant.

Sumner is actually incredibly vague about why NGDP is the correct indicator for monetary policy: he has previously refused to discuss transmission mechanisms, and appears to think the the general public understand what the monetary base is, a position that goes hand in hand with his emphasis on expectations. In fact, I’d go so far as to say the entire thing is becoming circular: the CB controls NGDP so it should target NGDP – we will judge this by the level of NGDP.

PKs & MMTers, contrary to MMs & NKs, view interest rate policy as exogenous, and the only monetary variable that the CB can reliably control. In fact, as Edward Harrison notes, this is probably the major difference between exogenous versus endogenous money.

The endogenous view lends itself to the views of Keynes himself, who saw low rates as the appropriate monetary stance. In this view, interest rates are a cost of investment and so if they increase it will have two effects:

(1) Net investment will decrease;

(2) Businesses that do invest will be forced to seek higher returns and therefore take more risk. This can lead to speculative bubbles.

However, evidence suggests that businesses making investment decisions do not look at short term interest rates – both because they are prone to changes, and because they are too, well, short term. The Radcliffe Report, for example, emphasises that business decisions are far more heavily influenced by long term rates of interest, and also by expectations over the future path of the long term rate of interest. Thus, successful monetary policy lies in a credible commitment to, and execution of, permanently low long term rates.  This also entails that monetary authorities have discretion over their jurisdiction, so capital controls would be a requirement.

As PKs & MMTers generally reject the IS/LM approach to the interest rate, generally sympathise with the views of Keynes himself and generally disregard ‘libertarian’ considerations when discussing international stabilisation, I do not see much of a reason that they should object to such a policy prescription.

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Can Macroeconomic Policy Only Influence The Nominal? A Critique of NGDP Targeting

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.

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