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I agree with your analysis of 1 and 2 but think there is a 3rd option. NGDP could have been kept on track and at least some of the fall in RGDP could have been averted. But this could only have been done by increasing the money supply by so much that medium/long term negative effect (inflation expectations? , asset price bubbles?, high nominal interest rates ?) of managing (and eventually draining) this huge increase in the base would have been even more costly than the RGDP shortfall we actually saw.

Nick, does finance matter even if NGDP expectations stay on target? I would say to a certain degree yes. Some time ago, you wrote a post "Are there "Peso Problem" recessions?", peso problem is one of the reasons finance matters.
And financial crisis does make the probability distribution of NGDP wider.

The financial crisis was large, so it is reasonable 1 would have been difficult, but it is hard to believe if inflation did not start off at 5% or 10%, other than some lag due to calibration and delay of its response that it could not have done so, that is, the main problem was conventional policy hitting the lower bound. I would look at depth of recession relative to starting inflation rate across countries. Even then it becomes difficult avoid a recession if your main trading partners plunge into one.

Questions:

1. Is there currently a central bank in existence which is doing monetary policy "right" (i.e. in a manner deserving of the blessings of Nick Rowe and Scott Sumner)?

2. If "yes" to 1, how long have they been doing it "right" and how have things gone for them?

Your question is hard to answer without a definition of monetary policy. You can't just say that monetary policy is what central banks do, since they vary in power, independence and resources.

You also haven't said whether you are assuming changes to central bank policy solely related to NGDP or their asserting their the full range of their prudential powers without political let or hindrance.

For example, congress restricted the Fed's powers as a result of the actions they took. Are you assuming expectations channels are so strong that the mere threat of central bank intervention will solve any problems, or are you assuming that central banks have a greater degree of independence than they been shown to have.

In any realistic case, I think the answer is 3. The Fed (since we are talking about 2007 in particular) could have cushioned the blow considerably and prevented the financial meltdown, but it's very unclear what the consequences would have been. There certainly would have been some.


Case 2 is impossible, since the necessary amount of inflation can't be an "only effect". It has its own consequences. US inflation would confiscate a huge amount of presumed safe assets worldwide. These are the savings of the demographic bulge which is starting to retire. Given the political and financial power of these seniors, there would have to be some ugly consequences (like election of anti-inflation governments and an all out war on central bank independence, for instance).


PeterN: You are missing the point. Every and each country that is using money as opposed to resorting to barter *has* some kind of "monetary policy". Even lack of official government stance on "monetary policy" *is* some kind of monetary policy.

So if there is a country where one branch of government prevents some other branch of government from enacting some particular "monetary policy" that has better long-term society-wide welfare results means that this country runs sub-optimal monetary policy. And experts in monetary policy, that is economists in our case, should shout loudly in the same way climate scientists shout warnings even if optimal solutions are not feasible given current institutional arrangements.

123 (I had to fish you out of spam, BTW): Stabilising expected future NGDP would help a lot in keeping actual NGDP stable. Just as stabilising expected inflation helps a lot in keeping actual inflation stable. But sure, expected future NGDP isn't the only thing that affects actual NGDP. Just as expected inflation isn't the only thing that affects actual inflation. The central bank would need to try to respond quickly and correctly to those other things too, if it wanted to keep actual NGDP perfectly on target.

But if central banks had tried to keep NGDP stable (instead of trying to do other things instead), and if people had expected that NGDP would have been more stable (especially if they had expected that NGDP would never deviate permanently from trend), instead of expecting other things instead, we can reasonably believe that NGDP would have been a lot more stable than it actually was.

Tom, No country has adopted NGDPLT. However one country has often tended to mimic the policy. Here's some data for Australia:

Australian NGDP growth from 1996:2 to 2006:2 averaged 6.54%

Australian NGDP growth from 2006:2 to 2012:2 averaged 6.49%

Australia hasn't had a recession since 1991. Admittedly the commodity boom helped them this time around. However commodities are volatile, and that should have made them more prone to recessions (compared to the US) when commodity prices crashed. But they also avoided recessions during commodity crashes.

Nick,

Stabilizing the expected mean future NGDP is not equivalent to stabilizing the full probability distribution of NGDP. And I believe rational economic agents should increase their estimates of variance of NGDP when a credit crunch happens.

In addition, I have noticed, that central bank forecast errors increase when credit crunch arrives. That is an additional reason for keeping finance in macro.

Here is my comment on Scott's blog: "Finance is a limiting factor. It can make the path NGDP takes along its level target too volatile. But of course, first you have to target NGDPLT, and only then you can take a look at finance."

I wrote my comment on a different computer, that's why perhaps it is spam.

Nick,

If people suffer violent swings and big losses on housing and stock market wealth, they are going to try to hoard money, and the natural rate will plummet. I don't believe that any amount of conditioning people's expectations during more benign periods is going to cause them behave any differently under extreme circumstances. And money hoarding/very negative natural rate is not consistent with rising inflation so you *will* hit a liquidity trap.

So I totally agree that 20 years of successful NGDPLT would have helped. It's good to try to condition constructive expectation changes. I just don't think it would have helped much. Maybe *you* would have gone on spending as usual, but *I* would have saved my money. The dynamics of the paradox of thrift are such that I take very little risk by saving, but you take a big risk by assuming everyone else isn't going to save.

"These worst case assumptions mean that there must exist some maximum Debt/NGDP ratio"

I think you were referring to public debt/gdp in the above quote. Two questions:

1) do the same dynamics you described apply to total debt/gdp?
2) if so, does finance matter?

Evan Soltas has noted that Israel's central bank appears to have been adjusting the monetary base to counteract any change in velocity, covertly targeting NGDP.

Diego: Yep, I was referring to public debt in that quote.
1. No. Because only governments can transfer the liability onto the next generation of taxpayers. I can't force my kids to be responsible for my debts.
2. Finance still doesn't matter, either way.

K: how much does consumption demand depend on current housing+stock market wealth, and how much does it depend on expected future income? And how much does investment demand depend on current stock prices, and how much does it depend on expected future demand? I confess I'm not up on the empirical literature, but I always thought the second was more important, in both cases.

Nick: I would object to your point 1. Yes, only governments can transfer the liability to next generation, but they can and in practice also do transfer some private debt into the public domain. Ireland being one fresh example.

K and Nick,

"If people suffer violent swings and big losses on housing and stock market wealth, they are going to try to hoard money, and the natural rate will plummet. I don't believe that any amount of conditioning people's expectations during more benign periods is going to cause them behave any differently under extreme circumstances."

Actually there are some theories that complacency and conditioning people's market expectations leads to instability. How many people were "conditioned" that equity prices or house prices only go up?

"How much does consumption demand depend on current housing+stock market wealth, and how much does it depend on expected future income? And how much does investment demand depend on current stock prices, and how much does it depend on expected future demand? I confess I'm not up on the empirical literature, but I always thought the second was more important, in both cases."

That would depend on the liquidity of the asset that is being valued. If the asset is highly liquid then it can be treated as expected future income from sale of asset.

> If in 2007 you told the world’s elite macroeconomists what the path of NGDP would look like over the next 6 years, most of them would have predicted a deep recession and slow recovery in the US, and a deep recession, slow recovery, and then double-dip recession in the eurozone. And that’s exactly what happened.

Isn't that begging the question? Within relatively tight bounds, NGDP and Real GDP are highly correlated. Seeing the nominal GDP curve and expecting real GDP growth would require unrealistic assumptions of serious deflation -- which in mainstream economics is inconsistent with that supposed real GDP growth.

Majromax: That's how I used to look at it too. Then I thought: "Hang on, if you believe that central banks could not have stabilised RGDP by stabilising NGDP, that means: either you don't believe they could have stabilised NGDP; or you believe that high correlation would have broken down if they had stabilised NGDP. Which is it?" Then I wrote this post, because neither looked plausible.

Nick, this is a really good summary of the monetarist credo. You are saying (at least, I think you are saying) exactly what what Scott Sumner would say but in a lucid way. So, +1.

However, the other shoe has not dropped. Your post remains a statement of belief and not a defense of that belief. I don't think for a moment that I would be able to debate you on the subject and shift your opinions an iota; why should I be able to? You are highly talented, highly trained on the subject matter, and you have spent much of your life thinking about the matter. Why should my alloy of ignorance and inattention - five minutes thinking on the matter - influence you at all?

But shouldn't you be able to influence me? Easily? My opinion should be like a wind-blown leaf before the breeze of your intellect. Yet it is not. If recessions are an artifact having to do with money, and if finance represents the mechanism by which money is distributed throughout our economy, why wouldn't our particular monetary arrangements form a constraint on the central bank? Would you argue that a gold standard (in the sense that the CB has no power to alter the price of gold) makes no difference to a fiat arrangement? So why would finance not matter to money?

What if our system of finance is not a purely arbitrary arrangement, like deciding to wear a navy suit rather than grey? Perhaps finance contributes to the real economy, in which case abrogating financial arrangement has a real cost to growth. Why should this not be a constraint on the CB? I like Scott Sumner's Australia example, but it is just an anecdote and a debatable one at that. What is the positive case?

Phil: Thanks! What I was trying to do was to restate what Scott is saying, in such a way so that anyone who disagrees with what he is saying is on the horns of a dilemma. But I had a particular audience in mind (I expect that audience was someone like me, only a few years ago). So I didn't go into all the details of why each of those two horns would be very implausible.

For example, a Real Business Cycle theorist would just shrug his shoulders and take the second horn, without worrying about it. And I didn't really make any attempt to convince him otherwise. But most macroeconomists wouldn't need to be convinced that the second horn is not where they want to go. All I did was remind them why they don't want to go there.

My imaginary audience would find the first horn more attractive, so I spent a little more time on it. Most economists are already convinced that 20 years of inflation targeting has given the BoC a lot of credibility, and has made it easier for the BoC to keep inflation on target. So I don't need to persuade them on that. I just remind them they believe that, and then draw the analogy to NGDP targeting. And I don't need to explain to my imaginary audience why current NGDP depends on expected future NGDP. They can fill in the details for themselves, via the consumption function, and the accelerator model of investment, and the distinction between real and nominal interest rates, even though each macroeconomist would have his own preferred way of making that link.

And I don't think my imaginary audience would think there is anything theoretically impossible about targeting NGDP, even given current institutional arrangements. The idea has a history. The arguments are only about how close the BoC could keep NGDP to target, and whether targeting NGDP would be better or worse than targeting inflation or exchange rates or something else.

But yes, for a more general audience I should perhaps have spelled out those bits I assumed in more detail. My post is flawed in that way. But I wouldn't be saying anything new there. The only things new in this post are: the early stuff about cows as money, where I try to break the standard framing and make the link between money and finance look as strange and contingent as the link between money and milk yields; re-stating Scott's point by posing it as a dilemma.

Nick,

"how much does consumption demand depend on current housing+stock market wealth, and how much does it depend on expected future income?"

I dunno. My first guess would be that we calculate our permanent income as a sum of expected future wage income and expected income from financial wealth. For people with a large fraction of financial versus human capital (i.e. older people), I would expect the financial capital value to dominate. For young people, not so much. Most wealth is human capital but there is still a lot of financial capital, the swings of which would be enough to impact GDP by many percent.

"much does investment demand depend on current stock prices, and how much does it depend on expected future demand?"

I would expect that it depends on the discounted expected future income from investment... i.e. current stock prices, or Q.

Taking a few steps back...

I think it's a mistake to consider NGDPLT independent of its impact on stock market volatility. Like I said above, I don't think you can successfully target NGDP with stocks swinging wildly, but perhaps stock volatility would be vastly reduced with successful NGDPLT. With uncertainty about future NGDP gone, the only uncertainty in stock valuation would be the result of the expected future NGDP share of the profits of current stocks as well as variations in the yield curve. But I would suspect that the yield curve would also be greatly tamed with successful NGDPLT.

But if, and when, it fails - and the longer it stabilizes a fundamentally unstable financial system the more spectacularly it will fail - the short rate *will* hit the ZLB, and all expectations go out the window. Then you need *real* action, i.e. fiscal intervention or negative policy rates requiring elimination or radical redefinition of currency, or you'll be right back in a great depression.

K: "I think it's a mistake to consider NGDPLT independent of its impact on stock market volatility. Like I said above, I don't think you can successfully target NGDP with stocks swinging wildly, but perhaps stock volatility would be vastly reduced with successful NGDPLT."

Yes. That I think is the biggest theoretical flaw in my post. I want to concede as much ground as possible to the other side, by assuming that NGDPLT would have made no difference to the financial crisis. But I think that's false. I think it would have reduced the magnitude of the financial crisis. The counterfactual conditional I'm putting forth (assume NGDPLT but same financial crisis) doesn't really make sense. If people had expected NGDP to stay on trend, house prices and stock prices wouldn't have fallen as much, and there would have been fewer defaults.

It's true that NDGP fell during the Great Depression and in the Great Recession. But wasn't there also a credit collapse in both cases? Maybe unemployment spikes are correlated to *both*, and not just one. Maybe people being kicked out of their homes means that *most* stimulus becomes inflation? Ex post, we would find ourselves in a stagflation environment.

> "Hang on, if you believe that central banks could not have stabilised RGDP by stabilising NGDP, [...]"

There are a few propositions here:

1) NGDP breakdown implies RGDP breakdown
2) NGDP growth implies RGDP growth
3) RGDP breakdown implies NGDP breakdown
4) RGDP growth implies NGDP growth

(1) and (4) are true supposing that deflation is inconsistent with real growth; those statements are contraposatives. Likewise, (2) and (3) are contrapositives, but I think that they are not necessarily true. A high-inflation regime is consistent with both NGDP growth and real-terms contraction, and it could even be encouraged by careless application of NGDP targets.

My hunch is that NGDP targetting probably would not have spared a recession, but it may have lessened the depth or duration. The root cause of the recession has been private-sector deleveraging after the financial crisis brought creditworthiness of some pretty large industries (aka homeowners, commercial paper) into question. Any central-bank action focused on relieving financial firms from default pressure is going to miss the boat, since they're not the ones using the debt for direct consumption or investment.

My own opinion is that NGDPLT would have prevented most of the crisis. Minsky cycle would be extended by 10-50 additional years.

Nick,

"If people had expected NGDP to stay on trend, house prices and stock prices wouldn't have fallen as much, and there would have been fewer defaults."

And maybe people would have continue to panic-buy houses for another five years, driving them way further up relative to GDP. And then what?

The more confident people become in their expectations, the more they will leverage themselves into positions which critically depend on their expectations being exactly realized. And the more they will be forced to panic-sell with even minor deviations from trend. And the more extreme will be the losses, defaults and forced selling.

The fundamental problem is the existence of a government guaranteed numeraire, whether the guarantee is inflation or NGDP. It's a pretend safety blanket which enables the disequilibrium paradox of thrift dynamic. Only capital asset backed money can fundamentally eliminate the instability.

K,

"The fundamental problem is the existence of a government guaranteed numeraire, whether the guarantee is inflation or NGDP."

Or government debt which is simply a guaranteed claim against tax revenue.

"Only capital asset backed money can fundamentally eliminate the instability."

That would depend on what capital asset it used. For it to properly function it would need some money like aspects:
1. Uniform standard of measurement
2. Divisibility
3. Either infinite or defined term durability (with gold it is infinite, with credit based money it is the term structure of the debt)
4. Low resistance transferrability

Obviously money backed by cows would not work very well.

"The more confident people become in their expectations, the more they will leverage themselves into positions which critically depend on their expectations being exactly realized."

The more confident people become in their market expectations, the more they will leverage themselves into postions which critically depend on the markets confirming their expectations. But people have other expectations that are not priced by markets - for instance expectations of a uniform legal system.

"Have we learned nothing?"

Nick, Bank of Japan had recently tried covertly to follow the NGDP methodology and failed (the prices of bonds dropped).

Do we learn anything from that experience?

Scott, that Australia data is fascinating. It's becoming clearer and clearer that recessions like 2008 are largely avoidable.

Nick,

Let me put it another way. I think we would all agree that the Fed appears to have an inflation target in the nature of 2%. In fact, I think that a market monetarist would say that since inflation expectations have in fact been anchored around 2% for many years, that is prima facie evidence that the CB must be targeting 2%.

But I think we would also agree that the Fed would be quite happy if the US economy were to achieve its long-run growth potential, say about 2.5%. I mean, can you make a convincing case that Ben Bernanke wants growth to be below potential? So in that sense we can also say that the Fed is targeting 2.5% growth, if ineptly.

Here's the thing. The monetarist position amounts to claiming that if the Fed targets 2% inflation and 2.5% growth, then it may achieve one or the other but not both. However, if it targets 4.5% nominal growth then, absent any supply shock the economy will grow at potential, assumed to be 2.5%, and therefore inflation must be 2%!

This is not a claim that is self-evidently true or even self-evidently plausible. It is not even persuasive in light of the whole body of your postings on the subject, which I have read and (I think) understood. Some other factor is needed to get beyond preaching to the choir.

Looking at past UK ngdp you would have believed they were targeting it, until 2008, so what changed peoples mind that they weren't, or no longer could? Perhaps the belief that it would continue supported the economy and finance until it became evident they couldn't/wouldn't. Perhaps they had no way of supporting it other than making good a lot of really bad loans, of absorbing the discrepancy between income and debt that had built up, or as K suggests, making even worse loans for an even larger crisis later.

This brings to mind how difficult a mistake this is to clear up. The ability to lower short rates further would have helped but lowering short rates does little to combat collateralized long debt that can't be refinanced. Even lowering long rates does little to solve the collateral problem. To prevent that incomes would have had to risen, so 2 may have been necessary to support existing debt values, even if some real growth came with it.

Nick,

Let's say we KNOW that had the Fed not allowed NGDP to fall in the summer and fall of 2008, then there would have been no Lehman Brothers crash, financial crisis, and Great Recession. That would logically mean that the NGDP crash caused Lehman Brothers crash and the ensuing financial crisis. This argument is the practical implication of Sumner's view, that the fall in NGDP caused the Great Recession. But I don't understand the following.... according what mechanism could that happen? According to what mechanism would the fall in GDP have caused Lehmans and the financial system to crash? What's the model?

Continuing with my recent trolling, I would bring up Gordon Ramsay's "Kitchen Confidential", which I have been watching now on youtube. It is a fascinating example of capitalism at work.

One of the interesting things about this show is to read up on what happens to the Restaurant entrepreneurs after Gordon leaves. Almost all of them go out of business, many become homeless, one becomes a prostitute and one commits suicide. Of those who don't make it, the #1 reason is that they have accumulated too many debts, and even though they have now turned their restaurant around, they can't make enough money to repay their debts. Finance introduces a memory that is missing from economics. If you make mistakes as a businessman (which are also missing from economics), you can end up with huge debts much larger than the purchase price of your capital stock. And even if you earn substantial profits going forward, it may not be enough to service those debts.

I think finance matters for many reasons, but this is one important one.

The other way for 1 to be true is if finance represents a large discontinuity while bank actions are only capable of gradual continuous change in trends.

@Scott or Nick,

What does Scott mean when he says Australia "mimicked" NGDPLT (or more generally, Rowe/Sumner approved monetary policy)? Does that mean they inflation targeted, but adjusted the target in a manner which had the effect of producing a quasi-NGDP target?

Thanks for the response Scott.

Alex: "Nick, Bank of Japan had recently tried covertly to follow the NGDP methodology and failed (the prices of bonds dropped).

Do we learn anything from that experience?"

Yep. see my old post.

Majro and 123 and rsj: A financial crisis, just like an outbreak of foot and mouth or a tsunami, is a real shock that will do some damage. But Scott did a post showing that the tsunami made barely a ripple in Japan's RGDP figures. And finance presumably matters for making sure savings go to the right investors, and helping with long run growth, but does it matter for recessions?

JoeMac: "But I don't understand the following.... according what mechanism could that happen? According to what mechanism would the fall in GDP have caused Lehmans and the financial system to crash? What's the model?"

For example: if a fall in NGDP causes a recession, that causes unemployment, and unemployed people are more likely to default on their mortgages.

Nick,

"And finance presumably matters for making sure savings go to the right investors, and helping with long run growth, but does it matter for recessions?"

That would depend on how you want the banking system to function. Do you need a system of credit intermediation - short term borrowers to lend long term? An inverted yield curve (short term rates above long term) is the surest way to a recession.

If you want a model, look at the S&L crisis. That's probably the closest. It took regulatory action as well as monetary policy. If people have expectations that their money isn't safe in the banking system or that they won't be able to roll over a loan or get inventory financing, you won't have very good NGDP expectations. You have to convince people that you are going to directly fix the problem. If you restore confidence in the financial system, monetary policy should do its job.

That's why the financial system is special, it's a choke point. Look at Roosevelt's bank holiday or the end of German hyperinflation. Expectations are important, but the Fed doesn't have a monopoly on them.

"Yep. see my old post."

Nick, I have seen it (got the link from Krugman's post).

You are saying that it's a real economic occurrence. I disagree with you. And I agree with Koo that it should be the financial market occurrence.

I'm trying to outline a model.

J.V. Dubois,

"Every and each country that is using money as opposed to resorting to barter *has* some kind of "monetary policy". Even lack of official government stance on "monetary policy" *is* some kind of monetary policy."

You're defining monetary policy as policy concerning money. So it's merely of finding an optimal one.

But by this definition any fiscal policy is a monetary policy. It's merely perhaps a non-optimal one. OK, then what policy mechanisms are part of the set of optimal ones, and which ones aren't.

Consider the national bank of China, it can do pretty much whatever the government wants it to, and do it without truthfully informing the public of its intentions. It cooks the books and funds money losing government owned businesses through the back door. So far, it seems to work. Having only a fraction of this latitude would make the Fed's job easier. Even having some of the powers of the Bank of Canada would.

But where do you draw the line? Is monetizing the deficit monetary policy or fiscal policy? The important thing isn't what you call your favored policies, but which ones they are, and, equally important, which ones they aren't.

It would be arguably more effective to send everyone a check for $1000 from the Fed's balance sheet (let it call the matching asset goodwill), then it is to spend 100's of billions exchanging assets with roughly equivalent opportunity costs. However, one of these it has the power to do, and the other it doesn't. But the Fed isn't really a bank any more than the Social Security Trust Fund is a trust fund, rather than just a notation on a balance sheet.

I'm neither clear on what activities an optimal monetary policy might consist of nor on how near the various central banks are to either operating one or being empowered to do so. The clearest point is that, whatever it is, it should effectively manage NGDP expectations by threatening actions sufficiently strong, that the threats forestall the need for their execution. People do lose faith in their central banks from time to time, so it would seem that the actions would have to be extremely potent so the threat would be credible. That is, Chuck Norris has to stay in training to fight the ninja hordes at any time, day nor night, and no retakes.

Peter N.

"The clearest point is that, whatever it is, it should effectively manage NGDP expectations by threatening actions sufficiently strong..."

Central Bank to Market: Here is a loan. If you don't hit our nominal GDP target, we are going to be very upset.
Market to Central Bank: Oh yeah, what are you going to do about it?
Central Bank to Market: In a "threatening voice" - here is another loan.

Frank Restly

The real problem, I think, is that a great deal of government debt is directly or indirectly an income paying asset of some current or future retiree. It's bad enough that they get no earnings to speak of, but inflation is anathema. We're getting the inflation policy this large politically active group wants. Unfortunately, at current valuations, the total money value of these financial assets exceeds the money value of future tangible assets if they were available at current prices. All the boomers can't just cash in their investments, sell their houses, buy boats and RVs and move to the sunny south. Their price to sell has to come down, relative to their price to buy. Otherwise markets won't clear. Financial asset deflation or product inflation, pick one or a mixture.

Peter,

"The real problem, I think, is that a great deal of government debt is directly or indirectly an income paying asset of some current or future retiree. It's bad enough that they get no earnings to speak of, but inflation is anathema. We're getting the inflation policy this large politically active group wants. Unfortunately, at current valuations, the total money value of these financial assets exceeds the money value of future tangible assets if they were available at current prices."

The government's debt is not a claim on future tangible assets, it is a claim on the government's future tax revenue. The problem is the federal government relies too heavily on guaranteed claims on future taxes to fund deficits.

"Financial asset deflation or product inflation, pick one or a mixture."

I pick neither. I instead choose - change risk profile of government securities.


All financial assets are vehicles to turn current consumption into future consumption. Financial assets have expected real returns. These expected returns apply to future consumption from future GDP. If the expected returns are large compared to actual future GDP, then when they are realized, their real value will be less than their former expected real value. One or both of the nominal values will have to change until the real values correspond or the market won't clear (this non-clearance is seen in the housing market after a crash. People refuse to sell and realize a loss.)

In the 10 years or so before 2008 there was a substantial increase in the net worth to GDP ratio. The crash wiped this out, but the ratio is climbing again.

In disagreeing with "1", Nick is agreeing with Mosler's law: "There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it."

Ralph: Neat! Leaving aside the fiscal/monetary question, I think that's right. And I think both Warren and Scott would reply, to anyone who questioned it: "you mean you have run out of paper and ink?"

Sometimes we agree.

Peter,

"If the expected returns are large compared to actual future GDP, then when they are realized, their real value will be less than their former expected real value."

That would depend on the legal protections the return has when the fiancial asset is sold. If the federal government sold a financial asset with a 30 year coupon of 7% and 20 years later GDP growth is only 4%, does that mean that the financial asset sold by the federal government is worth less? Because of the legal protections involved (paying taxes is a legal requirement, not a market function), that 7% return is still valid.

Public finance is fundamentally different from private finance.

Frank Restly,

I'm afraid I don't see the relevance. At time t1 1 million people save $100,000 each to buy a house, current prices being $100,000. At time t2, 1 million people try to use this savings to buy a house. If there are only 500,000 houses available, prices will rise until the market clears. If their expected real return was $100,000, then obviously their actual real return will be less than their actual real return. No financial guarantee by the government is going to magically create 500,000 houses.

The point is that if financial assets increase at a rate exceeding that of GDP, or there is a demographic mismatch causing more people and nominally wealthier people to be trying to convert financial assets to physical assets than the productive capacity of those creating them, the real value of these assets has to decrease relative to GDP in order for markets to clear.

A government guarantee can only favor certain people over others in getting stuff, it can't create more stuff.

This is just the commonly heard, "we weren't as rich as we thought we were."

What isn't determined is whether CPI prices go up, or financial asset prices come down, or which sorts of financial assets will take the biggest hits. It has been expected for many years, that as the boomers retired, they would try to sell their large northern family size houses and buy smaller ones in warmer climates. This would be a transfer in effect from the owners of the big houses to those involved in the construction of smaller southern ones.

We are already seeing this, with the wrinkle that some of the adjustment is due to a bubble in retirement area prices. The result is the same. The retirees got less than they expected out of their savings through price adjustments. Should this trend continue, the results could be very unpleasant. And you can see that any economic plan that involves significant inflation will meet strong resistance.

To be clearer in the above it should say "If their expected real return was the t2 value of one house."

Peter,

"I'm afraid I don't see the relevance."

The relevance is this: not all financial assets are claims against goods.

"At time t2, 1 million people try to use this savings to buy a house. If there are only 500,000 houses available, prices will rise until the market clears."

Or 500,000 additional houses are built to fulfill the added demand.

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