E(NGDP) level-path targeting for the people of the concrete steppes

"But what concrete steps will the Fed actually take to raise Nominal GDP? Can anyone tell me that?"

I must have heard that question a hundred times over the last couple of years. And a dozen more times in the last day, ever since Paul Krugman endorsed the proposal to target NGDP. I always imagine it being asked in a gruff Yorkshire accent, by some middle-aged no-nonsense practical man of business with a background in mechanical engineering.

So this is written for the people of the concrete steppes.

First off, you aren't thinking about this right.

Sure, I've used mechanical metaphors for monetary policy in the past. But those metaphors only take you so far. Machines don't have expectations; people do. The actions that people take now depend very much on their expectations of what other people will do, and on their expectations of what the central bank will do.

You want me to tell you a story in which the central bank pulls a lever, and that lever causes another lever to move next, followed by another lever, then another, spelling out a causal chain from beginning to end, where the end is a higher level of NGDP.

But economics isn't like that. Because people aren't like that.

Sometimes the future causes the present, because people's expectations of the future affect what they do in the present.

Sometimes it's not even what will happen in the future that causes the present. It's people's expectations of what would happen in future if they behaved differently today that causes them to behave the way they do today. I switch to snow tires in the Fall because I expect I would have an accident in the Winter if I didn't. It's the threat of an accident that makes me put on snow tires. I don't actually expect to have an accident.

Next week, millions of Canadians will get up and go to work about one hour later than they did this week, if we measure time by the sun. "What concrete steps will the government take to get Canadians to do this? Can anybody tell me that?"

No, I can't tell you that. I don't have a clue what concrete steps, if any, the government will take. But I fully expect it will work. All the government does is announce that it wants us all to do this, and to put all our clocks back one hour. Maybe the government has the power to force government clocks back one hour, and force some government workers to start and leave work one hour later by the sun. But the rest of us just follow along, simply because we expect everyone else to follow along.

There will be two groups of people who will continue to get up at the same time by the sun. People who didn't get the memo (and most of them will follow along with a short lag). And people who live very isolated lives, whose timing doesn't depend on what everyone else is doing.

Driving on the right side of the road is an equilibrium. If you expect everyone else to drive right, you too will drive right. Driving on the left side of the road is also an equilibrium. If you announce that beginning Sunday everybody will switch to driving on the left, and if people believe you, or simply believe that other people believe you...everybody will switch to driving on the left. You don't actually have to pull any levers. All you need is credibility. Or people to believe you have credibility. Or believe that others believe you have credibility.

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. Given what people expect other people to do, both now and in the future, each person is choosing to do what he is currently doing.

But this isn't the only possible equilibrium. I can imagine a better equilibrium, in which Nominal GDP is higher and growing faster, and expected to remain higher and growing faster. NGPG is higher and growing faster both because real GDP is higher and growing faster and because prices are higher and growing faster. It's a better equilibrium. And those of us who advocate E(NGDP) level-path targeting want the US economy to move to that better equilibrium.

What would the Fed be doing differently, in that other, better equilibrium? The Fed will be smaller than it is today, and the Fed's interest rate will be higher than it is today. Real interest rates will need to be higher, because consumption and investment demand will be higher, because consumers and investors will have higher expectations of future real income and real expenditure. Nominal interest rates will be higher because prices are expected to be growing faster. The Fed will be smaller, because people won't want to hold as much money, and banks won't want to hold as many reserves at the Fed, now the economy is growing and interest rates are higher.

So, all the Fed needs to do to get the economy to that new, better equilibrium is to pull the lever in the right direction, right? Raise interest rates, and reduce the money supply, right?

Of course not. If the Fed did that, without changing expectations, the result would be a a move even further away from the better equilibrium, as demand fell even further.

The Fed needs to change expectations. Get people to expect that NGDP will follow the higher path. That's what the "E" in "E(NGDP)" stands for.

"Right!" the people from the concrete steppes exclaim gruffly "and how exactly will the Fed do that?!"

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.

"Why should anyone believe the Fed can hit that path?"

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).

"What assets will the Fed buy?"

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.

A few people were nearly indifferent to being in the second room. So they leave even if the chance of them getting beaten up is tiny. That means there are fewer people left in the second room. This makes the second room slightly less attractive for those who want to be where everyone else is. And it slightly raises the probability of being beaten up by Chuck Norris. So more leave. Which repeats the process, so still more leave. And if you and I can see what's coming, so can the people in the room, who don't want to be the last to leave. There's a rush for the exits, and Chuck doesn't even have to lift a finger. OK, if someone didn't hear the threat, or doesn't recognise Chuck Norris, he might actually have to carry out his threat for a few minutes. But simply seeing all the others leave the room will be enough to induce most to leave the room very quickly.

Chuck Norris doesn't have to beat up everyone in the room. He just has to threaten to beat up as many as it takes to clear the room. The number of people he will actually beat up is a lot less than the number he threatens to beat up. If his threat is credible, and everyone hears it, he doesn't need to beat up anyone.

Eventually, if the Fed bought up every single asset in the economy, and swapped it for cash, NGDP would rise to the Fed's target path. Prices would rise without limit as the Fed bought up the last remaining assets because the sellers could name their price. And people would hire the unemployed to build factories which they could float on the stock and bond markets and sell to the Fed at any price they liked. Or sell to the people who had already sold all their assets to the Fed.

But there is no way it would ever get that far. That's like saying that Chuck Norris will eventually beat up everyone in the room. That's not an equilibrium.

Some people are just barely willing to hold cash in the current equilibrium. If they expect even the slightest rise in NGDP in even the distant future, they will get out of cash, and into real assets, or claims on real assets like commercial stocks and bonds. And this will increase the demand for goods today, either directly, or because firms find it easier to issue new stocks and bonds to finance investment. Which raises NGDP, and expected future NGDP, even if just a little. Which encourages additional people to exit cash too, and buy real assets and claims to real assets. Which raises NGDP and expected future NGDP still further. And so on. As soon as people figure out what's going on, and what's going to happen, expected NGDP rises to the target path. The Fed only has to carry out its threat until people catch on to what's happening. Then it has to reverse course and sell all the assets it bought, and then some more, to prevent the economy overshooting the new equilibrium.

Want me to make it more concrete still? OK. Here's the New Keynesian version:

Eventually, if it carries out its threat for long enough, NGDP will eventually rise. Some people figure this out. Maybe only a few. They expect either a rise in the future price level or a rise in future real income, or a bit of both. If they expect a rise in the future price level, that means lower real interest rates for given nominal interest rates. That encourages current consumption and investment demand. If they expect a rise in future real income, that also encourages current consumption demand and current investment demand. (People consume more today if they expect to have higher real income in future; firms invest more today if they think there will be bigger demand for the extra goods that will help them produce in future.) So current consumption and investment demand rises, which increases current NGDP.

The more slow-witted people and firms see that rise in current NGDP, and spend more on consumption and investment, and also revise upwards their expectations of future NGDP, which causes an additional rise in consumption and investment and NGDP.

More people begin to figure out that maybe the Fed's target is credible after all.

And so on.

Oh, and if you believe in the debt-deleveraging hypothesis, there's an additional channel. Higher expected future NGDP makes it easier to handle a given debt load, by reducing future expected debt/income ratios.

Update: I really want people to read a triad of very good posts by Bill Woolsey: his response to thoughts on NGDP targeting by Paul Krugman; Brad DeLong; and Steve Williamson. Bill lays out clearly some of the issues about how NGDP level path targeting works.

Comments

[Frances Woolley]

"if me measure time by the sun"

[Nick Rowe]

Ooops! Fixed. (BTW, it is this weekend, isn't it? I didn't get the memo.)

[K]

How about Chuck Norris says "I'm serving cake in the other room, if you would please come with me?"

Instead of your favourite fiscal-industrial policy (buying assets), the Fed could offer everybody some money (a helicopter drop). So long as it's a powerful enough inducement, they should never really have to use it much, whichever tool they are threatening. The threat of it ought to be enough. But just in case Chuck does have to use his special skills, the party goers would prefer cake. They've already had enough beatings (TARP, TALF, PPIP, etc).

[JKH]

What you've described is a massive QE program.

You've explained why you think such a QE program would be effective at generating economic activity.

What you haven't explained is why the effectiveness of such a program would depend on announcing an NGDP target associated with it.

Why not announce the same QE program with an unemployment/employment target?

I see the NGDP target as an excuse for massive QE, but certainly not the only excuse.

Question: What's so special about NGDP targeting in relation to massive QE?

Answer: there is nothing unique about the relationship between QE effectiveness and NGDP targeting.

And that's the reason why NGDP targeting won't prevail as policy, in addition to the difficulty of convincing people not to be concerned about the risks of massive QE, whatever the associated goal or target.

[Ian Lippert]

The thing I don't get about NGDP targeting is what happens if real GDP doesn't respond (or continues to fall) doesn't this NGDP targetting policy just become massively inflationary? If this causes real GDP to fall the NGDP supporters will call for more inflation to reach their NGDP targets. I'm not a hyperinflationist but this whole NGDP targetting seems like it might have some serious negative consequences and none of its supporters have properly addressed the possible downsides of this policy. Economists are all jumping on this policy in what seems like a desperate attempt to "just do something" even of that something ends up being bad policy.

[Nick Rowe]

K: Hmmm. You mean the *threat* of a (steadily increasing) helicopter drop. Hmmm. That would work fine, if credible. But if it weren't 100% credible, and you had to carry it out, you would have to reverse it as soon as you hit the target. Which is hard.

JKH: "What you've described is a massive QE program."

No. What I have described is the *threat* of a massive QE program.

"What you haven't explained is why the effectiveness of such a program would depend on announcing an NGDP target associated with it."

Because the threat is *conditional* on hitting/not hitting the target. The Fed is saying "I will steadily escalate QE as long as NGDP is below target, and steadily escalate reverse QE as long as NGDP is above target." So people figure out what level of NGDP to expect, and that expectation affects their current behaviour.

And it's that threat/promise to reverse QE that removes the risk of overshooting. Because there will be overshooting if the Fed doesn't reverse. Because the Fed is too big right now, relative to its size if people expected higher NGDP.

Ian. If RGDP fails to respond, then raising NGDP will cause 5% inflation, which is not a disaster. And if RGDP fails to respond, that means we were totally wrong about aggregate demand being the problem. The supply-siders, who say it's all structural, so fiscal and monetary policy demand-side policies can't work, would be right after all.

[Andy Harless]

I think it should be a Brando voice (from The Wild Ones) rather than James Dean.

But the answer to "What have you got?" in this case could be difficult. My guess is that the Fed could pull this off just by threatening to buy assets that it has unambiguous legal authority to buy, and that as a result it wouldn't actually have to buy those assets, but I'm far less than 100% confident in this guess. It's not too hard for me to imagine that there are some serious tough guys in the second room who will say to Chuck Norris, "Yeah, I'd like to see you try!" And it is hard for me to imagine the Fed being as tough as Chuck Norris, so there's a serious risk that you end up with a lot of people getting their heads smashed and then the Fed eventually backing down, particularly since the people getting beat up may have friends in Congress. It'll definitely work if we can get the antimatter counterpart of Paul Volcker to play the part of Chuck Norris, but one doesn't get the sense that Ben Bernanke is up to the role.

[Niklas Blanchard]

Ian: I believe it would take a fundamental breakdown of everything that makes modern society work for an NGDP level target of 5% to fail to produce ANY change in RGDP over anything but the very short term. However, it is theoretically possible under an NGDP level targeting regime to have something like 6% on inflation and -1% on real growth (a point Milton Friedman brought up once), and we would rightfully term that a "recession". The virtue of constant nominal spending is that it smooths out the fluctuations inherent in recessions.

Modern recessions associated with a large and long-running decline in real material welfare are also associated with a plunge in NGDP, not offset by the monetary authority to return to trend...leaving adjustment to the vagaries of prices.

[Max]

Explain how this would have worked in Japan in 1990. The stock and real estate bubbles have begun to pop, and and CB responds by buying everything. How does the CB not lose money?

It seems to me that you can't take the position that QE-on-crack can always work by driving asset prices to silly levels and that the CB won't lose money. The CB can definitely lose money unless it only buys assets at realistic prices - but with that constraint, it isn't guaranteed to be able to hit an NGDP target.

[Andy Harless]

Max, If the Fed loses money (or is expected to lose money), so much the better for its credibility! If the Fed loses money, it could be forced into inflationary policies, which would be all the more reason for people to take its threats to raise NGDP seriously. A Fed that doesn't mind losing money is like a psychotic Chuck Norris that might keep beating up people in the second room just because he enjoys it, even after everyone is clearly headed for the exit.

[Rob]

I have a question.

If there were no expectations and people waited until things really happened before acting would NGDP targeting stop working ? Suppose we have a very secretive CB that sees that NGDP has moved below the target it has set (but has not shared with anyone). It decides it needs to increase the money supply. Without telling anyone it just starts buying up assets for newly printed money. People can either hold onto that money or spend it. As you point out they must eventually start spending it or the CB will end up owning every asset in the world. Once they start spending then NGDP increases and eventually the CB may have to start reselling the assets it has bought in order to stop NGDP rising too much (once people see spending really is increasing they start to spend more too). The CB keeps NGDP on a steady path without anyone knowing what it is doing.

It might have to do more buying and selling of assets than in the expectatio-based model, and it would certainly make it harder for businesses to plan ahead (though they would eventually get used to NGDP rising at a steady rate and plan accordingly) - but I can't see why this model would not work.

So my question is: Is the expectations piece just a cool thing that makes everything work faster and better or does the whole model break without it ?

[Nick Rowe]

Andy: Oops! Brando it is. Fixed. I don't spend enough time watching old movies. (How do you do a strikeout in Typepad anyway?)

JP Koning is my goto man on what central banks can legally do. See his comments on the Chuck Norris post.

My view is that the Fed is large, relative to any individual player. Plus the Fed has very deep pockets (it can print). Plus, who would really gain from standing up to the Fed, and trying to fight? Only someone who held large stocks of Tbills. And if they are that rich, they must be smart, and would realise they could get richer still by beating the crowd to the exits.

Niklas: Yep. There is that (mistaken) view though that fiscal policy affects RGDP and monetary policy affects NGDP but not RGDP. (Scott addressed it in one of his posts). So there is this view out there that the recession is caused by a shortage of AD, but that monetary policy can only affect P. Might be what's behind this.

Max: wouldn't (at least some) asset prices be higher if expected NGDP were higher?

Rob: "So my question is: Is the expectations piece just a cool thing that makes everything work faster and better or does the whole model break without it ?"

Hmm. That's a hard thought-experiment for me. Because I find it hard to explain the current recession without saying that people's fear of future low real and nominal income plays such a large part in explaining why we are in a recession in the first place.

But yes, if everybody really was just very very slow in adjusting their expectations, for whatever reason, that would mean that the Fed would have to do much more of the heavy lifting, and it would take longer for its policy to have any effect.

[Andy Harless]

JKH: Three things, in combination, make NGDP targeting special: (1) it's simple, (2) it involves both the price level and real output, and (3) it's cumulative (at least it would be under proposals being advanced by the market monetarists). There are other ways to combine price level and real output/employment (such as what Gov Evans suggests), but why not use the simplest combination? You couldn't, though, use just employment, because that would leave the price level indeterminate, and inflation-phobes would have a legitimate objection with which the vast majority of economists would agree. NGDP targeting tells just how much inflation you're willing to tolerate in each circumstance and thus provides a guarantee against hyperinflation. The cumulative aspect is important, too, because it allows (and requires) the Fed to make bigger and bigger threats the more the threats aren't heeded. If NGDP misses the first time, the Fed gets more aggressive.

[Max]

"wouldn't (at least some) asset prices be higher if expected NGDP were higher?"

Not necessarily, since expected NGDP doesn't fully determine asset prices.

If the CB doesn't want to lose money, it has to make a judgement about what prices are reasonable given the NGDP target.

[vjk]

JKH:

"Why not announce the same QE program with an unemployment/employment target?"

Quite agree with your comments. At least your proposed target has the advantage of "targeting" what bothers mots people in this economy.

Not sure why the futility of QEn shell game, no matter what is targeted, is not blindingly obvious.

[Nick Rowe]

vjk: we used to target the unemployment rate in the 1960's and early 1970's. It failed miserably. We figured out why. Friedman and (independently) Phelps explained why in 1969 (Hayek explained why earlier, but nobody understood what he was on about). Nobody believed Friedman at first. Eventually everybody did. That's why the Keynesians became New Keynesians.

[vjk]

Nick:

The feds can (a) control overnight interest rate in normal times; (b) engage in swapping government paper of various tenors in not so normal times. (a) is practically at zero, (b) has not had/is not having/won't have any real effect on economy other than temporary distortionary influence on commodity prices and causing stock market wild fluctuations due to mainly transient psychological reasons. Thus (b) is meaningless. Also, see research on Japanese QE experience which is arguably inconclusive, but still does not provide much ground for optimism in the context of the US QE madness. Just the opposite when considering leakages due to the US foreign trade imbalance, something Japan did not have to deal with.

It is also highly unlikely that the CB will repeat its Maiden Lane act with buying non-government paper. As I mentioned in the parallel thread, the Maiden Lane act was most likely illegal since 13(3) was misapplied, or as my legal colleagues would put it: "the feds overstepped its boundaries". Besides, thanks to the Frank-Dodd amendments, 13(3) is now severely limited exactly in order to prevent the ML from happening again.

So, we have a pretty weak Chuck dispensing empty threats. He might as well "target" a flight to Venus ! And more and more players are becoming aware of the feds impotence trying to play fiscal on an unknown and dangerous terrain.

[JKH]

A couple of more questions:

a) How is the threat of massive QE fundamentally different than the status quo, given that the market already believes the Fed will do more QE under sufficiently bad economic circumstances? I know that the target in this proposal is specific, but the fact is that the market perceives that the threat of action already exists, implicitly. The threat is not that much different, although the specificity of the target is.

b) If the target is specific in that it is NGDP, how does the threat have any follow through substance and credibility unless it is quantified by a formula for the contingent strength of QE under various scenarios where NGDP has not yet met target? What would be an example of such a formula quantifying the threat?

c) In Scott Sumner's original NGDP futures proposal, it was important that the Fed intervene in the futures market directly. How is the importance of such an intervention requirement consistent with the idea here that a mere threat will do the job?

[Too Much Fed]

How is the amount of medium of exchange going to increase?

Should positive productivity gains and other things be distributed evenly between the major economic entities?

This is not as off-topic as it sounds. If people produce more, how are they going to afford to purchase more, assuming they want to purchase more stuff, which they may not want to do?

For example, let's say the amount of vehicles that can be produced doubles over the next five(5) years. I'm not going to buy a vehicle more often or buy more of them.

It seems to me you are assuming real aggregate supply (AS) basically equals real GDP, which IMO does not have to be true, but can be true.

[Too Much Fed]

"Oh, and if you believe in the debt-deleveraging hypothesis, there's an additional channel. Higher expected future NGDP makes it easier to handle a given debt load, by reducing future expected debt/income ratios."

If price inflation rises (especially monthly expenses), but wages don't, I see that making it harder for workers to pay back currency denominated debt. Budgeting.

[Donald Pretari]

I'm a Conservative Investor. At these prices and in this climate, Stocks are iffy. Yields on Long Bonds are a joke. So, I'm fiddling around. If the Fed announces Inflation going forward, I will act ( Leave The Room ). I consider betting against the Fed Risky. I will buy Stocks and Long Bonds and Corporate Bonds when I see Yields ( & Quality ) that I can live with. If I'm right, at some point, other Investors will rush into the market late ( Leave The Room ). They always do. There is no doubt that some number of other people are thinking as I do. The question will be how many.

Now, I could be wrong, but I'm puzzled that people would find this hard to follow.

[Ian Lippert]

Thanks for the answers Nick, so if we want to increase the current NGDP of America what size would the QE styled operation have to be under current conditions?

[Nick Rowe]

JKH:

a. I think there are two differences: First, the implicit NGDP target under the status quo is just too damned low to get the economy to recover; all it can do is stop it getting worse. Second, it is because the implicit NGDP target is so damn low that the Fed has to do so much QE just to keep it there. The demand for money is so big, and interest rates are so low, simply because the implicit NGDP target is so low. With a credible higher NGDP target, the Fed could actually do negative QE, raise interest rates and shrink its balance sheet. It would have to, to stop overshooting.

b. I don't think the formula has to be very specific. (It would only have to be very specific if you wanted to hit the target exactly). The instructions: "keep pressing the gas pedal down harder and harder if you are below the speed limit, and keep easing off on the gas pedal if you are below the speed limit" will work pretty well for a young driver. Not perfectly, but good enough. Despite all the Bank of Canada's fancy model, that's really what it comes down to in practice. The model has lots of fudge factors built in, and they don't always do what it says.

c. I see Scott's proposal to use the futures market as a way to try to get a better answer to b above, that allows the wisdom of crowds to try to help out.

With the US economy right now, It's pretty obvious it needs looser monetary policy and more AD. Scott's specific proposals about NGDP futures markets are only relevant once you get NGDP up into the right ballpark, and are not sure whether you want to tighten or loosen monetary policy to fine tune it more exactly. That stuff comes later.

[Nick Rowe]

Ian: "Thanks for the answers Nick, so if we want to increase the current NGDP of America what size would the QE styled operation have to be under current conditions?"

We threaten unlimited positive QE until NGDP hits the target. If/when it hits the target, the Fed will need to do negative QE. I'm not sure how much.

It would be a lot easier to implement if there were an NGDP futures market, as Scott Sumner proposes, because then we could just watch that futures market like a car driver watches the speedo, and it would tell us if we had too much or too little.

[Gizzard]

The only assets that the Fed can purchase are assets that are held by the upper 1-2% of the population. I dont see how even if they sold every last one of their assets for twice the current price of them how this will increase any business sales levels .Money needs to get in the hands of working people NOT the investing people. If the fed could start paying every American twice their current house value (and rent it back to them), buy anyones car who wanted to sell it for twice its book value or any other number of things owned by average joes it might work. Until the average joes go back to buying things we wont get anywhere. This isnt a top end of town problem, its a lower end of town problem created by the excesses in the top end of town. QE I, II and III have failed and QE (infinity) will fail too unless the little guy gets to sell HIS stuff to the fed.

[Gizzard]

And what the hell is "Negative QE"??? The Fed FORCING you to buy assets back from them.............. and you guys call the Kenesians "Statists"!!??

[Ritwik]

Nick : Thanks for laying out the 'mechanism' in such detail - I'm now less confident than before! Everything really depends on the presumption of omnipotence of the central bank. Why couldn't the BoE convince George Soros, for example, that the value of the pound will remain where it wants it to remain? Perhaps there is some asymmetry there - printing currency to buy other assets is much simpler than selling assets to buy your own currency - but this just tells us that the central bank is not Chuck Norris, after all!

The Chuck Norris parable works perfectly when applied to one highly centralized market - the overnight inter bank market. But to extend it to the gross sum of all economic activity in a large country just doesn't scale so well. What about the change in expectations when the central bank's balance sheet itself starts becoming 'unsustainable'?

Of course, this does not mean that announcing a policy of 'we will level target the NGDP' is not good policy. It is. It is better policy than what most central banks have around the world. It will change expectations, for sure. That will make the task easier. It's just that sometimes, the central bank may be Sisyphus, not Chuck Norris.

[Nick Rowe]

Gizzard: "And what the hell is "Negative QE"??? The Fed FORCING you to buy assets back from them.............. and you guys call the Kenesians "Statists"!!??"

?

Negative QE = the Fed selling assets. Obvious really. Think ECON1000. Remember Open Market Operations? In open market operations, the central bank can either buy assets, or sell assets. "QE" is just a silly new name for "OMO".

Ritwik: interesting point. Defending the pound was an example of tightening monetary policy. Tightening monetary policy can be nasty, and difficult.

[jesse]

@Nick, what metric of NGDP would you use? In 2008 and 2009 NGDP varied wildly, I think, posting QOQ changes that could cause difficulties in predicting future quarters. From what I see, NGDP is often revised post hoc, making the numbers used for future targeting less certain. If there were a runaway situation the measures could be lagging more than price levels, which are better known (maybe that's not a good assumption?).

My concern with GDP targeting is that GDP is itself not necessarily a good measure of medium-term economic performance. That is, if there is an investment boom, GDP is booked early through capex but would subsequently fall if the investments are poor. In cases where investment is lacking and asset valuations are depressed maybe there isn't much danger in that, but what about the case where asset valuations are elevated relative to earnings? NGDP targeting might exacerbate the situation.

Anyways I'd be curious to hear your thoughts on this.

[Nick Rowe]

jesse: I worry about that too. The nice thing about CPI inflation or price level path targeting is that the numbers aren't revised.

[KH]

Is the Fed not barred by the Federal Reserve Act from buying assets not backed by the full faith and credit of the U.S. Treasury? Which would make dabbling in a futures market illegal under current law? Equity purchases would also be illegal?

[Too Much Fed]

Gizzard said: "This isnt a top end of town problem, its a lower end of town problem created by the excesses in the top end of town. QE I, II and III have failed and QE (infinity) will fail too unless the little guy gets to sell HIS stuff to the fed."

I agree. See here:

The origins of the economic crisis

http://bilbo.economicoutlook.net/blog/?p=277

"The question then arises: if the output per unit of labour input (labour productivity) is rising so strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself? This is especially significant in the context of the increasing fiscal drag coming from the public surpluses which squeezed purchasing power in the private sector since around 1997."

"The trick was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments. This seemed to be a much better strategy than paying higher real wages. The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers. The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold. And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis."

I call that a too much debt problem (both private and gov't). That means there is a medium of exchange problem. It also looks like this.

savings of the rich (including corporations) = dissavings of the gov't (preferably with debt) + dissavings of the lower and middle class (preferably with debt)

Gizzard, what if the "little guy" has no assets to sell?

[Nick Rowe]

KH: read the comments by JP Koning on my "Chuck Norris" post. He knows a lot more than me about that.

TMF: stop please.

[Determinant]

Nick, your comment on the uselessness of employment targeting is the heart of the problem with NGDP targeting. It might be good academics but it is terrible politics. Again I repeat that wages are the primary means in which we distribute wealth and consumption in the modern world. A policy that does not address wages and employment or is not clear about how these will be affected is useless.

Second, on Central Banks being crazy Chuck Norris who doesn't care about losses. ISTM that economists want Central Banks to act without a profit motive and therefore without costs, unlike every other market actor except government (sort of). As Soros episode shows, that isn't true. The Central Bank is not omnipotent and does have limits. We are testing those limits in many countries. ISTM macroeconomists are afraid of abandoning the only tool they are really comfortable with.

[Nick Rowe]

Determinant: UK politicians in the 1970's learned that trying to use monetary policy to target unemployment was both terrible economics and terrible politics. Dennis Healey said something memorable on the subject (though I, of course, have forgotten it). Using monetary policy to target real wages or real consumption would also be a miserable failure for exactly the same reason. Have we learned *nothing* from history? It took 20 years at least to repair the damage from that miserable failure, and it was very costly to repair. Look at one of Stephen's graphs of the 82 recession.

If I wanted the Bank of Canada to maximise profits I would recommend, hmmm, somewhere around 100% for the inflation target. Certainly not 2%. And impose 100% reserve requirements on commercial banks, so people couldn't get around it by using chequeing accounts.

[Prakash]

If the resource producing nations of the world and the speculators on natural resources get a hint of this, they might raise the prices so high that existing production might get hampered.
I guess that would translate into the 6% inflation and -1% growth that one commenter mentioned.

Also, a lot of the GDP growth in China right now seems like major malinvestment. I'm not sure that without proper institutional reform, it is just ok to pump away the cash.

[White Rabbit]

Nick:

There is a marked difference between Chuck Norris and Ben Bernanke: Chuck is wielding a bazooka.

As a rational (or irrational) actor I can be fully certain that Chuck is able to carry out his threat: I can see the weapon with my eyes and I have witnessed him using it on others.

Thus Chuck only has to suggest his intention and I'll be a first mover.

Where is Ben's bazooka and where is his track record of using it? I can only see that he bought three trillion dollars worth of bonds - which only had a transitory effect. Had I been a first mover in 2009, expecting higher rates from Ben's actions, I'd have lost a lot of money.

So can you outline exactly how Ben would be able to increase NGDP, for my eyes to see? And no, SPVs were highly controversial, if you think the Fed has the legal mandate to print money and distribute it to non-bank economic actors you'd be wrong: the Fed picking economic winners and losers in a fiscal manner goes against everything that CBs historically stand for.

So if Ben only buys financial bonds then the market will not accept the proven water pistol as a bazooka threat.

So Ben would have to demonstrate the capability and willingness to go fiscal, for him to be able to target NGDP, do you agree?

[K]

Both asset purchases or heli drops must have a chance of failure or we wouldn't ever have to use them ( we'd just have to threaten). If asset purchases fail, the CB can lose money which will result in them having to tax it back. So the same potential inefficiencies occur there too. *And* it's regressive.

There's a huge free lunch to be had and we are deciding who should eat it. You think that the risk of everyone eating a bit too much outweighs the benefit of everybody sharing it equally. So you'd rather just give it all to Mr Creosote cause you know it's partially reversible if he overeats.

[Matt Waters]

The first line is ironic because I am indeed a Mechanical Engineer with a business background, and my last comment on Sumner's blog was basically "well, how does this expectation thing actually work? What levers are pulled?" You got everything except for the Yorkshire accent, although I've dealt with people with a Yorkshire accent. You can't understand a bloody thing they say.

I will echo that an unemployment target is a terrible idea and it has actually already failed if you include the 1970's. The underlying issue is the structural rate of unemployment. Due to high unionization in both the US and UK economies, high rates of NGDP growth did not increase the real demand for workers by pushing down real wages. Real wages stayed level due to COLA's for union and government workers. NGDP can't do anything about structural factors and no economist should pretend that either monetary or fiscal policy can do anything about structural issues. If the number of workers is fixed through structural factors, then either monetary or fiscal policy will only go through to inflation, not RGDP.

All that said, I still have a hard time wrapping my head around how the Fed could have acted differently during, say, September of 2008. I guess theoretically the government could have purchased all Treasuries in the short-term market and put in a penalty interest rate on excess reserves. In such circumstances, people really, really, really want to be in the first room and Chuck Norris would have to beat up A LOT of people.

So I'm not exactly sold completely on market monetarism. Probably NGDP-level targeting is an ideal, but the country could also use reregulation of finance to prevent another credit bubble followed by a banking panic. Even if the Fed is perfect at responding to banking panics, such credit bubbles IMO do reduce RGDP growth and put more of the NGDP growth to inflation. Furthermore, I'm not sold that Chuck Norris could really beat up enough people to keep NGDP growth steady in such circumstances. At the end of the day, the market would not believe that the Fed could buy trillions of dollars of assets and push interest on reserves low enough to keep NGDP growth strong, and the market would be right.

[edeast]

Hi Nick:

I don't have the time to do a comment or your post justice, working >12hrs. But based on the weekends posts, etc, and past 4 years, my mind is firming up around a couple of ideas. I left a shorter version on delong's two days ago.

I do not want central banks engaging in asset buying. Random or not I think this is a political decision involving who to give the hot potato to. That was why I asked about the price level jumping economy wide on the bike post, or if it works itself out through multiple markets.
Central banks should be confined to conversion of the different time preferences between individuals and governments, and passing the liquidity premia = seigniorage back on to the gov.

Based on last convo where you said framing the optimal size of central bank between gov and central bank doing the asset buying no material difference. I think you and FTPL, are equivalent. I want you to revisit this,

Mccallum 06 argues nothing gained from adopting the ftpl over quantity theory, and kocherlakota shows that it is untestable. But the adopting it gives a different perspective on recession wrt to moa, from stocks or gov, a perspective more in line with your views, of moe walras law violation: maybe?

anyway in that comment you raise some objections, I can only work on one of them, you do not agree that a gov maximizes surpluses like a company maximizes profits. What about utility?

Anecdotal/unsound/scattershot/for shits'n giggles.
I worked in a gov briefly these things are huge with frickin laser beams on their heads, using the free market as only one of many ways of getting the outcomes they want. LOUD NOISES and hand waving. And you are telling me that they don't maximize.... i sure hope utility is equivalent to surpluses, otherwise I'm screwed.

And another thing governments are real just like humans are real. individual cells same dna build up into a humans, who combine into governments, with abilities that the individuals don't have, like um war boats.

anyway if i'm right, you and adamp agree on more than china.

summary: I don't like the stick you are giving chuck norris. ergo I will oppose giving chuck norris this stick, thereby affecting his ability to effect expectations.
but i need to read woolsey on delong

[Ralph Musgrave]

It is not the job of central banks to get involved in commercial risks, like buying assets which they might make a loss on when those assets are sold back to the private sector. In other words Krugman is right to say that it would be better to combine targeting with expansionary fiscal policy. Put another way, if new money is going to be distributed, it should be distributed to everyone, not just the asset rich.

Of course given the current intransigence by Congress, it is difficult to implement the above fiscal policy. But that just proves the idiocy of putting technical economic decisions into the hands of members of Congress, 90% of whom have not opened a basic introductory economics text book. It doesn’t detract from the basic merit of Krugman’s point.

I pointed out the merits of putting some fiscal into the targeting brew on David Beckworth’s blog two or three months ago.

[W. Peden]

Matt Waters,

"well, how does this expectation thing actually work? What levers are pulled?"

If someone told you that they were going to kick you in the leg, would you wait until they kicked you before you responded? Or would you move beforehand?

You don't have to pull levers if you're dealing with sentient beings, if you can communicate with them.

[Britmouse]

"Perhaps there is some asymmetry there - printing currency to buy other assets is much simpler than selling assets to buy your own currency - but this just tells us that the central bank is not Chuck Norris, after all! "

Surely there are symmetrical limits, but it pushes the Chuck Norris analogy too far?

The Fed could not *credibly* commit to raising US NGDP to $900bn by 2013, because the markets would know that would require too much inflation, and the Fed would get whacked by Congress.

HM Treasury could not *credibly* defend Sterling in the ERM, because the markets realised that would require interest rates to go higher than was technically feasible. It would have been technically feasible to defend Sterling, I think.

The legal mandate of an independent central bank sets the limits of its credibility, perhaps?

[Britmouse]

Sorry, I meant to write "politically feasible" in the "HM Treasury..." sentence.

[Andrew F]

My concern with NGDP targeting is that you are trading volatility in output for volatility in other dimensions. I imagine it would be manifested in interest rates, for one.

[Nick Rowe]

Prakash: "If the resource producing nations of the world and the speculators on natural resources get a hint of this, they might raise the prices so high that existing production might get hampered."

That isn't an equilibrium. You've got real GDP falling, and the real price of oil rising. Excess supply of oil, so price of oil comes back down.

WR: it can be unlimited in magnitude, and/or unlimited in duration. Having it both makes it easier for me to tell the story, but the unlimited in duration (or rather the threat of it being so) is what really matters. If you have a permanent 10% rise in Ms, the only equilibrium is an eventual 10% rise in P, and hence NGDP. The US economy won't be in a liquidity trap forever.

K: "Both asset purchases or heli drops must have a chance of failure or we wouldn't ever have to use them ( we'd just have to threaten)."

Start in equilibrium. If something caused the demand for money to rise, you would need to do an actual (not just a threatened) increase in the supply of money, in order to stay in that equilibrium.

Matt: so you are precisely my intended audience!

Agree with your second paragraph. You can't use monetary policy to cure a structural problem. The attempt to do so simply results in ever-accelerating inflation.

Third para: Yes. Starting in equilibrium, if something causes the demand for money to increase, you have to *actually* increase the supply (possibly by a very large amount) if you want to stay in that equilibrium, as well as *threaten* to do even more if needed, to stabilise expectations.

4th para: agreed too, probably. Finance has a supply-side effect, as well as demand side. Monetary policy can't fix the supply-side effect of a bad finance sector.

edeast" Wow, I had forgotten my old comment. Here's what I get when I revisit it: in the limit, as the rate of inflation falls, and the rates of return on all government liabilities approach equality, the QT approaches the FTPL. But that's probably when the central bank owns everything. FTPL is a special case of the QT.

Ralph: "Put another way, if new money is going to be distributed, it should be distributed to everyone, not just the asset rich."

It's not being "distributed" in the sense of being handed out for free. It's being sold in exchange for assets. Or, rather, that's what's being *threatened*.

When the economy will recovers, asset prices will rise (except on safe nominal assets like long government bonds).

Britmouse "The Fed could not *credibly* commit to raising US NGDP to $900bn by 2013, because the markets would know that would require too much inflation, and the Fed would get whacked by Congress."

Isn't US NGDP bigger than that already? (I think you have a couple of zeros missing in your example). Never mind, I get your point. But the Fed would not be committing to create massive inflation. It would be committing to do whatever is necessary to get NGDP up a few percentage points, and keep growing.

The legal mandate of the Fed might curtail its credibility.

[Nick Rowe]

Andrew: "My concern with NGDP targeting is that you are trading volatility in output for volatility in other dimensions. I imagine it would be manifested in interest rates, for one."

You are probably right. But it would probably mean greater volatility in P, rather than r, compared to inflation targeting, in the face of supply shocks. But that's more a long run question, of the best target. That's the Bank of Canada's current problem, not so much the Fed's current problem.

[JKH]

The closer interest rates are to zero, the less distinguishable is money from other financial assets. That means the less provable is the proposition that people want money per se, as opposed to saving (or wealth) per se. And if it turns out they want the saving characteristic rather than the money characteristic, swapping money for financial assets does little for aggregate demand, because it has no effect on saving.

[K]

Nick: "Start in equilibrium. If something caused the demand for money to rise, you would need to do an actual (not just a threatened) increase in the supply of money, in order to stay in that equilibrium."

Money is almost 100% endogenous in our economy - you don't have to add money. To balance an excess demand for *savings* you just have to raise inflation expectations, thereby dropping the real rate... you know the story.

[Nemi]

NDGP targeting seem like poorly concealed fiscal helicopter drops to the rich ("let me pay you so that I can hold some of your risk for a while, while inflating the value of your other assets in the process" somehow doesn’t look like a threat).

Also, why mess with the prices of financial assets, why not simply give the rich a lot of money instead?

Furthermore, wouldn’t you get bigger RGDP effects by dropping it on the poor instead?

[Nick Rowe]

JKH: basically yes. Which is why the threat must be bigger, than in normal times.

K: I know the story, and I know it's wrong. Money is not "endogenous" in the sense of M=Md, as I showed in Wicksell and the hot potato. And an excess demand for saving in the form of antique furniture cannot cause a recession, as I showed in lots of old posts.

Nemi: two sorts of people got hurt bad in the US recession: those who held large stocks of risky real and financial assets; those who lost their jobs, or couldn't get one, like the young. Restoring the old NGDP path equilibrium would help both those groups, yes.

Your comment reminds me of that old joke about the Russian peasant, who was offered anything he liked, except his neighbour would get twice what he asked for.

If you want to transfer wealth from one group to another, then argue it honestly. But don't let envy stand in the way of fixing the recession.

[K]

Nick: "I know the story, and I know it's wrong."

Nick: Sigh... I'll try to find some time this weekend to write the Why Liquidity Preference is Irrelevant to Macroeconomic Control Guide For Market Monetarists :-) That should settle this once and for all! For the most part I think Matt Rognlie did the heavy lifting in his last post.

The investors who lost money in '08 got what they deserve. You want the gains, you're supposed to take the losses. That's how our system works.

Nemi: It's not the targeting of NGDP that's wrong. It's the purchase of capital assets. Once we are beyond setting expectations of the path of the short rate we are in a world of fiscal policy that will have significant wealth impacts. There is a very large free lunch on the table and anything we do to get ourselves out of a liquidity trap will involve making decisions about who gets to eat it. That includes both helicopter drops and Nick's industrial policy.

[Britmouse]

"I think you have a couple of zeros missing in your example"

Magnitudes bigger than £1 are hard for me to comprehend. I meant $900tn. :)

[Oliver]

There are 2 aspects being fudged in the discussion here, imo. One is: is it sufficient for Chuck to stare at people for them to leave the room. And if so, why? The second is: even if the people do leave the room, for whatever reason, does it help anyone standing outside the building?

Personally, I find this explanation from above for question 1 to be quite convincing

Perhaps there is some asymmetry there - printing currency to buy other assets is much simpler than selling assets to buy your own currency - but this just tells us that the central bank is not Chuck Norris, after all!

For the simple reason that, for a central bank, its own fiat is inifinitely forthcoming whereas all other assets aren't. 'We will print all it takes to smack you over the head' is believable because it's physically possible, whereas 'we can sell you all the *insert favourite asset* in our vault at market prices 'til you cry' isn't.

Chuck Norris only manages to clear the room in films -because that's what script says. I doubt he's quite as successful behind the screen. When markets are significantly challenged, they will put up a fight. Whereas if the challenge isn't significant enough to evoke a reaction, who cares?

The second question is harder to answer. I suspect there is a continuum between pure monetary (i.e. system internal asset swaps such as in QEII) and pure fiscal (i.e. buying physical stuff in exchange for money) with varying effectiveness, depending on the ailment and on who profits in what way.

[Nick Rowe]

Oliver: "...whereas 'we can sell you all the *insert favourite asset* in our vault at market prices 'til you cry' isn't."

*If* a central bank has assets equal to its monetary liabilities, it can in principle sell all its assets and drive its outstanding money stock to zero. The danger is that selling its assets might drive the value of those assets, in money, down to zero. But in that case, in any case, driving asset prices to zero is about as far as is possible to go anyway.

"I suspect there is a continuum between pure monetary (i.e. system internal asset swaps such as in QEII) and pure fiscal (i.e. buying physical stuff in exchange for money) with varying effectiveness, depending on the ailment and on who profits in what way."

I tend to agree with this. But remember though, the central bank will be *threatening* to buy, not actually buying. It will actually be selling. But I don't see how this is related to your second question, which I take to be: "who gains and loses if the economy recovers back to its original path?"

[David Pearson]

Nick,

The Fed is only effective if there is demand for bank reserves. If not, buying equities merely changes the ownership of corporate profits from private individuals to the Treasury (through Fed profit remittances). If the Treasury decided to nationalize all publicly traded companies but leave their Boards intact, would this increase the value of equities? No. But magically, the Treasury taking ownership of those same assets via the Fed does?

Also, a little discussion of the risks would be useful. If the Fed buys massive amounts of equities at higher prices (assuming it raises those prices) and RGDP does not improve, the Fed will pass on a large loss to the Treasury. This will be a transfer of wealth from taxpayers to shareowners: a fiscal action. Failure would be disastrous for the Fed's independence.

[Ian Lippert]

"If you want to transfer wealth from one group to another, then argue it honestly. But don't let envy stand in the way of fixing the recession."

I think in today's world where the average person is either an anti-Fed Ron Paul type or a lefty occupy type its going to be very difficult politically for economists to push through their NGDP theories. Which means that if we see any inflation at all it will be a half hearted effort and not the required amount that economists want. This whole NGDP stuff seems like it will have too many difficulties and unforseen consequences that its almost not worth it. I say almost because I do find the ideas interesting even though they may not be practical.

[Nick Rowe]

David: are people indifferent between holding *any* proportions of cash and equities, forever? I don't think so. Equities rate of return dominate cash, and cash medium of exchange dominates equities.

Ian: Yep, it depresses me. Any attempt to cure the recession must either be a lefty plot to steal our savings or a righty plot to make the wealthy richer. I would like all the stupid conspiracy theorists of both sides to go off and form their own disfunctional country, where they could all riot away happily ever after, while people like Sumner and Krugman cobble together some sort of workable compromise despite their political differences (and happily argue fine points of theory for hours afterwards at the bar).

[Oliver]

Thanks for the reply!

To one, I had never thought of it in those terms. I'll chew on your answer and see what happens. I guess I'm not at ease, intuitively, with comparing an endless source with a finite one.

To two, I meant that, no matter how precise a central bank is in hitting its target, its effectiveness should be measured not by that precision but by how it impacts the majority of people. And I then jumped to the thought that different kinds of interventions will have different impact (duh) and I simultaneously came up with that continuum thingy to describe what I meant. Maybe my mind is even more fidgety than my fingers :-).

[David Pearson]

Nick,

People have a desired risk in their claims on future cash flows. If you do not change that risk, you do not change the required return. Transferring ownership of equities from private actors to tax payers leaves intact the aggregate risk of the private sector's portfolio of claims. They are "indifferent", in aggregate, to that action.

To believe otherwise, you have to argue that actors are constrained in their access to financial vehicles, or face high information costs to analysing their future tax liabilities. Basically, the same arguments for why fiscal policy works, which makes sense, since anything that does not create demand for bank reserves IS fiscal policy.

[Nick Rowe]

David: Money is more liquid. By definition (almost), since it's the medium of exchange. So MMT won't apply in this case.

(MMT=Modigliani-Miller Theorem. But, funnily enough, the two meanings of MMT do perhaps have a lot in common.)

[David Pearson]

Nick,
I'm not sure if I'm addressing your answer directly, but here goes: the Fed can change the aggregate liquidity risk of the private sector by virtue of the unique nature of its balance sheet (which extinguishes liquidity risk rather than passing it to Treasury). The reduction in aggregate risk caused by taking away the liquidity risk of risk assets, in normal times, is quite low. When liquidity risk spikes, QE is quite effective for this reason. Given the market measures of liquidity risk today are reasonably normal, I would argue QE would have little impact that cannot be produced by fiscal policy.

BTW, I'm not advocating fiscal policy, just pointing out that there are things the Fed does that are unique (supplying demanded reserves, extinguishing liquidity risk of assets), and things that the Treasury could do just as well, and is doing, given that the balance sheet of the Fed belongs to Treasury.

[Gizzard]

"Ralph: "Put another way, if new money is going to be distributed, it should be distributed to everyone, not just the asset rich."

Nick "It's not being "distributed" in the sense of being handed out for free. It's being sold in exchange for assets. Or, rather, that's what's being *threatened*.
When the economy will recovers, asset prices will rise (except on safe nominal assets like long government bonds)."

------------------------------------------------------------------

Its being sold for an extravagent price likely. Sold at twice its "market" value. And if thats threatened only its completely ineffective. What you are saying is that the fed needs to sit there and say " Now boys, you arent trading enough of this stuff at a high enough price...... either you buy things from each other or I'M going to come in and buy everything from all of you for twice the asking price...... GOT IT!!" And of course a number of people are going to say "FIne, buy it from me for twice what its worth....I'm in!!"

And this will do NOTHING for general commerce. Youll have a bunch of rich guys selling stuff to the govt (and insisting its the free market at work!) And saying "Look at the Dow take off, look at commodities take off, WHEEEE were all rich" And then everyone will look around and go "Why arent there any customers in my store, how come no one wants to buy my nice valuable stuff?"

This supply side fetish with asset prices is the worst tangent economics has ever gone off on. Rising asset prices should be a result of healthy economic activity. They are not a cure for low sales.

If nominal GDP targeting works, next time we can skip all this rigamarole and have some Fed Chair simply declare "On next Tuesday, I decree the Dow to be 20,000.... hear that 20,000 and I will release a list to each state what each counties house prices must be by the following Monday. Gold prices shall be 2,000$/oz and orange juice....."

It would be so easy if all we needed were higher asset prices

[Darren]

"Prakash: "If the resource producing nations of the world and the speculators on natural resources get a hint of this, they might raise the prices so high that existing production might get hampered."

Nick Rowe: That isn't an equilibrium. You've got real GDP falling, and the real price of oil rising. Excess supply of oil, so price of oil comes back down."

The currency effects of this policy seem theoretically uncertain but the market response to the past 2 QE programs should encourage an evaluation of them. In theory, if market participants anticipate a recovery via NGDP expectations, the currency effect could be positive. However, the policy is unproven so longer-term expectations will not initially be there and a massive unbounded QE program could be (initially) very negative for the USD, positive for risk assets and spike hard assets. Would likely cause additional inflation in China due to their peg and could blow up their investment-driven economy. An excess supply of oil would only result from a global recession due to relatively inelastic EM demand growth. The EU may not make it through another recession. Would the initial market-driven implications of the Fed committing to an unbounded QE campaign cause enough short-term dislocations that would cause a reversal of policy - meaning the equilibrium state you cite is never realized due to the process of getting there (not to mention the thought that I'm not sure I want to see those implications if I'm anywhere near accurate)? Sorry that last bit is a mouthful.

I would very much appreciate you evaluating the potential for currency effects - not just in a theoretical future equilibrium but through the process of getting there.

Thanks - Darren

[K]

Nick: "I would like all the stupid conspiracy theorists of both sides to go off and form their own disfunctional country, where they could all riot away happily ever after, while people like Sumner and Krugman cobble together some sort of workable compromise despite their political differences"

Who's rioting? I don't even think I have been that impolite. I did compare rich people to Mr. Creosote, which may have been a bit over the top, but there certainly was some excess pigging out before and at the peak of the crisis. But "*stupid* conspiracy theorists?" That seems unfair.

The Fed *can't* just go out and buy stocks. They are not allowed. If buying bonds doesn't work, somebody is going to have to use the democratic, legislative process to write some new rules. There is no "default" or obviously neutral policy that they can follow, and there *will* be wealth transfers involved. How is it that the nature of those new rules doesn't represent a legitimate democratic concern of all citizens?

[Gizzard]

Too Much Fed you said

"Gizzard, what if the "little guy" has no assets to sell?"

How bout this;

Fed guy: How bout that shirt on your back, how many holes does it have in it?

OWS guy: Uhh two

Fed guy: Are they in the armpits?

OWS guy: Yeah

Fed guy: Well we can fix that pretty easy, I could sew that myself......... I'll give ya 500$/month for the next 18 months for it.

OWS guy: Cool. How bout these jeans

Fed guy: Ooooooooh those jeans look nice.... 32 waist?

[JP Koning]

Very helpful post.

Still mulling it over, but I have two questions.

Will nominal GDP targeting work if it entirely affects prices and not quantities? Do you need some degree of money illusion in order to affect quantities?

"If they expect even the slightest rise in NGDP in even the distant future, they will get out of cash, and into real assets, or claims on real assets like commercial stocks and bonds. And this will increase the demand for goods today, either directly, or because firms find it easier to issue new stocks and bonds to finance investment. "

Since a bond promises to pay nominal amounts of cash, if the introduction of NGDP targeting is expected to lead to significant increases in prices, why would anyone want to get out of cash into bonds? It seems to me that everyone would want to simultaneously get out of bonds into a better inflation hedge.

[Morganwarstler]

The consistent mistake made in this discussion is that:

1. the LOWER the future NGDP level target - towards 3%, not 4.5% like GS wants.
2. the LOWER the trend line - so not from a hot money peak like 2008, but some lowered assumed trend, or just abasic giveback. Like since Q1 2011.

The more CREDIBLE the threat is.

And the more politically ACCEPTABLE it is.

I've yet to see its champions consider that we may get level target NDGP with 8.5% unemployment, which proves according to the hawks the problem is structural.

[Thomas LESINSKI]

QE1/2 was essentially Chuck Norris entering the room and threatening to beat up everybody in the room, except those holding a no-beating voucher that he'd distribute to everybody first.

STOP PAYING INTEREST ON EXCESS RESERVES.

[Donald Pretari]

"I always imagine it being asked in a gruff Yorkshire accent, by some middle-aged no-nonsense practical man of business with a background in mechanical engineering."

http://www.youtube.com/watch?v=Xe1a1wHxTyo

[Nick Rowe]

K: you weren't rioting. You were fine. (Except I could have done without being reminded of that particular MP sketch though!)

Morgan: If you pick a lower NGDP growth path target, and by implication a lower long run inflation target, do you really want the Fed to get bigger? http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/10/the-optimum-size-of-the-central-bank.html

Thomas: Yep, that would help.

JP: "Will nominal GDP targeting work if it entirely affects prices and not quantities? Do you need some degree of money illusion in order to affect quantities?"

If the recession was caused by a fall in AD, then presumably it can be fixed by an increase in AD. You need sticky prices, both for the recession, and for the cure to work.

"It seems to me that everyone would want to simultaneously get out of bonds into a better inflation hedge."

Agreed. They would want to get out of both money and safe nominal bonds. (Some risky or illiquid nominal bond prices might rise, if the reduction in risk offsets the higher safe nominal interest rate.)

Don: close, but there's another, similar one, with "trouble down pit", as the catchphrase IIRC?

Gizzard: "If nominal GDP targeting works, next time we can skip all this rigamarole and have some Fed Chair simply declare "On next Tuesday, I decree the Dow to be 20,000.... hear that 20,000 and I will release a list to each state what each counties house prices must be by the following Monday. Gold prices shall be 2,000$/oz and orange juice.....""

You are almost getting it there, but you are still hopelessly confused about what monetary policy can and cannot do. Monetary policy can pick one nominal target. It cannot pick two nominal targets.

[Gizzard]

I realize quite well that Monetary policy by law can only affect bond prices, which is why it cant have the affect that you are hoping for. Interest rates could go to zero permanently (actually there are those who advocate that) and it would still have very little affect on AD. Yes bondholders would move to stocks or any other number of commodities to chase return but the transmission channel to more salaries for the working stiff to pay his debts and buy a little extra just aint there.

If they changed the laws and allowed the fed to actually buy a larger number of things it might work, but then it would just be a fiscal mechanism by another name.

You may not realize it but you are advocating what Mosler has said all along about the fed controlling long term rates, focus on quantity of bonds not price. Stand willing to buy unlimited quantities and youll get the highest price (lowest interest rate) possible.

[David Pearson]

Nick,
I think its instructive to compare Fed asset purchases with Treasury asset purchases. Start with the premise that expectations have not changed (i.e. that the banking system demands no additional reserves).

If the Fed buys assets, it replaces them with a s.t. liquid asset -- ER's.
If the Treasury buys assets, it replaces them with a s.t. liquid asset -- T-bills.

What's the difference? ER's can be converted to reserves or currency, of course. But the assumption in the first paragraph (no demand for bank reserves) stipulates that they won't be. Under that conditions, there is no difference between an ER and a T-bill. In fact, banks should be indifferent between holding one or the other, such that their price would be equivalent (only market imperfections -- shadow bank non-access to the IOR -- prevent them from being exactly equal).

Of course, if you assume the Fed changes expectations at will, then what difference does QE make? If banks demand reserves (due to a Fed commitment) at the zero bound, they have only to put upward pressure on the FFR in competing for those reserves. The Fed would then supply all the reserves the system demanded to keep the FFR at target. QE would be irrelevant. The Fed need not promise threaten a fiscal action if it controls expectations; if it doesn't, a fiscal action will be just that.

[Silas Barta]

Who actually thinks about NGDP when deciding how much to spend in the first place. Maybe 1% of the population even heard of (or remembers) the concept, and probably even less for those who make the big private sector decisions. They care about the demand for their specific products, not goods-in-general. It is a grave mistake to confuse expectation of a sum with sum of expectations.

Nor would we even want people to have these expectations. When people hoard money, there's a reason for it. Forcing them to spend doesn't satiate the desire that led them to save that money -- the "real" factors behind it.

[David Pearson]

The basic disagreement is that ER's are not "money". I think of them as a "phase state". They are "ice" (a s.t. asset), which could be converted into "water" (medium of exchange), but only with the application of "heat" (higher NGDP expectations). In the phase state of "ice", reserves are no different from T-bills, and QE is fiscal policy.

You don't change the phase state of "ice" by threatening to create more "ice". Sure, if Treasury threatened to buy up all those assets -- and lock them away in a sovereign wealth fund -- this might raise their price and bring forth a Tobin's Q effect. Or the Fed could do it. No difference.

[Nick Rowe]

Gizzard: "I realize quite well that Monetary policy by law can only affect bond prices,...."

Oh dear. That's not what I meant at all. We aren't even speaking the same language. And no, I am not saying anything like the same thing as Warren Mosler. Warren would understand that. Warren thinks in terms of a very different model to me.

Silas: "It is a grave mistake to confuse expectation of a sum with sum of expectations."

Yes, which is precisely why the variance of monetary policy matters so much.

"When people hoard money, there's a reason for it. Forcing them to spend doesn't satiate the desire that led them to save that money -- the "real" factors behind it."

That reason might well be the fear of deflation and recession that comes from an overly tight monetary policy.

David: "Sure, if Treasury threatened to buy up all those assets -- and lock them away in a sovereign wealth fund -- this might raise their price and bring forth a Tobin's Q effect. Or the Fed could do it. No difference."

But I *think* that's what I'm talking about.

[don]

If comments here are any indication, the assertion that targeting NGDP all depends on expectations has already proven itself a failure.

[Nick Rowe]

don: Maybe. But comments are not a representative sample. Those who disagree are more likely to post. Plus, they're an ornery lot that hang around here. Google to see other bloggers' responses.

[rogue]

Nick, what mechanism prevents people who receive this newly-printed currency in exchange for their savings - from deserting to a foreign currency rather than spending it locally? A higher inflation expectation can cut two ways: it can cause people to spend their money now before it loses value, or it can cause people to put their savings in foreign currency, which is expected to keep its value.

[Nick Rowe]

rogue: Nothing. Some may indeed try to do just that, which would cause the exchange rate to fall, and increase net export demand, and raise the prices of traded or tradeable goods. In a small open economy, that would be one of the main channels. I left out that channel, mainly because I wanted to argue that it's not just a "demand-diversion", so that, in principle, all countries could do the same.

[Morganwarstler]

Nick,

1. You must be Canadian. If you argue end game, the final trump card played is always the Tea Party grab their 200M guns and the fed (bankers) eats donkey dick.

Repeat after me: the A power (the Tea Party) has votes and money. The B power (the oligarchs) have only money. The C power (the Dems ) have only votes.

If you don't properly weight power, you can't really do economics.

2. Since you end game Fed own everything argument is off the table, you got anything else?

3. So far my point stands: lower target, more recent date of start (Q1 2011) is BOTH more politically viable and more Fed credible (less future cloudiness).

C'mon Nick, be strong enough to consider what this means... what if level target 4% NGDP from Q1 2011 means we raise rates when unemployment is 8.5%

Why the rush to see Sumner's win as a liberal win? an adoption of bigger focus on employment by the Fed?

It can easily be just a good excuse to lock in 1% inflation going forward.

My narrative make far more sense.

[Max]

"If the Fed buys massive amounts of equities at higher prices (assuming it raises those prices) and RGDP does not improve, the Fed will pass on a large loss to the Treasury. This will be a transfer of wealth from taxpayers to shareowners: a fiscal action."

Right, and this means that asset price support is not a generally applicable method of increasing demand. It can only be implemented to the extent that asset prices are unreasonably depressed. Otherwise, instead of changing expectations, the CB will just create a massive rush to liquidate assets (since the CB's offer to buy everything at temporarily inflated prices is not credible and will inevitably be withdrawn).

[Ralph Musgrave]

Nick, You claim (October 21, 2011 at 08:42 AM) that having government buy assets gives stimulus, but that when the process is reversed (i.e. assets are sold) the stimulus effect is NOT reversed, and hence that government does not make a loss on the operation. I think that is a bold assumption.

If changing variable A changes variable B in a particular way, the best assumption that can be made, absent some good evidence to the contrary, is that reversing the change in A will reverse the change in B. Put another way, I think you are assuming a pump priming effect. You could be right, but I want to see some very good evidence for the effect before being convinced. I suspect plenty of others do as well.

[Nick Rowe]

Ralph: "Nick, You claim (October 21, 2011 at 08:42 AM) that having government buy assets gives stimulus, but that when the process is reversed (i.e. assets are sold) the stimulus effect is NOT reversed, and hence that government does not make a loss on the operation. I think that is a bold assumption."

That's a neat way of putting it. It's bizarre, isn't it? If you think of monetary policy in terms of pulling levers, it makes no sense at all. The Fed pulls a lever, and the economy moves forward; then the Fed pushes the lever back to where it was and the economy moves back to where it was. There would have to be some sort of ratchet in the mechanism to get any different results.

Chuck Norris starts beating people up. Then they all get the memo, and leave the room. Then he stops beating up. Maybe he even hands out pain-numbing drinks. But they don't go back into the room. Expectations have changed. They are in a new equilibrium.

[Gizzard]

Nick

Are you not suggesting that the Fed threaten to spend whatever it takes to turn ALL savings (in bonds) into cash. This is what monetary policy does as I understand it, it affects the amount of savings in bonds vs non bonds by adjusting interest rates. Your threatened end point is no bonds, "We'll buy em all for whatever price we have to pay" This will mean bond rates of zero of course ( This is referred to in some circles as monetizing the debt I believe) and the hoped affect is people borrowing all this free money to increase the level of economic activity. This ignores the fact that borrowing is suppressed not because interest rates are too high but because private debt levels are already too high relative to incomes. Any plan to restore bank lending activity must address incomes first or it will fail miserably.

I realize your not saying the same thing as Mosler, you dont understand Central Bank/banking operations as clearly as he does. But this NGDP targeting is QE to the nth power and can only "work" by increasing the wealth affect of the 1% and lowering the cost of loans to the 99%. Which is why it will fail

[Gizzard]

And regarding new equilibriums, what makes you think the "new" equilibrium has lower unemployment and higher productive economic activity? Your blithely assuming/asserting that it will but how? Just because one equilibrium has more cash and less bonds doesnt mean more people will be working. ZImbabwe had no bonds, what was their unemployment rate 50-75%?

You seem to be operating under the notion that higher inflation leads to higher employment. Higher employment can eventually lead to higher inflation but the reverse is not true at all.

Its the confidence fairies you're looking for isnt it?

[nemi]

Nick: "If you want to transfer wealth from one group to another, then argue it honestly. But don't let envy stand in the way of fixing the recession"

I could say the same thing since the best bang per printed dollar certainly is not acchived by the purchase of capital assets. Also, I could not think of another stimilus policy that would be more beneficial for the 1 %, including temporary tax cuts, so why else would you prefere this approach?

Yes,yes - i know - the "serious" policy option is always to throw money at the rich and hope that it somehow, magically, will trickle down to the poor and into the real economy- and this time it will surely work!

PS: Yes - I would like to transfer wealth - but that is beside the point. I think a helicopter drop to the poor would benefit everyone, but I have lost fate in trickle down policy a long time ago.

[Nick Rowe]

Gizzard: "Are you not suggesting that the Fed threaten to spend whatever it takes to turn ALL savings (in bonds) into cash."

Why stop at bonds? Sure, we could have a lovely semantic debate on where monetary policy ends and fiscal policy begins, but over the last few months and years I've been coming to the conclusion that that debate is sterile. There's a continuum. If the money supply changes, it's monetary. Depending on what is bought with that money, it can be also more or less fiscal, along a continuum. If you buy new bridges it's fiscal. If you buy shares in new bridges, or bridges that are 1 year old, is it fiscal? Buying 1 year-old bridges is not part of G, strictly speaking. But how different is it, economically (sod what the accountants say)?

"But this NGDP targeting is QE to the nth power and can only "work" by increasing the wealth affect of the 1% and lowering the cost of loans to the 99%."

Nope. That's not even correct if you take a mechanistic view of the monetary policy transmission mechanism, and totally ignore feedback and expectations. It leaves out Tobin's Q, for example.

"Its the confidence fairies you're looking for isnt it?"

You calling Chuck Norris a confidence fairy? Sure, when Chuck Norris enters the room, everyone suddenly becomes much more confident that everyone else will exit the room. So Chuck Norris must be the confidence fairy. But you'd better not mess with the confidence fairy. Because you will be facing him alone, if you stick to your beliefs. Even if they are not confident everyone else will exit the room, some people will leave anyway, because they were close to the margin of leaving in any case. And then others follow. And then some more.

nemi: What you say is correct. A helicopter drop to everyone would have a bigger effect than the same amount of money used to purchase assets. (As well as have different distributional consequences).

But you have forgotten something. When the policy works, the Fed must go into reverse. It actually has to reverse back *further* than it went forward. Because the stock of money it has issued is bigger than the equilibrium demand when NGDP hits the target. So when you say "helicopter", you are really talking "vacuum cleaner" (reverse helicopter) in the final equilibrium. If you want to use helicopters only, this is what it looks like: the Fed *threatens* to helicopter money to everyone. But as soon as the threat has changed expectations, the Fed taxes back *all* the money it handed out to make that threat credible, *and then taxes back some more*.

You don't want the Fed to do that. Nor do I.

[Gizzard]

Nick you said earlier

"You are almost getting it there, but you are still hopelessly confused about what monetary policy can and cannot do. Monetary policy can pick one nominal target. It cannot pick two nominal targets."

This was in response to me saying instead of doing this QE to nth why not just have the Fed decree what the prices of different assets are. Thats what their ultimate goal is(not to decree the price increase but to HAVE the price increase) so why not go full out authoritarian and just tell everyone what the price of gold, the Dow, OJ etc will be today.

Then when I talked about the "true fact" (thanks W!) that the fed can only change interest rates and affect (directly) bond prices by current LAW, you come back with;

"Why stop at bonds?"

So which is it? Can the fed target only bond prices by doing unlimited "monetization" of exisiting bonds or CAN it also target stock prices or gold prices or pantyhose prices by unlimited monetization of those items. Make up your mind. Can it pick more than one nominal target or not. Actually let me rephrase that, because I KNOW that currently the fed can only work with interest rates and ratio of cash to bonds; Are you suggesting that Congress ALLOW the fed to target multiple prices of multiple assets by purchasing whatever the f--k they want.? The FULL Chuck Norris..... "no g-dd--m COngress tells ME what to do.......... IM CHUCK NORRIS!!!"

[JP Koning]

"Agreed. They would want to get out of both money and safe nominal bonds. (Some risky or illiquid nominal bond prices might rise, if the reduction in risk offsets the higher safe nominal interest rate.)"

and

"Some people are just barely willing to hold cash in the current equilibrium. If they expect even the slightest rise in NGDP in even the distant future, they will get out of cash, and into real assets, or claims on real assets like commercial stocks and bonds. And this will increase the demand for goods today, either directly, or because firms find it easier to issue new stocks and bonds to finance investment. Which raises NGDP, and expected future NGDP, even if just a little. Which encourages additional people to exit cash too, and buy real assets and claims to real assets. Which raises NGDP and expected future NGDP still further."

One more question. Following the introduction of NGDP targetting, firms may find it easier to issue new stock to finance investment, but not new bonds. After all, bonds are unattractive when prices are expected to rise. You say that, given the expectation of higher NGDP, firms will be able to finance more investment, which increases NGDP. But what if the net effect is a wash? What if firms can finance more new investment with stock but less with bonds?

[Nick Rowe]

Gizzard: monetary policy can determine any level of any *single* magnitude measured in $ units. But it cannot determine any level of any *two* (or more) magnitudes measured in $ units. It has to choose between them. It can set the dollar price of bread, or the dollar price of beer, but it cannot set the dollar price of both bread and beer independently at the same time. Because that would mean setting the *relative* price of bread and beer, which has the units litres per kilogram, not $.

And let's not get into setting nominal bond prices (nominal interest rates), because those have the units today's dollars per tomorrows dollars per unit of time. So while it can be done, it is done in the exact opposite direction you think it is done. You raise nominal interest rates, in the long run, by loosening future monetary policy relative to current monetary policy.

[David Pearson]

Nick,
You said, "But I *think* that's what I'm talking about," in response to my comment that Fed and Treasury asset purchases are equivalent when there is no demand for bank reserves. So QE is a fiscal action at the zero bound?

As for Chuck Norris, there is another effect he could have. He threatens to come into the room and beat people up with high inflation; those in the room leave through the door marked, "unproductive inflation hedging" instead of "Tobin's Q-inducing investment". You get higher commodity prices, bloated inventories, chronically low savings, higher term premiums, higher equity risk premiums (single-digit P/E's), and a constantly-devaluing currency that puts at risk its "reserve" status.

"No," you respond, "Chuck Norris will threaten to beat up anyone that goes out that door". So you have, on the one hand, Chuck threatening to beat up anyone that leaves the room, and on the other, beating up anyone that does through the wrong door. Sounds like a recipe for start-stop policy and higher volatility.

[Stephen Gordon]

À propos of Brad DeLong's remark:

"The problem, I think, is that every time Nick Rowe writes 'Chuck Norris won't have to lift a finger' he is changing the situation from one in which Chuck Norris enters the room into one where a six-foot cutout of Chuck Norris is carried into the room, and an economist says: 'this cardboard cutout will beat you up unless you move.' And people laugh."

I think the real difference here is that Canadian macroeconomists are thinking of how the Bank of Canada has handled monetary policy over the past 20 years, and especially how it handled its inflation target mandate in the first few years of inflation targeting. In the early 1990s, the BoC *was* Chuck Norris beating up however many people it took to make it clear that it meant business. Ever since then, no-one has dared to test the BoC's mettle.

One might have thought that the Fed would have earned that reputation after the Volcker deflation, but somehow it didn't. Perhaps the lack of a clear mandate was to blame?

[Scott Sumner]

Thanks for doing this Nick. I wrote a similar post yesterday in response to a question by Kevin Drum, but can't post it on this lousy hotel computer. Maybe when I get home.

[Mandos]

Ian: Yep, it depresses me. Any attempt to cure the recession must either be a lefty plot to steal our savings or a righty plot to make the wealthy richer. I would like all the stupid conspiracy theorists of both sides to go off and form their own disfunctional country, where they could all riot away happily ever after, while people like Sumner and Krugman cobble together some sort of workable compromise despite their political differences (and happily argue fine points of theory for hours afterwards at the bar).

Yay! An economy without people!

[Mandos]

Your comment reminds me of that old joke about the Russian peasant, who was offered anything he liked, except his neighbour would get twice what he asked for.

If you want to transfer wealth from one group to another, then argue it honestly. But don't let envy stand in the way of fixing the recession.

Ah, yes. The "envy" card. Wealth is relative---socially sustainable polities need to reduce the gap, not maintain the enormous disparities.

[Nick Rowe]

JP: "One more question. Following the introduction of NGDP targetting, firms may find it easier to issue new stock to finance investment, but not new bonds. After all, bonds are unattractive when prices are expected to rise. You say that, given the expectation of higher NGDP, firms will be able to finance more investment, which increases NGDP. But what if the net effect is a wash? What if firms can finance more new investment with stock but less with bonds?"

If NGDP targeting works, and returns the economy to normal, I would expect investment demand to rise (because firms will be able to sell the extra output that extra capital goods can produce). That increased investment demand will cause the equilibrium real return on both corporate bonds and stocks to rise. That will make it harder for firms to finance new investment. But that's what's needed, to prevent excess demand for loanable funds and excess demand for output.

[Dave Thomas]

You forget that you have to convince the entire globe because "money" can go anywhere it wants in today's world. Also you have to compete with countries who aren't targeting NGDP also, aka market economies. There are a few left. So what you need for NGDP targeting to work is a vacuum where the "victims" of this manipulation can't get any information from other competing systems or move their "money" there.

[Sergei]

Nick: If the money supply changes, it's monetary.

Hm, no it is not. Yours is a misguided definition of monetary vs fiscal. If the Fed turns a zero result to the Treasury as the outcome of its operation then it is monetary. Anything but zero is fiscal. The probability of the Fed delivering exact zero is close to zero meaning that the Fed is constantly engaging in fiscal operations of different signs. In particular since we can never be sure today what the final outcome of any of its operations will be tomorrow. On the other hand in case of government bonds held to maturity it is clear. The outcome is exactly zero. And it is exactly the reason why central banks are allowed to deal only with government bonds. The fiscal effects are minimized to the minimum leaving only monetary effects.

[Nick Rowe]

Sergei: if you want to use a dictionary in which "monetary policy" is defined in such a way that the probability of monetary policy happening is zero.....OK. But I'm not going to use that same dictionary myself.