Arnold Kling  

Scott Sumner on NGDP Targeting

What Franklin Roosevelt Accomp... Rationing and Recalculation...

He makes his case in National Review.*

In 2009, the U.S. saw the biggest fall in nominal GDP (NGDP) since 1938. It is thus no surprise that we had a debt crisis: Borrowers almost always have trouble repaying debts when nominal income comes in much lower than was expected when the debts were contracted.

Just to be obnoxious, let me note that the debt crisis began late in 2006 when house prices started to level off, and the worst period was 2008. Why did the crisis get rolling in 2007 and reach a crescendo in 2008, if the biggest fall in NGDP was in 2009? Rational expectations?

Some economists use interest rates as an indicator of monetary policy. If the result is bad economic performance, they blame changes in the relationship between interest rates and the economy. Worst case, they blame the so-called "zero bound."

Other economists want to use a measure of the money supply as an indicator. If the result is bad economic performance, they might blame changes in velocity.

Sumner argues for what I call "no-excuses" monetary policy. You undertake whatever technical operations you would use to manipulate the money supply or interest rates, but you focus on hitting a target for NGDP.

The 1960's version of Milton Friedman would not have gone along with this. Back then, he would have said that the "long and variable lags" in monetary policy would make NGDP targeting a destabilizing practice. When you think NGDP is too low, you pump in lots of money, causing NGDP to overshoot, so you slam on the brakes and cause a recession, etc.

But Sumner's solution of focusing on expected future NGDP is an attempt to avoid such destabilization. I cannot speak for the late Milton Friedman, but I personally feel comfortable that Sumner's approach would not be destabilizing. If I could, I would appoint Sumner to run the Fed. As it stands now, the Fed appears to me to be conflicted over what to target, and I hate to say it, but the default has been to target bank profits. If banks are profitable, you can count on the Fed to stay the course. It only does something drastic when banks get in trouble. (Speaking of this, see Tyler Cowen's review of the new Perry Mehrling book, which is sitting beside me waiting for me to read next.)

Having said that, I think NGDP targeting poses a risk, particularly if my Recalculation Story is correct. If it takes a while for the entrepreneurs to arrive at new patterns of comparative advantage, you would hit the NGDP target primarily by causing inflation. Right now, one has to be aware of the possibility that expansionary monetary policy will feed a commodity boom, as opposed to magically putting people back to work.

(*Just as an aside, NR's web site is one that I detest, because of all the adware on it that makes it take forever to load, and every time you get careless with your cursor it zaps you with an annoying pop-up. Die, user-hostile web designers, die!)

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CATEGORIES: Monetary Policy

COMMENTS (6 to date)

I think it might have been Milton Friedman who asked something like this; what should the Fed do if NGDP were rising at 6% per year and the rate of inflation were 7% per year.

I've probably mangled the paraphrase, but maybe the idea is intact.

Pedro writes:

Ahem... Arnold, let your cursor wander over to the left side of this site...

marcus nunes writes:

Scott makes a mistake on dates. The first drop in NGDP since 1938 was in the second half of 2008, not 2009. The full 4.2% drop in NGDP tooke place between June and December 08. Also, by mid 08 the lionĀ“s share of the House price fall had already taken place. It is also after June 08, following the drop in NGDP that unemployment "explodes".

Lord writes:

If we had a commodity boom and this created some inflation, then at least real wages would fall and along with it unemployment. It can solve the real problem of sticky prices and it only has to create enough that previous expectations are reestablished. If the worst that can be expected is a commodity boom, then we can put some of our idle resources to work producing them, that we would eventually use anyway. They can be how we save, investing in inventory, and banking our efforts in real goods. And it makes any entrepreneurial recalculation easier by reducing risk and the costs of mistakes and increasing profit opportunities.

JPIrving writes:

Professor Kling,

Have you changed your view that inflation is primarily fiscal phenomena? Do you now view treasuries as sufficiently different from bank reserves?

Arnold Kling writes:

I agree, and I will notify the webmaster. I am constantly annoyed by the mouseover effects, but it hadn't occurred to me until your comment that they are in the code. I had this vague notion that my little netbook computer was the problem, but of course that can't be it.

I still think that inflation is a fiscal phenomenon, but only with a probability of about .6. If I am correct, then Sumner will do little or no harm. If I am wrong, he would do a lot of good. It's a Pascal's Wager play.

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