Scott Sumner  

Tyler Cowen on ECB policy

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Here's Tyler Cowen commenting on ECB policy options for addressing lowflation:

2. Nominal gdp targeting. In general I like this idea, but which ngdp gets targeted? Eurozone ngdp, presumably. But when you have multiple countries, individual countries can end up with insufficient nominal gdp even if the eurozone meets a well-specified target overall. (Given independent bank regulators, debt structures, fiscal authorities and the like, I view this as more serious than say the 50 U.S. states, which have a higher level of integration, most of all at the policy level.) How much of a guarantee is there that Portugal would reap expansionary benefits, given the private credit contraction in that country? The potential clustering of ngdp growth in some parts of the eurozone is another way of stating why the currency union wasn't a good idea in the first place. This is still much better than doing nothing, but as a monetary policy rule ngdp seems better designed for the single-country case.

A few comments:

1. The "which NGDP gets targeted" question is easy--you definitely target the overall eurozone. As an analogy, no one would advocate having the Fed target the NGDP of a particular group of states.

2. Of course that leads to the optimal currency zone problem, and I agree with Tyler that the eurozone is not an optimal currency zone. But it's also worth emphasizing that roughly 80% of the eurozone crisis is caused by insanely low NGDP growth overall (tight money) and 20% is caused by the one-size-fits-all problem.

3. Tyler's last sentence is true but perhaps slightly misleading. Yes, NGDP works less well in a multiple country setting, but that's probably equally true of inflation targeting. An NGDP target would have produced far superior policy during 2008-2014 than an inflation target. So the fact that the Europeans foolishly adopted a multiple country currency zone is actually an argument in favor of NGDP targeting.

3. A new and different inflation target. My current wish would be a new ECB mandate specifying a minimum core inflation rate of three percent for each of the largest countries in the eurozone, say France, Germany, Italy, and Spain. If any of these four countries seemed to be coming in under three percent inflation, the ECB would have to do more. And if need be, you could extend this rule through to more countries, with Malta and Cyprus probably at the end of that list.

Sumnerians should note this also might be the best way to actually meet an operational ngdp target for a fair number of eurozone countries. Note that I accept many of Scott's critiques of inflation rate targeting, at least on a theoretical level. The (only?) advantage of this policy is that citizens would know what it means. They would know they hate it, in the same way that say Americans hate higher gas prices. They would know this is a higher inflation policy and the ECB would know it could not spin it any other way. A fair amount of inflation and thus monetary stimulus would in fact result.

I strongly disagree with this. I can't emphasize enough that the average voter doesn't understand inflation targeting. They don't even have a clue. They think it has something to do with central banks trying to help shoppers by holding down the rate of inflation. Voters don't really understand monetary policy at all, indeed probably fewer than 5% even know what it is. (And no, "having something to do with controlling interest rates" is not an answer that shows they understand what it is.) Because they don't know what monetary policy is, it's best to think of public opinion in terms of outcomes. Europeans would prefer monetary policies that don't create depressions and banking crises and high unemployment to policies that do create depressions and banking crises and high unemployment, even if the latter case led to a 4% inflation rate, such as what we experienced during the last 5 years of Paul Volcker. When voters don't understand the issues, then it's best to think of them as simply wanting good outcomes. That's all. I refuse to believe that voters actually want outcomes that lead to a poor economy. Do European 60 year olds want policies where none of their 30 year old children can find jobs? Ask them that specific question; don't ask them about "inflation," with no distinction being made between supply-side inflation that lowers aggregate real incomes and demand-side inflation that raises overall aggregate real incomes. Even the Japanese elderly voted for Abe!

If you don't believe me, describe the actual, true, honest-to-God, "public opinion" if polls showed the following:

1. 90% oppose having the Fed try to raise inflation.
2. 90% support Fed policies that will lead to higher levels of incomes for Americans.

Say both polls are accurate. Then what is the "true" stance of public opinion? More or less monetary stimulus? The polls are about as meaningful as asking Americans if they agree with the Copenhagen interpretation of QM or the Many Worlds interpretation.

BTW, when ascertaining public opinion on something like a gas tax, it is important to include the counterfactual. Is it an alternative tax such as a higher income tax? Is it a cut in Medicare or Social Security? No repair of potholes? Tax increases NEVER happen in a vacuum. If you replaced the current US government with a set of ordinary private citizens, and then showed them the budget and asked them what to do, they would enact all sorts of policies that public opinion polls supposedly show that ordinary people oppose. I recall when the older Bush was President, polls showed that two thirds opposed his Medicare "cuts," but other polls showed that nearly 99% thought he was increasing Medicare spending too rapidly (when the polls discussed hypothetical options for percentage increases in Medicare spending.) So what did people actually believe?

There is no such thing as public opinion, just election outcomes.

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COMMENTS (13 to date)
Sisyphus writes:

A worthwhile point to remember is that every good polling question should present at least two options fairly. When they don't, that's when you end up with contradictory results. And when reputable polling firms don't include an alternative in a question, you should be suspicious of the question, because the pollsters know better and have likely chosen that question form intentionally.

Andrew M writes:

I hear or read a lot of rhetoric or internet memes casting an incredibly nefarious doubt on inflation, especially fed manufactured, to the effet of it being a way for the government and the big banks to bail themselves out on the backs of the american public suffering higher costs for goods and services. It's like a weird combination of populist and paranoid austrians joining forces in their misapprenetion (thinking rand paul meets elizabeth warren or something). It truly feels like the more inflation is talked about in the political sphere, the more liberty politicians take with it to run and the more resentfully misunderstood the voters become, finding all new and stranger ways to vocally oppose anything remotely suggesting it. I'm very glad this blog has adopted a focus on this very problem as what feels like a common point of concern.

Scott Sumner writes:

Thanks Andrew, I would encourage readers to ignore essentially all discussion of inflation in the media. Focus on NGDP growth, which is much more informative about the state of the economy.

"Do European 60 year olds want policies where none of their 30 year old children can find jobs? Ask them that specific question."

I'm not sure this is as clear cut as you'd write.

In Portugal, I've read defenses of the current monetary arrangements with reference to the policies pursued in the early 1980s (previous IMF bailout): "sure, unemployment was low; but inflation went up to 20% and pensions lost their value."

This is also why there is no support for leaving the euro in the PIGS.

Richard A. writes:

"and 20% [of the eurozone crisis] is caused by the one-size-fits-all problem"

That 20% could be solved in the long run if those countries in the eurozone brought back their own currencies.

ThomasH writes:

NGDP targeting sounds good to me but I have not been able to understand why people's (allegedly not understanding what "inflation" means is an argument against "inflation" targeting. Did the Fed fail to provide more monetary stimulus in 2009 because the public did not understand "inflation?"

ThomasH writes:

[disregard] "all discussion of inflation in the media"

But that is where the inflation hawks' views are published. How can they refuted by silence?

Michael Byrnes writes:

Thomas H wrote:

"Did the Fed fail to provide more monetary stimulus in 2009 because the public did not understand "inflation?""

It may well have been a factor. When Bernanke said he wanted higher inflation in 2010, it did not play well to the public.

Michael Byrnes writes:

BTW, Nick Rowe with another typically great post on money, coordination and recessions:

James writes:

Results like "1. 90% oppose having the Fed try to raise inflation.
2. 90% support Fed policies that will lead to higher levels of incomes for Americans." only seem contradictory when coupled with the belief that raising inflation raises real incomes, or when coupled with the assumption that incomes refers only to nominal incomes.

Nathan W writes:

As a very different kind of union, the politics of the EU dictate that greater consideration of individual states is not only sensible, but necessary.

Technically speaking, the ECB will want to be able to pursue monetary policy with the same flexibility of the fed in the USA. If Nebraska doesn't get the best deal because it's going down when the country is going up (or vice versa and the policy constrains their growth), then this is easily acknowledged as a cost of good monetary policy in the United States of America. The European Union, however, is an agglomeration of states with longer standing historical differences, greater cultural and language differences, and more importantly, greater autonomy for individual states paired with a far easier ability to walk out the door (although this would be very costly to be out of the customs and monetary union).

Basically, I agree with the logic, but once accounting for politics and various nationalisms within the EU (this isn't 2004 where "European" was a common identification in the Eurobarometer data), I think it doesn't stick. I.e., it really matters that the ECB cannot target all states at a time, and it is more likely that countermeasures for states who experience negative effects of broadly beneficial monetary policy could help to maintain consensus on the benefits of all of these countries working together within a trading and currency union.

Yancey Ward writes:
As an analogy, no one would advocate having the Fed target the NGDP of a particular group of states.

Well, of course not- honesty isn't really a good policy in this regard.

Garrett writes:
There is no such thing as public opinion, just election outcomes.

This strikes me as similar to someone looking at financial markets and saying, "there's no such thing as (intrinsic or relative) value, just asset prices." While value may not be directly observable, practitioners drive asset prices by estimating value and making trading decisions.

Similarly, while public opinion may not be directly observable, politicians drive election results by estimating public opinion and making platform decisions.

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