Scott Sumner  

Brad DeLong poses two questions about NGDP targeting

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Here's Brad DeLong:

Two Questions for Scott Sumner: First Question: Why has nominal GDP targeting not already swept the economics community? It really ought to have. Second Question: I believe in nominal GDP targeting--especially if coupled with some version of "social credit" at or near the zero lower bound. But a look back at the history of ideas about a proper "neutral" monetary policy--Newton's fixed price of gold, Hayek's fixed nominal GDP level, Fisher's fixed price-level commodity basket, Friedman's stable M2 growth rate, the NAIRU targeting of the 1970s, Bernanke's inflation-targeting--leads immediately to the conclusion that anybody who claims to have uncovered the Philosopher's Stone here is a madman. How can you reassure me that I (and you) are not mad?
My first reaction was that the first question was too polite. Something I'd expect from my mother, not a skilled debater like Brad DeLong. But perhaps he's just buttering me up for the kill.

Seriously, these are both really interesting questions, and I reserve the right to do a follow-up when I've had time to give them more thought. But here are some initial reactions, starting with the first question:

I'm not sure NGDP targeting has not "swept the economics community," at least in a sort of "glass half full" sense. Let's start with the initial position of market monetarists (MMs). I think I was pretty typical of my fellow MMs in not being very well known. Even today I can recall only being invited to two top 50 departments to present. One was DeLong's own Berkeley, back in the late 1990s, and the other was Dartmouth. Not once at the Fed, other than when I was on the job market in the late 1980s. So the Dartmouth invitation is it in terms of invites since I started blogging. Paul Krugman has an interesting piece on the inner circle of various fields of economics, and I'm clearly not in one of those elite groups of scholars, who share NBER papers with each other.

Thus given the initial starting position of MM, I think endorsements of NGDP targeting by the likes of Woodford, Christy Romer, Jeffrey Frankel, and some other top people is pretty good. And of course there's Brad DeLong, who clearly is in the elite group, especially in the intersection of macro/macro history/history of thought. Then there are also lots of prominent economists in the "it's worth a shot" category, including (AFAIK) Paul Krugman. When I speak to various people at conferences and after talks, I find lots of people who tell me privately that they are on board. But they don't necessarily announce it in the New York Times, (as Romer did). So given our humble beginnings, I do see a lot of progress.

I would add that in my view I'm not even at the 50% mark in terms of my effectiveness. The NGDP futures market has been slow to materialize, but it will happen in 2015. Recent discussion with various think tanks has suggested to me that there is still a lot of interest in the NGDP targeting idea, and people are looking for ways to help. Hopefully these discussions will lead to something soon. And note that it's the conservative/libertarian think tanks that invite me---I see that as being really important, given that the names I mentioned above are all at least slightly left of center. Here's a question to think about:

Is there any monetary policy proposal other than NGDP targeting that has substantial support in the Keynesian, monetarist and Austrian communities?

DeLong is surely aware that there is some important support in the Keynesian community, and knows about the MMs, plus people like Bennett McCallum in the monetarist community. But given the way Austrians have recently been perceived as being out on the fringes, I wonder if DeLong would be surprised to know that many Austrians tell me something to the effect, "You convinced me that if we must have a Fed, then NGDP targeting is the least bad policy." I'll take that! And there is a long history of interest in NGDP targeting in that group (Hayek, Selgin, etc., although perhaps Selgin is not a true Austrian.)

It's really hard to change monetary policy, and indeed it should be at least somewhat difficult to change policy. If it was easy, then policy would have little or no credibility. Obviously if there is significant support from all the various schools of thought, on both sides of the political spectrum, it will be much easier to enact the proposal. When I speak to free market groups like Cato/Heritage/AEI/Mercatus, and in Britain IEA/Adam Smith Institute, and the CIS in Australia, people seem very receptive to the ideas. Most of them have published at least one of my policy papers.

If Ben Bernanke had been in academia during the recent recession I believe he would have endorsed NGDP targeting. Of course he is in a rather difficult position today, and naturally would not want to undercut the current Federal Reserve Board. Thus I predict that when he eventually discusses the idea he will neither endorse it nor be hostile, but rather suggest that it's an interesting idea worthy of further study. In general, these sorts of ideas need to percolate around in academia for some time, and be extensively studied, before the central bank adopts the policy. In other posts I've discussed how NGDP targeting could be gradually phased in, leaving a residual 2% inflation goal, for a multi-decade transition period.

I also wonder whether some of the reluctance of elite macroeconomists to jump on board is due to the misperception that there is something "primitive" about NGDP. Many people seem to see it as an ungainly creature, the sum of two "fundamental" concepts, inflation and real growth. Readers of this blog know I think that's nonsense, like claiming the price level is merely the weighted average of goods and services prices. NGDP is the real thing, and inflation is a construct of bureaucrats who lack any solid theoretical foundation for decomposing NGDP into prices and real output. If you put a gun to my head, I could make a very respectable case that there has been no inflation in the past 50 years, and I could also make a very respectable case that the entire increase in per capita NGDP since 1964 has been 100% inflation, with no real growth. Both arguments would be well-founded in utility theory. (My next blog post?) The big mistake in macro was to construct models using P and Y, not PY as a single variable. The second mistake was not to think pragmatically about the "welfare costs of inflation," which on closer inspection are actually the welfare costs of unstable NGDP.

The second question is much easier. I believe I am mad, as is everyone else. It's only a question of how mad. As the title of my other blog suggests, I'm a sort of amateur psychologist who likes to talk about cognitive illusions. And since that talk can be rather insulting, let me point out that I personally have more money illusion than most people I meet. I've wasted many, many hours of my life doing things to save money, not realizing that a $20 bill has less value than in 1965. (BTW, in 1965 a twenty was the largest bill typically carried in wallets, and still is.)

But I'm also an extreme pragmatist, and thus plead innocent to the specific type of madness that worries DeLong. Two points to consider:

1. I suspect NGDP targeting is not a good policy for non-diversified economies, especially commodity exporters like Kuwait. A country like Australia would be a borderline case. It works best in big diversified economies like the US. That means it might not start out with small country experiments, as inflation targeting did in New Zealand, Canada, Chile, etc.

2. Even in the US, I suspect that some other target is slightly superior. It might be total labor compensation, or total compensation per working age adult, or average nominal hourly wages. I see NGDP as a good compromise in a world of uncertainty, which is a better focal point for Keynesians, monetarists and Austrians than a more controversial idea like wage targeting.

Obviously I didn't invent NGDP targeting, so I don't feel as possessive about the idea as say NGDP futures targeting, which I arguably did co-invent with Hall/Thompson/Hetzel/Glasner, etc.


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CATEGORIES: Monetary Policy




COMMENTS (9 to date)
Sam writes:

Scott, any thoughts on the Hypermind NGDP prediction market's price action so far? It's hovering just below the Philly Fed's consensus from mid November (4.3%) at a market price of 4.1-4.2%, with a bid-ask spread of about 0.2%. Trading volume has been light.

(Disclaimer: I am short in that market. Without being expert in the matter, I expect both the strong Q3 revisions in RGDP on 11/25 [3.5% to 3.9% annualized growth rate] and the commodity crash on 11/28 to decrease the Q4 annualized NGDP growth rate, the former for real reasons and the latter for nominal ones.)

Bob Murphy writes:

Scott, I have never heard you say before that you thought NGDP targeting might be a poor policy for small, commodity exporting countries. Have you written about that?

Scott Sumner writes:

Sam, Sorry, I haven't had time to focus on that question. You sound like you know more about it than I do.

Bob, Yes, many times.

Johannes Fritz writes:

About your comments on better goals than NGDP (wages in the US, something else in less diversified economies): Can you provide a reading pointer or list for what drives the goal suitability?

I think I understand diversification as you don't want the target's evolution to be dominated by a few volatile components.
But why does the economy have to be big?

This in not in any way intended as an insult or mathematical economics snobbism. Pure curiosity for the literature underlying your thinking.

ChrisA writes:

Here's how I would answer the second question, by analogy; Isaac Newton's proposal for a metallic standard was not actually a bad answer for the time. The same for his explanation of celestial mechanics. These explanations have now been supplanted by better understanding, but the initial thinking was not flawed and was an advance on previous thinking. Same as for NGDP targeting. It doesn't have to be the best answer for ever, just an improvement on what we have now.

ThomasH writes:

I think the welfare cost of variable inflation are not entirely due to unstable ngdp. Variable inflation makes long term debt contracts more difficult to structure and nominal capital gains more difficult to tax. Moreover, at high and variable rates it is also more difficult to set and estimate even near future contracts, e.g. wages.

Scott Sumner writes:

Johannes, I don't know about reading lists, but it's easy to illustrate with an example. Suppose the price of oil doubles and the output of oil in Kuwait is unchanged. If oil was originally 50% of NGDP, then after price doubles the oil industry alone is equal to the NGDP target for Kuwait, and non-oil output must fall to zero, That's obviously not optimal.

An extreme example, but it gets at the problem. You are right that size per se is not the issue, it's just that big economies are usually more diversified.

Chris, Yes, I've made that argument elsewhere, and should have made it here. Good point.

Thomas, I'd argue that it's NGDP shocks that makes for problems in debt contracts. George Selgin has some papers that explain this better than I can. Ditto for taxes. Nominal earnings on capital are more closely correlated with NGDP growth than inflation. Since all capital income taxation is inefficient, stabilizing NGDP will minimize the deadweight loss of taxes on capital.

Nick Zbinden writes:

I think some elite macro economists would also think that MM generally dont write the sort of mathematical models other macro econ prof do.

Even just people in comments on blogs write things like "why should I listen to them, they have not put out a formal model". I dont even know if that is true because I dont really care, but that what people seem to be saying.

Greg Jaxon writes:

Regarding question 2: as a follower of Menger, I am not prepared to say "if we must have a Fed, then NGDP targeting is the least bad policy", only that it would be better than the current Fed policy. That may be enough of a recommendation to suit you.

NGDP-targeting vaguely resembles, but is worse than, the policies that constituted the "original intent" of the 1913 Federal Reserve Act. I would characterize those as "targeting the demand for circulation credit". Specifically, the 1913 Fed was directed to fill its bank reserves with acceptable commercial bills of the day.

As these mature in about 90 days, said money base would rather closely track the core demand for circulation credit. Bankers then did not accept long gov't bonds as reserves nor bills drawn for goods being stockpiled speculatively. So acceptable commercial credit is far less than the sum of all GDP (e.g., it excludes most gov't spending). That smaller "money base" was carefully filtered to include only the segment of economic activity that is quite certain to mature as planned - the diligence involved being analogous to (though far less than) the effort to mine, purify, and assay gold. That is the inherent cost of a high-entropy product like sound money.

Also, I don't believe the pivotal question is whether "we must have a Fed". The structure of the Fed as a non-profit bank (except for those great expense accounts) is economically absurd. By 1918, the Fed's reserves consisted almost entirely of War Bonds of various sorts, by the 20s the Fed couldn't even be bothered to post the required collateral for issuing FRNs and the international market for Bills never recovered from the terms of the Armistice. So the best of original intents paved a road to centrally planned economic whimsy.

The root question is whether "we must have gov't-monopoly legal tender". Once you accept that infringement on free banking, the rest is just a negotiation with a monopolist.

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