Scott Sumner on Lars von Trier

I never thought I would mention the Danish movie director Lars von Trier in one of my posts, but here we go. After all I am Danish and I share the first name with von Trier.

Other than being a leading Market Monetarist Scott Sumner also is a movie buff. He has a post today in which he has list of movies he likes. Number 3 on the list is von Trier’s Melancholia.

Here is what Scott has to say about it:

“Melancholia (Danish/English) 3.7 From the opening image you know you are in the hands of a master filmmaker. The only thing that keeps him from being universally recognized as a great director is that his subject matter doesn’t make people feel “comfy.” Completely unrealistic and yet utterly authentic.”

I am no big fan of von Trier and surely has a hard time understanding what is point is in most of his movies, but I never watched Melancholia and now Scott has recommend it I think I better watch it.

And then a little secret. I never met Scott in real life, but I met von Trier. In fact I have a minor roll in von Trier’s The Kingdom (In Danish Riget) and I mean minor (7 seconds or so…).


Japan shows that QE works

I am getting a bit worried – it has happened again! I agree with Paul Krugman about something or rather this time around it is actually Krugman that agrees with me.

In a couple of posts (see here and here) I have argued that the Japanese deflation story is more complicated than both economists and journalists often assume.

In my latest post (“Did Japan have a productivity norm?”I argued that the deflation over the past decade has been less harmful than the deflation of the 1990s. The reason is that the deflation of the 2000s (prior to 2008) primarily was a result of positive supply shocks, while the deflation of in 1990s primarily was a result of much more damaging demand deflation. I based this conclusion on my decomposition of inflation (or rather deflation) on my Quasi-Real Price Index.

Here is Krugman:

“A number of readers have asked me for an evaluation of Eamonn Fingleton’s article about Japan. Is Japan doing as well as he says?

Well, no — but his point about the overstatement of Japan’s decline is right…

…The real Japan issue is that a lot of its slow growth has to do with demography. According to OECD numbers, in 1990 there were 86 million Japanese between the ages of 15 and 64; by 2007, that was down to 83 million. Meanwhile, the US working-age population rose from 164 million to 202 million.”

This is exactly my view. In terms of GDP per capita growth Japan has basically done as good (or maybe rather as badly) other large industrialised countries such as Germany and the US.

This is pretty simple to illustrate with a graph GDP/capita for the G7 countries since 1980 (Index 2001=100).

(UPDATE: JP Koning has a related graph here)

A clear picture emerges. Japan was a star performer in 1980s. The 1990s clearly was a lost decade, while Japan in the past decade has performed more or less in line with the other G7 countries. In fact there is only one G7 country with a “lost decade” over the paste 10 years and that is Italy.

Quantitative easing ended Japan’s lost decade

Milton Friedman famously blamed the Bank of Japan for the lost decade in 1990s and as my previous post on Japan demonstrated there is no doubt at all that monetary policy was highly deflationary in 1990s and that undoubtedly is the key reason for Japan’s lost decade (See my graph from the previous post).

In 1998 Milton Friedman argued that Japan could pull out of the crisis and deflation by easing monetary policy by expanding the money supply – that is what we today call Quantitative Easing (QE).

Here is Friedman:

“The surest road to a healthy economic recovery is to increase the rate of monetary growth, to shift from tight money to easier money, to a rate of monetary growth closer to that which prevailed in the golden 1980s but without again overdoing it. That would make much-needed financial and economic reforms far easier to achieve.

Defenders of the Bank of Japan will say, “How? The bank has already cut its discount rate to 0.5 percent. What more can it do to increase the quantity of money?”

The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.

There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately. A return to the conditions of the late 1980s would rejuvenate Japan and help shore up the rest of Asia.”

(Yes, it sounds an awful lot like Scott Sumner…or rather Scott learned from Friedman)

In early 2001 the Bank of Japan finally decided to listen to the advise of Milton Friedman and as the graph clearly shows this is when Japan started to emerge from the lost decade and when real GDP/capita started to grow in line with the other G7 (well, Italy was falling behind…).

The actions of the Bank of Japan after 2001 are certainly not perfect and one can clearly question how the BoJ implemented QE, but I think it is pretty clearly that even BoJ’s half-hearted monetary easing did the job and pull Japan out of the depression. In that regard it should be noted that headline inflation remained negative after 2001, but as I have shown in my previous post Bank of Japan managed to end demand deflation (while supply deflation persisted).

And yes, yes the Bank of Japan of course should have introduces much clearer nominal target (preferably a NGDP level target) and yes Japan has once again gone back to demand deflation after the Bank of Japan ended QE in 2007. But that does not change that the little the BoJ actually did was enough to get Japan growing again.

The “New Normal” is a monetary – not a real – phenomenon

I think a very important conclusion can be drawn from the Japanese experience. There is no such thing as the “New Normal” where deleveraging necessitates decades of no growth. Japan only had one and not two lost decades. Once the BoJ acted to end demand deflation the economy recovered.

Unfortunately the Bank of Japan seems to have moved back to the sins of 1990s – as have the Federal Reserve and the ECB. We can avoid a global lost decade if these central banks learn the lesson from Japan – both the good and the bad.

HT JP Koning

Guest blog: Growth or level targeting? (by David Eagle)

We continue the series of guest blogs by David Eagle on his research on NGDP targeting and related topics.

See also David’s first guest post “Why I Support NGDP Targeting”.

Enjoy the reading.

Lars Christensen


Guest blog: Growth vs. level targeting

by David Eagle

In my first guest blog for “The Market Monetarist” I stated that I am in favor of targeting the level of Nominal GDP (NGDP) and not the growth rate of NGDP.  Some economists such as Bennett McCallum (2011) are in favor of NGDP-growth-rate targeting (ΔNT) over NGDP Targeting (NT).

I have long opposed inflation targeting (IT) and I view ΔNT as almost as bad as IT because both cause what we call negative NGDP base drift. In order to understand my arguments against ΔNT and against IT, we need to understand the concepts of NGAP and NGDP base drift.

In this blog, I use an example to illustrate these concepts and the difference between NT and ΔNT.  It also uses another example to help us understand the concepts of PGAP and price-level base drift, and the difference between price-level targeting (PLT) and IT.

Growth vs. Level NGDP Targeting

To see the similarities and differences between targeting the growth rate of NGDP (ΔNT) and the level of NGDP (NT), assume the central bank’s target for NGDP growth  would be 5%.  As long as the central bank (CB) meets that target, NGDP would follow the path Nt = N0 (1.05)t where N0 is the NGDP for the base year and Nt is the NGDP occurring t years after the base year.

For consistency, assume that the CB’s target for NGDP (if it targets the NGDP level) would be Nt* = N0 (1.05)t.  Hence, as long as the central bank meets its target, then NGDP will be the same whether the central bank targets the growth rate or the level of NGDP.

The difference between growth rate targeting and level target occurs when the central bank misses its target.  Assume for example N0 = 10.  Initially, both NT and ΔNT have the same intended NGDP trajectory of Nt = 10(1.05)t; in particular, both NT and ΔNT aim for N1 to be 10.5.  However, assume the central bank misses its target and N1 = 10.08, which is 4% below its targeted level of NGDP.  We define NGAPt as the percent deviation at time t of NGDP from its previous trend; hence in this example NGAP1 = -4%.  Under NT, the central bank will try to make up for lost ground to reduce NGAP to zero and return NGDP back to its targeted path of Nt = 10(1.05)t.

In contrast, under NGDP growth targeting, the central bank will only try to meet its targeted NGDP growth rate of 5% in the future. Hence, under NGDP growth targeting, the central bank will shift its NGDP trajectory to Nt = 10.08(1.05)t-1, which is 4% below the initial NGDP trajectory of Nt = 10(1.05)t. In other words, under NGDP growth targeting, the central bank would let the 4% NGAP continue indefinitely. NGDP base drift occurs when the central bank allows NGAP to continue rather than trying to eliminate that NGAP in the future.

Price Level Targeting vs. Inflation Targeting

The concept of NGDP base drift is related to the concept “price-level base drift,” which many economists such as Svensson (1996) and Kahn (2009) have long recognized to be the theoretical difference between price-level targeting (PLT) and inflation targeting (IT).

In particular, Mankiw (2006) states, “The difference between price-level targeting and inflation-targeting is that price-level targeting requires making up for past mistakes,” while Taylor (2006) states, “Focusing on a numerical inflation rate tends to let bygones be bygones when there is a rise [or fall] in the price level” [brackets added].

Also, Meh, et al (2008) state, “Under IT, the central bank does not bring the price level back and therefore the price level will remain at its new path after the shock.” They go on to say that under PLT, “the central bank commits to bringing the price level back to its initial path after the shock.”

To see the similarities and differences between PLT and IT, assume the central bank’s target for inflation (if it follows IT) would be 2%.  Then the CB’s trajectory for the price level will be Pt = P0 (1.02)t where P0 is the price level for the base year and Pt is the price level occurring t years after the base year.  Similarly assume that the central bank’s price-level target (if it follows PLT) would be Pt* = P0 (1.02)t.  Hence, when the central bank meets its target, the price level will be the same regardless if the central bank follows PLT or IT.

The difference between PLT and IT occurs when the central bank misses its target.  For this example, assume P0 = 100.  Initially, both PLT and IT have the same price-level trajectory of Pt = 100(1.02)t.  In particular, under both PLT and IT, the CB is aiming for Pt  to be 102 at time t=1.  However, assume that the central bank misses its target and Pt = 100.47, which is 1.5% less than its targeted price level of 102.  We define PGAPt to be the percent deviation of the price level at time t from its previous trend; hence, in this example; PGAP1 = ‑1.5%.

Under PLT, the central bank will try to return PGAP back to zero by increasing the price-level back up to its targeted price-level path of Pt = 100 (1.02)t.  Under IT, the central bank will “let bygones be bygones” and merely try to meet its inflation target of 2% in the future.  Hence, under IT, the central bank shifts its price-level trajectory to Pt = 100.47 (1.02)t-1, which is 1.5% below its initial trajectory.  In other words, the central bank lets the -1.5% PGAP continue into the foreseeable future.  Price-level base drift occurs when the central bank allows PGAP to continue rather than trying to eliminate that PGAP in the future.

Price-level base drift implies NGDP base drift

Because IT leads to price-level base drift, it also leads to NGDP base drift.  To illustrate with an example, assume the long-run growth rate in real GDP (RGDP) is 3% and RGDP in the base year is Y0 = 10 trillion dollars.  Therefore, when the central bank expects RGDP to grow at its long-run growth rate, it expects Yt = 10(1.03)t.

Initially in this example when the central bank has a 2% inflation target, the central bank’s trajectory for the price level under inflation targeting is Pt = 100 (1.02)t.  Since Nt=PtYt/100 when we use 100 as the price level in the base year, this means that the CB’s trajectory for NGDPt is Nt = 10 (1.02)t(1.03)t.  When it turned out that P1 was 100.47 instead of 102, the central bank following IT would shift its price level trajectory to Pt = 100.47 (1.02)t-1 and its NGDP trajectory to Nt = 10.047 (1.02)t-1(1.03)t, which is 1.5% below its initial NGDP trajectory.  Therefore, NGAP under this trajectory will be -1.5%, which means a negative NGDP base drift.

“Inflation targeting” can be many things

In practice, inflation targeting is not as simple as I described above or even as several of the economists I quoted described it.   In practice, central banks following inflation targeting target a long-run rather than a short-run inflation rate.  They also try to target “core inflation” rather than general inflation.  Also, they do consider output gap and unemployment as well as inflation.  Therefore, the question whether IT in practice leads to NGDP base drift is primarily an empirical one.

According to my empirical research that I plan to report in a later blog, past U.S. monetary policy has on average resulted in a significant negative NGDP base drift.  Also, that research indicates that the primary reason for the prolonged high unemployment following a recession is this negative NGDP base drift.


Kahn, George A. (2009). “Beyond Inflation Targeting: Should Central Banks Target the Price Level?” Federal Reserve Bank Of Kansas City Economic Review (Third quarter),

Mankiw, Greg (2006). “Taylor on Inflation Targeting,” Greg Mankiw’s Blog (July 13)

McCallum, Bennett, “Nominal GDP Targeting” Shadow Open Market Committee, October 21, 2011,

Meh, C. A., J.-V. Ríos-Rull, and Y. Terajima (2008). “Aggregate and Welfare Effects of Redistribution of Wealth under Inflation and Price-Level Targeting.” Bank of Canada Working Paper No. 2008-31,

Svensson, Lars E. O. (1996). “Price Level Targeting vs. Inflation Targeting: A Free Lunch?” NBER Working Paper 5719,, accessed on January 4, 2012.

Taylor, John (2006). “Don’t Talk the Talk: Focusing on a numerical inflation rate tends to let bygones be bygones when there is a rise in the price level.” The Economist (July 13),

© Copyright (2012) David Eagle

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