NGDP level targeting – the true Free Market alternative

Tyler Cown a couple of days ago put out a comment on “Why doesn’t the right-wing favor looser monetary policy?”

Tyler has three answers to his own question:

1. There is a widespread belief that inflation helped cause the initial mess (not to mention centuries of other macroeconomic problems, plus the problems from the 1970s, plus the collapse of Zimbabwe), and that therefore inflation cannot be part of a preferred solution.  It feels like a move in the wrong direction, and like an affiliation with ideas that are dangerous.  I recall being fourteen years of age, being lectured about Andrew Dickson White’s work on assignats in Revolutionary France, and being bored because I already had heard the story.

2. There is a widespread belief that we have beat a lot of problems by “getting tough” with them.  Reagan got tough with the Soviet Union, soon enough we need to get tough with government spending, and perhaps therefore we also need to be “tough on inflation.”  The “turning on the spigot” metaphor feels like a move in the wrong direction.  Tough guys turn off spigots.

3. There is a widespread belief that central bank discretion always will be abused (by no means is this view totally implausible).  “Expansionary” monetary policy feels “more discretionary” than does “tight” monetary policy.  Run those two words through your mind: “expansionary,” and “tight.”  Which one sounds and feels more like “discretion”?  To ask such a question is to answer it.

There is a lot of truth in what Tyler is saying. I especially like #2. There seem especially among US conservative and libertarian intellectuals a need to be “tough”. The dogma seems to be “no pain, no gain”. This obviously is an idiotic position. It seems like the tough guys have forgotten that sometimes there are indeed gains to be made with little or no pain. Just remember what the supply siders like Arthur Laffer taught us – sometimes you can cut tax rates and increase revenues. In fact most market reforms are exactly about that – economists call it a Pareto improvement. Unlike other monetary policy rules NGDP level targeting can actually be shown to ensure Pareto optimality (yes, yes I know it is based on questionable theoretical assumptions…)

Even though I like Tyler’s explanations to his question I think there is one big problem with his comment and that is his premise that Market Monetarists are advocating “expansionary” monetary policy. We are not – at least I am not and I don’t think Scott Sumner is. I have again and again argued that NGDP level targeting is not about “stimulus” and it is certainly not discretionary. Rather NGDP level targeting is about ensuring that monetary policy is “neutral” and does not distort the price system.

As I have earlier argued that if the central bank is pursuing a policy of NGDP level targeting then (ideally) relatively prices would be unaffected by monetary policy and hence be equal to what they would have been in a pure barter economy.

This is what I have called Selgin’s Monetary Credo:

The goal of monetary policy ought to be that of avoiding unnatural fluctuations in output…while refraining from interfering with fluctuations that are “natural.” That means having a single mandate only, where that mandate calls for the central bank to keep spending stable, and then tolerate as optimal, if it does not actually welcome, those changes in P and y that occur despite that stability

Hence, what we line with George Selgin are arguing is the true Free Market alternative to the present monetary policy in for example the euro zone and the US. Contrary to for example the Taylor rule which anybody who has studied David Eagle or George Selgin would tell you is leading to distortions of relative prices. How can any conservative or libertarian advocate a monetary policy rule which distorts market prices?

Furthermore, Scott Sumner, Bill Woolsey and myself have suggested that not only should the central banks target the only non-distortionary policy rule (NGDP level targeting), but the central bank should also leave the implementation of this rule to the market through the use of predictions markets (e.g. NGDP futures). I have not seen conservative economists like John Taylor or Allan Meltzer showing such trust in the free market. (The gold bugs and Rothbard style Austrians do not even want to let the market decide on was level of reserves banks should hold…)

Of course there is a position which is even more Free Market and that is of course the Free Banking alternative. However, as I argued the Market Monetarist position and the Free Banking position are fundamentally not in conflict. In fact NGDP targeting could be seen as a privatisation strategy. Free Banking theorists like George Selgin of course understand this, but will John Taylor or Allan Meltzer go along with that idea? I think not…

But why do people get confused and think we want monetary stimulus? Well, it is probably partly our own fault because we argue that the present crisis particularly in the US and Europe is due to overly tight monetary policy and as a natural consequence we seem to be favouring “expansionary” monetary policy or “monetary stimulus”.  However, the point is that we argue that the ECB and Fed failed in 2008 and to a large extent have continued to fail ever since and that they need to undo their mistakes. But we mostly want the central bank to stop distorting relative prices and we would really just like to have a big nice “computer” called The Market to take care of the implementation of monetary policy. That is also what Milton Friedman favoured and what right-winger would be against that?

PS I assume that Tyler uses the term “right-winger” to mean somebody who is in favour of free markets. That is at least how I here use the term.

Leave a comment


  1. This post reminded me of the title of a book by Alan Blinder from the 80s: Hard Heads, Soft Hearts. Maybe that´s how NGDPT should be “peddled”.

  2. Marcus, first we start peddling the people who should be in favour of NGDP targeting in the first place – the free market crowd. And we don’t have to convince Krugman – he is already in favour despite his enormous distrust in the market.

  3. Something from me on the NGDP targeting debate. Specifically see the graphs further down the page from me.

  4. Thanks Jason – and thanks a lot for the input. I hope to be able to return your comments on your excellent blog in the coming days.

  5. Rob

     /  February 24, 2012

    I have become sold on the idea of NGDP-level target and have started to get an understanding of the various transmission channels available (essentially alternatives to the credit channel emphasized by Keynesian, that they believe fails to work in a liquidity trap).

    However I have a question on the statement:

    “However, as I argued the Market Monetarist position and the Free Banking position are fundamentally not in conflict”

    As the alternative channels (currency interventions, various forms of QE, straight “helicopter drops” etc) seem much more viable in a central bank model than a free-banking model.

    Are not free-banks likely to use only the “credit channel” ? That is when demand for money increases they will increase lending in response (and lower the interest rate as a side-effect) . Do you see the potential for profit-maximizing free-banks to increase the money supply though non-credit channels ? If so – how would you see this working ? (that is: what would be the profit incentive for a free-bank to create more money via means other than lending it out ?).

    Hope this question makes sense.

  6. Rob, you are of course right that under Free Banking “monetary policy” will be very different. However, I think the important thing is under both NGDP level targeting and Free Banking the money supply is “elastic”. Any increase in money demand is met by a similar increase in the money supply.

    The two are of course very hard to compare institutionally. Under a system of Free Banking there will be no need for a lender of last resort as banks at anytime will be able to get all the liquidity they want – they are after all printing their own money. Therefore, there will not be a need for open market operations etc. That said, it is very likely that under a Free Banking system we will see the emerges of clearing house etc. that might play the role of a “central bank”.

    Furthermore, ideally under a Free Banking system the economic equilibrium will be one in which the the NGDP level is fixed. That mean that the transmission mechanism in many ways will work under NGDP level targeting. For example if a shock push the NGDP level lower then investors will expect the free banks to increase the money supply. That would for example as under NGDP level targeting lead to a rally in the stock market and inflation expectations would increase. So the same stabilizing factors as under NGDP level targeting will be in place under Free Banking.

  7. Rob

     /  February 25, 2012

    Thanks for the detailed reply.

    I am intrigued by your view that ‘it is very likely that under a Free Banking system we will see the emerges of clearing house etc. that might play the role of a “central bank”’. It would be a very interesting thought experiment to see how this could emerge and what shape it would take,

    I think it also a great point that people’s expectations that free-banks will adjust the money supply will reinforce the recovery from an economic shock.

    The real take away from me is this: In a true free market mechanisms and institutions would emerge that would stabilize NGDP. NGDPT simulates this effect. What really needs to be justified is not these models that tend towards stability but the “orthodox” Central Bank model where complacent central bankers allow the money supply to deviate away from its equilibrium level (in both directions) and harm the real economy in the process.

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