St. Louis Fed’s Bullard comes out in support of NGDP targeting

St. Louis Federal Reserve president James Bullard just came out in support of nominal GDP targeting – or rather he has co-authored a rather interesting new Working Paper, which concludes that NGDP targeting under some circumstances would be the best policy to pursue.

The paper with the ambitious title Optimal Monetary Policy at the Zero Lower Bound Bullard has co-authored with Costas Azariadis, Aarti Singh and Jacek Suda.

As the abstract reveals it is a rather technical paper:

We study optimal monetary policy at the zero lower bound. The macroeconomy we study has considerable income inequality which gives rise to a large private sector credit market. Households participating in this market use non-state contingent nominal contracts (NSCNC). A second, small group of households only uses cash and cannot participate in the credit market. The monetary authority supplies currency to cash-using households in a way that changes the price level to provide for optimal risk-sharing in the private credit market and thus to overcome the NSCNC friction. For succinctly large and persistent negative shocks the zero lower bound on nominal interest rates may threaten to bind. The monetary authority may credibly promise to increase the price level in this situation to maintain a smoothly functioning (complete) credit market. The optimal monetary policy in this model can be broadly viewed as a version of nominal GDP targeting.

I think the interesting thing about the paper is the focus on non-state contingent nominal contracts (NSCNC) as the key rigidity in economy rather wage and price rigidities. Simply stated, essentially NSCNC means that debt is nominal rather than real – and when a major negative shock to nominal incomes (NGDP) occurs then that causes debt/NGDP to rise and that is really at the cure of the financial distress that follows from a major negative NGDP shock (this by the way is why Greece now has a problem).

We can solve this problems in two ways – either by introducing (quasi) real contracts rather than nominal contract or by having the central bank targeting NGDP.

As such the paper is part of a growing, but small literature that focuses on NSCNC and the importance of this for the optimal monetary policy rule.

I was, however, a bit disappoint to see that the authors of the paper did not have a reference to any of the paper on this topic by the extremely overlooked David Eagle. I have written numerous blog posts on David’s work since 2011 and David has even written a number of guest posts for my blog. I list these posts below and I suggest everybody interested in this topic read not only the posts but also David’s papers.

The authors on the other hand do have a reference to the work of Evan Koenig who has done academic work very much in same spirit as David Eagle. I have also written about Evan’s work on this blog over the last couple of years and also list these blog posts below.

Will this change anything?

For those of us deeply interested in monetary policy matters the new paper obviously is interesting. First of all, it is helping deepening the theoretical understanding of monetary policy and second the paper could help further push the Federal Reserve (and other central banks!) toward in fact officially implementing some version of NGDP targeting – or at least I hope so.

That said there is a huge difference between in principle supporting NGDP targeting in a theoretical paper and then actually advocating NGDP targeting the real world and so far as I can see Jim Bullard has not yet done that. But obviously this is a huge step in the direction of Jim Bullard actually becoming an NGDP advocate and that obviously should be welcomed.

I have numerous times argued that the Fed actually from mid-2009 de facto started a policy to NGDP level targeting around a 4% path and this policy effectively has continued to this day (see here and here). However, this has never been articulated by any Fed official, which makes the “policy” much less effective and less credible.

Therefore, it would be great if we not only would get a theoretical endorsement of NGDP targeting from the likes of Jim Bullard, but rather a concrete proposal on how to actually implement NGDP targeting. I hope that will be the next paper Jim Bullard authors.

PS My friend Marcus Nunes also comments on the paper here.

PPS One of the authors of the paper discussed above is Jacek Suda from the Polish central bank (NBP). I would love to see a discussion of introducing NGDP targeting in my beloved Poland!


Blog posts on and by David Eagle:

Guest post: Central Banks Should Quit “Kicking Them While They Are Down!” (by David Eagle)

Guest post: GDP-Linked Bonds (by David Eagle)

Guest blog: NGDP Targeting is NOT just for Central Banks! (David Eagle)

Guest blog: Why Price-Level Targeting Pareto Dominates Inflation Targeting (By David Eagle)

Guest Blog: The Two Fundamental Welfare Principles of Monetary Economics (By David Eagle)

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

Guest post: Why I Support NGDP Targeting (by David Eagle)

Dubai, Iceland, Baltics – can David Eagle explain the bubbles?

David Eagle’s framework and the micro-foundation of Market Monetarism

David Eagle on “Nominal Income Targeting for a Speedier Economic Recovery”

Selgin and Eagle should be best friends

Quasi-Real indexing – indexing for Market Monetarists

David Davidson and the productivity norm

Two Equations on the Pareto-Efficient Sharing of Real GDP Risk (a paper David and I co-authored in 2012)

Blog posts on Evan Koeing:

The Integral Reviews: Paper 1 – Koenig (2011)

“Monetary Policy, Financial Stability, and the Distribution of Risk”


UPDATE: Scott Sumner also comments on the Bullard el al paper.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or


Dude, here is your model

Here is Scott Sumner:

“Whenever I get taunted about not having a “model,” I assume the commenter is probably younger than me, highly intelligent, but not particularly wise.”

So Scott has a problem – he does not have a fancy new model he can show off to the young guys. Well, Scott let me see if I can help you.

Here is your short-term static model:

An Eaglian (as in David Eagle) equation of exchange:

(1) N=PY

Where N is nominal GDP and P is the price level. Y is real GDP.

An Sumnerian Phillips curve:

(2) Y=Y*+a(N-NT)

Where NT is the target level for nominal GDP and N is nominal GDP . Y* is trend trend RGDP.

(1) is a definition so there can be no debate about that one. (2) is a well-established emprical fact. There is a very high correlation between Y and N in the short-run. If you need a microfoundation that’s easy – it’s called “sticky prices”.

N (and NT) is exogenous in the model and is of course determined by the central bank. And yes, yes N=MV where  M is the money and V is velocity.

In the short run P is “sticky” and N determines Y. Hence, the Sumnerian Phillips curve is upward sloping.

If you want a financial sector in the model we need to re-formulate it all in growth rates and we can introduce rational expectations. That not really overly complicated. Bond yield is a function of expected growth nominal GDP over a given period and so is stock prices.

In the long-run money is neutral so Y=Y* …so if you need a model for Y* you just go for a normal Solow growth model (or whatever you need…). I the long run the Sumnerian Phillips curve becomes vertical.

It don’t have to be more complicated than that…

That said, I think it is very important to demand to see people’s models. In fact I often challenge people to exactly spell out the model people have in their heads. That will show the inconsistencies in their arguments (the Austrian Business Cycle model is for example impossible to put on equations exactly because it is inconsistent). Mostly it turns out that people are doing national accouting economics and there is no money in their models – and if there is money in the model they do not have a explicit modeling of the central bank’s reaction function. So Scott you are certainly wrong when you tell of to get rid of the models. The problem is that far too many economists and especially central bankers are not spelling out their models and their reaction functions. I would love to see the kind of model that make the ECB think that monetary policy is easy in the euro zone…

That damn loss function

Scott further complains:

“Some general equilibrium models are used to find which stabilization policy regime is optimal from a welfare perspective.  Most of these models assume some sort of wage/price stickiness.  And 100% of the models taken seriously in the real world assume wage/price stickiness.  The problem is that there are many types of wage and price stickiness, and many ways of modeling the problem.  You can get pretty much whatever policy implication you want with the right set of assumptions.  Unfortunately, macroeconomists aren’t able to prove which model is best.  I think that’s because lots of models are partly true, and the extent to which specific assumptions are true depends on which country you are looking at, as well as which time period.  And then there’s the Lucas Critique.”

Translated this mean that implicit in most New Keynesian models is a assumption about the the central bank minimizing some sort of “loss function”. The problem with that is that assumes that there is some kind of representative agent. In terms of welfare analysis of monetary policy rules that is a massive problem – any Austrian economist would (rightly) tell you so and so would David Eagle. See my earlier post on the that damn “loss function” here.

Scott has one more complaint:

“To summarize, despite all the advances in modern macro, there is no model that anyone can point to that “proves” any particular policy target is superior to NGDPLT.  There might be a superior target (indeed I suspect a nominal wage target would be superior.)  But it can’t be shown with a model.  All we can do is construct a model that has that superiority built in by design.”

Scott, I am disappointed. Haven’t you read the insights of David Eagle? David has done excellent work on why NGDPLT Pareto dominates Price Level Targeting and inflation targeting. See here and here and here. Evan Koeing of course makes a similar point. And yes, neither David nor Evan use a “loss function”. They use proper welfare theory.

Anyway, no reason to be worried about models – they just need to be the right ones and the biggest complaint against most New Keynesian models is the problematic assumption about the representative agent. And then of course New Keynesian models have a very rudimentary formulation of asset markets, but that is easy to get around.

PS I am sure Scott would not disagree with much what I just wrote and I am frankly as frustrated with “models” that are used exactly because they are fancy rather because they make economic sense.

Selgin and Eagle should be best friends

David Eagle has a comment on Integral’s piece on Evan Koeing. Here is some of the comment:

“This is my first comment, Integral’s review states that Koenig “notes that since nominal debts are paid out of nominal income, any adverse shock to income will lead to financial disruption, not just shocks to the price level.” This drew my attention for reasons I will state in a moment so I looked at what Koenig wrote on p. 1, which is “Households and firms obligated to make fixed nominal payments are exposed to financial stress whenever nominal income flows deteriorate relative to expectations extant when the obligations were accepted, independent of whether the deterioration is due to lower-than-expected inflation or to lower-than-expected real income growth.” Both of these statements seem to indicate that the financial distress from an aggregate-supply shock is due to the income being in nominal form. I disagree; the financial distress related to aggregate-supply shocks will occur on average to people regardless whether their income is in real terms or nominal terms. The reason is because real aggregate supply is basically also real income. If real aggregate supply falls so must real income and so must average real income, by the same proportion. Hence what happens to a household’s income on average is the same whether the income is in real or nominal terms. Now we look at two households A and B where B is making a nominal payment to A. Also, assume that these households are average in the sense that both of their real incomes not including this nominal payment change proportionately to real aggregate supply as they do in Koenig’s model. Under successful price-level or inflation targeting, the real value of that nominal payment will be unchanged. Hence household B will be squeezed between his declining real income and the constant real payment he must make to A. On the other hand, while A is only exposed to her own real income declining, not the real value of the payment she is receiving from B. Therefore, under price-level or inflation targeting, the payer of the nominal payments absorbs more of the aggregate-supply risk than does the receiver.”

Note especially the bold part. Here is George Selgin in “Less than Zero” (page 41-42):

“… if the price level is kept constant in the face of unexpected improvements in productivity, readily adjusted money incomes, including profits, dividends,and some wage /payments, will increase; and recipients of these flexible money payments will benefit from the improvements in real output. Creditors, however, will not be allowed to reap any gains from the same improvements, as debtors’ real interest payments will not increase despite a general improvement in real earnings. Although an unchanged price level does fulfil creditors’ price-level expectations, creditors may still regret having engaged in fixed nominal contracts, rightly sensing that they have missed out on their share of an all-around advance of real earnings, which share they might have been able to insist upon had they (and debtors also) known about the improvement in productivity in advance.

Now imagine instead that the price level is allowed to fall in response to improvements in productivity. Creditors will automatically enjoy a share of the improvements, while debtors will have no reason to complain: although the real value of the debtors’ obligations does rise, so does their real income, while the nominal payments burden borne by debtors is unchanged. Debtors can, in other words, afford to pay higher real rates of interest; they might therefore, for all we know, have been quite happy to agree to the’ same fixed nominal interest rate had both they and creditors been equipped with perfect foresight. Therefore the debtors’ only possible cause for regretting the (unexpected) drop in prices is their missed opportunity to benefit from an alternative (zero inflation) that would in this case have given them an artificial advantage over creditors.” 

It seems to me that David and George more or less have the same model in their heads…what do you think?

The Integral Reviews: Paper 1 – Koenig (2011)

I am always open to accept different guest blogs and I therefore very happy that “Integral” has accepted my invitation to do a number of reviews of different papers that are relevant for the discussion of monetary theory and the development of Market Monetarism.

“Integral” is a regular commentator on the Market Monetarist blogs. Integral is a pseudonym and I am familiar with his identity.

We start our series with Integral’s review of Evan Koeing’s paper “Monetary Policy, Financial Stability, and the Distribution of Risk”. I recently also wrote a short (too short) comment on the paper so I am happy to see Integral elaborating on the paper, which I believe is a very important contribution to the discussion about NGDP level targeting. Marcus Nunes has also earlier commented on the paper.

Lars Christensen

The Integral Reviews: Papers 1 – Koenig (2011)
By “Integral”

Reviewed: Evan F. Koenig, “Monetary Policy, Financial Stability, and the Distribution of Risk.” FRB Dallas Working Paper No.1111

Consider the typical debt-deflation storyline. An adverse shock pushes the price level down (relative to expected trend) and increases consumers’ real debt load. This leads to defaults, liquidation, and general disruption of credit markets. This is often-times used as justification for the central bank to target inflation or the price level, to mitigate the effect of such shocks on financial markets.

Koenig takes a twist on this view that is quite at home to Market Monetarists: he notes that since nominal debts are paid out of nominal income, any adverse shock to income will lead to financial disruption, not just shocks to the price level. One conclusion he draws out is that the central bank can target nominal income to insulate the economy against debt-deflation spirals.

He also makes a theoretical point that will resonate well with Lars’ discussion of David Eagle’s work. Recall that Eagle views NGDP targeting as the optimal way to prevent the “monetary veil” from damaging the underlying “real” economy, which he views as an Arrow-Debreu type general equilibrium economy. Koenig makes a similar observation with respect to financial risk (debt-deflation) and in particular the distribution of risk.

In a world with complete, perfect capital markets, agents will sign Arrow-Debreu state-contingent contracts to fully insure themselves against future risk (think shocks). Money is a veil in the sense that fluctuations in the price level, and monetary policy more generally, have no effect on the distribution of risk. However, the real world is much incomplete in this regard and it is difficult to imagine that one could perfectly insure against future income, price, or nominal income uncertainty. Koenig thus dispenses of complete Arrow-Debreau contracts and introduces a single debt instrument, a nominal bond. This is where the central bank comes in.

Koenig considers two policy regimes: one in which the central bank commits to a pre-announced price-level target and one in which the central bank commits to a pre-announced nominal-income target. While the price-level target neutralizes uncertainty about the future price level, it provides no insulation against fluctuations in future output. He shows that a price level target will have adverse distributional consequences: harming debtors but helping creditors. Note that this is exactly the outcome that a price-level target is supposed to avoid. By contrast a central bank policy of targeting NGDP fully insulates the economy from the combination of price and income fluctuations. It will not only have no adverse distributional consequences, it obtain a consumption pattern across debtors and creditors which is identical to that which is obtained when capital markets are complete.

At an empirical level, Koenig documents that loan delinquency is more closely related to surprise changes in NGDP than in P, providing corroborating evidence that it is nominal income, not the price level, which matters for thinking about the sustainability of the nominal debt load.

Koenig’s conclusion is succinct:

“If there are complete markets in contingent claims, so that agents can insure themselves against fluctuations in aggregate output and the price level, then “money is a veil” as far as the allocation of risk is concerned: It doesn’t matter whether the monetary authority allows random variation in the price level or nominal value of output. If such insurance is not available, monetary policy will affect the allocation of risk. When debt obligations are fixed in nominal terms, a price-level target eliminates one source of risk (price-level shocks), but shifts the other risk (real output shocks) disproportionately onto debtors. A more balanced risk allocation is achieved by allowing the price level to move opposite to real output. An example is presented in which the risk allocation achieved by a nominal-income target reproduces exactly the allocation observed with complete capital markets. Empirically, measures of financial stress are much more strongly related to nominal-GDP surprises than to inflation surprises. These theoretical and empirical results call into question the debt-deflation argument for a price-level or inflation target. More generally, they point to the danger of evaluating alternative monetary policy rules using representative-agent models that have no meaningful role for debt.”

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