All posts tagged Nominal Income Targeting

Don’t forget the ”Market” in Market Monetarism

As traditional monetarists Market Monetarists see money as being at the centre of macroeconomic discussion. To us both inflation and recessions are monetary phenomena. If central banks print too much money we get inflation and if they print to little money we get recession or even depression.

This is often at the centre of the arguments made by Market Monetarists. However, we are exactly Market Monetarists because we have a broader view of monetary policy than traditional monetarists. We deeply believe in markets as the best “information system” – also about the stance of monetary policy. Even though we certainly do not disregard the value of studying monetary supply numbers we believe that the best indicator(s) of monetary policy stance is market pricing in currency markets, commodity markets, fixed income markets and equity markets. Hence, we believe in a Market Approach to monetary policy in the tradition of for example of “Manley” Johnson and Robert Keheler.

In fact we want to take out both the “central” and “banking” out of central banking and ideally replace monetary policy makers with the power of the market. Scott Sumner has suggested that the central banks should use NGDP futures in the conduct of monetary policy. In Scott’s set-up monetary policy ideally becomes “endogenous”. I on my part have suggested the use of prediction markets in the conduct of monetary policy.

Sometimes the Market Monetarist position is misunderstood to be a monetary version of (vulgar) discretionary Keynesianism. However, Market Monetarists are advocating the exact opposite thing. We strongly believe that monetary policy should be based on rules rather than discretion. Ideally we would prefer that the money supply was completely market based so that velocity would move inversely to the money supply to ensure a stable NGDP level. See my earlier post “NGDP targeting is not a Keynesian business cycle policy”

Even though Market Monetarists do not necessarily advocate Free Banking there is no doubt that Market Monetarist theory is closely related to the thinking of Free Banking theorist such as George Selgin and I have early argued that NGDP level targeting could be see as “privatisation strategy”. A less ambitious interpretation of Market Monetarism is certainly also possible, but no matter what Market Monetarists stress the importance of markets – both in analysing monetary policy and in the conduct monetary policy.

—-

See also my earlier post from today on a related topic.

13 Comments
by Lars Christensen on January 13, 2012  •  Permalink
Posted in Free Banking, George Selgin, Monetary institutions, Monetary policy, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Scott Sumner
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Posted by Lars Christensen on January 13, 2012

https://marketmonetarist.com/2012/01/13/dont-forget-the-market-in-market-monetarism/

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

Welcome to David Eagle

I am extremely happy that professor David Eagle have accepted to write a series of guest blogs on my blog. I only recently became aware of David’s impressive research, but consider it to be truly original and in my view his research presents an extremely strong theoretical and empirical case for Nominal GDP level targeting, which of course is at the core of Market Monetarist thinking.

I have already written a number of posts on David’s research and even tried to elaborate on his research specifically in terms of suggesting a method – based on David’s research – to decompose inflation between demand inflation and supply inflation based on what I strongly inspired by David has termed a Quasi-Real Price Index (QRPI) and it is my hope that my invitation to David to write the guest blogs will help give exposure to his very interesting research. Furthermore, I hope that other researchers will be inspired by David’s truly path-breaking research to conduct research into the advantages of NGDP level targeting and related topics.

So once again, thank you David. It is an honour to host your guest blogs.

Lars Christensen  

 

Why I Support NGDP Targeting

By David Eagle

Nominal GDP (NGDP) represents the total spending in the economy, which in essence is the total aggregate demand in the economy.  The term “nominal” means that we ignore the effect of inflation on the value of the spending.  If we adjust for the effect of inflation, we then get a “real” value.  In particular, real GDP (RGDP) represents the total spending adjusted for the effect of inflation on the purchasing power of that spending.  RGDP also represents the conventional measure of total real supply in the economy because usually demand equals supply in a free economy.  I believe that, for most contingencies in the economy, both monetary policy and fiscal policy (as far as its aggregate-spending effects) should focus on targeting the total spending in the economy as measured by NGDP.  That way we will (i) reduce the prolonged high unemployment that has usually followed past recessions, (ii) minimize the demand-caused inflation uncertainties people experience while maintaining the role inflation or deflation plays in the sharing of aggregate-supply risk, (iii) reduce the likelihood of the economy experiencing a liquidity trap, and (iv) eliminate the “stimulate-the-economy” excuse for perpetual fiscal deficits when NGDP is at or above its target.

While I support nominal-GDP targeting (NT), I do not support nominal-GDP-growth-rate targeting (ΔNT).  I have long been an opponent of inflation targeting (IT), and I view ΔNT to be almost as bad as IT.  Both ΔNT and IT expose the economy to negative NGDP base drift, which is the source of several economic problems: (i) prolonged unemployment following recessions, (ii) greater uncertainty for borrowers, lenders, and other payers and receivers of fixed nominal future payments, and (iii) price-level indeterminacy, which can manifest itself in a liquidity trap like what many central banks throughout the world are currently facing.

I also am an opponent of price-level targeting (PLT) even though the NGDP base drift under PLT will be substantially less than under IT.  The reason is because Pareto efficiency requires people with average relative risk aversion to proportionately share in the risks of changes in real aggregate output.  Nominal contracts under NT naturally lead to this proportionate sharing.  However, PLT circumvents that proportionate sharing so that borrowers and other payers of fixed nominal payments absorb all the aggregate-supply risk of those payments in order to protect lenders and other receivers of fixed nominal payments from this risk.

I find that NT Pareto dominates PLT, IT, and ΔNT.  The only reason why NT is not Pareto efficient is a central bank cannot always meet its NGDP target.  I also find through empirical simulations that NT can eliminate the vast majority of the higher-than-normal, long-term unemployment that has usually plagued our economies following recessions.  Hence, I look at NT as the most desirable targeting regime from both a theoretical, Pareto-efficiency standpoint and from an empirical standpoint.

In the upcoming weeks, I plan to write several more guest blogs for “The Market Monetarist” to explain the theoretical and empirical justification for the points I have made in this introduction.  In some cases I will explain the full basis for that justification; in other cases, I will refer to other papers I or others have written.  My proposed blogs (which may change as I write this blogs) are as follows:

  1. Understanding NGAP, NGDP Base Drift, and Growth Vs. Level Targeting
  2. The Two Fundamental Welfare Principles of Monetary Economics
  3. Why Price-Level Targeting Pareto Dominates Inflation Targeting
  4. NGDP Base Drift – Why Recessions are followed by Prolonged High Unemployment
  5. NGDP Base Drift, Price Indeterminacy, and the Liquidity Trap
  6. Three Reasons to Target the Level of rather than the Growth Rate of Nominal GDP

My second blog will use examples to explain the concepts of NGAP, NGDP base drift, and the difference between targeting the level of NGDP and Targeting the growth rate of Nominal GDP.  This blog will also summarize the difference between price-level targeting and inflation targeting, and discuss the concepts of PGAP and price-level base drift.

© Copyright (2012) David Eagle

 

11 Comments
by Lars Christensen on January 5, 2012  •  Permalink
Posted in David Eagle, Guest blog, MM Research agenda, Monetary institutions, Monetary policy, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Quasi-Real Indexing, Quasi-Real Price Index, Reading recommendations
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Posted by Lars Christensen on January 5, 2012

https://marketmonetarist.com/2012/01/05/guest-post-why-i-support-ngdp-targeting-by-david-eagle/

Ambrose Evans-Pritchard once again endorses Market Monetarism

Here is the Daily Telegraph’s Ambrose Evans-Pritchard:

“Central banks have the means to prevent a 1930s outcome, even with rates at zero, if willing to deploy Fisher-Friedman monetary stimulus with conviction, buying assets from non-banks and targeting nominal GDP growth of 5pc. But policy defeatism is in the air, and Austro-liquidationists are winning the popular debate.”

Ambrose continue to be the most outspooken British commentator in favour of NGDP targeting – Market Monetarist style.

See also my earlier post on Ambrose’s views.

 

5 Comments
by Lars Christensen on January 3, 2012  •  Permalink
Posted in Ambrose Evans-Pritchard, NGDP Targeting, Nominal Income Targeting
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Posted by Lars Christensen on January 3, 2012

https://marketmonetarist.com/2012/01/03/ambrose-evans-pritchard-once-again-endorses-market-monetarism/

NGDP targeting would have prevented the Asian crisis

I have written a bit about boom, bust and bubbles recently. Not because I think we are heading for a new bubble – I think we are far from that – but because I am trying to explain why bubbles emerge and what role monetary policy plays in these bubbles. Furthermore, I have tried to demonstrate that my decomposition of inflation between supply inflation and demand inflation based on an Quasi-Real Price Index is useful in spotting bubbles and as a guide for monetary policy.

For the fun of it I have tried to look at what role “relative inflation” played in the run up to the Asian crisis in 1997. We can define “relative inflation” as situation where headline inflation is kept down by a positive supply shock (supply deflation), which “allow” the monetary authorities to pursue a easy monetary policies that spurs demand inflation.

Thailand was the first country to be hit by the crisis in 1997 where the country was forced to give up it’s fixed exchange rate policy. As the graph below shows the risks of boom-bust would have been clearly visible if one had observed the relative inflation in Thailand in the years just prior to the crisis.

When Prem Tinsulanonda became Thai Prime Minister in 1980 he started to implement economic reforms and most importantly he opened the Thai economy to trade and investments. That undoubtedly had a positive effect on the supply side of the Thai economy. This is quite visible in the decomposition of the inflation. From around 1987 to 1995 Thailand experience very significant supply deflation. Hence, if the Thai central bank had pursued a nominal income target or a Selgin style productivity norm then inflation would have been significantly lower than was the case. Thailand, however, had a fixed exchange rate policy and that meant that the supply deflation was “counteracted” by a significant increase in demand inflation in the 10 years prior to the crisis in 1997.

In my view this overly loose monetary policy was at the core of the Thai boom, but why did investors not react to the strongly inflationary pressures earlier? As I have argued earlier loose monetary policy on its own is probably not enough to create bubbles and other factors need to be in play as well – most notably the moral hazard.

Few people remember it today, but the Thai devaluation in 1997 was not completely unexpected. In fact in the years ahead of the ’97-devaluation there had been considerably worries expressed by international investors about the bubble signs in the Thai economy. However, the majority of investors decided – rightly or wrongly – ignore or downplay these risks and that might be due to moral hazard. Robert Hetzel has suggested that the US bailout of Mexico after the so-called Tequila crisis of 1994 might have convinced investors that the US and the IMF would come to the rescue of key US allies if they where to get into economic troubles. Thailand then and now undoubtedly is a key US ally in South East Asia.

What comes after the bust?

After boom comes bust it is said, but does that also mean that a country that have experience a bubble will have to go through years of misery as a result of this? I am certainly not an Austrian in that regard. Rather in my view there is a natural adjustment when a bubble bursts, as was the case in Thailand in 1997. However, if the central bank allow monetary conditions to be tightened as the crisis plays out that will undoubtedly worsen the crisis and lead to a forced and unnecessarily debt-deflation – what Hayek called a secondary deflation. In the case of Thailand the fixed exchange rate regime was given up and that eventually lead to a loosening of monetary conditions that pulled the

NGDP targeting reduces the risk of bubbles and ensures a more swift recovery

One thing is how to react to the bubble bursting – another thing is, however, to avoid the bubble in the first place. Market Monetarists in favour NGDP level targeting and at the moment Market Monetarists are often seen to be in favour of easier monetary policy (at least for the US and the euro zone). However, what would have happened if Thailand had had a NGDP level-targeting regime in place when the bubble started to get out of hand in 1988 instead of the fixed exchange rate regime?

The graph below illustrates this. I have assumed that the Thailand central bank had targeted a NGDP growth path level of 10% (5% inflation + 5% RGDP growth). This was more or less the NGDP growth in from 1980 to 1987. The graph shows that the actually NGDP level increased well above the “target” in 1988-1989. Under a NGDP target rule the Thai central bank would have tightened monetary policy significantly in 1988, but given the fixed exchange rate policy the central bank did not curb the “automatic” monetary easing that followed from the combination of the pegged exchange rate policy and the positive supply shocks.

The graph also show that had the NGDP target been in place when the crisis hit then NGDP would have been allowed to drop more or less in line with what we actually saw. Since 2001-2 Thai NGDP has been more or less back to the pre-crisis NGDP trend. In that sense one can say that the Thai monetary policy response to the crisis was better than was the case in the US and the euro zone after 2008 – NGDP never dropped below the pre-boom trend. That said, the bubble had been rather extreme with the NGDP level rising to more than 40% above the assumed “target” in 1996 and as a result the “necessary” NGDP was very large. That said, the NGDP “gap” would never have become this large if there had been a NGDP target in place to begin with.

My conclusion is that NGDP targeting is not a policy only for crisis, but it is certainly also a policy that significantly reduces the risk of bubbles. So when some argue that NGDP targeting increases the risks of bubble the answer from Market Monetarists must be that we likely would not have seen a Thai boom-bust if the Thai central bank had had NGDP target in the 1990s.

No balance sheet recession in Thailand – despite a massive bubble

It is often being argued that the global economy is heading for a “New Normal” – a period of low trend-growth – caused by a “balance sheet” recession as the world goes through a necessary deleveraging. I am very sceptical about this and have commented on it before and I think that Thai experience shows pretty clearly that we a long-term balance sheet recession will have to follow after a bubble comes to an end. Hence, even though we saw significant demand deflation in Thailand after the bubble busted NGDP never fell below the pre-boom NGDP trend. This is pretty remarkable when the situation is compared to what we saw in Europe and the US in 2008-9 where NGDP was allowed to drop well below the early trend and in that regard it should be noted that Thai boom was far more extreme that was the case in the US or Europe for that matter.

1 Comment
by Lars Christensen on January 3, 2012  •  Permalink
Posted in Austrian economics, Bubbles, David Eagle, Deflation, Economic and monetary history, Emerging Markets, Exchange rate policy, George Selgin, Hayek, Inflation, MM Research agenda, Monetary institutions, Monetary policy, NGDP Targeting, Nominal Income Targeting, Productivity Norm, Quasi-Real Indexing, Quasi-Real Price Index, Robert Hetzel
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Posted by Lars Christensen on January 3, 2012

https://marketmonetarist.com/2012/01/03/ngdp-targeting-would-have-prevented-the-asian-crisis/

Guess what Greenspan said on November 17 1992

This is then Federal Reserve chairman Alan Greenspan at the meeting of the Federal Open Market Committee on November 1992:

“Let me put it to you this way. If you ask whether we are confirming our view to contain the success that we’ve had to date on inflation, the answer is “yes.” I think that policy is implicit among the members of this Committee, and the specific instruments that we may be using or not using are really a quite secondary question. As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions. I would say in that context that on the basis of the studies, we have seen that to drive nominal GDP, let’s assume at 4-1/2 percent, in our old philosophy we would have said that [requires] a 4-1/2 percent growth in M2. In today’s analysis, we would say it’s significantly less than that. I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that. And I don’t see any change in our view…and we will know they are convinced (about “price stability”) when we see the 30-year Treasury at 5-1/2 percent.“

So in 1992 the chairman of the Federal Reserve was targeting 4.5% NGDP growth and 30-years yields at 5.5% and calling it “price stability”. Imagine Ben Bernanke would announce tomorrow that he would conduct open market operations until he achieved the exact same target(s)?

PS I got this from Robert Hetzel’s great book on the history of the Fed “Monetary Policy of the Federal Reserve – A History”.

 


11 Comments
by Lars Christensen on December 30, 2011  •  Permalink
Posted in Alan Greenspan, Federal Reserve, Monetary policy, NGDP Targeting, Nominal Income Targeting, Robert Hetzel
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Posted by Lars Christensen on December 30, 2011

https://marketmonetarist.com/2011/12/30/guess-what-greenspan-said-on-november-17-1992/

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.”

22 Comments
by Lars Christensen on December 27, 2011  •  Permalink
Posted in "Integral", David Eagle, Evan Koeing, MM Research agenda, Monetary policy, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Reading recommendations
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Posted by Lars Christensen on December 27, 2011

https://marketmonetarist.com/2011/12/27/the-integral-reviews-paper-1-koenig-2011/

Monetary policy can’t fix all problems

You say that when you have a hammer everything looks like a nail. Reading the Market Monetarist blogs including my own one could easing come to the conclusion that we are the “hammer boys” that scream at any problem out there “NGDP targeting will fix it!” However, nothing can be further from the truth.

Unlike keynesians Market Monetarists do think that monetary policy should be used to “solve” some problems with “market failure”. Rather we believe that monetary policy should avoid creating problems on it own. That is why we want central banks to follow a clearly defined policy rule and as we think recessions as well as bad inflation/deflation (primarily) are results of misguided monetary policies rather than of market failures we don’t think of monetary policy as a hammer.

Rather we believe in 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“

So monetary policy determines nominal variables – nominal spending/NGDP, nominal wages, the price level, exchange rates and inflation. We also clearly acknowledges that monetary policy can have real impact – in the short-run the Phillips curve is not vertical so monetary policy can push real GDP above the structural level of GDP and reduce unemployment temporarily. But the long-run Phillips curve certainly is vertical. However, unlike Keynesians we do not see a need to “play” this short-term trade off. It is correct that NGDP targeting probably also would be very helpful in a New Keynesian world, however, we are not starting our analysis at some “social welfare function” that needs to be maximized – there is not a Phillips curve trade off on which policy makers should choose some “optimal” combination of inflation and unemployment – as for example John Taylor basically claims. In that sense Market Monetarists certainly have much more faith in the power of the free market than John Talyor (and that might come to a surprise to conservative and libertarian critics of Market Monetarism…).

What we, however, do indeed argue is that if you commit mistakes you fix it yourself and that also goes for central banks. So if a central bank directly or indirectly (through it’s historical actions) has promised to deliver a certain nominal target then it better deliver and if it fails to do so it better correct the mistake as soon as possible. So when the Federal Reserve through its actions during the Great Moderation basically committed itself and “promised” to US households, corporations and institutions etc. that it would deliver 5% NGDP growth year in and year out and then suddenly failed to so in 2008/9 then it committed a policy mistake. It was not a market failure, but rather a failure of monetary policy. That failure the Fed obviously need to undo. So when Market Monetarists have called for the Fed to lift NGDP back to the pre-crisis trend then it is not some kind of vulgar-keynesian we-will-save-you-all policy, but rather it is about the undoing the mistakes of the past. Monetary policy is not about “stimulus”, but about ensuring a stable nominal framework in which economic agents can make their decisions.

Therefore we want monetary policy to be “neutral” and therefore also in a sense we want monetary policy to become invisible. Monetary policy should be conducted in such a way that investors and households make their investment and consumption decisions as if they lived in a Arrow-Debreu world or at least in a world free of monetary distortions. That also means that the purpose of monetary policy is NOT save investors and other that have made the wrong decisions. Monetary policy is and should not be some bail out mechanism.

Furthermore, central banks should not act as lenders-of-last-resort for governments. Governments should fund its deficits in the free markets and if that is not possible then the governments will have to tighten fiscal policy. That should be very clear. However, monetary policy should not be used as a political hammer by central banks to force governments to implement “reforms”. Monetary policy should be neutral – also in regard to the political decision process. Central banks should not solve budget problems, but central banks should not create fiscal pressures by allowing NGDP to drop significantly below the target level. It seems like certain central banks have a hard time separating this two issues.

Monetary policy should not be used to puncture bubbles either. However, some us – for example David Beckworth and myself – do believe that overly easy monetary policy under some circumstances can create bubbles, but here it is again about avoiding creating problems rather about solving problems. Hence, if the central bank just targets a growth path for the NGDP level then the risk of bubbles are greatly reduced and should they anyway emerge then it should not be task of monetary policy to solve that problem.

Monetary policy can not increase productivity in the economy. Of course productivity growth is likely to be higher in an economy with monetary stability and a high degree of predictability than in an economy with an erratic conduct of monetary policy. But other than securing a “neutral” monetary policy the central bank can not and should not do anything else to enhance the general level of wealth and welfare.

So monetary policy and NGDP level targeting are not some hammers to use to solve all kind of actual and perceived problems, but  who really needs a hammer when you got Chuck Norris?

——
Marcus Nunes has a related comment, but from a different perspective.

13 Comments
by Lars Christensen on December 22, 2011  •  Permalink
Posted in Bubbles, Chuck Norris, Chuck Norris Effect, David Beckworth, Federal Reserve, Financial markets, George Selgin, MM Research agenda, Monetary institutions, Monetary policy, NGDP Targeting, Nominal Income Targeting, Selgin's Monetary Credo
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Posted by Lars Christensen on December 22, 2011

https://marketmonetarist.com/2011/12/22/monetary-policy-cant-fix-all-problems/

Defining central bank credibility

In a comment to my previous post on QE and NGDP targeting Joseph Ward argues that the Federal Reserve has “relatively solid central bank credibility”. The question is of course how to define central bank credibility.

To me a central bank is credible if the markets (and the general public) expect the central bank to hit the targets it have. The problem of course for the Fed is that it does not have a target. That makes it pretty hard to say whether it is credible or not.

Another way of saying whether a central bank is credible or not is to look at the predictability of nominal variables: money suppy, velocity, nominal wages, prices, inflation, NGDP, the exchange rates etc. I am pretty sure that if you estimate of example simple AR-models for these variables you will see the error-term in the models has exploded since 2008. I must, however, say I am guessing here. but I am pretty sure I am right – maybe an econometrician out there would try to estimate it?

In the case of the ECB the collapse in credibility is pretty clear. The ECB used to have a two-pillar policy – targeting directly or indirectly M3 growth and inflation. Judging from market expectations for medium term inflation the credibility is not good – in fact it has never been this bad. Medium-term inflation expectations are well-below the 2% inflation target. In terms of M3 the ECB has normally targeted a reference rate around 4.5% y/y. The actual growth rate on M3 is much below this “target”.

HOWEVER, if the central banks were indeed so credible then the markets should fully believe any nominal target they would announce. So if the Fed is 100% credible and announce that it will increase NGDP by 15% over the coming two years then there should be no problem meeting this target – without printing more money. What would happen is the money-velocity would jump, which with an unchanged money supply would increase NGDP.

During the Great Moderation there was a very high degree of negative correlation between M and V growth in the US. This indicates in my view that markets expected the Fed to meet a NGDP “target” and in that sense monetary policy became endogenous – pretty much in the same way as in a Selgin-White Free Banking model.

4 Comments
by Lars Christensen on December 14, 2011  •  Permalink
Posted in Chuck Norris, Monetary institutions, Monetary policy, Monetary policy rules, MV=PY, NGDP Targeting, Nominal Income Targeting, The Great Moderation
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Posted by Lars Christensen on December 14, 2011

https://marketmonetarist.com/2011/12/14/defining-central-bank-credibility/

How much QE is needed with a NGDP target?

Today I got an interesting question: “does NGDP targeting equate to more quantitative easing (QE) of monetary policy?”.

The simple answer is that it all depends on Chuck Norris, or rather on the Chuck Norris effect. I have earlier defined the Chuck Norris effect in the following way:

“You don’t have to print more money to ease monetary policy if you are a credible central bank with a credible target.”

Let’s say we have a central bank – for example the Federal Reserve that tomorrow announces a target for the level of nominal GDP (NGDP) 15% higher than the present level and that it will hit that target within 24 months.

The “clever” reader would of course ask how you can achieve that target with interest rates at near zero. Well, through quantitative easing, of course – by printing money. Or rather by increasing the supply of money more than the demand for money.

So the relevant measure is not the supply of money, but rather the supply of money relative to demand for the dollar. The demand for money of course is extremely dependent on the expectation of the future value of money.

So let’s assume that the announcement of the +15% NGDP level target is credible – what would happen? This announcement would effectively mean that the central bank would try to reduce the purchasing power of the money it issues, which effectively of course would equate to “burning” households and companies cash holdings. If we know that the value of cash we have today will be worth less tomorrow we would course do everything to get rid of that cash – that goes for households, banks, companies and institutions.

This is key for how the transmission mechanism works under credible NGDP level targeting. The expectation of a 15% increase in NGDP would cause de-hoarding of cash, which is the same as to say that private consumption and investments would increase, banks would increase lending (ease credit conditions) and the currency would weaken, which would spur exports. This would automatically lead to an increase in NGDP.

Hence, if the Chuck Norris effect is strong enough then the central bank could achieve its NGDP target without undertaking any QE at all.

In the “real world” it is unlikely that any central bank will be able to raise NGDP by 15% without actually increasing money supply. After all, the problem in the present crisis is exactly that the major central banks of the world are lacking credibility about their targets – otherwise for example market expectations in the eurozone would not be below 2%. Therefore, to get the needed credibility the central bank would probably need to announce clearly that it would undertake unlimited amounts of QE if needed to achieve its +15% NGDP target level and probably also define through which channel the increase in the money supply would occur – for example, through the buying of foreign currency (which in our view would probably be the most effective as you would circumvent the crisis-hit banking sector), or through buying or government or corporate bonds, etc.

However, if this were done it is likely that the goal of lifting NGDP by 15% could be achieved by printing significantly less “extra” money than if it simply implemented QE without a clear target of what it wants to achieve. So once again, the central banks need to call in Chuck Norris. It’s all about the anchoring of expectations and you will only achieve this by announcing a credit NGDP and credible strategy of how to achieve it.

7 Comments
by Lars Christensen on December 13, 2011  •  Permalink
Posted in Chuck Norris, Chuck Norris Effect, Monetary institutions, Monetary policy, NGDP Targeting, Nominal Income Targeting, Transmission mechanism
Tagged , , ,

Posted by Lars Christensen on December 13, 2011

https://marketmonetarist.com/2011/12/13/how-much-qe-is-needed-with-a-ngdp-target/

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

I have recently been giving a lot of attention to the work of David Eagle and his Arrow-Debreu based analysis of monetary policy rules. This is because I think David’s work provides a microfoundation for Market Monetarism and adds new dimensions to the discussion about NGDP targeting – particularly in regard to financial stability.

I have now come across a paper that is using a similar model as David’s model. However, this might be a slightly more interesting for the conspiratorial types as this paper is written by a Federal Reserve economist – Evan F. Koeing of the Federal Reserve Bank of Dallas.

Here is that abstract of Koeing’s paper “Monetary Policy, Financial Stability, and the Distribution of Risk”:

“In an economy in which debt obligations are fixed in nominal terms, but there are otherwise no nominal rigidities, a monetary policy that targets inflation inefficiently concentrates risk, tending to increase the financial distress that accompanies adverse real shocks. Nominal- income targeting spreads risk more evenly across borrowers and lenders, reproducing the equilibrium that one would observe if there were perfect capital markets. Empirically, inflation surprises have no independent influence on measures of financial strain once one controls for shocks to nominal GDP.”

This paper obviously is highly relevant and as the euro crisis just keeps getting worse day-by-day we can always hope that some influential European policy makers read this paper.

After all the euro crisis is mostly a monetary crisis rather than a fiscal crisis – which David Beckworth forcefully demonstrates in a recent comment.

HT Arash Molavi Vasséi

7 Comments
by Lars Christensen on December 11, 2011  •  Permalink
Posted in Arash Molavi Vasséi, Banking crisis, David Beckworth, David Eagle, euro crisis, Federal Reserve, NGDP Targeting, Nominal Income Targeting
Tagged , , , , , ,

Posted by Lars Christensen on December 11, 2011

https://marketmonetarist.com/2011/12/11/monetary-policy-financial-stability-and-the-distribution-of-risk/

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