All posts tagged Nominal Income Targeting

Friedman should have supported NGDP targeting, but never did

I found yet another gold nugget in David Eagle’s research:

“In 2005 at the WEAI conference in San Francisco, Milton Friedman participated in panel where he strongly endorsed IT. After the panel presentations, an economist from the audience asked Friedman how he thought the Federal Reserve should respond to a broad-based 10% drop in real GDP. After spending some time trying think about what could possibility cause such a drop, Friedman responded by saying that the Federal Reserve should respond with a 10% drop in the money supply. However, immediately thereafter, Friedman inserted, “If you ask a foolish question, you get a foolish answer.””

Eagle continues:
“We disagree with Friedman concerning the foolishness of considering unexpected deviations in real GDP because that is when NIT (NGDP targeting) diverges from PLT (Price Level Targeting). Only by considering such unexpected real deviations can we see the differences in central bank responses under IT (Inflation targeting) or PLT from NIT (which we consider to be the equivalent of Friedman’s k percent rule). According to the new equation of exchange, N=PY, if Y unexpectedly increased while N (Nominal spending) remained as expected, the price level would unexpectedly fall. Under NIT, the central bank would be content to do nothing since N is on target. However, under PLT, the central bank would try to interject funds into the monetary system to try to raise N to match the increase in Y in order to return P to its targeted level. Similarly, if Y unexpectedly decreased while N remained as expected, the price level would unexpectedly increase. Under NIT, the central bank would be content to do nothing since N is on target. However, under PLT, the central bank would try to withdraw funds to try to cause N to fall to match the decline in Y in order that the price level not change.”

Hence, shortly before his dead Friedman indirectly said that he was not in favour of NGDP targeting. In my view that is not overly surprising. At that time official inflation targeting had been a success around the world for more than a decade and Friedman undoubtedly saw it as an vindication of his view that central banks should follow rules. So as always Friedman was the pragmatic revolutionary he simply support the successfully (at that time) version of a monetary rule, but I think that was on purely pragmatic reasons. Furthermore, one have to remember that at that time the primary monetary mistakes in recent history was too loose monetary policy rather than too tight monetary policy so from a pragmatic perspective it made “sense” to support inflation targeting.

As I have earlier argued Milton Friedman also acknowledged that velocity was no longer stable and that probably moved him from the left hand side to the right hand side of equation of exchange. By the way that shows that John Taylor’s use of Friedman to criticizing NGDP targeting by stating that Friedman argued that rules should be instrument rules really does not live up to what Friedman came believe in the final years of his life. Yes, Friedman endorsed inflation targeting, but NOT the Taylor rule (See David Glasner’s excellent critique of John Taylor views here). Furthermore, acknowledging that he did not think that velocity was stable (anymore) really makes it hard to use Friedman as an argument against NGDP targeting. BUT, BUT Friedman nonetheless to the end of his life preferred inflation targeting more than anything else.

Would that have change if he had live to see the Great Recession? I really don’t know and does it really matter? I still consider myself a Friedmanite and to me the best pupil of Friedman around is Scott Sumner!

——

See also my earlier post on related topics:

Friedman provided a theory for NGDP targeting
Friedman’s thermostat and why he obviously would support a NGDP target

4 Comments
by Lars Christensen on December 7, 2011  •  Permalink
Posted in David Eagle, David Glasner, Milton Friedman, MM Research agenda, Monetary institutions, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Scott Sumner
Tagged , , , , ,

Posted by Lars Christensen on December 7, 2011

https://marketmonetarist.com/2011/12/07/friedman-should-have-supported-ngdp-targeting-but-never-did/

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

Over the last couple of days I have done a couple of posts on the work of David Eagle (and Dale Domian). I guess that there still are a few posts that could be written on this topic. This is the next one.

Even though David Eagle’s work has been focusing on what he and Dale Domian have termed Quasi-Real Indexing I believe that his work is highly relevant for Market Monetarists. In this post I will try to draw up some lessons we can learn from David Eagle’s work and how it could be relevant to formulating a more consistent micro-foundation for Market Monetarism.

There are a no recessions in a world without money

The starting point in most of Eagle’s research is an Arrow-Debreu model of the world. Similarly the starting point for Market Monetarists like Nick Rowe and Bill Woolsey is Say’s Law – that supply creates its own demand. (See for example Nick on Say’s Law here).

This starting point is a world without money and both in the A-D model and under Say’s Law there can not be recessions in the sense of general glut in the product and labour markets.

However, once money and sticky prices and wages are introduced – both by Market Monetarists and by David Eagle – then we can have recessions. Hence, for Market Monetarists and David Eagle recessions are always and everywhere a monetary phenomenon.

N=PY – the simple way to illustrate some MM positions

In a number of his papers David Eagle introduces a simplified version of the equation of exchange where he re-writes MV=PY to N=PY. Hence, Eagle sees MV not some two variables, but rather as one variable – nominal spending (N), which is under the control the central bank. This is in fact quite similar to Market Monetarists thinking. While “old” monetarists traditional have assumed that V is constant (or is “stationary”) Market Monetarists acknowledges that this position no longer can be empirically supported. That is the reason why Market Monetarists have focused on the right hand side of the equation of exchange rather than on the left hand side like “old” monetarists like Milton Friedman used to do.

I, however, think that Eagle’s simplified equation of exchange has some merit in terms of clarifying some key Market Monetarist positions.

First of all N=PY gets us from micro to macro. Hence, PY is not one price and one output, but numerous prices and outputs. If N is kept constant that is basically the Arrow-Debreu world. That illustrates the point that we need changes in N to get recessions.

Second, N=PY can be a rearranged to P=N/Y. Hence, inflation is the “outcome” of the relationship between nominal spending (N) and real GDP (Y). In terms of causality this also illustrates (but it does not necessary prove) another key Market Monetarist point, which often has been put forward by especially Scott Sumner that nominal income (N) causes P and Y and not the other way around (See here and here). This is contrary to the New Keynesian formulation of the Phillips curve, where “excessive” growth in real GDP relative to “trend” GDP increases “price pressures”.

Third, P=N/Y also illustrates that there are two sources of price changes – nominal spending (N) and supply shocks. This lead us to another key Market Monetarist position – also stressed strongly by David Eagle – that there is good and bad inflation/deflation. This is a point stressed often by David Beckworth (See here and here). David Eagle of course uses this insight to argue that normal inflation indexing is sub-optimal to what he has termed Quasi-Real Indexing (QRI). This of course is similar to why Market Monetarists prefer NGDP targeting to Price Level Targeting (and inflation targeting).

The welfare economic arguments for NGDP targeting

In an Arrow-Debreu world the allocation is Pareto optimal and with fully flexible prices and wages changes in N will have no impact on allocation and an increase or a drop in N will have no impact on economic welfare. However, if we introduce sticky prices and wages in the model then unexpected changes in N will reduce welfare in the traditional neo-classical sense. Hence, to ensure Pareto optimality we have two options.

1)   The monetary institutional set-up should ensure a stable and predictable N. We can do that with a central bank that targets the NGDP level or with a Free Banking set-up (that ensures a stable N in a perfect competition Free Banking system). Hence, while Market Monetarists mostly argue in favour of NGDP from a macroeconomic perspective David Eagle’s framework also gives a strong welfare theoretical argument for NGDP targeting.

2)   (Full) Quasi-Real Indexing (QRI) will also ensure a Pareto optimal outcome – even with stick prices and wages and changes in N. David Eagle and Dale Domian have argued that QRI could be used to “immunise” the economy from recessions. Market Monetarists (other than myself) have so far as I know now directly addressed the usefulness of QRI.

Remaining with in the simplified version of the equation of exchange (N=PY) NGDP targeting focuses on left hand side of the equation, which can be determined by monetary policy, while QRI is focused on the right hand side of the equation. Obviously with one of the two in place the other would not be needed.

In my view the main problem with QRI is that the right hand side of the equation is not just one price and one output but millions of prices and outputs and the price system plays a extremely important role in the allocation of resources in the economy. It is therefore also impossible to expect some kind of “centralised” QRI (god forbid anybody would get such an idea…). I am pretty sure that my fellow Market Monetarist bloggers feel the same way. That said, I think that QRI can useful in understanding why the drop in nominal spending (N) has had such a negative impact on RGDP in the US and other places.

Furthermore, as I stressed in an earlier post QRI might be useful in housing funding reform in the US – as suggested by David Eagle. Furthermore, it is obviously QRI based government bonds could be used in the conduct of NGDP targeting – as in line with what Scott Sumner for example has suggested and as in fact also suggested by David Eagle.

David Eagle should inspire Market Monetarists

In conclusion I think that David Eagle’s and Dale Damion’s on work on both NGDP targeting and QRI will be a useful input to the further development of the Market Monetarist paradigm and I especially think it will be helpful in a more precise description of the micro-foundation of Market Monetarism.

PS David Eagle has also done work on interest rates targeting and is highly critical of Michael Woodford’s New Keynesian perspective on monetary policy. This research is relatively technical and not easily assessable, but should surely be of interest to Market Monetarists as well.

—-

See my other posts on David Eagle and Dale Domian:
Quasi-Real indexing – indexing for Market Monetarists
A simple housing rescue package – QRI Mortgages and NGDP targeting
David Eagle on “Nominal Income Targeting for a Speedier Economic Recovery”

9 Comments
by Lars Christensen on December 4, 2011  •  Permalink
Posted in Bill Woolsey, David Beckworth, David Eagle, MM Research agenda, Monetary institutions, NGDP Targeting, Nick Rowe, Nominal Income Targeting, Quasi-Real Indexing, Reading recommendations, Say's Law, Scott Sumner
Tagged , , , , , , , , , ,

Posted by Lars Christensen on December 4, 2011

https://marketmonetarist.com/2011/12/04/david-eagles-framework-and-the-micro-foundation-of-market-monetarism/

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

I am continuing my mini-review of the research done by Dale Domian and David Eagle. The next paper in the “series” is a truly excellent paper on an empirical investigation of the impact of different monetary policy targets (inflation targeting, Price Level Targeting and Nominal Income Targeting) on the speed of recovery in the US economy.

Here is the abstract of the paper “Nominal Income Targeting for a Speedier Economic Recovery”:

“Using panelled time-series event studies of U.S. recessions since 1948, this paper studies the speed at which the unemployment rate recovers from a recession. This paper identifies recessions (such as the 1990s and 2001 recessions) as ones consistent with inflation targeting, whereas other recessions are more consistent with nominal-income targeting. We then find that the unemployment recovery time is significantly faster for those recessions consistent with nominal-income targeting than for those recessions consistent with inflation targeting. We then discuss the theoretical superiority of nominal income targeting from a Pareto-efficient micro foundations standpoint. Also, by studying the time path of nominal aggregate spending, we find definite empirical evidence of the “let bygones be bygones” property of inflation targeting.”

The paper is extremely innovative in its method. The characteristics of the three types of targeting are used to identify what type of targeting the Federal Reserve (implicitly) has used during different recessions since World War II.

It is then shown that in those recessions the Fed has targeted nominal income the recovery was speedier than in those periods when the Fed targeted inflation.

The very innovative methods in my view clearly should inspire Market Monetarists to adopt these methods in future research to test and demonstrate the merits of Nominal Income Targeting.

Furthermore, David Eagle demonstrates in a numbers of his papers that Nominal Income Targeting (NGDP targeting) is Pareto optimal. Hence, contrary to most Market Monetarists who focus on the macroeconomic advantages of NGDP Targeting Dr. Eagle demonstrates the microeconomic advantages and has a clear welfare perspective on NGDP Targeting. I think this is a tremendous strength in his (and Domian’s) research. Eagle’s and Domian’s research in many ways remind me of George Selgin’s argument for the so-called Productivity Norm.

I certainly hope that Eagle and Domian will continue to pursue research in this area (and the related area of Quasi-Real Indexing) and I hope that the future will lead to exchange of ideas between Eagle and Domian and the Market Monetarists. Maybe one day they might even join the “club”.

4 Comments
by Lars Christensen on December 3, 2011  •  Permalink
Posted in David Eagle, George Selgin, Inflation Targeting, MM Research agenda, Monetary institutions, NGDP Targeting, Nominal Income Targeting, Productivity Norm, Quasi-Real Indexing
Tagged , , , , , ,

Posted by Lars Christensen on December 3, 2011

https://marketmonetarist.com/2011/12/03/david-eagle-on-nominal-income-targeting-for-a-speedier-economic-recovery/

A simple housing rescue package – QRI Mortgages and NGDP targeting

This is from Eagle’s and Domian’s paper “Quasi-Real-Indexed Mortgages to the Rescue”:

“With the U.S. Federal Government owning so many mortgages through its bailout of Fannie Mae and Freddie Mac, there may be a unique opportunity for the government to provide a principal break to mortgage holders in return for converting the mortgages to QRIMs. Based on a old January 2009 estimate, the principal reduction would be about 7.8%. With a principal reduction of 7.8% and QRIM payments being 22% below traditional mortgage payments, we are talking about approximately 30% reduction in the monthly mortgage payments relative to the traditional mortgage payment.

Some readers might consider this a government give away. However, if the central bank was trying to target nominal aggregate demand (nominal income targeting), then the fact that nominal GDP is 7.8% below its target means that the central bank will be trying in the future to get nominal GDP back up to its nominal GDP target. To do so, the central bank will need to increase nominal GDP 7.8% in addition to the long-run growth rate in real GDP and the “targeted” inflation rate of 2.5%. Thus, if the central bank was committed to a nominal-GDP target, then if the central bank meets its target eventually, then nominal GDP will recover which means that through quasi-indexing, the principal will also recover.”

I am certainly no expert on the US housing market, but to me this seems like a great idea for a US housing rescue package.

——–

Note:

QRIMs are Quasi-Real-Indexed Mortgages which “index mortgage payments to one and only one of the two causes of inflation. That cause is aggregate-demand-caused inflation. QRIMs share an advantage of its cousin Price-Level-Adjusted Mortgages (PLAMs) in that the initial mortgage payments are smaller than with conventional mortgages making the mortgages more affordable.”  

3 Comments
by Lars Christensen on December 3, 2011  •  Permalink
Posted in David Eagle, NGDP Targeting, Nominal Income Targeting, Quasi-Real Indexing
Tagged , , , , ,

Posted by Lars Christensen on December 3, 2011

https://marketmonetarist.com/2011/12/03/a-simple-housing-rescue-package-qri-mortgages-and-ngdp-targeting/

Quasi-Real indexing – indexing for Market Monetarists

This morning when I was looking for something else on the internet I by coincidence came across Dr. David Eagle’s website. Dr. Eagle is an Associate Professor of Finance at the Eastern Washington University.

I regret to say that I had never heard of David Eagle before and I have never seen any of his research before and I had never heard about an idea that he has developed with Dr. Dale L. Domian a Professor of Finance in the School of Administrative Studies at York University. The idea is what Eagle and Domian call Quasi-Real Indexing (QRI).

I am quite delighted, however, that I have now come across Eagle’s and Domian’s research and I am happy to share some of it with my readers. I think their work on QRI will be of interest Market Monetarists and QRI could be a interesting and useful supplement to NGDP targeting.

The idea behind QRI is that normal inflation indexing of wage contacts, bonds etc. is imperfect as it does not differentiate between the causes of inflation. Hence, it is crucial whether inflation is caused by demand or supply shocks. A parallel discussion to this is George Selgin’s discussion of the so-called productivity norm, which also argues that one should differentiate between the causes of inflation (or deflation).

Here is Eagle and Domian (from the abstract in a recent working paper: “Immunizing our Economies against Recessions – A Microfoundations Investigation”)

“We find that, instead of using derivatives or expensive fiscal stimuli, we can achieve recession protection through indexing wages, mortgages, bonds, etc., to changes in nominal GDP but not to aggregate-supply-caused inflation. This type of indexing we call, “quasi-real indexing.”

Hence, the idea is to shield economic agents from swings in nominal GDP. This can be done as Market Monetarists argue with NGDP targeting (something Eagle and Domian agrees on and support), but also with QRI.

Here is a bit more on QRI (from another paper “Unsticking those Sticky Wages To Mitigate Recessions Without Expensive Fiscal Stimuli”):

”The conventional form of inflation indexing, also known as cost of living adjustments (COLAs), is based on price changes no matter what the cause… there are two and only two determinants of inflation: (1) aggregate demand as measured by nominal GDP, and (2) aggregate supply as measured by real GDP. QRI is linked to only one of these causes — nominal GDP, but not to real GDP. Because QRI is based on a cause, not the price level itself. QRI is proactive; if the price level is sticky as most economists believes, then QRI can respond to changes in nominal GDP prior to the price level being affected by those changes.”

I think this makes quite a bit of sense – and it is pretty much how Market Monetarists think.

Everything Eagle and Domian write on the topic of QRI seems to be a bit of a gold mine for Market Monetarists thinking and their modelling could be helpful in the further theoretical development of Market Monetarism. See here for example:

”Many economists may criticize QRI because it only responds to aggregate-demand-caused inflation and not to aggregate-supply-caused inflation. They may cite the almost universally accepted goal in monetary policy and macroeconomic policy of minimizing an objective function involving inflation (or the price level) and output gap (or unemployment or output). In fact, this objective function has been institutionalized into the legislative mandate for the Federal Reserve… However, that objective function, which is an ad hoc assumption of economists, has blind economists from what microfoundations says should be the objective of monetary and macroeconomic policy. Later in this paper, we present Pareto-efficiency arguments why we should only adjust for aggregate-demand-caused inflation and not for aggregate-supply caused inflation. At this point in the paper, realize that at one time medical science considered all cholesterol as bad; now they consider there to be both good cholesterol and bad cholesterol. Up to now, economists have considered any inflation above the targeted inflation rate to be bad inflation. Our view, supported by microfoundations involving Pareto efficiency is that unexpected aggregate-demand-caused inflation (or deflation) is bad but aggregate-supply-caused inflation (or deflation) is necessarily for the economy to efficiently handle the lower (or higher) supply.”

This is exactly what Market Monetarist are saying – and this discussion gives an excellent input to for example the discussion of the Taylor rule versus NGDP targeting.

There are many aspects of QRI and as I state above I have only become familiar with the topic today so I will not go in to it all in this post. However, as I see it the (for now) small literature seems very interesting and the QRI could sheet a lot of light on the advantages of NGDP targeting and it also seems like QRI could be helpful in crisis resolution in both Europe and the US. In that regard Eagle’s and Domian’s papers on QRI linked bonds seem especially of interest.

I sincerely hope that my fellow Market Monetarist bloggers will have a look at Eagle’s and Domian’s interesting work on QRI and finally I would like to quote an appeal from David Eagle’s website posted on February 26 2009:

“I write this internet note with the hope that it gets to someone with influence. That someone could be a state or other local legislator struggling with how to cut their budget. That someone could be an administrator with a federal government trying to find some way to help their economy get through the current financial debacle. That someone could be working in a bank with the task of figuring out a way to refinance mortgages to avoid foreclosures and make it more affordable for homeowners to stay in their houses. That someone could work for a firm who is struggling to meet payroll in this time of lower demand for their product. That someone could even be President Obama as he struggles with many of these issues on the macroeconomic level. All these people are looking for ways to either better deal with the current recession or help others better deal with the current recession. I write this note, because I have a solution, a cheap solution, although the solution involves a major change in how businesses, governments, workers, lenders, and borrowers deal with each other. The solution is quasi-real indexing, a type of inflation indexing Dale Domian and I have designed.
Many of you will be skeptical and will ask, “What does inflation indexing have to do with the current recession?” A quick economic lesson will answer this question for you. Remember the debate between the Keynesian economists and the classical economists in the 1930s during the Great Depression. The classical economists criticized Keynesian economics by arguing that in the long run, prices and wages will adjust to return real output to its normal level. In response, John Maynard Keynes said, “In the long run, we all are dead!” The essence of Keynesian economics is that prices and wages are sticky, especially in the downward direction. Inflation indexing can then be very relevant if that indexing causes prices and wages to adjust very quickly.

However, the current recession makes this indexing really relevant. If most contracts were quasi-real indexed, then the current financial crisis would not be having such a negative effect on the overall economy.

Why is the financial crisis having such a negative effect on the economy? Because the financial crisis has caused nominal aggregate spending to decline. This can be explained relatively simply with one equation, N=PY, where N is the level of nominal aggregate spending, P is the general price level, and Y is real GDP. When N decreases, either P or Y must decrease. Prior to Keynesian economics, the classical economists thought that the decline in N would be felt by a decline in P, with no effect on Y. However, in the 1930s during the Great Depression, John M. Keynes challenged that premise, by arguing that in the short run, prices and wages would be sticky, which means that a drop in N will lead to a drop in Y. Even Milton Friedman and the Monetarists would not argue with this statement, but Friedman put the blame for the drop in N during the Great Depression on an over 30% decrease in the money supply between 1929 and 1933.

The important lesson to learn from the above paragraph is that a drop in nominal aggregate spending (N), as is occurring today, impacts the real output (Y) because prices and wages do not adjust much in the short run. This is where quasi-real indexing can help. If wages and some prices were quasi-real indexed, they will immediately respond to changes in nominal aggregate spending, one of the major causes of inflation. This is one of the advantages of quasi-real indexing over traditional inflation indexing — quasi-real indexing responds almost immediately to changes in nominal aggregate spending, rather than waiting for the price effects to occur.

A second advantage of quasi-real indexing is that it does not filter out the inflation caused by aggregate-supply shocks. Why is this advantage? Realize that 30 years ago, medical professionals thought that all cholesterol was bad. Now, they have come to recognize that some cholesterol is good while other is bad. Our research indicates that aggregate-supply-caused inflation is actually good; only aggregate-demand-caused inflation is bad. Quasi-real indexation filters out the bad inflation while leaving the good inflation intact. When all wages, prices, mortgages, bonds, and other contracts are quasi-real indexed; the economy becomes immune to fluctuations to nominal aggregate spending. In this sense quasi-real indexation immunizes an economy against recessions caused by drops in nominal aggregate spending. It also protects workers, employers, lenders, and borrowers from the uncertainties caused by unexpected changes in nominal aggregate spending. Hence, quasi-real indexation improves the economic efficiency of an economy.

One concern in the current economy that is contributing to the financial crisis are mortgages. An objective of the Obama administration is to help households refinance their mortgages in such a way to make them more affordable for people to stay in their homes and avoid foreclosure. Quasi-real mortgages can do just that. Realize that quasi-real mortgages are a lot like Price-Level-Adjusted Mortgages (PLAMs), except quasi-real mortgages do not have the defect of increasing monthly mortgage payments when aggregate-supply-caused inflation occurs. The initial payment on both quasi-real mortgages and PLAMs is significantly lower than with a fixed-nominal-rate, fixed payment mortgage. The literature on mortgages calls this effect the “tilt” effect. For example, the initial payment on a 7.2%, fixed-rate, fixed-payment 30-year, $200,000 mortgage is $1357.58. However, the initial payment on a 3.6%, quasi-real 30-year, $200,000 mortgage is $909.29, which is over 30% less than under a traditional mortgage.

Wages are difficult to reduce in a recession, but they really should come down for economic efficiency. One reason why workers may be reluctant to give in to wage cuts is because of their fixed obligations like mortgages, although if they refinanced with a quasi-real mortgage, that would be less of an issue. A second reason why workers may be reluctant to give in to wage cuts is because once their wage is cut, they may think it will be difficult to get their wage raised when the economy returns to normal. That is part of the reason that quasi-real indexing would work so well; quasi-real indexing would automatically increase wages when the economy (nominal aggregate spending) recovers. Also, if nominal aggregate spending increases too much, leading to high inflation, the quasi-real indexing will take care of that, usually before the inflation took place.

Furthermore, employers may try to bring down wages down or make other cuts so that they are prepared for even bleaker times. However, quasi-real indexing of wages would do those reductions automaticly when nominal aggregate spending falls, so there would be no need for employers to bring down the wages below where they otherwise should be. Also, employees may be more willing to accept these wage cuts in return for quasi-real indexing being there to protect them in the future when the economy rebounds.

In the past, I have been frustrated with the publication barriers put up by economic journals, which have prevented me from getting my ideas exposed. With this note, I am bypassing those journals (although Dale and I will still try to publish in those journals). I hope that someone in Cyberland will find our message and investigate and try to contact us. Dale and I are currently writing more papers to help communicate these very important ideas. However, our previous papers were written at a very high theoretical level; we are now trying to bring these papers down to earth, making them more readable to more people. When we get those papers in more polished forms, I will try to make them available on this web site.”

Well Dr. Eagle – now I done a bit to spread your idea, which I find intriguing and I am sure my fellow Market Monetarist bloggers will take up the idea as well and discuss it. I don’t think QRI will take us out of this recession – we probably need NGDP level targeting for that – but I am pretty sure that the QRI literature will help us understand the present crisis better and could be very helpful in the crisis resolution.

PS When I read about Dr. Eagle’s frustrations I am reminded of how Scott Sumner felt back in 2009.

—-

Eagle’s and Domian’s papers on QRI and NGDP targeting:

Immunizing our Economies against Recessions — A Microfoundations Investigation


Unsticking those Sticky Wages To Mitigate Recessions Without Expensive Fiscal Stimuli


Nominal Income Targeting for a Speedier Economic Recovery


Quasi-Real-Indexed Mortgages to the Rescue

Using Quasi-Real Contracts to Help Mitigate Aggregate-Demand-Caused Recessions and Inflations

Quasi-real Government Bonds — Inflation Indexing With Safety 

20 Comments
by Lars Christensen on December 3, 2011  •  Permalink
Posted in David Eagle, George Selgin, John Taylor, MM Research agenda, Monetary institutions, NGDP Targeting, Nominal Income Targeting, Productivity Norm, Quasi-Real Indexing, Scott Sumner
Tagged , , , , , ,

Posted by Lars Christensen on December 3, 2011

https://marketmonetarist.com/2011/12/03/quasi-real-indexing-indexing-for-market-monetarists/

Exchange rate based NGDP targeting for small-open economies

The debate about NGDP targeting is mostly focused on US monetary policy and the focus of most of the Market Monetarist bloggers is on the US economy and on US monetary policy. That is not in anyway surprising, but this is of little help to policy makers in small-open economies and I have long argued that Market Monetarists also need to address the issue of monetary policy in small-open economies.

In my view NGDP level targeting is exactly as relevant to small-open economies as for the US or the euro zone. However, it terms of the implementation of NGDP level targeting in small open economies that might be easier said than done.

A major problem for small-open economies is that their financial markets typically are less developed than for example the US financial markets and equally important exchange rates moves is having a much bigger impact on the overall economic performance – and especially on the short-term volatility in prices, inflation and NGDP. I therefore think that there is scope for thinking about what I would call exchange rate based NGDP targeting in small open economies.

What I suggest here is something that needs a lot more theoretical and empirical work, but overall my idea is to combine Irving Fisher’s compensated dollar plan (CDP) with NGDP level targeting.

Fisher’s idea was to stabilise the price level by devaluing or revaluing the currency dependent on whether the actual price level was higher or lower than the targeted price level. Hence, if the price level was 1% below the target price level in period t-1 then the currency should devalued by 1% in period t. The Swedish central bank operated a scheme similar to this quite successfully in the 1930s. In Fisher’s scheme the “reference currency” was the dollar versus gold prices. In my scheme it would clearly be a possibility to “manage” the currency against some commodity price like gold prices or a basket of commodity prices (for example the CRB index). Alternatively the currency of the small open economy could be managed vis-à-vis a basket of currencies reflecting for example a trade-weighted basket of currencies.

Unlike Fisher’s scheme the central bank’s target would not be the price level, but rather a NGDP path level and unlike the CDP it should be a forward – and not a backward – looking scheme. Hence, the central bank could for example once every quarter announce an appreciation/depreciation path for the currency over the coming 2-3 years. So if NGDP was lower than the target level then the central bank would announce a “lower” (weaker) path for the currency than otherwise would have been the case.

For Emerging Markets where productivity growth typical is higher than in developed markets the so-called Balassa-Samuelson effect would say that the real effective exchange rate of the Emerging Market economy should gradually appreciate, but if NGDP where to fall below the target level then the central bank would choose to “slowdown” the future path for the exchange rate appreciation relative to the trend rate of appreciation.

I believe that exchange rate based NGDP level targeting could provide a worthwhile alternative to floating exchange (with inflation or NGDP targeting) or rigid pegged exchange rate policies. That said, my idea need to be examined much closer and it would be interesting to see how the rule would perform in standard macroeconomic models under different assumptions.

Finally it should be noted that the there are some clear similarities to a number for the proposal for NGDP growth targeting Bennett McCallum has suggested over the years.

8 Comments
by Lars Christensen on November 30, 2011  •  Permalink
Posted in Exchange rate policy, Exchange rates, McCallum, MM Research agenda, Monetary policy, NGDP Targeting, Nominal Income Targeting
Tagged , , ,

Posted by Lars Christensen on November 30, 2011

https://marketmonetarist.com/2011/11/30/exchange-rate-based-ngdp-targeting-for-small-open-economies/

Lorenzo´s Socratic dialogue on NGDP Targeting

Lorenzo from Oz suggested the following “Socratic dialogue “on NGDP targeting in a comment to my previous post – I think it is so good it need to be repeated:

Q: What has caused more damage; entrenched inflation (the 1970s) or massive deflation (1929-32)?
A: Deflation. But that is not what we face.
Q: What has caused more damage; entrenched inflation (the 1970s) or unexpected disinflation during a leveraging crunch (2008-?).
A: But inflation is evil.
Q: Why is inflation bad?
A: Because it distorts private decisions.
Q: Does it do that making basic parameters for judgement unreliable?
A: Yes.
Q: So it is about creating a clear and reliable framing for private decisions?
A: Yes.
Q: So, a central bank should provide a reliable framework for private decisions?
A: Yes.
Q: So it is about framing expectations in a credible way?
A: Yes.
Q: So, what is more important to people, expectations about income or expectations about prices?
A: [Some obfustication]
Q: So, should not a central bank seek to credibly generate expectations about income?
A. [Some more obfustication]
Q: In a highly leveraged age with many wages set by contracts operating across time and a range of “sticky” prices, which is more important to people, expectations about money income or “real” income?
A. [Even more obfustication]
Q: So, would not a clear target about aggregate income (aka NGDP aka Py) create a framework to anchor expectations in what people actually care about?
A: [Meltdown]

PS off to Vilnius, Lithuania today – nice city and nice people. I am among other things having a presentation about 1931 vs 2011 – and more important about whether 2012 will bring the same horrors as 1932 (My answer is – I fear so, but it is not too late to avoid).

6 Comments
by Lars Christensen on November 23, 2011  •  Permalink
Posted in NGDP Targeting, Nominal Income Targeting, Uncategorized
Tagged , ,

Posted by Lars Christensen on November 23, 2011

https://marketmonetarist.com/2011/11/23/lorenzo%c2%b4s-socratic-dialogue-on-ngdp-targeting/

Taylor fires at NGDP targeting – the Market Monetarists fire back

John Taylor has a comment on NGDP targeting. Let’s just say he is not a fan of NGDP targeting.

Taylor’s comments have provoked the Market Monetarists bloggers to fire back at Taylor. See the comments from:

Scott Sumner
Nick Rowe
Marcus Nunes
Bill Woolsey

I don’t have a lot to add, but I would note that it seems like Taylor wrongly thinks that NGDP targeting is discretionary. I have already commented on that common misperception.

See my comment “NGDP targeting is not a Keynesian business cycle policy”

PS To me actually the worst thing about the Taylor rule is that it has created the very damaging misconception that monetary policy is about controlling interest rates. Interest rates is NOT the price of money – it is the price of credit.

2 Comments
by Lars Christensen on November 20, 2011  •  Permalink
Posted in John Taylor, NGDP Targeting, Nominal Income Targeting
Tagged , ,

Posted by Lars Christensen on November 20, 2011

https://marketmonetarist.com/2011/11/20/taylor-fires-at-ngdp-targeting-the-market-monetarists-fire-back/

The Fed can save the euro

David Beckworth has a excellent comment on the correlation between NGDP in the US and the euro zone.

David shows that US NGDP growth leads NGDP growth in the euro zone. This means that if the Federal Reserve were to move to push NGDP back to the pre-crisis trend level then it would likely lead to a similar increase in the NGDP level in the euro zone.

Hence, if the Fed were to introduce a NGDP level target then because the US is a “global monetary superpower” then the ECB would effective be forced to do the same thing. Interestingly this would probably mean that the ECB would overshoot it’s 2% inflation in the short-run as NGDP shifts from on level to another. How would the ECB react to that? Well, first of all the EUR/USD would undoubtedly spike, which would curb short time inflationary pressures and the question is really whether the ECB would have time to do anything about the jump in NGDP. Paradoxically because the ECB is targeting future inflation then it could say “well, inflation is now at 5%, but that is really not something we can do anything about and inflation nonetheless be back to 2% once US NGDP settles down at the new (old) NGDP trend level so no tightening of monetary policy is needed”.

For now the ECB refuses any easing of monetary policy, but if the Fed were to act decisively then the ECB probably would import an easing of monetary policy – and that would probably save the euro. So please Ben can you help us?

Leave a comment
by Lars Christensen on November 15, 2011  •  Permalink
Posted in David Beckworth, euro crisis, Federal Reserve, MM Research agenda, Monetary institutions, Monetary policy, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Reading recommendations, The euro, The Great Recession
Tagged , , , , ,

Posted by Lars Christensen on November 15, 2011

https://marketmonetarist.com/2011/11/15/the-fed-can-save-the-euro/

NGDP targeting is not a Keynesian business cycle policy

I have come to realize that many when they hear about NGDP targeting think that it is in someway a counter-cyclical policy – a (feedback) rule to stabilize real GDP (RGDP). This is far from the case from case and should instead be seen as a rule to ensure monetary neutrality.

The problem is that most economists and none-economists alike think of the world as a world more or less without money and their starting point is real GDP. For Market Monetarist the starting point is money and that monetary disequilibrium can lead to swings in real GDP and prices.

The starting point for the traditional Taylor rule is basically a New Keynesian Phillips curve and the “input” in the Taylor rule is inflation and the output gap, where the output gap is measured as RGDP’s deviation from some trend. The Taylor rule thinking is basically the same as old Keynesian thinking in the sense that inflation is seen as a result of excessive growth in RGDP. For Market Monetarists inflation is a monetary phenomenon – if money supply growth outpaces money demand growth then you get inflation.

Our starting point is not the Phillips curve, but rather Say’s Law and the equation of exchange. In a world without money Say’s Law holds – supply creates it’s own demand. Said in another way in a barter economy business cycles do not exist. It therefore follows logically that recessions always and everywhere is a monetary phenomenon.

Monetary policy can therefore “create” a business cycle by creating a monetary disequilibrium, however, in the absence of monetary disequilibrium there is no business cycle.

So while economists often talk of “money neutrality” as a positive concept Market Monetarists see monetary neutrality not only as a positive concept, but also as a normative concept. Yes, money is neutral in that sense that higher money supply growth cannot increase RGDP in the long run, but higher money supply growth (than money demand growth) will increase inflation and NGDP in the long run.

However, money is not neutral in the short-run due to for price and wage rigidities and therefore money disequilibrium and monetary disequilibrium can therefore create business cycles understood as a general glut or excess supply of goods and labour. Market Monetarists do not argue that the monetary authorities should stabilize RGDP growth, but rather we argue that the monetary authorities should avoid creating a monetary disequilibrium.

So why so much confusing?

I believe that much of the confusing about our position on monetary policy has to do with the kind of policy advise that Market Monetarist are giving in the present situation in both the US and the euro zone.

Both the euro zone and the US economy is at the presently in a deep recession with both RGDP and NGDP well below the pre-crisis trend levels. Market Monetarists have argued – in my view forcefully – that the reason for the Great Recession is that monetary authorities both in the US and the euro zone have allowed a passive tightening of monetary policy (See Scott Sumner’s excellent paper on the causes of the Great Recession here) – said in another way money demand growth has been allowed to strongly outpaced money supply growth. We are in a monetary disequilibrium. This is a direct result of a monetary policy mistakes and what we argue is that the monetary authorities should undo these mistakes. Nothing more, nothing less. To undo these mistakes the money supply and/or velocity need to be increased. We argue that that would happen more or less “automatically” (remember the Chuck Norris effect) if the central bank would implement a strict NGDP level target.

So when Market Monetarists like Scott Sumner has called for “monetary stimulus” it NOT does mean that he wants to use some artificial measures to permanently increase RGDP. Market Monetarists do not think that that is possible, but we do think that the monetary authorities can avoid creating a monetary disequilibrium through a NGDP level target where swings in velocity is counteracted by changes in the money supply. (See also my earlier post on “monetary stimulus”)

I have previously argued that when a NGDP target is credible market forces will ensure that any overshoot/undershoot in money supply growth will be counteracted by swings in velocity in the opposite direction. Similarly one can argue that monetary policy mistakes can create swings in velocity, which is the same as to say hat monetary policy mistakes creates monetary disequilibrium.

Therefore, we are in some sense to blame for the confusion. We should really stop calling for “monetary stimulus” and rather say “stop messing with Say’s Law, stop creating a monetary disequilibrium”. Unfortunately monetary policy discourse today is not used to this kind of terms and many Market Monetarists therefore for “convenience” use fundamentally Keynesian lingo. We should stop that and we should instead focus on “microsovereignty”

NGDP level targeting ensures microsovereignty

A good way to structure the discussion about monetary policy or rather monetary policy regimes is to look at the crucial difference between what Larry White has termed a “macroinstrumental” approach and a “microsovereignty” approach.

The Taylor rule is a typical example of the macroinstrumental approach. In this approached it is assumed that it is the purpose of monetary policy to “maximise” some utility function for society with includes a “laundry list” of more or less randomly chosen macroeconomic goals. In the Taylor rule this the laundry list includes two items – inflation and the output gap.

The alternative approach to choose a criteria for monetary success (as Larry White states it) is the microsovereignty approach – micro for microeconomic and sovereignty for individual sovereignty.

The microsovereignty approach states that the monetary regime should ensure an institutional set-up that allows individuals to make decisions on consumption, investment and general allocation without distortions from the monetary system. More technically the monetary system should ensure that individuals can “capture” Pareto improvements.

Therefore an “optimal” monetary regime ensures monetary neutrality. Larry White argues that Free Banking can ensure this, while Market Monetarists argue that given central banks exist a NGDP level targeting regime can ensure monetary neutrality and therefore microsovereignty.

This is basically a traditional neo-classical welfare economic approach to monetary theory. We should choose a monetary regime that “maximises” welfare by ensuring individual sovereignty.

A monetary regime that ensures microsovereignty does not have the purpose of stabilising the business cycle, but it will nonetheless be the likely consequence as NGDP level targeting removes or at least strongly reduces monetary disequilibrium and as recessions is a monetary phenomenon this will also strongly reduce RGDP and price volatility. This is, however, a pleasant consequence but not the main objective of NGDP level targeting.

—–

Marcus Nunes has a similar discussion here.

—-

UPDATE: There are two follow up article to this post:

“Be right for the right reasons”

“Roth’s Monetary and Fiscal Framework for Economic Stability”

28 Comments
by Lars Christensen on November 12, 2011  •  Permalink
Posted in Chuck Norris Effect, Free Banking, Larry White, MM Research agenda, Monetary institutions, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Reading recommendations, Say's Law, Scott Sumner
Tagged , , , , , ,

Posted by Lars Christensen on November 12, 2011

https://marketmonetarist.com/2011/11/12/ngdp-targeting-is-not-a-keynesian-business-cycle-policy/

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