What is Nominal GDP targeting ?
“Just when I thought I was out… they pull me back in” I tried to resist asking “what does “Nominal GDP targeting even mean.” I managed, but now Krugman is burying the hatchet and I am digging it up.
So what is the proposal ? That the Fed have a target for 2012 nominal GDP or first quarter of 2012 nominal GDP ? Even if it isn’t measured, the Fed could try to get the November 2011 nominal GDP it wants. As far as I know, advocates of nominal GDP targetting don’t even acknowledge this question.
I have some longer and more substantive thoughts below.
update: spelling of title corrected. I thank Brad DeLong
I think Krugman understates his case when he claims that the Fed can’t target nominal GDP when we are in a liquidity trap. I would define targeting X as making the conditional expected value of X equal to the target. There will be a disturbance, but if the expected value is different from the target no matter what one does, then on can’t target X. The concept of daily GDP is meaningful (although it would be crazy to try to measure it and correct accounting for inventories would be key). Do quasi-monetarists really think that the Fed can make the expected value of tomorrow’s nominal GDP whatever it wants ?
I admit I am being fairly twitty, but I think this question isn’t totally stupid, because I think it shows that they just don’t think about what monetary policy can and can’t do. The Fed can move the Fed funds rate very fast. The Fed can change the money supply quickly at least if it wants to reduce it or we are not in a liquidity trap. Nominal GDP can only jump if prices are flexible. Monetary policy is effective because they are sticky. We have a problem.
OK a more serious issue. Can the Fed get the 2012 annual nominal GDP it wants by buying Treasuries. Jah Hatsius (and Brad DeLong) argue that the Fed should declare its intention of buying whatever quantity it takes of long term Treasuries to achieve a nominal GDP target. But what if there is no such quantity ? Then the announcement would be a false claim.
Is there any such quantity ? I think not. Certainly not if one wants 2011-2012 growth to be well over the trend growth rate say 10% (Brad DeLong seemed to call for this when he said to target the level). I admit that I will go rational expectations and argue that if it can’t happen, then people won’t believe it can happen. So I assume model consistent expectations.
First the Fed can drive the risk premium on Treasuries to zero. The public will accept returns equal to the risk free rate if the Fed buys all the treasuries on the market. So far, I think this would be a small effect. There just isn’t much room for a risk premium even in 30 year rates. Importantly, a zero short term rate and a zero risk premium does not imply a zero long term rate. Even without a risk premium the long term rate would be equal to an average of current and future short term rates. We are discussing about a mega QE policy not a credible commitment to causing high inflation in the distant future when unemployment is normal (nor are we discussing a unicorn or a flying pig).
I would expect a small effect on interest rates — about on the order of the effect of operation twist (of course I predicted a smaller than observed effect of operation twist). Note this is for about $10 trillion of QE. The effect of the volume on the market on risk premia is not linear.
The risk is mostly inflation risk (not default risk — that is best hedged with canned food, bottled water and guns). But wait aside from the illusory wealth of Treasuries, total inflation risk adds up to around zero as there are nominal creditors as well as nominal debtors.
I have admitted I use rational expectations. And I have assumed that Fed policy now doesn’t have a big effect on expected Fed policy in 2020.
OK so mega QE if needed to target nominal GDP levels might work if it massively affects expectations somehow, even though there is a rational expectations equilibrium with a small change in expectations. But that sure sounds a lot like the confidence fairy to me.
I admit that because the first time I encountered the term it was sourced as Goldman Sacks, I just moved on assuming it was a new name for just some more gimme, gimme, gimme – especially when OWS wants to threaten future handouts.
Interesting. I still think that the Fed should in some way target AD, but I admit, that I can’t think of an easy way to target this.
As far as REH, Muth would be proud of you Robert…..LOL.
There are no uses for “money” that yield a rate of return over ZERO except treasuries (financial assets do not necessarily feed grandma) who determine their pay out with the FR (printing presses, recently).
To me, the problem is no (very small relative to money supply) physical projects to put money in.
So, I vote for Krugman that there is a need to borrow at ZERO for bridges, roads, hospitals and schools.
The function to use/watch: risk of too much infrastructure, which should not be a problem since the past 30 years most money was invested in wall st “instruments” of mass destruction. And pentagon uber-war toys.
The GOParty Austrians (allied with the current regime in the euro reich) want the US to look like the Germany (ancestor of the euro reich) which went fascist in 1933.
So, on the same logic, those who want the Fed to increase its inflation target are caught in the same conundrum. Right, Angry Bear?
I do not have any problems with targeting nominal GDP. But I really would not expect it to make any difference.
As far as I am concerned monetary policy works by changing incentives via interest rates and targeting nominal GDP does not change any incentives.
It probably would be like the experiment with targeting money supply under Volcker in the 1980s.
To achieve the money supply targets required the Fed to raise rates to record high levels. That is
what caused people to change their behavior, not hitting the money supply target. But it gave the Fed the political cover of denying that they were responsible for the high rates — it was the market not the Fed that was driving up rates. Moreover, Congress also pretended to believe the argument so everyone could deny responsibility for high rates.
I’m willing to listen, but someone will have to explain the mechanism of how targeting GDP will cause individuals to change their spending behavior for me to believe it will make any difference.
I agree with Michael Halasy that targeting AD somehow is the right way to go, assuming away any practical, technical difficulties. But if we believe in REH, the specific target simply can’t matter as much as whether or not we use a growth target or a level target. To borrow Krugman’s phrase, the level target acts like a commitment to being irresponsible for the central bank and this is what is truly needed.
ilsm: “To me, the problem is no (very small relative to money supply) physical projects to put money in.”
You don’t realy need physical work projects (although they are a good idea). All you need to do is to put money into the hands of people who will spend it. One easy way to do that is to give money to the poor.
There are debates, going back to at least the 19th century, about the effectiveness of trickle down economic policies. But who doubts that if you pump money into the base of the economic pyramid, it will move up towards the top?
The Fed could buy Freddie and Fannie or their loan portfoliio.
The Fed could buy Sallie and other student loan.
The Fed could fund Small Business loans.
At what point does “Monetary policy” creep into Fiscal policy territory?
Such “monetary” moves might set off a battle with Congress.
In liquidity trap, monetary policy will have weak effects compared to fiscal policy. How can GDP be targeted if fiscal policy of States and BigG are contractionary? How can weak monetary stimulus offset strong fiscal contraction?
Monetary and fiscal policy must work together and they have not since 1999.
spencer: “I do not have any problems with targeting nominal GDP. But I really would not expect it to make any difference.”
I gather that you mean any **economic** difference. FWIW, I am skeptical that it would. But I think that that would make a difference in one important aspect. If the Fed announced a nominal GDP target and it did not result in approaching the target in a relatively short time, the credibility of the Fed would be damaged.
John B. Chilton – No. The Fed’s ability to target an inflation level is not in doubt. (That it often misses on the low side of its stated target can be treated as a model-multiplier question.) Printing money with the intention that it circulates–combined with cutting the interest paid on Excess Reserves–would raise inflation expectations. And if they are missing 4% (not at all a magic number) but still getting to the 3-3.5% range, the inflation will cause a shift of asset allocation and investment choices. (See Spencer’s comment above for an example.)
The Fed’s ability to buy–let alone successfully unwind–enough Treasuries to make a difference is very much in question. And if–as, say, Brad DeLong has suggested–they were to buy corporate bonds, equities, etc. in stead or in addition, the prices of those securities would go up, when the problem right now is that the risk of those securities is underpriced. So that, at best, doesn’t work (even ignoring the unwind problem).
As Nick Rowe noted a few days ago, the Central Bank (here, the Fed) could, if it had any credibility, announce a higher inflation target and let the market do its thing. Lacking that, it would have to act–but the actions needed are clear and well within our past experience.
Announcing an NGDP target at the bottom of a cycle is difficult at best–and several of the practices required to hit the target (or at least be on the range) are included in what we already know the Fed can do well.
From a process POV, it’s a simple decision–raise the inflation target. At that point, you’ve primed the pump for NGDP targeting (short description: we’re not taking away the punch bowl, we’re just making certain that only Kevin McHale gets to spike it [Glee reference]) in a stronger economy, if everyone still wants to go that way during an up cycle.
As Krugman keeps saying change the IS-LM graphs, yes put money to folks who will use the MV side.
Yes an inflation target and a nominal GDP target are basically the same thing. Real GDP growth does depend on inflation (that’s the point) but it is hard to change it much, so most of the nominal GDP growth would be achieved (if at all) via inflation.
Krugman notes that it is politically much wiser to advoce trying to get higher nominal GDP than trying to get higher inflation. They are the same policy, but one sounds good and the other sounds crazy.
But my concern is the same — can the Fed cause high nominal GDP or high inflation. If it can’t without help from expectations, then aren’t we assuming that the people who expect hgh inflation are fools ? Are the people who make a difference that foolish ? etc etc.
In any case, it’s worth a try and that is the practical question.
The Fed definitely can loan to Fannie and Freddie. The problem is that the guy (DeMarco) running Fannie and Freddie will not use them to stimulate the economy. His officially assignment is to minimize Fannie/Freddie losses and he insists on doing just that. There is nothing Bernanke (or Obama) can do about DeMarco.
The Fed does not have the legal authority to loan to small businesses. That might not matter — arguably it didn’t have the legal authority to set up and lend to Maiden Lane I,II and III either. But the law says the Fed can loan to anyone during a financial crisis — a slow recovery with risk of a double dip is not a financial crisis. Also Dodd-Frank shortened the Fed’s leash a bit.
I’m pretty sure that, this time, if the Fed tests the limits of the law, the Supreme Court will block it. I am also pretty sure that if the Fed were to do the same thing in December 2012 the Supreme Court’s reading of the Constitution and the law would be different. I don’t think that the other Republicans will allow Ben Bernanke to do anything which might help Obama win re-election.
I agree with John and disagree with you. If the Fed can hit any inflation target it can hit any nominal GDP target. Real GDP will not fall 50% so inflation somewhat over 100% would be too much. Then the intermediate value theorem.
Clearly I am not confident that the Fed can target inflation. In your explanation expectations appear with a starring role. I am much inclined to argue that if you can’t explain why expectations must do that (because if people expected 1% inflation when the Fed declared a 4% target they would end up losing money) then your appeal to expections is a hope not a proof.
Yes I am going all rational expectater.
Partly this is semantics. I claim that if one says the Fed can target X, one says that the Fed can make the expected value of X equal to any number it choses. Subject to the zero lower bound, I think the Fed can target the federal funds rate. When not in a liquidity trap the Fed can target monetary aggregates. But surely you aren’t asserting that the Fed can achieve a 10% target for November 2011 inflation. I was thinking of a 10% annual rate, but given my definition of “to target” I could as well ask about 10% monthly inflation, or a daily rate of 10% sustained for the month.
Once you accept a limit on what inflation rate the Fed can achieve, you have to ask if you really think it could achieve 4% inflation in 2012. Where is the line between 10% monthly in November and 4% annual next year ? Might the highest the Fed could manage be less than 2% next year ? I think that these are questions which shoud be asked, but which shouldn’t be asked if the argument in your comment were valid.
let me doubt it for a minute… because it is very close to something i said before O found a way to “stimulate” the economy by giving money to people who were sitting on what they already had.
i think if you just give money to poor people.. they will spend it and prices will go up for rent and groceries and a few plastic toys from Wal Mart… but there may be no “productivity” gain from all this. at the end of the day, the money is spent and it’s all in the hands of Mr Wal and your landlord and … they sit on it.
and people are somewhat resistant to the idea of money for nothing, or money for make-work. better we should spend it on real work for real value. plenty out there that needs doing.
All right. I’ll ask the dumb question here. What would happen if the Fed targeted a higher federal funds rate? Wouldn’t this have some positive effect on the payment of intrest on excess reserves? By positive I mean it wouldn’t pay to hold excess reserves, if it cost more to borrow than what is being paid in interest on reserves. Or, do I have this totally wrong?
coberly: “at the end of the day, the money is spent and it’s all in the hands of Mr Wal and your landlord and … they sit on it”
That’s what I said, the money percolates up the pyramid. 🙂
Compare that with giving the money to the Wal family and the landlord directly, through tax cuts, for instance. Then they simply have the money and sit on it.
It is not the end of the day that counts. It is the meanwhile, when there is economic activity.
coberly: “and people are somewhat resistant to the idea of money for nothing, or money for make-work. better we should spend it on real work for real value. plenty out there that needs doing.”
Oh, I am resistant to the idea, too. I am just pointing out that the key is that the money be spent. It is better, in my view, that the money be spent for road repair than for Ripple. But there are three problems with gov’t spending. First, gov’t spending usually takes time. Second, there are “losers” and “winners”. Third, people generally know what they want better than the gov’t. The point of giving poor people money is not charity or welfare. It is that they will spend it. Local and state gov’ts would spend it, too. Let’s give them money, as well. 🙂
Robert Waldmann: “But the law says the Fed can loan to anyone during a financial crisis — a slow recovery with risk of a double dip is not a financial crisis.”
Ay, there’s the rub. The disease is chronic, not acute. 🙁