A bottleneck in the economy

The Federal Reserve’s choice to allow only a slow recovery in NGDP has essentially created a bottleneck in the economy, behind which a large crowd of would-be workers is swelling. 

That sentence really captures the US challenge. I recommend this 27 September post by Ryan Avent at Free Exchange, where he attempts to rebut the claim that it is too late for monetary policy to be effective.

(…) Let’s look at some charts. First, here is the year-on-year change in NGDP since 1990:

So, the first thing to note is that NGDP growth is clearly not back to the trend rate for recent expansions. Nominal output routinely grew above 5% per year during the boom of the 1990s (with an average closer to 7% than 5% during the latter, stronger half of that period). Nominal growth decelerated slightly during the 2000s expansion but was clearly and persistently above 5% during the period of meaningful employment growth. Nominal output then shrank at a pace matched only in the postwar period by demobilisation before settling at a rate persistently below 5%. Average year-on-year growth over the whole of this period, including recessions, is 4.7%. Average growth since the end of this recession has been 3.1%. Average growth since the beginning of 2010 has been 3.9%.



Ryan discusses the key points, including the evidence that wages are still sticky three years after the 2008 crash. Read the whole thing.

US Fed members are shifting to consensus on “economic lift-off”

My caption probably overstates the “lift-off” consensus, but there definitely is a movement from the “hawk” to the “dove” perspective on inflation vs. economic growth. Ryan Avent examines the very significant shift of Kocherlakota to a policy square near to the “Evans Rule”.  


NARAYANA KOCHERLAKOTA, the president of the Reserve Bank of Minneapolis, has long been a member of the club of more hawkish voices within the Federal Open Market Committee (to which he’ll return as an alternate next year and a voting member in 2014). But where other hawks like Philadelphia Fed president Charles Plosser and Dallas Fed president Richard Fisher advance criticisms of expansionary Fed action that seem rooted in confusion over just how monetary policy works, Mr Kocherlakota understands monetary policy just fine. His concern has instead been that economic potential has fallen more than is appreciated, and that structural unemployment is correspondingly higher. It’s a perfectly coherent view, albeit one that has seemed to be at odds with labour-market data. 

And so a frisson of excitement ran through the economics commentariat yesterday when Mr Kocherlakota abruptly signed on to a strategy resembling the one pushed by Chicago Fed president Charles Evans, a supporter of much more aggressive action to help the economy. Speaking in Michigan, Mr Kocherlakota described a plan for ‘liftoff’:

The substance of this liftoff plan is that, as long as longer-term inflation expectations remain stable, the Committee will not raise the fed funds rate unless the medium-term outlook for the inflation rate exceeds a threshold value of 2 1/4 percent or the unemployment rate falls below a threshold value of 5.5 percent. Note that neither of these thresholds should be viewed as triggers—that is, once the relevant cutoffs are crossed, the Committee retains the option of either keeping the fed funds rate extraordinarily low or raising the fed funds rate. 

Ryan has much more analysis at Free Exchange.

The Fed’s welcome shift is still not nearly as effective as NGDP-Level-Targetting.

Lars Christensen: NGDP level targeting – the true Free Market alternative

Danish economist Lars Christensen wrote a terrific post that I think will be helpful to anyone trying to get their head around NGDP level targeting for the first time. Lars also attempts to explain why many skeptical free market economists have some fundamental misunderstandings — which he attempts to correct. For those who wish to study this topic in more depth, Lars closes with an excellent reference list of earlier posts.

I’m trying to figure out whether the new Fed policy means new USD weakness. Bernanke didn’t adopt NGDPLT  (the Market Monetarists like Lars are celebrating anyway). But the policy looks to me like a directional move towards expectation-based policy, which may be the most powerful tool the Fed has. Especially near the ZLB. If that’s the case the Fed would be expected to ease until NGDP is closer to the 2007 trend, if not all the way back to trend.

Snippet from Lars original post: July 19, 2012… 

Most of the blogging Market Monetarists have their roots in a strong free market tradition and nearly all of us would probably describe ourselves as libertarians or classical liberal economists who believe that economic allocation is best left to market forces. Therefore most of us would also tend to agree with general free market positions regarding for example trade restrictions or minimum wages and generally consider government intervention in the economy as harmful.

I think that NGDP targeting is totally consistent with these general free market positions – in fact I believe that NGDP targeting is the monetary policy regime which best ensures well-functioning and undistorted free markets. I am here leaving aside the other obvious alternative, which is free banking, which my readers would know that I have considerable sympathy for.

However, while NGDP targeting to me is the true free market alternative this is certainly not the common view among free market oriented economists. In fact I find that most of the economists who I would normally agree with on other issues such as labour market policies or trade policy tend to oppose NGDP targeting. In fact most libertarian and conservative economists seem to think of NGDP targeting as some kind of quasi-keynesian position. Below I will argue why this perception of NGDP targeting is wrong and why libertarians and conservatives should embrace NGDP targeting as the true free market alternative.

Why is NGDP targeting the true free market alternative?

I see six key reasons why NGDP level targeting is the true free market alternative:

1) NGDP targeting is ”neutral” – hence unlike under for example inflation targeting NGDPLT do not distort relative prices – monetary policy “ignores” supply shocks.
2) NGDP targeting will not distort the saving-investment decision – both George Selgin and David Eagle argue this very forcefully.
3) NGDP targeting ”emulates” the Free Banking allocative outcome.
4) Level targeting minimizes the amount of discretion and maximisesthe amount of accountability in the conduct of monetary policy. Central banks cannot get away with “forgetting” about past mistakes. Under NGDP level targeting there is no letting bygones-be-bygones.
5) A futures based NGDP targeting regime will effective remove all discretion in monetary policy.
6) NGDP targeting is likely to make the central bank “smaller” than under the present regime(s). As NGDP targeting is likely to mean that the markets will do a lot of the lifting in terms of implementing monetary policy the money base would likely need to be expanded much less in the event of a negative shock to money velocity than is the case under the present regimes in for example the US or the euro zone. Under NGDP targeting nobody would be calling for QE3 in the US at the moment – because it would not be necessary as the markets would have fixed the problem.

So why are so many libertarians and conservatives sceptical about NGDP targeting?

Common misunderstandings:

1) NGDP targeting is a form of “countercyclical Keynesian policy”. However, Market Monetarists generally see recessions as a monetary phenomenon, hence monetary policy is not supposed to be countercyclical – it is supposed to be “neutral” and avoid “generating” recessions. NGDP level targeting ensures that.
2) Often the GDP in NGDP is perceived to be real GDP. However, NGDP targeting does not target RGDP. NGDP targeting is likely to stabilise RGDP as monetary shocks are minimized, but unlike for example inflation targeting the central bank will NOT react to supply shocks and as such NGDP targeting means significantly less “interference” with the natural order of things than inflation targeting.
3) NGDP targeting is discretionary. On the contrary NGDP targeting is extremely ruled based, however, this perception is probably a result of market monetarists call for easier monetary policy in the present situation in the US and the euro zone.
4) Inflation will be higher under NGDP targeting. This is obviously wrong. Over the long-run the central bank can choose whatever inflation rate it wants. If the central bank wants 2% inflation as long-term target then it will choose an NGDP growth path, which is compatible which this. If the long-term growth rate of real GDP is 2% then the central bank should target 4% NGDP growth path. This will ensure 2% inflation in the long run.

[snip important commentary]


Related posts:

NGDP targeting is not about ”stimulus”
NGDP targeting is not a Keynesian business cycle policy
Be right for the right reasons
Monetary policy can’t fix all problems
Boettke’s important Political Economy questions for Market Monetarists
NGDP level targeting – the true Free Market alternative
Lets concentrate on the policy framework
Boettke and Smith on why we are wasting our time
Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed

Update (July 23 2012): Scott Sumner once again tries to convince “conservatives” that monetary easing is the “right” position. I agree, but I predict that Scott will fail once again because he argue in terms of “stimulus” rather than in terms of rules.

That last comment is important: NGDPLT is all about a rule-based, not discretionary, policy. It is definitely NOT an argument for more discretionary monetary stimulus.

Please read Lars’ complete commentary, and follow up with a careful read of the prior posts.

Are we still in the short run?

Via Tyler Cowen

The excellent Eli Dourado reports:

I think there is good reason to think that the short run is over—it is short, after all.

My first bit of evidence is corporate profits. They are at an all time high, around two-and-a-half times higher in nominal terms than they were during the late 1990s, our last real boom…

If you think that unemployment is high because demand is low and therefore business isn’t profitable, you are empirically mistaken. Business is very profitable, but it has learned to get by without as much labor.

A second data point is the duration of unemployment. Around 40 percent of the unemployed have been unemployed for six months or longer. And the mean duration of unemployment is even longer, around 40 weeks, which means that the distribution has a high-duration tail…

Now, do you mean to tell me that four years into the recession, for people who have been unemployed for six months, a year, or even longer, that their wage demands are sticky? This seems implausible.

A third argument I’ve heard a lot of is that mortgage obligations have remained high—sticky contracts—while income has gone down. Garett Jones endorses this as a theory of monetary non-neutrality, and I agree. In fact, I beat him to it. But just because debt can make money non-neutral in the short run does not mean that we are still in the short run.

In fact, there is good evidence that here too we are out of the short run. Household debt service payments as a percent of disposable personal income is lower than it has been at any point in the last 15 years.

There are numerous pictures at the link.

How the market monetarists changed the debate

Ryan Avent at The Economist explains just how influential Scott Sumner has been:

First, Dylan Matthews has a very nice interview with Michael Woodford that I recommend reading in its entirety. As part of it, however, Mr Woodford disavows any influence from Scott Sumner in his choice to move toward a recommendation of a nominal GDP target. It is certainly correct to say that Mr Woodford has been focusing on these issues for a while and making important contributions to the literature. That, however, helps illustrate the importance of Mr Sumner and the market monetarist emergence. It seems very possible—probable even—that Mr Woodford and other prominent monetary economists would have been led by the events of the crisis and recovery to approximately the position in the debate they now occupy without Mr Sumner’s influence. But despite the fact that many of the ideas in Mr Woodford’s Jackson Hole paper were already circulating in 2009, most of the economists engaging in public debate and most of those writing about that public debate were then operating under the assumption that fiscal policy was the main if not the only game in town. Mr Sumner helped convince many of those of us with a familiarity with monetary economics to rethink the frame within which we were operating and to reconsider the conclusions we’d drawn. His work made us more receptive to research by people like Mr Woodford.

I’m also am sceptical that Mr Woodford would have included in his Jackson Hole paper a statement of support for nominal GDP targeting—rather than something a bit more obscure-sounding, like “output-gap adjusted price level targeting”—if Mr Sumner had not encouraged so many of us to think of NGDP targeting as an appropriate, viable, and relatively straightforward alternative policy to inflation-rate targeting. As Mr Woodford says in the interview, he was trying in his most recent paper “to express a more helpful proposal”. An NGDP-oriented policy fits that description largely because we’ve all been primed to think in those terms, thanks mostly to the conversation Mr Sumner initiated.



Evan Soltas: Bloomberg Endorses NGDPLT

Good news, in the “every little bit helps” department. Thanks for this Evan:

Bloomberg Endorses NGDPLT: “Bloomberg View’s editorial board endorsed using monetary policy to target the path of nominal GDP yesterday — making them, as far as I know, the first major media outlet in the United States to endorse the practice. Naturally, this is excellent news for supporters of NGDP level targeting like myself.

We suggest looking at an old idea that is again attracting attention among monetary economists. Recast the target that the Fed and other central banks are told to follow. Instead of a target for low inflation plus an additional primary or secondary target of high employment, focus on the money value of output — nominal gross domestic product unadjusted for inflation. This combines prices and output in a single number.

Suppose the target was 5 percent. Over the longer term, with the economy growing at 2 percent or a little more, inflation would be 3 percent or a little less, similar to the inflation targets most central banks (including the Fed) have adopted. Here’s the advantage: In the short term, the Fed would be on target if the economy were growing at 5 percent and inflation were zero, or if the growth were zero and inflation were 5 percent.

In other words, the system would call for faster-than- normal growth when inflation is too low, and faster-than-normal inflation when the economy is in a slump. Setting a nominal GDP target wouldn’t be telling the bank to choose between so much inflation and so many jobs, so you could still grant operational independence

We think it’s worth a careful look, and we’re convinced of one important advantage: This approach would make the bank’s actions easier to understand and explain.

As a matter of disclosure, I write for Bloomberg View but was not involved in their endorsement.

Bernanke and the Fed’s superpower

Before we get into superpowers, first read Scott Sumner: The Zen Master: Money is too tight.

OK, got that? The Zen Master is telling the Fed to use it’s most powerful monetary tool, the “expectations channel”. Ezra Klein at the Washington Post Wonkblog does a very nice job of explaining how these concepts are applied using the Spiderman metaphor.

(…)The best way to think about the Federal Reserve is that it basically has a superpower. It can create as much money as it wants. Real, American money.

And the Fed doesn’t need anybody’s permission. It’s not like when the president says he wants to do something, like the American Jobs Act, and you have to ask, “What does Congress think?” Or when John Boehner wants to pass something, and you have to ask, “Well, what does Harry Reid think?” Once the Board of Governors decides to move forward, they don’t need 60 votes in the Senate — they just do it. And that makes them incredibly powerful.

But, as Spider Man would say, with great power comes great responsibility. And so the Fed is very cautious in using its powers.

By law, it needs to try to keep unemployment and inflation low. Over the past two years or so, inflation has stayed low, and unemployment has been very, very high. But the Fed has not been doing all that much about it. It’s been hoping the situation would turn around of its own accord, or that Congress and the president would stop bickering and unleash more stimulus — anything so that the Fed didn’t have to further unleash its powers.

But it didn’t happen. And so, on Thursday, Fed Chairman Ben Bernanke said the Fed had finally decided to do something about unemployment. Something big. Something that might actually work.


If the Fed staff is quietly doing NGDPLT to a 4.5 or 5% target level in the back office, while guiding the FMOC to adjust policy to get back on track, then I believe this is likely to finally get the US economy going. Ezra Klein explains how it actually works.

I think Bernanke’s cautious wording is telling the markets that 2% is no longer the inflation ceiling but the medium term target. The markets seem to be getting that message.



Cardiff Garcia: Lingering thoughts and questions about QE3

“…the portfolio balance channel works better when accompanied by use of the expectations channel”

Indeed – this is the first time under Bernanke that the expectations channel has been engaged. Some argue that the expectations channel is the most powerful weapon in the Fed’s arsenal.

Lots of smart analysis by Cardif Garcia at FT Alphaville. More here.

Joe Weisenthal on Scott Sumner “The Blogger Who May Have Just Saved The American Economy”

I’m impressed with Joe Weisenthal’s coverage of the NGDPLT and the Thursday Fed announcement of a non-quantitative but important step to exploit the monetary expectations channel. Joe is giving proper credit to Scott Sumner for his tireless efforts, and in this piece references a number of luminaries who have become supports of NGDPLT:

(…)It’s a step in the direction of Nominal GDP targeting, the hot idea endorsed recently by Michael Woodford at the Jackson Hole conference.

But while Woodford is one of the most respected monetary academics in the world, the economist who deserves the most credit for taking a wonky idea and making it mainstream is Bentley economics Professor Scott Sumner who writes the blog The Money Illusion.

Tyler Cown of Marginal Revolution writes:

I haven’t seen anyone else say it yet, so I will.  The Fed’s policy move today might not have happened — probably would not have happened — if not for the heroic blogging efforts of Scott Sumner.  Numerous other bloggers, including the market monetarists and some Keynesians and neo Keynesians have been important too, plus Michael Woodford and some others, but Scott is really the guy who got the ball rolling and persuaded us all that there is something here and wouldn’t let us forget about it.

And Matt Yglesias writes:

Professors at Bentley University who’ve never published a famous book don’t normally shift the public debate. But Sumner’s vigorous and relentless blogging throughout the crisis on the potential of expectations-focused monetary policy really broke through. It all began with some links from Tyler Cowen and perhaps a tiff with Paul Krugman. I became a regular reader and his ideas have done a lot to influence me, and you can clearly see the influence on Ryan Avent at the Economist, Matt O’Brien at the Atlantic, Ramesh Ponnuru at National Review, Josh Barro at Bloomberg, and a few of the Wonkblog contributors. Outside the exciting world of online economics punditry, NGDP targeting hasn’t (yet!) caught fire as rapidly but it gained explicit allegiance from Christina Romer, Krugman, the economics team at Goldman Sachs, and eventually Chicago Federal Reserve President Charles Evans who started out with a different but similar-in-spirit program.

That really is the key here: Not only has he been incredibly influential, but he really has done it almost entirely through his blog. Also, the bi-partisan swath of his adherents is remarkably rare for an economic pundit.

It’s also rare for ideas to simultaneously gain currency among academics and Wall Street economists like Goldman’s Jan Hatzius, who endorsed the idea about a year ago in a much buzzed-about note.

The jury, obviously, is still out on the Fed’s actions, but the folks we like to listen to, like Bill McBride at Calculated Risk, are very hopeful that this can accelerate the economy.

Read more — Joe explains NGDPLT referencing Scott Sumner’s FAQ.

Goldman Sachs economist Jan Hatzius Advises Fed to switch to Nominal GDP Level Targeting

Joe Weisenthal  Oct. 15, 2011. Joe did a nice job of explaining concisely both NGDP Level Targeting and the Goldman Sachs bulletin:

In his latest US Economics Analyst note, Goldman’s Jan Hatzius offers up his suggestion for the next phase of Fed policy.

With short-term interest rates near zero and the economy still weak, we believe that the best way for Fed officials to ease policy significantly further would be to target a nominal GDP path such as the one shown in the chart on the right, indicating that they will use additional asset purchases to help bring actual nominal GDP back to trend over time. The case would strengthen further if deflation risks reappeared clearly on the radar screen.

More specifically:

The specific path in Exhibit 1 is calculated as the level of nominal GDP in 2007 extrapolated forward at a rate of 4½% per year. We can think of this number as the sum of real potential GDP growth of 2½% and inflation as measured by the GDP deflator of about 2%. The specific numbers matter less than the Fed’s willingness to a target path that is anchored at a point like 2007, when the economy was near full employment, and that they indicate that they will pursue this target aggressively.


Ultimately, says Hatzius, a shift towards this kind of Fed policy could bring down unemployment much faster than the current path foresees.