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.

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.