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Scott Sumner Plumps for Nominal GDP Targeting--of a Sort


It is a very interesting article. The first half of it is the best conservative argument for nominal GDP targeting that I have ever seen. Then the going gets somewhat weird, for it is a somewhat strange form of nominal GDP targeting he ultimately calls for...

The start of his essay:

Money Rules: Once the devastating costs of deflation are acknowledged, one can no longer imagine an earlier age when the dollar was “as good as gold.” A gold standard stabilizes the price of one good, gold itself, at the cost of allowing instability in the overall price level.... Nor can we avoid the pitfalls of previous gold-standard regimes by getting government out of the picture. If governments did not hold gold reserves for monetary purposes, the value of gold would be even more closely tied to fluctuations in the industrial demand for the metal. In recent years, almost all metals prices have become highly unstable, as rapid industrialization in Asia has pushed up their prices relative to those of other goods. Fixing the nominal price of gold will not lead to price stability.

For better or worse, conservatives need to acknowledge that we live in a fiat-money world, and we need to figure out a way of managing paper money... we can’t dodge the hard questions of macroeconomics and blithely assert that we oppose the Fed’s “meddling” in the economy. There is no laissez faire in fiat money. If the Fed holds the money supply constant, it will be changing the interest rate and the price level. And if it holds interest rates constant, it loses control over the price level and money supply. As a result, many economists now favor some sort of inflation-targeting regime.... But inflation targeting has several defects that in my view make nominal income (or GDP) stabilization a better goal.

One well-known argument against inflation targeting is that there are times when price-level fluctuations are desirable... during a productivity boom, it might be better to have a mild deflation in order to prevent labor markets from overheating. Conversely, a negative supply shock ought to make inflation rise: We don’t want to force all non-energy prices to fall to make up for an oil embargo.

Most of the problems that are believed to flow from an unstable price level actually result from nominal-income instability... Borrowers almost always have trouble repaying debts when nominal income comes in much lower than was expected when the debts were contracted. Some people overlook this problem because they focus on the most spectacular debt problems.... But those cases are merely the tip of the iceberg; the sort of systemic debt problem now faced by the Western world goes far beyond these isolated cases, and can be explained only by the fall in nominal income.

Would my proposal for NGDP targeting merely bail out reckless borrowers? No; I am asking the Fed to provide a stable policy environment for the negotiation of wage and debt contracts. Right now, a sudden fall in NGDP growth tends to lead to mass unemployment, lower profits, and sharply higher debt defaults. An unexpectedly large increase in NGDP would cause problems of its own when the stimulative effects wore off. In fact, it is our current policy that is unfair....

If the Fed decides to target NGDP, it will need to choose an optimal growth rate.... There are two NGDP target paths that might be politically acceptable... 3 percent... 5 percent.... The Fed clearly thought that 5 percent nominal growth was fine during the Great Moderation, but the near-zero nominal growth over the past few years has had a disastrous impact, much worse than it would have, had it been expected and factored into wage and debt contracts negotiated in earlier years...

Then, however, things in the essay do get somewhat weird, for it is a somewhat strange form of nominal GDP targeting he ultimately calls for.

It is not that the Federal Reserve buys and sells bonds (government and perhaps private) for cash in order to try to get the money stock and other variables to levels that lead its forecasters to predict that nominal GDP will grow at, say, 5% per year.

Instead, Scott writes that:

[t]he Fed would simply define the dollar as a given fraction of 12- or 24-month forward nominal GDP, and make dollars convertible into futures contracts at the target price.... The public, not policymakers in Washington, would determine the level of the money supply and interest rates most consistent with a stable economy...

As I understand Scott's proposal, it is this: Nominal GDP in the fourth quarter of 2007 was $14.291 trillion. A 5% growth rate from that base would give us a value of $17.455 trillion for the fourth quarter of 2011. Add on another 3% for the average short-term nominal interest rate we would like to see, and we have $18.153 trillion. Therefore the Federal Reserve would, today, announce that it stands ready to buy and sell dollar deposits to qualified customers at a price of $1 = 1/18,155,000,000,000 of 2011Q4 GDP.

If investors thought that nominal GDP in the fourth quarter of 2011 was likely to be lower than $18.15 trillion, they would take the Fed up on its offer: demand the cash now, pay off the contract in a year by then paying 1/18,155,000,000,000 of 2011Q4 GDP, and (hopefully, if they were right) make money--thus the money stock would increase. If investors thought that nominal GDP in the fourth quarter of 2011 was likely to be greater than $18.155 trillion, they would take the Fed up on its offer: give cash to the Fed now, collect the contract in a year by receiving 1/18,155,000,000,000 of 2011Q4 GDP, and (hopefully, if they were right) make money--thus the money stock would fall.

If nominal GDP were expected to fall, the Federal Reserve would be shoveling money out the door at negative expected nominal interest rates. If his scheme were applied today it would be quantitative easing on a pan-galactic scale, as everybody would run to the Fed with bonds to use as collateral for their promises to pay the expected futures contract in a year in exchange for the cash now.

The Federal Reserve would then become truly the lender of not just last but first resort. Why would anybody borrow on the private market even at 0% per year when they could borrow from the Fed at -3%/year? Savers would simply hold cash rather than try to match the terms that the Fed was offering borrowers. Borrowing firms would borrow from the Fed exclusively. The Fed would thus create a wedge between the minimum nominal interest rate that savers would accept (zero, determined by the alternative of stuffing cash in your mattress) and the nominal interest rate open to borrowers.

I see how this would solve a monetarist downturn--a shortage of liquid cash money projected to lead to nominal GDP below its target. Once arbitrage had kicked in there would be no shortage of cash money.

I see how this would solve a Keynesian downturn--a shortage of savings vehicles that means that balancing savings and investment at full employment requires a nominal interest rate of -3%, which the zero-bound keeps you from getting to. The Fed would lend to all comers at a nominal interest rate of -3%.

I cannot quite see how this would solve a Minskyite downturn--a flight to quality because of a collapse in the market's risk tolerance and a shortage of safe assets. But perhaps this is because I am a bear of too little brain to figure it out during the Econ 1 final when the GSIs are glowering at me because I am supposed to be outlining the answers for the essay questions...

Scott goes on, anticipating that implementation of his proposal would bring the New Jerusalem: "And the building of the wall of it was of jasper: and the city was pure gold, like unto clear glass. And the foundations of the wall of the city were garnished with all manner of precious stones. The first foundation was jasper; the second, sapphire; the third, a chalcedony; the fourth, an emerald; 20: The fifth, sardonyx; the sixth, sardius; the seventh, chrysolite; the eighth, beryl; the ninth, a topaz; the tenth, a chrysoprasus; the eleventh, a jacinth; the twelfth, an amethyst":

This sort of policy regime addresses many of the liberal arguments for big government. Right now conservatives don’t have good counterarguments to Paul Krugman’s insistence that all the laws of economics go out the window when we are in a “depression.” Classical economics assumes full employment; how credible are classical arguments against federal job-creation schemes when unemployment is 9.8 percent? Yes, government intervention doesn’t even work very well when there is economic slack. But with NGDP futures targeting, there is no respectable argument for fiscal stimulus, as the money supply would already be set at the level expected to produce the desired level of future nominal spending.

In a world of NGDP futures targeting, liberals would no longer be able to mock those who invoke Say’s Law (supply creates its own demand). It would be transparently obvious that any auto demand created by a bailout of GM would be at the expense of less demand in some other sector of the economy. Nor would the Washington elites be able to intimidate people into bailing out the big banks by pointing to the specter of an economic depression. Banks would fail, but the money supply would adjust so that expected future nominal spending continued to remain on target. Creative destruction could do what it’s supposed to do, with jobs lost in declining industries being offset by jobs gained in creative new enterprises.

There are two types of conservatism. One is pessimistic, resentful, dismissive of any claims of progress in governance. It relies on nostalgia for a mythical golden age, before big government ruined everything. It is scornful of intellectual inquiry into new policy approaches. Nominal GDP futures targeting is part of an optimistic, forward-looking conservatism; it is progressive in the best sense of the term. It is based on time-tested conservative principles, such as the fact that markets can set prices and quantities better than government can, but also builds on the serious academic work of scholars such as Milton Friedman, who understood the devastating effects of a serious plunge in nominal output. There’s no going back, but we can build a monetary regime that undercuts the liberal arguments for big government while providing an economic environment where capitalism can flourish.

I am somewhat skeptical. It seems to me that sensible fiscal policy might be better than mega-TARP helicopter drops to bankers under some circumstances. And people even quarrel over the construction of the New Jerusalem. Wikipedia:

Revelation lacks a list of the names of the Twelve Apostles, and does not describe which name is inscribed on which foundation stone, or if all of the names are inscribed on all of the foundation stones, so that aspect of the arrangement is open to speculation. The layout of the precious stones is contested. All of the precious stones could adorn each foundation stone, either in layers or mixed together some other way, or just one unique type of stone could adorn each separate foundation stone...