Though a wide-swath of economists have bought into NGDP, I think there is still much dissention over exactly what it would.

Robert Waldaman makes some detailed critiques. Let me address them one by one.

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 suggest putting NGDP language into the policy statement. The “instrument of record” will remain the Federal Funds rate. This is the opportunity cost on bank lending and banks understand what it means.

However, we make movements in the Funds Rate conditional on Nominal GDP. I have offered as a draft policy statement.

The Committee judges that economic conditions will warrant exceptionally low levels for the Federal Funds rate until current value Gross Domestic Product exceeds $19.5 Trillion.

Since I am a Burkean at heart I see no need to jettison Fedspeak or the Feds Funds rate as the instrument of record. What we are saying here is that we will guarantee low interest rates until we see a specific level of economic performance.

And, note NGDP is not only constantly measured but very easy for the public to understand since it involves no deflating. It is literally an adding up of all the value produced by the US economy. That’s sounds like a thing policy makers should try to promote.

Waldmman goes on

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.

I don’t think there is a problem here. I am not quite sure what Waldmman means by jump but our best case scenario is that Nominal GDP will move towards the long run path over a matter of months to a year. That would, however, represent blazingly fast economic growth and be consistent with a strong reduction in unemployment – which is what we should really care about.

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.

I obviously want to come to consensus on this issue as fast as possible but I don’t think we have to worry about Quantitative Easing or Qualitative Easing. A well designed target and what I am going to start calling the Smith-Sumner Rule*, will get us there.

Why?

There are a couple of ways to think about it. Intuitively it makes sense to me to say that all long interest rates are simply the expectation of the time path of short rates adjusted for the probability that you might be wrong. Thus if you give clear guidance on the path of short rates you have immediately set long rates, regardless of whether you buy Treasuries or not.

Perhaps a more common sense way of putting it is this. You are guaranteeing banks that they will have access to low cost credit until the level of spending in the economy picks up. This straight forwardly means that the opportunity cost of lending will be low until such time that your borrowers have more money to pay you back.

That instantly makes every loan a better deal. A bank might worry that it has all of this long money outstanding, much of it potentially going bad and then suddenly the Fed raises rates on it. However, the new target says this explicitly will not happen. Either, the economy gets better or your money stays cheap. Either, way you are not going to get squeezed.

If you like to do analysis in BL-MP then you would say that expectations of Future Monetary Policy (MP) pushs out Bank Lending (BL) in the current period.

*Not-yet tenured Professors can always use a little shameless self-promotion.

About these ads