. . . economics [took] a momentous wrong turn. Under the influence of Wicksell, and then later Keynes, macroeconomists began to see the change in interest rates as not some sort of epiphenomenon associated with an increase in the money supply, but rather as monetary policy itself. This culminated in the work of Woodford, who developed monetary models without money, where interest rates were all that mattered.
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It seems to me that Woodford’s approach is capable of rescuing the QTM. Think about it. The QTM is criticized as only being able to explain price level changes in the long run. And yet Woodford says that the current level of aggregate demand is mostly determined by the expected future course of monetary policy; i.e. the long run.
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The rate of growth in NGDP between now and 2014 will be strongly influenced by where people think NGDP will be in 2017. There is no interest rate path that the Fed can describe that would give people even a ballpark estimate of NGDP in 2017. But if they say they will set the currency stock at $1.6 trillion in 2017, (twice the 2007 level) then people will know that 2017 NGDP is also likely to be roughly twice 2007 NGDP. And if they do that, NGDP will grow very rapidly over the next two years.
Are you simply saying that we can’t solve for the interest rate path and therefore it is difficult to set up an effective communications strategy?
I think that’s true though we have to be aware the problem works both ways. The actual economy consists of millions of different economic agents all of whom face an interest rate that is based off of the Funds rate or the Interest on Reserves rate. However, each of their relationships to NGDP is less clear.
To know what this policy means they – or more realistically their banker – has to solve backwards.
For example, suppose I am expanding a hot new burrito chain in East Texas. Does a 30% higher NGDP for the US in 2017 mean I – and my banker – want to expand faster or slower?
Its not clear. The overall growth path of NGDP for the US is only loosely connected the actual revenue that I am going to receive. A booming national NGDP might mean I grow at 14% nominal rate rather than a 11% nominal rate. Though it could go the other way if my customers get lured away to work in West Texas.
However, the interest rate over this period is going to determine whether dumping a bunch of money into new restaurants is a good idea or not. Is that going to be higher or lower because of your target. Again, its not clear.
So, its not clear what I should do.
On the other hand if you said – interest rates will be zero through at least 2014, then it is at least certain that no one is getting any surprises over the construction loan period and that more than likely some decent loan is going to be available when my stores are done.