Policy Pragmatism

What concrete step caused the British Pound to appreciate rapidly on the 18th April?

The correct answer is “we’ll never know what confluence of events caused that particular movement.” Any concrete answer should be ignored. But please allow me to tentatively suggest (tentative suggestion is fine) that the price of Sterling, and hence the stance of British monetary policy, was changed by news that Adam Posen had withdrawn his support for more Quantitative Easing. This unexpected action caused sterling to hit a 19 month high against the euro.

So when Chris says to Nick Rowe “that relying upon expectations to do work is to rely upon a weak lever” I am somewhat sceptical. Adam Posen changed monetary policy by changing the future expected path of monetary policy – his actions lessened the chances of more QE and brought forward rate rises and the unwinding of the Bank’s balance sheet – and the market acted accordingly.

A similar mechanism might be all that is required for NGDP to work. A credible commitment to change the path of future policy would have immediate effects, we know this because (I tentatively suggest) we have already seen it happen.

Similarly, if Chris agrees that a higher sterling reflects tighter Bank of England policy and if Chris agrees a looser policy would help create jobs – as the sentence “I don’t doubt that more QE – the likeliest tool of an NGDP target – would create some jobs” implies – then there is something illogical in his pessimism towards adopting NGDP targeting.

I don’t think it could come from the Bank; Andrew Sentence is completely unable to offer a credible commitment to NGDP level targeting. But were the Treasury to change the Bank’s mandate then it could commit to change the path of future policy easily. Thanks (!) to  New Labour’s habit of concentrating power ever more in the executive, this change could happen at any point because the Treasury is empowered to change the Bank’s mandate at will.

I don’t think you can accuse me of Policy Utopianism, as I said in my last post many problems would remain after the adoption of NGDP level targeting. If the Doctor’s creed is “first do no harm,” the economic policy maker’s should be “first pick up the free lunches.” To ignore monetary policy, as Chris often does, is to leave all-you-can eat buffets to one side. Pragmatism requires adopting policies that put what labour, capital and land available to work. Even a “small improvement” would be a huge improvement to thousands.

Filed under: Economics, Adam Posen, Chris Dillow, Market Monetarism, Mervyn King, NGDPLT, Nick Rowe, Scott Sumner, Unemployment

How to End this Depression!

Targeting the path of Nominal Gross Domestic Product (NGDP) is probably the most “fashionable” solution proposed for dragging the developed world’s economies out of depression. This post will refer to the UK, but lots more work has been done on the US from this perspective, particularly by Scott Sumner and David Beckworth. Britmouse has blogged about NGDP from a UK perspective.

Real GDP is a proxy for our incomes adjusted for inflation, how well off we are. Nominal GDP is the same but refers to our incomes in cash terms. This nominal measure deviating from trend has been what has driven the wild swings in employment and production the developed world has seen since 2007.

NGDP matters because wages and debt are sticky.

Wages: NGDP can decrease if all other prices decrease with it, the relative prices between them will not change and apart from updating some menus nothing will have really changed. But it is incredibly hard to cut wages, look at the clustering of wage changes around zero in the below graph (via Paul Krugman). This means a decrease in NGDP relative to wages will throw people out of work as employers become unwilling to employ them at the prevailing nominal wage.

Debt: We care about what real resources we can consume but all our contracts are written in nominal terms. If I owe someone £10,000 then at some point I have to hand over some bits of paper, or packages of electrons, to someone for that amount. But, if NGDP grows below trend the total nominal size of the economy will be smaller than expected when I took out the debt, but the size of my debt will not. The real cost of my debt will have increased and this will work to depress the economy because this dynamic will affect a number of people.

If NGDP sinks below trend there are then at least two mechanisms which can act to depress an economy. [1] Has it sunk below trend? Yes it has.

Is off trend NGDP growth associated with weak real GDP growth? Yes it is.

Are changes from trend NGDP correlated with changes in employment? Yes they are.

That might be a little difficult to make out for some. So I zoomed in and inverted the unemployment figures. Are they correlated? Yes, and closely.

Let me tell you a story with a different ending to the one you know. The year 2007 began with NGDP growing to trend, and employment decreasing against the backdrop of international inflationary pressures and financial distress. NGDP reversed course and began to decline during the second quarter of 2007 as did employment, crucially this was before the Lehmann Brother’s bankruptcy and the ohmygodwereallgoingtodie stage of the financial crisis. Unemployment had already increased by nearly 200,000 after NGDP began declining but before the financial crisis began in earnest.

This doesn’t exhonerate any bankers, they put the Bank and Treasury in this position after all. But it does imply different priority for actions. Occupy Threadneedle Street, my friends, not the London Stock Exchange.

Scott Sumner and Ben Bernanke

Looking at the third graph you can see NGDP decline, recovery and stagnation correlating closely with decline, (mild) recovery and stagnation in UK employment. The Bank of England controls the country’s printing presses and hence the nominal economy and responsibility for this depression lies with the Monetary Policy Committee for doing too little to avert it and with the Treasury for doing so little to force them to do more.

In the UK and US the last couple of decades have seen NGDP grow at about 5% a year, and this nominal growth has been split between price increases and economic growth. In 2008 NGDP collapsed and we saw deflation, disinflation, and recession. To date NGDP has not yet recovered to trend, in fact it remains over 10% below trend – and this is our main problem.

Increase NGDP and employment, incomes and taxes would increase, many intractable problems would vanish (though many would not). There are risks and there are methodological problems, but there huge gains for everyone if they right policy is adopted and I want to do my part to try and make sure the right policy is adopted.

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[1] Data from here, I’ve used basic prices to strip out the effect of VAT jumping up and down

Filed under: Economics, Foreign Affairs, History, Politics, Society, Adam Posen, Britmouse, Market Monetarism, Mervyn King, NGDPLT, Scott Sumner, Unemploy, Unemployment

Scott Sumner’s victory is total…

Phewee…

“Market monetarists” like Scott Sumner and David Beckworth are crowing about the new respectability of nominal GDP targeting. And they have a right to be happy…. And now that we’re almost four years into the Lesser Depression, I’m willing, out of a combination of a sense that support is building for a Fed regime shift and sheer desperation, to support the use of expectations-based monetary policy as our best hope.

I for one welcome our new NGDP targeting, level targeting overlords, but in the UK it sounds like we may have had something similar for a while.

Scott’s having a good week, and good for him, it sounds like he’s sacrificed a fair amount of time with his daughter (during the years when a child actually wants to spend time with its parents) to push for market monetarism. I’d certainly buy him a beer were he to ever visit LSE.

Filed under: Economics, Inflation, Krugman, Level Targeting, macroeconomics, Market Monetarism, NGDP Targeting, Sumner