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that the price of Sterling, and hence the stance of British monetary policy, was changed by news that Adam Posen had withdrawn his support for more Quantitative Easing.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.

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4 thoughts on “Policy Pragmatism

  1. The “rapid” appreciation in the chart is a rise of 0.5% – surely not enough to have a significant impact on the economy even if it persists. You need much better counter-examples to convince me that expectations aren’t a weak lever.
    The issue here is one of degree; how much good would NGDP targeting do, if adopted now? (the claim that it would have mitigated the 08-09 downturn, even if true, is irrelevant for policy purposes)
    I’m asking NGDP targeters to give me some estimates for how much unemployment would fall by, and through what mechanisms, relative to present policy (which I suspect is close to NGDP targeting anyway).
    Yes, a small improvement is worth having. My gripe is with those who think it sufficient.

  2. I think this is the best example of the power of expectations: http://www.bloomberg.com/news/2011-09-06/swiss-national-bank-sets-minimum-exchange-rate-of-1-20-against-the-euro.html?cmpid=

    A clear target and a credible commitment, and the exchange rate immediately changed to reflect it. I don’t think there’s any other way to interpret this than as an expectation driven event.

    The real issue with using the expectations lever is that credible commitment is difficult when you have 9 MPC members with different views about the optimal path of policy. Pay by performance might be a solution. The members would still have discretion, but it would come at a cost if it conflicted with the target.

    Or something like Sumner’s idea: create a futures contract in NGDP (paying out, say, one one hundredth of NGDP) that the central banks stands ready to buy (with new base money) at a target price (equal to one one hundredth of target NGDP). That puts base money into the economy when NGDP is below target. The central bank would also hold corresponding auctions, selling contracts in exchange for base money until the sale price fell to the target. That would take money out of the economy when NGDP is above target.

    No discretion required. And note also that the zero lower bound is no longer a problem because the base is the instrument, not an interest rate. A potential problem I can see (with both pay by performance and futures contracts) is how revisions to GDP data would be dealt with.

  3. “The issue here is one of degree; how much good would NGDP targeting do, if adopted now?”

    Do you agree with the view that we have a deficiency in aggregate demand? If not, then it would do nothing except raise inflation from your perspective. If you accept that we have an AD deficiency, then increasing AD should increase output and lower unemployment, along with increasing inflation somewhat.

    Precisely what happens depends on what target time path of NGDP is used. Do we go all the way back to the pre-recession trend? Do we let bygones be bygones and simply ensure that all future NGDP grows at x%? Or do we do something in between?

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