What would the “failure” of a NGDP targeting central bank look like?

Nominal Gross Domestic Product is depressed, that leads real GDP to be depressed because it is very difficult to accommodate rapid and large deflation so logically it must be lower. It also leads to the quantity of people employed to be depressed because the same is true of aggregate wages.

I don’t fully understand what critics of NGDP targeting mean when they say they suspect the policy would fail. I think the language NGDP targeting is something of a handicap, because once you start thinking in this language you begin to translate people’s statements and in the process they cease to make sense.

Chris Dillow says…

I fear, though, that economists who invoke “expectations” and “credibility” are making the error of mistaking the tidy maps of models for the messy terrain of reality.

Unlearning Economics says…

This is a clear example of confusing correlation and causation. When looking at two correlated variables, a good question to ask is which one moves first – here, the drop in RGDP clearly precedes the drop in NGDP. This suggests that the decline in RGDP is not a result of the decline in NGDP; rather, its the opposite.

So what happened in 2008? Obviously, the conventional story is true: a large drop in asset prices made many households and firms realise they were less wealthy than they thought; this caused firms to lay off workers; real production decreased; nominal income followed; expectations dropped; this created a spiral. The NGDP-driven story doesn’t withstand scrutiny, else we’d expect the NGDP drop to come first.

First of all, I agree with Chris that relying on expectations is a weak lever. But, if you are powerful enough to not have to rely on expectations, the market should anticipate that and you will be able to rely on expectations. To he that hath shall be given, and we hath in abundance. I think a Bank with a fairly doveish reputation with the printing press combined with the supremacy of parliament, the Royal prerogative and a government intent on re-election is more than powerful enough for the above to hold true.

Secondly, I disagree with UE. In 2007/8 asset prices fell because expectations of future NGDP fell which was priced into current asset prices. This lead to a fall in real GDP contemporaneous with a fall in NGDP, but both were caused by fall in expectations of future NGDP as is argued by adherents (cultists?) of NGDP targeting. Asset prices are forward looking and money is an asset, hence you have to look at expectations of future NGDP rather than looking at which moved first by a few months, RGDP or NGDP.

So what I don’t understand is what non-NGDP monomaniacs think will happen were a central bank to adopt a NGDP targeting regime. Say the treasury ask the Bank of England to adopt NGDP targeting and to catch up entirely to trend from 2008. What does failure look like?

  1. NGDP does not reach trend because the bank lacks credibility and the policy is abandoned.
  2. NGDP fails to reach trend for a long time, and so has little effect on anything important.
  3. NGDP reaches trend but nominal growth consists (almost) entirely of price changes.
  4. NGDP over shoots target massively and cannot be contained because  inflation expectations become unmorred and accelerate upwards: the price level spirals out of control.
  5. NGDP targeting is effective and a la Kalecki capitalists stage some sort of investment strike and must be abandoned for political reasons.
  6. NGDP targeting is effective and workers/voters realise it is a way of moderating their wage demands and must be abandoned for political reasons.
  7. NGDP targeting is effective and we realise we’ve seen a series of unsustainable booms rather than real growth because of a slow down in innovation and all economic growth ends up accruing to land and rents and must be abandoned for political reasons.
  8. NGDP targeting is effective and some combination of 5,6 and 7 occur.
  9. Other?

Can anyone fill me in?


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.

Its catching…

One down, eleven to go

From Matt O’Brien at The Atlantic:

Chicago Federal Reserve president Charles Evans doesn’t look the part of a heretic. But in the cozy, conservative club that is central banking, he certainly qualifies. While most of his colleagues at the Fed have recently taken an even more hawkish turn, Evans remains a champion of additional monetary stimulus. And on Tuesday he took an even bigger step: He became the first sitting Fed member to endorse nominal GDP (NGDP) level targeting.

.   .   .


The Fed is still a long way off, if ever, from adopting an NGDP level target. But Evans’ endorsement of the idea is a big first step in what could be a hugely important paradigm shift. Even if there isn’t a large difference between the quasi-NGDP level target that is the Evans Rule and an actual NGDP level target, it’s a fairly radical new way of framing policy. Rather than the central bank letting the economy recover faster, it puts the onus for a faster recovery on the central bank.

Most incredible is how quickly the idea is gaining acceptance. It’s true that writers like The Atlantic’s own Clive Crook have long advocated the merits of NGDP targeting. But as recently as 2009, it was mostly just a few lonely bloggers like Scott Sumner and David Beckworth who picked up the torch. Then Goldman Sachs chief economist Jan Hatzius and Paul Krugman said they were willing to give it a try. Now, a sitting Fed president is on board.

At this rate, it might not be long until we describe Evans as an orthodox central banker. Now that would be progress.

That is one of the US’s top central bankers supporting NGDP level targeting as endorsed on this blog. Hopefully a UK central banker will make the leap soon too, senior figures inthe

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 BeckworthBritmouse 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.


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