I fear an alien life force has taken over our dear friend Tyler Cowen. Or, maybe it is just his evil twin Tyrone pretending to be Tyler on his blog. Either way, the real Tyler Cowen would never have written this post. For it contains some really head-scratching statements on nominal GDP targeting. Probably the most puzzling one is this:
I get nervous at how ngdp lumps together real and nominal in one variable, and I get nervous at how the passive voice is applied to ngdp.
No, NGDP is *all* nominal. That’s why it has the “nominal” in front. RGDP is an artificial concept requiring that we estimate an index of the aggregate price level.
Amen! The occasional, if tacit, treatment of NGDP as a value that is “derived” by taking the product of two directly observable magnitudes, real output and the price level, is as mischievous as it is wrong. We must understand the behavior of both P and y to depend, the first in the long run and the second in the short run, on that of Py, rather than the other way around. That is why it is also important to insist that stabilizing NGDP is not just a rough-and-ready way of minimizing a loss function in which fluctuations of P and Y are separable components. No and no again: if the natural rate of y plummets (natural disaster or war, say), what is desirable is not that we should minimize both P and y movements subject to the supply-shock “constraint. It is rather than we should see P move the opposite way from y, which is done by stabilizing Py level.
My framing is different. My framing is that the private sector can manufacture its own ngdp. It can do so by trade and it can do so by credit and of course velocity is endogenous to the available gains from trade...
To say “ngdp is low,” or “ngdp is on a low growth path,” or “ngdp is below trend,” and so on — be very careful! Those claims do not necessarily have causal force. Arguably they are simply repeating, in a new and somewhat different language, the point that the private sector has not seen fit to engage in more trade, credit creation, velocity acceleration, and so on. Formally speaking, the claims are not wrong, but I don’t find them useful as an explanation for why economic growth or recovery, at some point in time, is slow. It is one way of repeating or re-expressing the slowness of economic growth, albeit with some transforms applied to the vocabulary of variables.
Sorry, but the whole point of NGDP level targeting is to catalyze the private sector into a sustained expansion by changing their expectations about the future path of nominal income. If done right, households and firms would do the heavy lifting, not the Fed. This a point I and other Market Monetarist have made many times. For example, here is an excerpt from a post I did earlier this year:
Now imagine how the public would respond if tomorrow Ben Bernanke called a press conference and announced the Fed was adopting this new monetary regime. This announcement would send shock waves through the markets. Portfolios would automatically adjust toward riskier assets in anticipation of the Fed actually doing these conditional LSAPs. This would raise asset prices and raised expectations of future nominal income growth. Current aggregate nominal spending would respond to these developments, helping push NGDP to its targeted path and thus reduce the onus on the Fed to do LSAPs. In short, a conditional LSAP program tied to an explicit NGDP level target would be a significantly different and far more effective monetary program than any of the LSAPs the Fed has tried so far.
And here is an example from early 2011 where I explain a NGDP level target would solve a coordination problem where no household or firm wants to be the first mover in a deleveraging economy:
deleveraging is a drag on the economy, but for every debtor deleveraging there is a creditor getting more payments. (And if the debtor is not making payments and defaulting then the debtor still has funds to spend.) In principle the creditor should increase their spending to offset the debtor's drop in spending. The reason they don't--creditors sit on their newly acquired funds from the debtor instead of spending them--is because they too are uncertain about the economy. There is a massive coordination failure, all the creditors are sitting on the sideline not wanting to be the first one to put money back to use. If something could simultaneously change the outlook of the creditors and get to them to all start using their money at the same time then a recovery would take hold. Enter monetary policy and its ability to shape nominal spending expectations.
Again, the point is to catalyze the private sector into jump starting a robust NGDP recovery. Finally, we do have a causal story here, it is called an ongoing excess money demand problem that has kept NGDP below trend. My previous post provides ample evidence for this view. My hope is that alien-infested Tyler or Tyrone will wrap his minds around these points and be scared off. We need the real Tyler Cowen to return.