Monday, March 29, 2010

Recommended Readings


  1. David,

    The Bill Woosley piece you linked to raises a question that you may be able to answer. Woosley argues that, in effect, the Fed's 2003 asymmetrical policy was consistent with NGDP level targeting. By implication, if something results in returning to trend level NGDP, then it can't be a cause of NGDP crashing.

    The question arises from how nominal spending returned to trend. Private credit exploded during those years, so that the "productivity" of credit growth was quite low: for every dollar of credit created, we got fewer and fewer dollars of spending.

    The question is, essentially, do credit levels and leverage (total credit to GDP) matter? If they don't, then Woolsey is correct. But if leverage contributed or somehow caused the crash in spending, then there is, perhaps, an inherent flaw in NGDP targeting. That is, if the Fed "forces" credit-led spending during a period when real return on assets across the economy are low, then the only way it gets spending to grow is by creating higher returns on incresingly levered equity. I believe this is, in effect, is what happened after the internet bubble, and what the Fed is trying to engineer today (i.e. another desparate search for levered yield).

    I suppose it boils down to the assumption about "trend" spending. I'm implying that trend spending shifted down after the internet bubble (available returns on assets fell), and that the Fed could only try to maintain it by artificially pumping up leverage. The biggest problem with NGDP level targeting is with the assumption of the long term spending trend, because if it is too high, then the economy will be subject to Fed-created booms and busts, with lower real spending and higher inflation over time.

  2. David:

    I have been wrestling with that very issue. On one hand, level-targeting NGDP makes sense for cases like the early 1930s when spending fell by 50%. On the other hand, it makes less sense for 2003 when credit growth and leverage where taking off. That is why I am not 100% convinced level targeting is correct. Now If you looked at the growth rate of NGDP during 2003-2005 it is growing above trend. Targeting the growth rate in 2003-2005 would have made a lot more sense.

    Ultimately, it may boil down to the fact the stabilzing NGDP is not a sufficient condition for ensuring macroeconomic stability. Given these lingering doubts, I am for a combination of stabilizing NGDP and applying macroprudential regulation (e.g. procyclical capital requirements)that would address the buildup of financial imbalances. If you come to any resolution here let me know.