Wednesday, August 3, 2011

The Fed Can Raise Nominal Incomes Too!

Ken Rogoff is one smart guy and his writings are typically fun to read.  His latest piece, however, left me feeling a little disappointed.  It concedes too much to the "balance sheet" view of recessions which for reasons spelled out here and here is an inadequate view of the crisis.  Moreover, his analysis ignores what monetary policy is really capable of doing for the U.S. economy: increasing nominal spending and nominal incomes.  Ramesh Ponnuru, the resident quasi-monetarist and Senior Editor at the National Review, makes this point:
Kenneth Rogoff writes that “the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years.” It certainly would be a way to reduce the real burden of debt, but is it the only or the best way?

The Federal Reserve has more direct control over nominal spending/nominal income than it has over inflation, and higher nominal income—whatever the ratio between the higher inflation and higher real growth that compose it—makes it easier to pay down debts (most of which are contracted in nominal terms). Because of wage stickiness, at least some of any increase in nominal spending that the Fed generates will take the form of real growth—and obviously one would prefer that portion to be as large as possible.

What we need, then, is not more inflation. We need for the Fed to stop holding the money supply below the demand for money balances. That might increase inflation, which would be a price worth paying to get nominal spending back to trend. But inflation shouldn’t be the goal.
Well said.

Update: Marcus Nunes makes a similar point here.


  1. I think the balance sheet view is repeated because bankers repeat it. A lot of articles in the papers on community banks here include quotes like "we've cut back on making loans because people have stopped applying for loans." People are either not working, or afraid of losing their income, and are already too in debt to take on more. Businesses aren't expanding because they don't see where customers are going to come from. In the end, doesn't it just point back to aggregate demand?

  2. I said the same thing on August 2
    "Why talk about inflation, the dreaded word in the post “Great Moderation” world? Why not say “the Fed should strive to increase nominal spending by 7% or 8% per year until it brings nominal spending to a stated level and let the “chips” (the breakdown of spending between inflation and real growth) fall where they may"?

  3. Inflation expectations plummet. Fed failure:

  4. Marcus, thanks for the link. I provided an update that links to it.

    JDTapp, the TIPs breakeven inflation numbers are troubling. Let's hope the Fed is watching.

  5. David,

    The issue weighing on TIPS spreads is the prospect of a deflationary European banking crisis. Dollars are exiting Italian and periphery banks. This is apparently causing a wave of repatriated dollars coming into U.S. banks. The following headline casts some doubt as to whether a lower IOR would be an effective policy tool at this point:

    WSJ UPDATE: BNY Mellon Charging Large Depositors To Hold Cash

  6. Yes, Marcos Nunes and Beckworth and Sumner are right--but grab allies where ever you can find them.

    Rather than parsing hairs, you guys need to get together under a banner or platform, perhaps waving a bit of George Gilder about.

    The point is, monetary stimulus is good, and can be used even as federal deficits are restrained. In the USA and Europe.

    More important than minute rates of inflation are policies to reward innovation and and business growth. I would rather live in a robust economy with mild inflation, than a dead economy with no inflation.