Monday, January 7, 2013

Michael Woodford Continues to Do God's Work

Michael Woodford continues to do God's work on the pages of the Wall Street Journal and an in an interview with Bloomberg.  In the former, he, along with Frederick Mishkin, advance the case for nominal GDP (NGDP) level targeting by showing how the current innovations to Fed policy are effectively a step in that direction.  They carefully point out these changes allow for catch up aggregate demand growth while still anchoring long-run inflation expectations, the very essence of a NGDP level target.  Woodford further expounds on this idea in his Bloomberg interview.    

This is an important point, because many see nominal GDP level targeting as giving license to the Fed to do excessive money creation.  On the contrary, it provides a solid long-run nominal anchor while allowing inflation to move in response to supply shocks in the short-run.  Here is how I described it earlier:
A level target anchors long-run inflation expectations, but allows for temporary catch-up growth or contraction in NGDP so that past misses in aggregate nominal expenditure growth do not cause NGDP to permanently deviate from its targeted path.  Woodford notes that currently NGDP is anywhere from 10-15% below its trend (and thus expected) growth path.  Any increase in inflation under this target, therefore, would not be some ad-hoc temporary increase but part of a systematic approach that would return NGDP to its trend.  I have used the following figure before to illustrates this idea:
The black line has NGDP growing at a 5% annualized rate.  Then, at time t a negative aggregate demand (AD) shock causes NGDP to contract through time t+1.  There is now an a NGDP shortfall.  To make up for it, the Fed must actually grow NGDP  significantly faster than 5% to return aggregate nominal spending to its targeted level.  For example, if NGDP fell 6% between t and t+1 it is now 11% under its trend.  Next period the Fed must make up for the 11% shortfall plus the regular 5% growth for that period.  In short, the Fed would need to grow NGDP about 16% between t+1 and t+2 to get back to trend.  There might be temporarily higher inflation as part of the rapid NGDP growth, but over the long-run a NGDP level target would settle back at 5% growth.  Nominal and thus inflationary expectations would be firmly anchored...Woodford also notes that such a rule would actually tend to reduce AD shocks since it would create well-anchored nominal spending and nominal income expectations that wold prevent such a shock from materializing in the first place:3
A commitment not to let the target path shift down means that, to the extent that the target path is undershot during the period of a binding lower bound for the policy rate, this automatically justifies anticipation of a (temporarily) more expansionary policy later, which anticipation should reduce the incentives for price cuts and spending cutbacks earlier, and so should tend to limit the degree of the undershooting. Such a commitment also avoids some of the common objections to the simple Krugman (1998) proposal that the central bank target a higher rate of inflation when the zero lower bound constrains policy.
And since it ignores supply shocks--e.g it would allow positive productivity shocks to result in lower inflation as long as NGDP growth was stable--NGDP level targeting tends to avoid swings in the stance of monetary policy that can be destabilizing.  The future of monetary policy is NGDP level targeting.


  1. "Michael Woodford continues to do God's work"

    A FIXED, IMMUTABLE, and ABSOLUTE concept (NGDPLT), under which all individuals are to prostrate under and be subjected to, in order to provide humanity with ORDER, STABILITY, and HAPPINESS...

    Nah, that can't be a God. It's so different!

  2. Major Freedom, unlike the religious belief in Murray Rothbard and the gold standard, right :)

  3. "Major Freedom, unlike the religious belief in Murray Rothbard and the gold standard, right :)"

    With the exception of the fact that I am not a gold standard advocate (but rather an advocate of whatever money you or anyone else wants to use in their own dealings, without imposing it on others as FIXED, IMMUTABLE, and ABSOLUTIST etc...), and with the exception of the fact that I view Rothbard (whose libertarianism derived from "natural", rational grounds, not religious grounds) as just another individual and in no sense an "idol" or "role model", yeah, that was a great zinger reply.

    Just FYI: Very few if any libertarians are in favor of using state violence to coerce people into using paper, or gold, or any other commodity as money. You know, that whole non-aggression principle thingy of libertarianism.

    1. So you would be for a free banking system if that emerged as the outcome? My impression is that you were a big commodity standard advocate. I stand corrected. Historically, when true free banking systems (i.e. no limits on branch banking and entrance into market)have been allowed they have been relatively successful like in Scotland and Canada. I take your above statement to mean you would support these emergent financial systems that were based on fractional reserve banking.

    2. Virtually every libertarian/Austrian has been accused of being a gold standard advocate by central banking apologists/advocates at some point or another. I think it happens because the perception in most academic circles these days, and in the general population thanks to the last few generations of statist intellectuals, is that if Mr. Smith is against mandatory fiat, he must be in favor of mandatory gold, because heck, everyone must be in favor of mandatory something, right?

      Unfortunately most economists want to treat other people in the economy the way a physicist treats atoms and molecules. This isn't too surprising considering how economists, thanks in large part to Milton Friedman, have succumbed to "physics envy" and began to copy the natural scientist's methodology of studying non-conscious, non-acting subject matter. So it was only a matter of time before economists began to tacitly presume people to be non-conscious, non-acting automatons, who are expected to react in the same constant way to the same constant stimuli. Ring a bell for NGDPLT?

      I am accused of being a goldbug so often that I no longer even get testy about it anymore. I just become sarcastic, to amuse myself. What else can I do in the face of a constant barrage of "You can't eat gold" and "Gold is a barbarous relic", despite constant protests that I don't want to force my preferences on others through the state?

      For fractional reserve free banking:

      My position is that as long as all relevant parties are aware of what banks are doing with demand deposits, and that includes not only the direct customers (the majority of whom historically have believed the demand deposit money is their property), but also third parties who are paid in such claims (the majority of whom historically have believed they are being paid with final money, rather than a credit instrument), then sure, I am all in favor of such contracting. If people want to be paid for their labor and goods with bank promises (debt), rather than transferable claims to existing money, then so be it. It's not for me to say they can't do that because they haven't aggressed against me.

      I will say though that most people throughout history, and today still, don't understand what is happening with demand deposit money, or who is the rightful owner of the money in the event of a dispute, so I will argue that fractional reserve contracts to this particular extent are unjustified, and have no place in a contract-based free society. Whether a crime has been committed would be on a case by case basis.

      Fractional reserve banking is justified in a society where individuals are educated enough to know what's going on. Unfortunately, I suspect that the only way most people will learn it at this stage is by experiencing the pain of losing their money through depositing their money in a fractional reserve bank that went bust.

      I hold that a major reason why central banks were able to arise in the first place, is due to a public being snookered too often by fractional reserve banks, and when people don't know what's going on in the world of money, financial instability is a certainty. This instability is what I think led to opportunists to take advantage of the political turmoil to establish a central bank to "end instability once and for all", and the public (Congress) let it happen.

    3. I am hesitant to go full on advocacy of FRB. If people remain uninformed, then central banking would probably arise yet again. So in my view, the way to ensure individuals are free to choose their own money, and keep choosing their own money, is for enough people to be strict and prudent, but not mindless thugs who harass, FRB contracts. I don't see people remaining ignorant forever if they keep losing the money deposited into an FRB bank that goes bust. Bank run after bank run will eventually make people clue in to the fact that it's better to keep their money at 100% reserve banks. But bankers have such a high incentive to lend that money out (due to state threats of money confiscation, and/or profit making opportunities in secret) that we may even need to abolish the state if free banking is to ever become a permanent reality.

      I think the fact that the Fed has backstopped fractional reserve banks for so long (combined with FDIC), that most people have been lulled into a dreary state of apathy and ignorance towards FRB. Now I am not making any universal claim when it comes to people's potential intelligence in this respect, just that this is what I think is currently transpiring, and has transpired, while neither the Fed, nor the banks, nor the rest of the government, have had any incentive to educate the general population as to the true nature of FRB, and therefore have not been upfront about it. The result of state/Fed dependency and lack of incentives to educate, has been mass ignorance, and instability in the financial system that arises from more than one party believing they are owners of the same property.

      Regardless of what actually transpires in a free banking world, at the very least every individual has the freedom to choose whatever money they have the opportunity to use, by soliciting competing money producers and bankers who do not have any government privilege in the creation of money. Of COURSE this would be "relatively successful"! It's how success is had in electronics: competition based on contracting.

      Finally, it doesn't matter if the outcomes will be "worse" in your opinion, or anyone else's opinion, because your judgment and everyone else's judgment as to what other people do with their own property in their trades with others, is not contingent upon your approval, nor is it contingent upon the approval of anyone in the state. The burden is not on free banking advocates to prove how it is superior to fiat central banking, before it can be adopted. The burden is on "paperbugs(?)" to prove why introducing coercion, in an otherwise peaceful industry of free banking, is justified. Against libertarians, you will never succeed in this, because libertarianism holds a prohibition on such coercion. In this respect, there is no area of compromise. Peace that compromises with violence, means that violence wins and peace loses. For coercion and peace, it's one side wins and the other side loses. If fiat wins, violence wins. If free banking wins, peace wins.

      "We cannot negotiate with people who way what's mine is mine and what's yours is negotiable." - JFK

      Though I cannot make any scientific predictions, a free banking world will almost certainly be precious metals based (If even central banks still hold precious metals in a fiat world where they have a monopoly on money, I don't see any reason why precious metals would not be held by most private competing banks in a free banking world). This isn't an advocacy, it's a guess (hopefully an educated one). Every individual can "advocate" for their money of choice, but in the sense of consumers advocating for what the next tablet PC should have, or what options the next Cadillac should have. It's not an advocacy in the sense of governmental force the way paperbugs advocate for central banking.

  4. Excellent blogging, and the new look is very nice also.

    Yes, I think we should try to get back to the level, and "make up" for the lost output.

    BTW, the WSJ had a commentary today that perhaps central banks should not be independent.

    It is a truism that the words "independent public agency" are synonymous with the word "ossified."

  5. ...continues doing God´s his representative on earth, "the Monetary Pope":

  6. how do you figure out that too much time has elapsed and it's too late to try to get 'all the way back'?

    in other words, if I understand him correctly, Sumner has stated that he recognizes that it's too late to try to get back to a 5% trend from 2008, and so he only wants to get part of the way back...

    but how do you figure that out? what sort of criteria do you use.. ?

    1. "but how do you figure that out? what sort of criteria do you use.. ?"

      It's purely subjective. There are no principles.

      It's interesting how the boundaries of desired catch up times in the NGDPLT theory are admittedly subjective, but we're supposed to consider the desires for present time NGDP targeting as scientific.

      Or, we can wait for unemployment to fall to 5-6%. Then we'll know we're there and the wait time is over. Hope and change, but for economists.

  7. Go Treasury!! Make the trillion dollar coin and return seinorage to where it should be. Free banking advocates forget that the federal reserve was created in large part because the panic of 1907 was too big for the free banking world to contain and the government had to step in. It was clear at that time that free banking was no longer able to handle the changes that capitalism was undergoing during the industrial revolution, let alone handle today's information age economy. We only need to look at the plight of farmers during the Great Deflation after the civil war to know that the gold standard is a not-so-bright idea whose time has come and gone. The future is fiat, the Fed has proven it can act independently, but we need to take seignorage away from the banks and give the Fed a more effective lever on the money supply. The special profits of seignorage belong to the people's treasury.