Monday, September 9, 2019

Some Assorted Macro Musings

Dollar Dominance
I have been part of a dollar dominance conversation for the past few weeks. It started with my NRO article, discussions on the topic at the Jackson Hole conference, and a follow-up blog post. Later, there were twitter conversations, an interview on Bloomberg TV, and several podcast recordings. This all culminated in an article I wrote for The Bridge that summarizes what I see as the main issues of dollar dominance and what realistically can be done about it. Check it out and also see the follow-up twitter thread I provided that documents some of the claims made in the piece.

Paul Volcker is What the Public Wanted
Back in May, I interviewed Robert Samuelson about his book on the Great Inflation of the early 1970s to early 1980s. One of the claims he makes is that inflation was a bigger deal than Watergate or Vietnam for most Americans during that time. Samuelson notes most histories of this period overlook this fact even though it is supported by poll data. I finally decided to track down this poll data for myself to verify this claim. Here is the Gallup Poll data I found:

Yes, inflation was the "most important problem" for a majority of people during most of the period between early 1970s and early 1980s. This implies that Paul Volcker's war on inflation was exactly what the body politic desired at that time. It would also explain why President Reagan supported him in his efforts to fight inflation. 

Loss Functions and NGDP Targeting
I was pleasantly surprised to see Lars Svensson's updated paper from the Chicago Fed conference that took place this past June. Due to some pushback he got at the conference, he included a section in his revised paper on NGDP targeting. Here is an excerpt:

Obviously, I was thrilled to see Svensson cite my paper and recognize the financial stability argument for NGDP targeting. Ultimately, though, he rejects this monetary framework based on a loss function that assumes it is optimal to minimize the variance of output and inflation. A good central bank, in other words, is one that tries to reduce volatility in both inflation and the real economy as much as possible.

NGDP targeting, however, makes the opposite case. It explicitly aims for increased inflation flexibility in the shortrun--while still anchoring the dollar size of the economy--so that a central bank will not respond to swings in inflation caused by supply shocks. Doing so serves to minimize the variability of output and, ironically, inflation itself.

This point is vividly illustrated by the ECB in 2011. It succumbed to the siren call of temporarily higher inflation caused by negative supply shocks and, as a result, raised its target interest rate twice. This tightening helped create a second recession in the Eurozone and caused inflation to subsequently undershoot its target. In short, the ECB in its efforts to offset supply-shock induced inflation in 2011, actually increased the variability of output and inflation. 

Ideally, central bankers should be able to see through such temporary changes in inflation, but in real time this is extremely hard to do. Especially, if central bankers have in the back of their mind the kind of loss function Svensson applies above. This is the very problem that NGDP targeting helps central bankers overcome as shown by Garin et al (2016) and Beckworth and Hendrickson (2019).


  1. I like the loss function framework though.

  2. David,

    One question has puzzled me. Japanese Yen has been appreciating against Dollar for decades. Why international community don't just accumulate Yen.

  3. Congratulation, David!

    Incidentally, do you recommend as of today the fed policy interest rate should be cut by 25bp at the next FOMC on September 18, in accodance with your NGDP targetting strategy?

    As you are aware, recent NGDP is currently running at around 4%, which is not far from the historical average.

    Your kind help would be highly appreciated.

    Tomo Nakamaru

  4. Well, good post and I always like the work of David Beckworth.

    But maybe a couple quibbles here.

    Reagan did not back Volcker, in fact the Reaganauts loathed Volcker (originally a Carter appointee). Hagiographers have burnished the Reagan legacy, but...

    In fact, Reagan even (publicly!) proposed placing the Federal Reserve into the Treasury Department, where it would ultimately report to the Oval Office.

    Imagine the howling if Trump proposed this.

    Reagan also packed the FOMC with "easy money" types, who outvoted Volcker to ease money once...but Volcker threatened to quit, and they backed down. Then there was the famous meeting at the White House, where James Baker told Volcker to ease up while Reagan silently watched. Alan Meltzer termed Reagan's macroeconomic and monetary policies to be "incoherent."

    A second quibble, on the chart regarding inflation. Unfortunately, the chart (and I guess the survey question) conflates "inflation" with "high living costs." Which might be another way of saying "lower living standards." Based upon this muddy question, it is hard to say the public backed Reagan or not in his imaginary war on inflation.

    In truth, Reagan ran huge budget deficits, bargained for a cheaper dollar at the Plaza Accords, and wanted easier money.

    But hey, when caught between the legend and the truth...print the legend.

    1. Benjamin, ultimately, Reagan did have Volcker's back during the inflation fight. He got rid of him later in the Reagan presidency. See the Robert Samuelson book I mentioned above. It provides a good discussion of this point.

    2. Well, perhaps it is better said that ultimately Reagan was uninvolved. My take on Robert Samuelson (and many other DC journalists) is that they tend to embrace the "the DC literati view" of politics. Reagan is seen as an inflation-fighter. Many other public figures or stories fall into accepted re-tellings (sometimes with mirror left- and right-wing views).

      It is interesting that Reagan could personally and publicly call to place the Federal Reserve into the Treasury Department (echoing the oft-expressed views of his Treasury Secy Don Regan----this idea of ending Fed independence was no one-off trial balloon) and no one took much umbrage at the time, and no one recalls this today.

      That about suns things up.