Who Said This?

The following are some excerpts from a paper on the problems Japan faced in the 1990s. If one were to replace Japan with the United States you might think you were reading a Market Monetarist article.  Consider first, this paragraph:

As already suggested, I do not deny that important structural problems, in the financial system and elsewhere, are helping to constrain Japanese growth. But I also believe that there is compelling evidence that the Japanese economy is also suffering today from an aggregate demand deficiency. If monetary policy could deliver increased nominal spending, some of the difficult structural problems that Japan faces would no longer seem so difficult.

Sounds very Scott Sumnerian.  But it gets better.  The author also makes the Market Monetarist claim that low interest rates can actually be a sign of tight monetary policy:

The argument that current monetary policy in Japan is in fact quite accommodative rests largely on the observation that interest rates are at a very low level. I do hope that readers who have gotten this far will be sufficiently familiar with monetary history not to take seriously any such claim based on the level of the nominalinterest rate. One need only recall that nominal interest rates remained close to zero in many countries throughout the Great Depression, a period of massive monetary contraction and deflationary pressure. In short, low nominal interest rates may just as well be a sign of expected deflation and monetary tightness as of monetary ease.

 And there is this flippant dismissal of liquidity traps like there are a walk in the park:

It is true that current monetary conditions in Japan limit the effectiveness of standard open-market operations. However, as I will argue in the remainder of the paper, liquidity trap or no, monetary policy retains considerable power to expand nominal aggregate demand. Our diagnosis of what ails the Japanese economy implies that these actions could do a great deal to end the ten-year slump.

 Finally, this critique of the uncertainty created by the vagueness of the Bank of Japan's policy objective seems almost eerily similar to the Market Monetarists' critique that the Fed lacks a clear policy objective and that in turn creates more macroeconomic uncertainty:

A problem with the current BOJ policy, however, is its vagueness. What precisely is meant by the phrase “until deflationary concerns subside”? Krugman (1999) and others have suggested that the BOJ quantify its objectives by announcing an inflation target, and further that it be a fairly high target. I agree that this approach would be helpful, in that it would give private decision-makers more information about the objectives of monetary policy. In particular, a target in the 3-4% range for inflation, to be maintained for a number of years, would confirm not only that the BOJ is intent on moving safely away from a deflationary regime, but also that it intends to make up some of the “price-level gap” created by eight years of zero or negative inflation.

In other words, the author is saying here that the Bank of Japan needs do price-level targeting to restore aggregate demand.  In such circumstances, that also amounts to an argument for nominal GDP targeting. But the author is no Market Monetarist. No, he just happens to be Federal Reserve Chairman Ben Bernanke, back when he was an academic.  If Chairman Bernanke ever needed a reason to adopt a nominal GDP level target it is his own work in this paper.  I encourage him to sit down, replace all the Japan references with United States in the above paper, and then ponder its implications for the Fed today.

Christina Romer Goes to Bat for Nominal GDP Targeting

And she hits a home run. Actually, if I may extend the baseball analogy a bit, she hits a grand slam.  The bases were loaded with Scott Sumner on third, Goldman Sachs on second, and Paul Krugman on first.  Coach Bennett McCallum was standing near the dugout screaming instructions.   Digging her cleats into the clay and readying her bat, Christina Romer took a hard swing at the fastball.  The ball exploded off the bat, flew over the fence, and hit baseball fan Ben Bernanke right in the gut.  After getting his breath back, Ben Bernanke picked up the ball and to his surprise found the following message on it:  "Time to man up and act like a Volker.  Initiate Nominal GDP level targeting."  Will he?  Or will he take the home run baseball and its message and throw it back on the field?

Brad DeLong gives reasons why he may not adopt nominal GDP level targeting.  Paul Krugman explains why now more than ever he should run with it.  Ultimately, Christina Romer is reminding Ben Bernanke that fortune favors the bold.  And a move to nominal GDP level targeting would be bold, the kind of bold the economy sorely needs.

The Fed is Talking About a Nominal GDP Target

Robin Harding reports that the Fed trying to improve its communication policy:

A long and contentious debate on communications is set to occupy most of the Federal Reserve’s time when it meets on Tuesday and Wednesday next week... Three different issues are tangled together. The first is whether to clarify the Fed’s goal by agreeing on a clear inflation objective. Second is explaining how the Fed is likely to change policy in the future to reach that goal. Third is whether to use communication to ease policy now with, for example, a pledge to keep rates low until unemployment falls to 7 or 7.5 per cent.

A working group is attacking the problem from first principles, with every option – including innovations such as setting a target for growth in nominal gross domestic product over time – up for discussion.

I am glad to see them include a nominal GDP target in their discussion, but there is a more important point here. One of the key reasons behind the Fed's inability to restore robust nominal spending is its inability to clearly communicate the future path of monetary policy.  By failing to properly shape expectations about where it wants to guide the nominal economy, the Fed has created much uncertainty.  There is no way programs like QE2 and Operation Twist will have lasting power if there is no explicit and well understood target assigned to them. That is why these talks are important.  As Nick Rowe explains, the Fed is one of the worst communicators among central banks so anything would be an improvement.  

And for those who question whether expectations really do make that much difference take a look at the figure below.  Using data from the Survey of Professional Forecasters, it shows the average annualized quarterly growth rate forecasted for nominal GDP over the next year and compares it to the actual growth of nominal GDP over the next year.  It shows that a systematic and positive relationship exists between the two measures.
 

Along these same lines, Josh Hendrickson and I have a working paper that I am presenting next month at the SEA meetings in Washington, D.C. that shows shocks (or unexpected changes) to the inflation forecast causes a rebalancing of household portfolios that in turn leads to a change in nominal spending.  The importance of expectations cannot be understated. 

Hat tip Mark Thoma.

The Godfather Speaks

The Godfather of nominal GDP targeting has spoken.  Bennett McCallum, who has authored numerous academic papers on nominal GDP target and is probably the foremost expert on it, weighs in on the growing attention being given to this approach to monetary policy.  An important point that he makes is that a nominal GDP target would be easier to understand by the public than an inflation target:

It seems ironic then that, when academic economists suggested nominal income targeting to Federal Reserve officials in the 1980s, often the main objection put forth was that it would be difficult for the public to understand. But it seems likely that it would be easier for the public to understand nominal GDP growth than a target that includes an unspecified weighted average of an inflation rate and some unreported major adjustment to take account of output and/or unemployment conditions. Indeed, I would argue that “total spending” in the economy is a way of describing nominal GDP that would make that concept at least as easy to understand by average citizens as “core inflation” or even CPI inflation.

I have always believed that marketing a nominal GDP target would be fairly easy for the reasons laid out above.  Another way of framing this for the public is to say that the objective of such an approach to monetary policy would be to stabilize nominal income or wage growth (though technically that would require a nominal GDP per capita target).  The public understands their current dollar wages far better than the various CPI measures.   Thus, selling a NGDP target as a way to stabilize wage growth should have broad appeal.  And then there are good macroeconomic reasons to stabilizing nominal wage growth, but that is a topic for another post.

PS.  Lars Chrisentensen prefers to call Bennett McCallum the grandfather of Market Monetarism.  Meanwhile, Steve Randy Waldman and Kevin Drum say favorable things about nominal GDP targeting.

The Six Myths of US Monetary Policy During the Great Recession

Clark Johnson has written an article (here for smaller file size) that does a fabulous job addressing the six common myths about U.S. monetary policy since 2008. It is accessible but informed and should be required reading for anyone thinking about U.S. monetary policy.  I am adding it to my required reading list for my money and banking class.  It is really that good. 

Here are the six myths Johnson addresses:

Myth 1:  The Federal Reserve has followed a highly expansionary monetary policy since August, 2008.

Myth 2:  Recoveries from recessions triggered by financial crises are necessarily low.

Myth 3:  Monetary policy becomes ineffective when short-term interest rates fall close to zero.

Myth 4:  The greater the indebtedness incurred during growth years, the larger the subsequent need for debt reduction and the greater the downturn.

Myth 5:  When money policy breaks down there is a plausible case for a fiscal response.

Myth 6:  The rising prices of food and other commodities are evidence of expansionary policy and inflationary pressure.

Read the rest of the article.

Three Objections to NGDP Level Targeting

Not everyone is a fan of nominal GDP level targeting.  Here are three objections to it that I have run across recently followed by responses to them. 

1.  Further monetary stimulus is pointless since banks aren't doing much lending.

The ability of the Fed to influence total current dollar spending does not depend on banks creating more loans.  Rather, it depends on the Fed's ability to change expectations so that the non-bank public rebalances their portfolios appropriately.  Recall that a nominal GDP level target means the Fed makes an unwavering commitment to buy up assets until some pre-crisis nominal GDP trend is hit.  As Nick Rowe notes, just the threat of the Fed doing this would cause the public to expect higher nominal spending growth and higher inflation.  This change in expectations, in turn, would cause investors to rebalance their portfolios away from liquid, lower-yielding assets (e.g. deposits, money market funds, and treasuries) toward higher-yielding assets (e.g. corprate bonds, stocks, and capital).  The shift into higher-yielding assets would directly affect nominal spending through purchases of capital assets and indirectly through the wealth effect and balance sheet channels.  The resulting increase in nominal spending would increase real economic activity, improve the economic outlook, and thus further reinforce the change in expectations.

Bank lending would probably respond to these developments, but it would not be driving them.  It is interesting to note that FDR did something similar to nominal GDP level targeting in 1933 and it sparked a sharp recovery that lasted through 1936.  Bank lending, however, did not recover until 1935.  Bank lending, therefore, was not essential to that recovery.  That may be less true today, but in any event the key point here is that if bank lending does increase it would do so as a consequence of the improved economic conditions brought about by the change in expectations.  

2.  Additional monetary stimulus will only further harm savers and banks' capital position.
The concern here is that additional monetary stimulus would require a further lowering of interest rates, particularly long-term interest rates since short-term interest rates are already at the zero percent bound.   This would harm savers and banks' capital position by lowering net interest margins.  The latter is a big deal given the problems in the banking industry.  But here is the thing.  If a credible nominal GDP level target is implemented there should be real economic gains (as noted above) that would  lead to higher real interest rates.   Savers and banks would benefit.  If we can agree that primary cause of the recession is insufficient aggregate demand, then the fact that the U.S. economy is still sluggish is a sign that monetary policy has failed to do its job.  It has passively allowed the economy to weaken by failing to shore up aggregate demand.  Once it does shore up aggregate demand, as it should under a nominal GPP level target, interest rates will increase and these concerns will disappear.

3.  Nominal GDP targeting has been shown theoretically to increase volatility.
Laurence Ball (1999) demonstrated theoretically in a widely-cited paper that nominal GDP targeting can lead to increased volatility of output and inflation.  Lars Svenson (1999) later reconfirmed Ball's findings. This made some observers questions whether nominal GDP had any future.  Bennett McCallum (1999), however, said not so fast.  He showed that their conclusions were based on special backward-looking IS and Phillip curve relations that are "theoretically unattractive" (because they are backward looking)  and whose results fail to hold up with more general specifications.  Richard Dennis (2001) later confirmed that Ball and Svenson's results were fragile.  Finally, Kaushik Mitra (2003) showed that even with adaptive learning, nominal GDP targeting remains a desirable objective for monetary policy.  Thus, there have been no robust studies that show nominal GDP targeting increases volatility. 

More Nominal GDP Targeting Links

Nick Rowe and Bill Woolsey have chimed in with some new thoughtful pieces on nominal GDP targeting.  Nick Rowe  explains how expectations management is key to nominal GDP level targeting, while Bill Woolsey responds to the nominal GDP targeting comments of Paul Krugman, Brad DeLong, and Stephen Williamson.