A few short comments
1. Many commenters were skeptical of my claim (in the previous post) that Robert Barro seemed dismissive of demand-side theories of the cycle. Noah Smith linked to this 1989 paper by Barro, which is consistently skeptical of demand playing an important role in business cycles. The impression created by the article is exactly the same impression I got from reading Barro’s 2011 WSJ piece. He didn’t completely rule out demand having some effect, been seemed very skeptical that it could have a significant effect.
2. Several of my more reliable commenters thought this Econlog post gave useful insights into the way I look at NGDP targeting. I can never tell which posts are interesting (I’m too close) but you might want to take a look.
3. David Beckworth has a nice post on forward guidance, with a great title:
Forward Guidance is Hard. So is Navigating a Ship By Focusing on the Expected Path of its Rudder
Note that this is especially applicable to time dependent guidance. State dependent guidance is better, albeit still has a problem with an interest rate rudder that locks up just when you need it most.
BTW, I see a lot of confusion in the press on forward guidance. There are claims that the Fed has reneged on previous guidance. That’s not quite right. It you promises to visit California and then later promise to visit San Francisco, you have not reneged on your earlier promise. The recent Fed decision to hold interest rates low at least until a considerable period after unemployment falls to 6.5%, is more specific that the promise to hold rates low at least until unemployment falls below 6.5%. There is a problem with the current techniques for forward guidance, but it’s not about reneging on promises. Rather the real problem is using unemployment and inflation as thresholds, when they should use NGDP. And not doing level targeting. In that case they would not have to constantly adjust the threshold as new information about the natural rate of unemployment came in.
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27. January 2014 at 06:33
I’ll echo a Britmouse comment on Beckworth’s blog and say that ship-navigation metaphors seem to be the most effective rhetorical devices to explain monetary policy.
27. January 2014 at 07:20
In control theory we have receding horizon and infinite horizon optimal control…
The basic idea being that if you have a physical model of your vehicle and a map you can at every moment plot as optimal trajectory.
So announcing the position of the rudder in the future is not completely bogus. Naturally though what makes this work is revising your forecasted path in the future to adjust for errors.
General criticism of forward guidance is too much. I would restrict my criticism to the fed for the following reason: before announcing the intended rudder positions, announce the destination. The fed scores poorly at enunciating their target.
27. January 2014 at 07:34
“Several of my more reliable commenters thought this Econlog post gave useful insights into the way I look at NGDP targeting. I can never tell which posts are interesting (I’m too close) but you might want to take a look.”
This paragraph makes me twitch:
“Real GDP is (an admittedly crude estimate of) the total amount of final goods and services produced during a given period. Nominal GDP is the dollar value of that output. Both NGDP and exchange rates are nominal variables, and the difference between a real and a nominal variable is vast, much greater than the difference between two nominal variables. Indeed if I had put Keats’ Ode on a Grecian Urn in the number three slot, you could still make an argument that number one is the outlier. NGDP and poems are both abstractions, RGDP is concrete.”
Yes, I agree that NGDP is an abstraction, as is any aggregate quantity. But RGDP is definitely not something “concrete”. RGDP is the “real” value of NGDP, and so is an abstraction of an abstraction. In fact all “real” variables are abstractions of nominal variables.
I think this sort of hierachy is vital to maintain. Recall that Goodhart, Posen and others are subject to the delusion that NGDP is derived from RGDP. It’s important to keep pointing out that aggregate measures of price levels, and their rates of change (inflation), are themselves extraordinarily abstract concepts, which is all the more reason why they are inappropriate as monetary policy targets.
In short, there is nothing concrete about “real” variables.
27. January 2014 at 07:39
Scott,
Off Topic.
Jeffrey Frankel said the following about thresholds yesterday:
http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/2014/01/26/recent-%e2%80%9cu-turns%e2%80%9d-in-central-banks%e2%80%99-forward-guidance-were-avoidable/
January 26, 2013
Recent “U-turns” in Central Banks’ Forward Guidance Were Avoidable
By Jeff Frankels
“…Both the Fed and the Bank of England are accordingly now subject to much criticism for having delivered forward guidance that they were subsequently unable to stick to. Some of these attacks are unfair. No one should want the central bank to slavishly follow statements made in the past if circumstances have changed in an unexpected way. Any fair critic must acknowledge that the ubiquitous demand for transparency with respect to the central bank’s plans (phrased simply) inevitably conflicts with the reality that the future is unpredictable, in particular with respect to such developments as unexpected fluctuations in the labor force participation rate. Aware of the uncertainty, the monetary authorities have always hedged their foreign guidance: nobody is now violating a past promise. Are the critics then being entirely unfair?
Not entirely. There was another way. A year or two ago, many of us were suggesting that the monetary authorities could announce a target or threshold for Nominal GDP, instead of for inflation, real income, unemployment, or other alternatives. Some of us explicitly warned that a threshold phrased in terms of the unemployment rate would be vulnerable to extraneous fluctuations such as workers exiting the work force, and argued that a nominal GDP threshold would be more robust with respect to such unforecastable developments.
Just over a year ago, for example, I wrote in favor of “a commitment to keep monetary policy easy so long as nominal GDP falls short of the target. It would thus serve a purpose similar to the Fed’s December 12, 2012, announcement that it would keep interest rates low so long as the unemployment rate remains above 6.5% – but it would not suffer the imperfections of the unemployment number (particularly its inverse relationship with the labor force participation rate…).” [Central Banks Can Phase in Nominal GDP Targets without Losing the Inflation Anchor blog, December 25th, 2012.]
This is yet another instance of a long-standing point: if central banks are to focus attention on a single variable, the choice of Nominal GDP is more robust than the leading alternatives. A target or threshold is a far more useful way of communicating plans if one is unlikely to have to violate it or explain it away later.”
27. January 2014 at 08:11
SG and Jon, I agree.
Mark, What I meant is that RGDP is measuring something concrete, actual goods and services being provided. NGDP is measuring a nominal quantity–a pure number. It’s simply a way of defining the value of money.
Yes, I agree with Frankel.
27. January 2014 at 08:28
Scott,
Off Topic.
Recall that Krugman recently made the argument that the recent surge in the UK’s economy was attributable to the slowdown in fiscal austerity:
http://krugman.blogs.nytimes.com/2013/12/18/the-three-stooges-do-westminster/
We agreed that this didn’t make much sense unless fiscal policy works with extremely long lags.
Well, it turns out that Gavyn Davies didn’t buy Krugman’s argument either. Here is what Davies said about a month ago (I didn’t notice until now). He claims that claim was “widely” made, but I don’t recall anybody but Krugman making it so explicitly:
http://blogs.ft.com/gavyndavies/2013/12/04/an-astonishing-but-very-british-recovery/
“…One possibility, which has been widely suggested, is that the recovery has followed from a reversal in the government’s fiscal squeeze. If this were true, it would suggest not that “austerity works”, but that it needs to be relaxed in order to allow the economy to recover further. This does not seem to be the case, however. After removing the effects on the fiscal arithmetic of large one-off financial events such as the privatisation of Royal Mail and the remittance of Bank of England profits to the Treasury, the underlying fiscal stance seems to have continued tightening in 2013-14.
Both the International Monetary Fund and Kevin Daly at Goldman Sachs remove the impact of these one-off capital items from their calculations of the structural budget deficit. They conclude that the fiscal stance in the current year will have tightened by about 1.2-1.8 per cent of GDP, which is little different from the average since 2010. Furthermore, only last month the Bank of England noted: “The direct drag on GDP growth from the consolidation is expected to persist throughout 2013/14.”
So unless there is any new data in the Autumn Statement, it therefore appears difficult to attribute the recovery in GDP to a significant reversal in the fiscal squeeze…”
Note that he refers to the IMF’s CAB estimates which are closely related to the IMF’s CAPB estimates that Krugman and we were using.
This is good to know because I’ve noticed a lot of commenters buying into his silly Three Stooges-head banging-relief analogy, when it doesn’t match the timeline at all.
27. January 2014 at 08:45
Scott,
“What I meant is that RGDP is measuring something concrete, actual goods and services being provided. NGDP is measuring a nominal quantity-a pure number. It’s simply a way of defining the value of money.”
I gathered what you were trying to say.
But the fact is that RGDP no more measures actual goods and services than NGDP does. It’s also a monetary measure, only it adds an even thicker layer of abstraction in the form of an aggregate price level.
27. January 2014 at 10:36
Mark A. Sadowski,
Re: the idea that the George Osborne’s supposed fiscal stimulus in 2012 (neglected by Keynesians critics of the UK government at the time for some reason) caused the UK recovery, Simon Wren-Lewis was the first economist I saw to put forward that argument.
27. January 2014 at 11:16
Scott, thanks for the plug. I just put up a new post where I argue the Fed’s forward guidance is not truly state dependent.
http://macromarketmusings.blogspot.com/2014/01/the-feds-foward-guidance-is-not-trully.html
27. January 2014 at 12:12
Fascinating new article by Matt O’Brien:
“Why Is the American Dream Dead in the South?”
http://www.theatlantic.com/business/archive/2014/01/why-is-the-american-dream-dead-in-the-south/283313
27. January 2014 at 14:37
“Mark, What I meant is that RGDP is measuring something concrete, actual goods and services being provided. NGDP is measuring a nominal quantity-a pure number. It’s simply a way of defining the value of money.”
I have to agree with Mark on this one. NGDP is a measure of actual transactions, plus a fudge for those things produced but not actually sold. And, RGDP is NGDP adjusted for the estimated change in the price level.
Sales seems to me to be the most concrete measure of the set.
27. January 2014 at 15:20
O/T: anybody see this one:
http://pre.aps.org/abstract/PRE/v88/i6/e062814
Scott, how do you distinguish between a boom and a bubble?
27. January 2014 at 17:23
Christopher Mahoney:
“Flirting With Recession”
http://capitalismandfredom.blogspot.com/2014/01/flirting-with-recession.html
27. January 2014 at 17:41
I know you favor targeting NGDP, but how would you feel about a regime of targeting some level (or growth rate) of wages?
27. January 2014 at 17:42
It is important to note that Barro did no argue that the Keynesian multiplier does not work because the effects of expansionary fiscal policy will always be offset by the central bank with monetary policy in he opposite direction, but because, according to regular economics it canot work because, in the absence of a divine miracle one cannot get back more than one puts in. That would be a free lunch.
Barro’s “regular economics,” which implies this is the case is a special theory of macroeconomics, which assumes that prices always adjust quickly enough to clear markets, so that no transactions take place and are finalized when markets do not clear. When transactions do take place and are finalized when markets do not clear, and that is what happens when an economy is depressed, as it is now, this special theory, regular economics, does not apply for such an economy. What is needed to explain what is happening in such an economy requires a GENERAL THEORY that hold whether markets are clearing or not. And it has to be able to explain what happens as a result of the non-market-clearing transactions. Regular economics becomes a special case of such a general theory that only holds when all markets clear.
Keynes developed such a general theory in which, due to downwardly inflexible wages, when aggregate demand decreases, transactions take place and are finalized when the labor market does not clear. As a result of such non-market-clearing transactions, there is involuntary unemployment, the effects of which spill over into the product market through the consumption function since the involuntarily unemployed workers consume less. Through the consumption functon there is a further decrease in aggregate demand producing a downward multiplier. An upward increase in aggregate demand works the same way in the upward direction until the labor market is at full employment and clearing. There are a lot of ways Keynes can be criticised, including the market monetarist argument that the central bank will always offset the changes in aggregate demand, but the logic is consistent and explains where the “miraculous” free lunch comes from if the central bank does not offset the effect.
27. January 2014 at 17:47
Mark, Thanks for the British info. I don’t agree that RGDP is a monetary variable. I know it’s often reported in dollar terms, but fundamentally it’s a quantity, not a monetary (nominal) variable. If the economy produced only one good (widgets) then in the equation of exchange, Y would be the number of widgets and P would be the price of widgets. Because output involves multiple goods we pretend like it’s a dollar amount. But RGDP is basically a quantity, or a weighted average of quantities, nothing more. NGDP is a dollar amount.
Thanks David, I’ll take a look.
Travis, He didn’t mention that you’ll get more upward mobility with traditional values (stay at home moms.) I wonder if that explains Utah.
Doug, Yes, I have probably made a similar argument. I meant something different, but didn’t express myself well. I meant that RGDP is trying to measure a concept that is itself concrete (quantity of actual goods and services), whereas NGDP is trying to measure a purely nominal concept (dollar value of actual goods and services). NGDP and RGDP are on entirely separate planes of reality. Like poems and dump trucks.
Tom, A boom is when output exceeds the natural rate. Bubbles don’t exist, but if they did it would be when prices were clearly above true value, and anyone could get rich simply by selling short and waiting a decade or so.
27. January 2014 at 17:53
dbeach, I’ve supported nominal hourly average wage targeting in the past. I mostly talk about NGDP for practical reasons.
27. January 2014 at 17:54
Barro and Grossman in their 1975 book also developed a General Theory. This is a much more sophisticated theory than Keynes’ and allows for non-market-clearing transactions in both the labor and the product markets and uses Walrasian, rather than Marshallian, terminology. It contains a much more sophisticated analysis of the spillovers from the non-market-clearing transactions in one market into the others than Keynes did. This model also produces a multiplier. If Barro wants to know where this miraculous free lunch comes from he should reread his own book.
This was a major contribution to the “disequilibrium theory” derived from Clower’s dual decision hypothesis introduced in his 1965 paper, “The Keynesian Counter-Revolution.” For a time this appeared to provide a basis for a very productive research agenda. Unfortunately it was killed off before it had a real chance to develop by the New Classical Economics, whose special theories are based on the fiction that markets continuously clear. The abandonment of the approach by Barro was the most dramatic incidence of this effect. The loss of this approach has been a major loss to macroeconomics, which would be much farther along in understanding how economies function during recessions if it had been fully deveoped than it currently is.
27. January 2014 at 18:06
“in their 1975 book”
Correction, that should be “their 1976 book.”
27. January 2014 at 18:06
Mark Sadowski:
Mark I cannot help but notice the unnecessarily narrow approach you are taking here. Identifying all variables as underneath “nominal” ones, is inconsistent with what people are doing when they engage in economic activity.
For example, you claim that “RGDP is the real value of NGDP.” Why not claim “NGDP is the nominal value of RGDP”? In fact, one should not put these two concepts in a hierarchical relationship. For NGDP and RGDP are two sides of the same (abstract, aggregated) coin.
Exchanges in a division of labor economy consist of people valuing goods and money differently from each other in a non-hierarchical, mutually offsetting fashion. If you and I make an exchange, you value the money more than the good you sell, and I value the good more than the money I sell, or vice versa.
Neither the good nor the money is “measured” as against each other. The notion of money as a measure of value is an artifact of the value theory of the classical economists Smith, Ricardo, and Mill. The classical economists by and large believed that the value of a good was an objective attribute of the good itself. Economic actors, according to classical theory, only exchanged goods if the respective values of the goods were equal, which is a fallacy that goes back to Aristotle.
And how do economic actors determine if an objective attribute of one thing is equal to the same objective attribute of another thing? Well, how do you determine equality between other objective attributes, like length, weight, volume, temperature, etc? You measure, of course! And assuming value is an objective quantitative attribute, it would seem that the best unit of its measurement would be the money unit.
But economists have known since the 1870s that value is subjective. Value is derived from individual utility. Valuation is a matter of preferring one good over another, according to the goods’ respective utilities. To prefer one good over another is to give the goods a rank order.
But preferring is not measuring.
Marginal utility does not posit any unit of value, since it is obvious that the value of two units of a given stock is necessarily greater than, but less than double, the value of a single unit.
Irving Fisher tried to discover a unit for the measurement of utility. And he purported to do so in a way that took the law of diminishing marginal utility into account. Fisher’s conclusion only follows if it is supposed that the marginal utility of a given amount of oil (B) is twice the marginal utility of half that amount (B/2), which of course assumes that the marginal utility of a first increment of oil is equal to the marginal utility of a second equal increment of oil. But we now know that the marginal utility of a second increment of oil must be less, not more, than the marginal utility of the first increment.
27. January 2014 at 18:38
Nice Q&A with Narayana Kocherlakota here:
http://economix.blogs.nytimes.com/2014/01/27/qa-a-voice-for-an-activist-fed/?_php=true&_type=blogs&_r=0
A couple of Kocherlakota quotes:
” Even if we were a single-mandate bank [focused solely on inflation] it would be clear that we should do more.”
“It’s a little embarrassing to say this, but you make a speech in August of 2010 and it inspires a whole quantity of work where people say, “This is what Kocherlakota says and we will now show in this paper that Kocherlakota was wrong.” There’s a number of ways that people can react to that, and I reacted in the only way that a sensible person can, which is to update.”
27. January 2014 at 20:00
“It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed.” – Edward Prescott.
http://www.nytimes.com/2014/01/28/business/a-federal-reserve-policy-maker-urges-it-to-do-more.html
27. January 2014 at 20:14
Not only does the method of science preclude one from making “established fact” claims, but even if miracles were possible and economy experiments could be run and tested and re-run and tested by changing just one initial variable, only a seriously misguided thinker would believe central banking would have “virtually no effect” on output and employment.
27. January 2014 at 21:02
Major_Freedom is back!!!!
Here is my all-time favorite post of his:
http://www.themoneyillusion.com/?p=15602#comment-173676
“Sure, I have always said that NGDP targeting is superior to consumer price level targeting. But I also think productivity norm is superior to NGDP targeting, and I also think a free market in money production is superior to the productivity norm.
I vehemently reject the illusion that we have to choose between NGDP targeting and dual mandate. If I said killing 1 million innocent people is superior to killing 100 million innocent people, then it would be absurd to support killing 1 million people on the silly foundation that “we have to choose between these two, so choose.”
I think anyone who did support it would only be doing so to manifest a desire to harm people. The fake “If it’s not 1 million, it will be 100 million” is a cop out.
Life is not tough. Like is wonderful. Ideas can change. Knowledge can spread. We are not doomed to NGDP or dual mandate.
I refuse to capitulate, Morgan. If enough people thought like me, NGDP targeting would be an impossibility and the optimal that you say is not possible, will become possible.
If we lived in a concentration camp, and everyone capitulated, then who will abolish the concentration camps? The guards? No, the prisoners are the only hope. But they can’t abolish it if they are being educated by people who apologize for the guards.
Being a true intellectual is not like a 9-5 job where you punch in and punch out and secure your income in the warm bosom of taxpayer financing. Those are court intellectuals. Technocrats. Bureaucrats. Political strategists. Opportunists. True intellectuals are radicals, bordering on insanity in the eyes of others, at the fringe.
When you look back on history, and you think of influential intellectuals, do you think of back office econometricians who collect economic data for the statesmen’s pleasure? Or do you think of those who were so crazy in the eyes of others that the rabble jailed them and killed them (Socrates)?”
27. January 2014 at 21:17
“It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed.” – Edward Prescott.”
That is an established fact only in the minds of the discredited real business cycle dogmatists. It is a statement about dogma and not science. Fortunately he only received a Pseudo Nobel Prize and not a real one.
People like Prescott and Barro, who refuse to recognize the central role of fluctuations in aggregate demand in determining the state of output during the ups and downs of the business cycle have become bitter enders fighting a loosing battle against the growing evidence of the effects of aggregate demand and will eventually end up as a laughing stock. Keynesians and market monetarists are on the same side here.
27. January 2014 at 23:45
Full Employment Hawk:
While there is much to agree with what you said in the initial part of your comment, this quoted part has some problems.
One, it is not fluctuations in aggregate demand that are “central” to the business cycle, but rather interest rates, relative prices and relative spending.
If every single price throughout the economy were increased the same exact percentage, it would have zero effect on real output. Why? It’s because if every price increased at the exact same rate, then there would be no change to any business’s profitability. Selling prices, and cost prices, would all rise together, leaving the difference between the two unchanged.
The reason why inflation affects the real economy at all is because of its effects on interest rates, relative spending and relative prices.
That is how we get the “booms”.
Two, if one considers history, it very much LOOKS as though demand plays a “central role”, but the trick about history is that more than one theory will ALWAYS be consistent with history. You are actually bringing a theory with you when you say there is not just some, but plenty, of evidence, in favor of the theory you believe is correct. The data isn’t driving you to one theory over another, but rather you are continually bringing the same theory to subsequent periods of data every time and quite naturally seeing the theory confirmed over and over.
My “nominal causes real causes nominal” theory has also been confirmed over and over again. For 2007-2009, we were looking at both the “real causes nominal” portion of that theory, which put downward pressure on nominal demand, as well as the “nominal causes real” portion, which set about another boom. Initially, the real causes nominal dominated, but was soon dominated by nominal causes real from the reinflation. Both counter-forces were always operating, they were just doing so to different degrees.
You might not be on board with the following, but the entirety of history is consistent with the theory that demand fluctuates for two reasons, not just one. Real phenomena, such as investment, production, and labor allocation, can have effects on nominal demand, both aggregate and relative. Similarly, inflation also has effects on nominal demand.
28. January 2014 at 00:49
Alex Tabarrok doesn’t see how wage and price stickiness is consistent with massive “churn” in jobs (somewhere after the 45 minute mark): http://www.cato.org/multimedia/events/undercover-economist-strikes-back-how-run-or-ruin-economy
28. January 2014 at 04:53
“But RGDP is basically a quantity, or a weighted average of quantities, nothing more. NGDP is a dollar amount.”
I don’t understand that comment. I thought money was the unit of measure for those quantities that make up RGDP, or rather it was money deflated by the CPI, ostensibly a unit-less measure, but one actually calculated based on the change in monetary value of a somewhat arbitrarily chosen basket of goods. Hence, Mark’s claim, at least as I see it, that RGDP is actually more abstract than NGDP.
28. January 2014 at 05:28
@W. Peden,
“Re: the idea that the George Osborne’s supposed fiscal stimulus in 2012 (neglected by Keynesians critics of the UK government at the time for some reason) caused the UK recovery, Simon Wren-Lewis was the first economist I saw to put forward that argument.”
Yes, you’re right, but only by one day:
http://mainlymacro.blogspot.com/2013/12/osbornes-plan-b.html
And I believe the more general “Three Stooges-head banging-cessation-theory of economic recovery” was coined by Krugman earlier that month.
@Doug M.
“Sales seems to me to be the most concrete measure of the set.”
Succinctly put. Almost everyone can tell you what their income was last year, but very few can tell you what their income was last year in 2009 dollars.
@TravisV,
Christopher Mahoney said:
“This slowdown has most recently manifested itself in the weak December jobs report, and will become visible in the 4Q13 growth numbers. (The strong 3Q13 growth numbers were a statistical anomaly; I expect the 4Q numbers to be much lower.)”
Does he realize that PCE soared in October and November, that capital goods shipments spiked in November and that inventory accumulation was healthier than expected through November? Morgan Stanley is forecasting 3.8% RGDP growth in 2013Q4 and Macroadvisers 3.9%. (I’m nowcasting 2.5% RGDP growth and 4.2% NGDP growth.) The BEA advance report of 2013Q4 RGDP is released in two days. What will it take to cause Mahoney to be embarrassed by all of his doomsaying?
@Major Freedom,
“For example, you claim that “RGDP is the real value of NGDP.” Why not claim “NGDP is the nominal value of RGDP”?”
Because RGDP is NGDP adjusted by the GDP implicit price deflator?
28. January 2014 at 06:32
One can only hope that David Beckworth is never captain of a large ship. I say this because his analogy presents a most illogical way of thinking. To the point: How can one observe that unexpected demand shocks happen and at the same time ague that “Nominal expectations would be firmly anchored.”
Anchored in what? Are we to assume that with NGDPLT demand shocks would never again occur? No, they will occur. And when they do happen those who have their nominal expectations anchored are going to be in for a rude surprise. Sure, in some time t+n NGDP will be back to trend (so says the theory) but how far away is n and what policy guides the central bank during the disaster recovery?
More importantly, what caused the demand shock in the first place? Did the ship crash because the captain was drunk? Did it crash because he was showing off and drove out of the designated channel? Did the ship fail due to inadequate maintenance? It behooves an advanced society to understand the cause of failure and then institute measures that make the system more robust.
NGDPLT advocates and macro econs in general display a most interesting lack of curiosity in the real world. In their work they observe that stuff happens but they never want to be bothered with the details of why. Credit markets blow up and their answer is that the fix is more credit, or more money. Perhaps one or both would be a fix but neither addresses why credit markets blew up in the first place!
If the goal is to safely sail the ship passengers deserve better than a promise that when the ship sinks the captain has a great recovery plan.
28. January 2014 at 07:57
Dan Alpert: “Fed tapering will lead to LOWER, not higher, rates”
http://finance.yahoo.com/blogs/daily-ticker/fed-tapering-will-lead-to-lower–not-higher-rates–dan-alpert-213546835.html
28. January 2014 at 08:20
Dan W wrote:
“Are we to assume that with NGDPLT demand shocks would never again occur? No, they will occur. And when they do happen those who have their nominal expectations anchored are going to be in for a rude surprise. Sure, in some time t+n NGDP will be back to trend (so says the theory) but how far away is n and what policy guides the central bank during the disaster recovery?”
I don’t think there any market monetarists who believe that NGDPLT would eliminate all demands shocks. (Maybe some “internet market monetarists” like me who believe it, though personally I don’t). I think Scott has said many times that he doesn’t believe nominal shocks would vanish forever under NGDPLT – only that they would be moderated.
If there was a well-anchored expectation that NDGP will return to target after a nominal shock, people would act on that expectation, and their actions would tend to push NDGP back toward its target path.
You can see an analogous example of this today, with inflation expectations. Inflation expectations are well anchored, to the point that a massive and unprecedented increase in the monetary base hasn’t caused inflation to exceed (or even reach) its target.
“NGDPLT advocates and macro econs in general display a most interesting lack of curiosity in the real world. In their work they observe that stuff happens but they never want to be bothered with the details of why.”
I think it would be more accurate to say that NGDPLT advocates do not want to micromanage events in the real world. Ultimately, NGDPLT advocates want to avoid one set of problems: the problems that happen when the supply of base money differs from the demand to hold base money. The job of the monetary system is to supply as much base money as the public wants to hold and no more. NGDPLT is a better way to approach this than flexible inflation targeting, or a gold standard, or anything else central banks have tried.
28. January 2014 at 08:47
I second the point that a lot of people have made that RGDP comes after NGDP. The only logical way you can measure output is by looking at what people paid for stuff. Otherwise you end up literally comparing apples to oranges. So to measure first you have to measure NGDP then try to get an idea of what inflation is before you can create RGDP. NGDP has a real meaning although the level of prices does not.
About forward guidance, the markets see this as a confidence scam for the Fed to try and get lower rates farther down the yield curve. I don’t think anyone is fooled and everyone knows that rates will go up when the inflation/real growth trade-off gets outside the Fed’s comfort zone. Therefore, forward guidance probably does very little because everyone knows that words and promises from a politician or central banker mean nothing.
28. January 2014 at 09:14
Dan W.
Good post. It’s fascinating how the conventional macroeconomic view seems to lose entirely or even reverse what macroeconomists would consider basic causal relationships.
28. January 2014 at 11:19
RGDP vs. NGDP: All you commenters seem to be confusing an estimate, for a definition. Yes, as a practical matter, RGDP reporting is done (essentially) by first adding up NGDP, and then estimating a GDP deflator in some way, and then reporting RGDP as a discount to the NGDP measurement. So the process is an imprecise estimate on an abstract nominal quantity.
But that’s not what RGDP means. It means: the total amount of stuff made. It’s pretty obvious with things that don’t change over time. How many apples were grown annually in 1950, vs. how many last year? How many tons of steel and concrete were made? You could have a barter economy with no money at all, and RGDP is still a concept that makes sense.
The fact that, as a practical matter, we estimate it by starting from NGDP, does not invalidate Sumner’s point that RGDP is a concrete, real, quantity. While NGDP is an entirely different kind of beast, an arbitrary numerical abstraction.
28. January 2014 at 11:27
“But that’s not what RGDP means. It means: the total amount of stuff made. It’s pretty obvious with things that don’t change over time. How many apples were grown annually in 1950, vs. how many last year?”
What percentage of the “stuff made” is comprised of “things that don’t change over time”?
Cars? IPhones? Etc.
How does this rationale apply to services?
While the point might be valid with respect to apples (the edible kind), does this mean that the the “concrete real, quantity” is valid for a total simply because it is valid for a small percentage of that total?
28. January 2014 at 11:39
Also, I don’t think that RGDP means “the total amount of stuff made” even for commodities.
Take the total number of apples grown (I presume sold), the tons of steel sold, etc (Geddis’s examples). RGDP doesn’t tell us how many apples or tons of steel were sold, it tells us perhaps what the *value* of that was in constant dollar terms, but these constant dollars tell us nothing about the inflation rate for that particular commodity. If the price of apples increased by 10 percent but the overall rate of inflation was only 5 percent, RGDP does not tell us how many apples were sold. We have separate statistics for the number of barrels of oil produced, etc., because value statistics, even in “real” terms are not adequate.
28. January 2014 at 12:12
Michael, Saturos. That’s worth a post.
Carl, No, money isn’t the unit of measure for RGDP, it’s real output. When RGDP changes over time the data show changes in physical output, not the dollar value of the output.
I do agree it can be viewed as abstract in the sense that there are measurement problems, which would not exist in a single good economy.
Mark, (or anyone else), Is there a quote from late 2012 by Krugman saying that British fiscal policy was austere in 2012? If so, that would make for a great post, when combined with his later claims.
Dan W, You must be new here, all those issues have been discussed many times. Once you figure out our views you can start responding to those views.
John, You are confusing two issues. It’s true that in the base year you will use money to establish the weights in RGDP. Thus suppose oranges sell for twice what apples sell for. Then RGDP = (Q of apples) + 2*(Q of oranges) in the base year. From that point forward you merely measure a weighted average of quantities, price plays no role.
Don, That’s right. For a minute I thought I was going crazy.
28. January 2014 at 14:46
Scott: What’s the unit of measure of real output for an economy?
To expand the terms in your example (and throw in mangoes for good measure):
((1 Apple/1 Apple) * (x Apples)) + ((2 Apples/1 Orange) * (y Oranges)) + ((8 Apples/1 Mango) * (z Mangoes)) = (x + 2y + 8z) Apples
In this equation, haven’t apples just become your currency?
28. January 2014 at 14:50
Scott,
The point I was trying to make is that looking at final prices actually paid for all goods and services produced in the United States is a more tangible concept than taking that number (NGDP in the base year) and then trying to measure a weighted average of the quantities in that during the next year. Since every individual’s consumption basket will be different, there is non-arbitrary way to find a weighted average. Here’s my summed up argument.
1. There’s no precise and non-arbitrary way to find a weighted average of prices.
2. Discovering Real GDP would require a way of measuring inflation that would apply to everyone. The weighted average would have to be perfect which is completely impossible.
3. Therefore, Nominal GDP represents something actually measurable while Real GDP does not.
28. January 2014 at 15:11
What I mean to say is that you CANNOT add, subtract, or compare real goods. It is theoretically possible to sum up the dollar (or Euro or Yen) value of all goods and services sold in the United States in a particular year. However, it is not theoretically possible to calculate how much that bundle is worth to consumers without reference to money prices and it is not possible to compare the value to consumers of the giant bundle of goods produced in year x versus this giant bundle of goods produced in year y without reference to money prices.
Comparing the GDP value between years is not theoretically possible. Trying to do so is inherently unscientific. I believe Scott agrees with this when he admits the flaws with measuring GDP.
28. January 2014 at 16:15
John Becker: again, you seem to be confusing the question of whether something is easy to measure (yes, RGDP is hard to measure), with what the concept even means.
Currency can be manipulated overnight (e.g. peso devaluation). A central bank can take off a zero on every price (or add another one), by fiat, essentially instantly. So NGDP could change by a factor of 10 (or more) in a day.
The real economy, with moving atoms around and using energy, is different. Yes, in practice it’s hard to estimate. But surely you can appreciate what the concept means. If the US produced 10% more each of concrete and steel and apples than the year before, then RGDP went up by 10%. Whether NGDP went up or down by a factor of 10, at the same time, is not relevant. (Yes, it gets harder in the real world, if steel went up by 10% but concrete went down by 10%, and you try to ask what happened to RGDP overall. It’s not so clear any more, and you need to start making assumptions and estimates.)
Yes, yes, it’s hard to compare RGDP over decades (it works best just year to year), and we generally estimate it by a calculation off of NGDP instead. But that’s not what the concept means. When there’s a recession, and RGDP is claimed to have declined, it means that actual physical output must have gone down.
(And yes, Vivian, services and technological improvement also make RGDP more complex, agreed.)
28. January 2014 at 16:36
Mark, Scott – Krugman is generally so ignorant of the UK data I’m not sure we could pin him down on any claims in 2012.
Wren-Lewis is different though. Compare and contrast…
http://mainlymacro.blogspot.co.uk/2012/10/the-uk-and-austerity-some-facts.html
http://mainlymacro.blogspot.co.uk/2013/12/osbornes-plan-b.html
The IMF CAPB estimates have changed so that the “facts” of austerity are apparently less “factual” and more “estimates”. And I think all has changed is the cyclical adjustment not the actual path of nominal deficits. Maybe Mark can decode what has happened there.
28. January 2014 at 18:50
Don Geddis,
I don’t appreciate what the concept of RGDP means anymore than I think you can measure how much I enjoyed the slice of pizza I’m currently eating.
NGDP is hard to measure (difficult but theoretically possible), the “real” value of the goods and services we produce is impossible to measure. The only measure of a good’s value is money. There is no way to measure “real” value. Measuring “real” value is like measuring cardinal utility. I understand that money is not a stable yardstick but there is no other way of measuring value. As Mises said, “Prices aren’t measured in money, they consist in money.”
28. January 2014 at 19:00
Don Geddis,
Think of it this way, you can’t say that everyone is 10% better off because we produced 10% more of all the same things. What if consumer’s didn’t want a 10% increase in apples, steel, and concrete from the year before but would have wanted 2% more apple and 12% more orange production , 1% more steal and 15% more aluminum, and 12% more concrete but fewer bricks than the year before?
In this scenario, even though more stuff was produced, the value of it in money might mean that nominal GDP is less than the year before. Just because more stuff gets made doesn’t mean that real or nominal GDP is higher!
28. January 2014 at 19:31
John Becker:
The intuition of what you said is perhaps better stated this way:
“you can’t say that everyone is 10% better off because we produced 10% more of all the same things. What if consumer’s didn’t want a 10% increase in apples, steel, and concrete 10 years from now but would have wanted 2% more apple and 12% more orange production, 1% more steal and 15% more aluminum, and 12% more concrete but fewer bricks 5 years from now?”
28. January 2014 at 19:33
John Becker:
“Although it is usual to speak of money as a measure of value and prices, the notion is entirely fallacious. So long as the subjective theory of value is accepted, this question of measurement cannot arise.” – Mises
http://mises.org/books/Theory_Money_Credit/Part1_Ch2.aspx
29. January 2014 at 00:56
Major Freedom,
I believe I quoted what Mises said right after that from the same book. Prices aren’t measured in money, they consist in money. Money allows you to simply reduce different goods into a common denominator which renders economic calculation possible. I was NOT referring to money as a yardstick.
29. January 2014 at 01:22
Don Geddis,
Are you aware that services comprise about 80 percent of US GDP (real or nominal)? And, if we add the manufacture of technological goods….
29. January 2014 at 06:54
Scott,
“Mark, (or anyone else), Is there a quote from late 2012 by Krugman saying that British fiscal policy was austere in 2012? If so, that would make for a great post, when combined with his later claims.”
Britmouse,
“The IMF CAPB estimates have changed so that the “facts” of austerity are apparently less “factual” and more “estimates”. And I think all has changed is the cyclical adjustment not the actual path of nominal deficits. Maybe Mark can decode what has happened there.”
I did a search of the Krugman archives and I find that he consistently claimed that the UK was doing fiscal austerity until mid-December when he pointed out that the change in IMF CAPB was negative in 2012, and this explains why the UK economy is doing so well over a year later. (Sarcasm.) Prior to that he didn’t really discuss UK fiscal policy in detail, he just asserted that they were doing fiscal austerity.
Britmouse, however, brings up a good point. The estimates of the UK’s 2012 fiscal stance have grown progressively looser between late 2012 and the present. But this is due primarily to changes in the estimates of the UK’s potential GDP, not to any actual policy changes.
According to the October 2012 IMF Fiscal Monitor the actual deficit in 2010, 2011 and 2012 was 9.9%, 8.5% and 8.2% of GDP respectively. The October 2013 IMF Fiscal Monitor says it is 10.0%, 7.8% and 7.9% of GDP respectively, so the biggest difference is that the actual deficit fell more in 2011 according to the more recent estimate. The October 2012 IMF Fiscal Monitor’s estimate of CAPB was 6.1%, 3.9% and 2.8% of potential GDP in 2010, 2011 and 2012 respectively, so the change in CAPB was 2.2% and 0.9% of potential GDP in 2011 and 2012 respectively. The October 2013 IMF Fiscal Monitor’s estimate of CAPB was 5.9%, 3.3% and 3.5% of potential GDP in 2010, 2011 and 2012 respectively, so the change in CAPB was 2.6% and (-0.2%) of potential GDP in 2011 and 2012 respectively. So as you can see the estimate of fiscal policy tightness became slightly tighter in 2011 and became significantly looser in 2012.
So why has the estimate of 2012 fiscal policy stance changed so much in the past year? Probably the best way to answer that question is to ask how much of that change is due to changes in estimates of potential GDP.
The amount of the deficit that is due to the output gap can be crudely estimated by computing the difference between the actual deficit and the CAPB. For the October 2012 IMF Fiscal Monitor this comes to 3.8%, 4.6% and 5.4% in 2010, 2011 and 2012 respectively. For the October 2013 IMF Fiscal Monitor this comes to 4.1%, 4.5% and 4.4% in 2010, 2011 and 2012 respectively.
Thus the decrease in the estimated CAPB change in 2012 is more or less entirely accounted for by the reduction in the amount of the deficit that is due to the output gap. In other words, the estimated fiscal policy stance in 2012 has become looser because the estimates of the UK’s 2012 potential GDP have fallen. It’s worth reminding ourselves that little has changed in terms of the actual estimated UK 2012 economic performance in the past year.
What makes this so interesting is that Krugman did a couple of posts on October 5, 2012 on “official” estimates of the UK output gap and their relationship to UK fiscal policy stance. By “official” he means estimates by the IMF, the OECD, the OBR, the European Commission and the various large banks. Here’s what he said in the first post on that date:
http://krugman.blogs.nytimes.com/2012/10/05/britains-gap-trap/
“…The always interesting Izabella Kaminska points us to a study suggesting that Britain’s output gap “” the difference between real GDP and the economy’s capacity “” is much bigger than the official estimates. This is actually a theme I’ve heard from a number of people.
Why might we think this? The official estimates assume that Britain’s productive capacity “” not just the actual level of output, but the economy’s potential “” took a huge hit from the financial crisis. It’s never been clear why this should be so.
And here’s the thing: if British capacity is a lot bigger than estimated, everything people say about fiscal policy, in particular, is wrong. The structural budget deficit is much smaller than claimed, as is the need for adjustment. The case for austerity is also weaker, and the costs of austerity in keeping the economy depressed are much larger…”
The irony is of course that Krugman was criticizing the official estimates of the UK’s output gap as being too small because they were being used to justify tighter fiscal policy, but now he’s implicitly relying on reductions in these very same too small estimates of the output gap to argue that UK fiscal policy became looser in 2012, and then claiming that’s what explains why the UK’s economy has rebounded more recently.
29. January 2014 at 17:24
Carl, You could say that, but you could also say 1/2 orange is your currency.
John, I agree that NGDP is far more measurable. But you are trying to explain a purely nominal aggregate, a number, whereas estimated RGDP is (badly) trying to measure something concrete–real output. The point is that nominal and real variables are utterly different. Think Zimbabwe. I’ve argued that nominal and real exchange rates should not even be taught in the same course.
Thanks Britmouse. Very Useful.
Mark, Very useful, I’m going to try to do a post on this. I can’t get to the very next Krugman post after the one you quote from, but it looks like it might be relevant. It’s behind the paywall for me. Can you read it? It’s October 5, 2012 and entitled Wages, Prices, Depressions, deficits (Wonkish)
29. January 2014 at 18:31
Scott,
Here’s the very next Krugman post:
http://krugman.blogs.nytimes.com/2012/10/05/wages-prices-depressions-deficits-wonkish/
October 5, 2012
Wages, Prices, Depressions, Deficits (Wonkish)
By Paul Krugman
“I mentioned the piece by Capital Economics arguing that policy makers in Britain are greatly understating the output gap, the amount of excess capacity in the economy, which is leading to badly skewed policies. This actually raises a whole set of related issues, with bearing on the US as well. So here’s a longish, wonkish discussion.
So: the starting point here is the official estimate by the Office of Budget Responsibility that Britain right now has an output gap of less than 3 percent. This is a remarkable assertion, when you bear in mind that real GDP remains well below its level pre-crisis, and that we used to think that Britain’s long-run growth rate was around 2.5 percent. As the CE guys say, simple trend projection would indicate a shortfall of 14 percent; how did that become less than 3?
Part of the answer is the assertion that the UK economy was operating well above sustainable levels in 2007, even though there were none of the usual signs of overheating. Beyond that, however, is the claim that the financial crisis somehow reduced potential output by a huge amount. As CE says, there is no plausible story about how that might have happened.
But, say the small-gap people, if Britain is deeply depressed relative to potential, we should be seeing deflation, whereas there’s actually inflation. Is this a decisive argument?
Well, the great bulk of UK inflation these past few years reflects one-off factors: VAT increases, commodity prices, and import prices. Domestically generated inflation is low, and headline inflation is declining too.
But that’s not deflation; shouldn’t we be seeing that right now? Indeed, standard textbook Phillips curves do say that if you’re below the natural rate of output, you should have falling inflation eventually turning into accelerating deflation.
Yet there are very good reasons to believe that these standard Phillips curves break down at low inflation, because nominal wage cuts are always and everywhere very hard to demand or accept.
A side observation: I’ve always wondered about the numbers one often sees for U.S. average wages in the 1930s, which show a sharp decline in the early part of the Depression. Has wage stickiness been exaggerated? My thought was always that this might be a misleading number, because average earnings might have fallen due to greatly reduced overtime and such rather than through big cuts in basic wages. And it turns out that there is a really early NBER study on just that question; sure enough, the fall in basic wage rates was much less than the fall in average earnings. (Advocates of internal devaluation take heed: even in the Great Depression, US wages fell only about 7 percent before rising again):
[Graph]
Oh, by the way: the failure of wages to fall more was a good thing, not a bad thing.
http://www.voxeu.org/article/debt-deleveraging-and-liquidity-trap-new-model
Back to the main argument: as the CE report says, if you have a false view that excess capacity necessarily leads to accelerating deflation, you can all too easily come to believe that a deeply depressed economy represents a “new normal” that must be adjusted to:
“If the Phillips Curve is horizontal over wide ranges of the inflation/unemployment/spare capacity relationship, but policymakers believe that a stable inflation rate means that the economy is operating at its potential, this raises the risk that they will persistently allow the economy to operate below its potential. After all, the conventional signal that this is the case – falling inflation – will not be flashing.”
In Britain, this translates both into complacency about monetary and fiscal policy in the short run, and into excessive alarm about the long-run fiscal picture. If you like, Cameron/Osborne are imposing harsh cuts to deal with a fiscal crisis that exists only in their minds, while failing to address a current crisis of inadequate demand that falls into their statistical blind spot.
But it’s not just British policy that gets messed up. In America, monetary hawks like James Bullard look at stable inflation and conclude that the Fed is doing fine, failing to appreciate the likely possibility that we have depression-type stability with a massive output gap.
And the preponderance of evidence is that we do indeed have massive output gaps, on both sides of the pond. It’s a huge failure of both intellect and will that we allow these gaps to persist.”
29. January 2014 at 18:43
Mark, Thanks, very helpful.
29. January 2014 at 22:07
Major:
“If every single price throughout the economy were increased the same exact percentage, it would have zero effect on real output. Why? It’s because if every price increased at the exact same rate, then there would be no change to any business’s profitability. Selling prices, and cost prices, would all rise together, leaving the difference between the two unchanged.”
That is correct if the prices not only are prices on current transactions, but also prices on fixed contracts, such as debt issues, and if the prices increase together, increase instantaneously, and it is expected that the price changes are permanent. The reason changes in aggregate demand affect output is that prices (including wages) are sticky and only change gradually and sequentially, as David Hume already understood.
One other qualification is needed: The money supply has to increase by the same percentage as the prices. If the money supply were to remain unchanged the amount of real balances would decrease. That would increase the interest rate and affect aggregate demand and output.