“If we could guarantee 5% NGDP growth for several years, it would be great.”
Frequent commenter Derrill Watson sent me a recent post from his own blog:
Mr. Dudley, President of the NY Federal Reserve Bank, is speaking at Cornell today. One of the economics faculty got him to make a presentation in his class. He could speak a little more freely in exchange for no audio or video recording. I eagerly attended and took copious notes.
. . .
I had communicated with Sumner about Dudley’s arrival and asked what question I should ask if I got the chance. I got the chance. Given that the Fed’s purpose right now is to lower the cost curve, it seems to me that there is a political economy question of how to sell it. If stimulating aggregate demand is your goal, why not tell people you are targeting a proxy for aggregate demand, like NGDP growth, and announce you are working on raising people’s average incomes rather than trying to raise inflation? His response:
[Dudley:] That is the right point. We would like to see something like 1.75% inflation. It’s too low right now. We are worried about NGDP because people can’t leverage. [He made several statements about why low NGDP growth is bad.] We could try targeting NGDP, but would it be credible? Could we actually hit our targets? There’s also a communication problem. People hear “nominal income” and don’t know what to do with it. But this is a key issue. If we could guarantee 5% NGDP growth per year for several years, it would be great.
[Me:] Personally, I score a big win here for Sumner et al. I’ll do another post tomorrow about his comments on the recession itself and the steps Congress, the Fed, and international policy makers are doing to prevent this all from happening again.
I do understand that the underlined statement is ambiguous. I recall Krugman once said something similar, and was expressing skepticism about whether the Fed could actually hit that NGDP target. Nonetheless, I think the most likely interpretation is that Dudley thinks a 5% NGDP target would actually be a good idea, as long as some practical communication issues could be overcome. I think this bodes well for the future. The appeal of NGDP growth (and 5% no less!) is becoming better understood. Of course I’d actually like to see above 5% growth for a couple years, and then 5% thereafter.
However this comment worried me:
When is the time to exit? At one point, he tossed a couple numbers into the air. Until aggregate demand has grown enough that unemployment is back down to below 8% or if inflation got above 2%, they really aren’t looking at exit.
I hope something was lost in translation. It should be “and,” not “or.” If Dudley actually said or, and meant it, he would be violating the Fed’s dual mandate. There would be no justification for the Fed to tighten policy if inflation was 1% and unemployment was 7.5%. And that scenario might well occur in 2012 or 2013.
This is also slightly worrisome:
[Back to me:] Paying interests on reserves (IOR) has been fingered by Sumner, Beckworth, and others as a cause of much of the monetary contraction since 2008. Yes, the Fed sent out $800 billion, but all of it went straight back into Fed deposits instead of into the economy. It shored up banks and kept more of them from failing, but didn’t produce growth. The big take away for me was understanding what the Fed thinks it’s doing, keeping up a contractionary policy while claiming it’s trying to ease more.
[Back to Dudley:] The answer is that IOR is a major new tool to reduce the costs of quantitative easing. It allows the Fed to convince investors and other people that they can and will mop up excess reserves later. By shifting the cost curve down, it allows them to do more easing. “We can control the demand for credit” by changing the costs of credit directly. The combination of reserves which cost them 25 basis points (0.25%) and the long term assets they purchase at about 4% return means that the Fed is currently bringing in an $80 billion annual profit, so they are very popular on the Hill right now. If, in order to mop up excess liquidity, they have to raise the IOR to more than 4%, however, they start losing money. So the risk of QE2 is that it becomes a major liability later.
If the Fed was forced to raise IOR to 4%, that would mean we got a very robust recovery. In that case the gains to the Treasury would far outweigh any losses to the Fed from QE2. The Fed is part of the US government’s consolidated balance sheet. I hope misguided fears of capital losses are not holding back the Fed.
Off topic, Tyler Cowen raised this interesting question today:
Question: When the measured expected real return is below zero, how well can any recovery program work?
Recovery programs can work quite well. Let’s break this down into two parts:
1. Can the monetary authority raise NGDP when real rates are negative?
2. Does higher NGDP boost RGDP when the economy has slack and real rates are negative?
The answer to both questions is clearly yes. If on a gold standard, just raise the price of gold. Svensson correctly called that a “foolproof”; method of inflation. If on a fiat money standard, peg the price of NGDP or CPI futures at the desired level, or at the very least raise your inflation target and do level targeting.
Once NGDP rises, output will rise if there is slack. This is because nominal wages are sticky when unemployment is high, so the higher NGDP will induce firms to produce more.
I think it’s a mistake to see interest rates (nominal or real) as an important part of the monetary policy transmission mechanism. They mostly reflect the state of the economy—whether output is expected to be high or low relative to trend. Of course if the economy did recover, real rates would rise back above zero.
Tags: QE 2
26. October 2010 at 09:47
This seems like good news overall.
I still think “nominal income targeting” is a much easier sell to the general public than “NGDP targeting,” and both of these are way easier sells than “inflation targeting.”
26. October 2010 at 10:15
He actually says everything he needs to say…
If we could guarantee 5% NGDP growth per year for several years, it would be great…. as long as inflation doesn’t go over 2%.
Which is exactly what I keep saying. The question then falls back to Bentley College:
Are you really going to moan about dual mandates when inflation is 2% and unemployment is 9%? We are on target! At 2.5% we need to cool this hot sucker thing off.
Because if you are going to keep moaning, JUST SAY IT – so your opponents know you should be destroyed. We’ll get Fox News calling you a commie jihadist by December.
There comes a point (hint: it is 2%) when the “good” macro guys turn and say “ok we did our bit, now it is all Obama’s fault.”
Can we trust you Scott Sumner? If so… leave your shades in your office window drawn.
26. October 2010 at 10:25
‘By shifting the cost curve down…’
IOW, we’re conducting policy through interest rates?
26. October 2010 at 10:50
Scott
Nick Rowe has a nice post on the subject of “Fed communication”:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/10/a-self-contradictory-communications-strategy.html
26. October 2010 at 12:22
Targeting the Federal Funds rate is great! Why? Because the Fed can hit the target.
Oh no! During the financial crisis, the actual Federal Funds rate was frequently below target. The Fed was loosing credibility. So, start paying interest on reserves to try to get that Federal Funds rate back up to target. That was close!
Why exactly are money income targets less credible than inflation targets?
26. October 2010 at 13:20
No, no, no.
During the financial crisis, the actual Federal Funds rate was frequently way above target, look at the actual intraday data from the NY Fed. And this abnormal situation was expected to persist by markets.
The solution was to print unlimited amounts of monetary base (October 13, 2008), and start paying IOR (October 6, 2008), in order to lower Federal Funds rate expectations.
Bill Woolsey’s talk that “During the financial crisis, the actual Federal Funds rate was frequently below target” is a very common but very harmful myth.
26. October 2010 at 13:48
Morgan, why should inflation be capped at 2 percent?
Although I would not want inflation to exceed 2 percent on a regular basis, there are reasons why it should temporarily do so. Moreover, a good case can be made that we are currently in such a situation.
26. October 2010 at 14:03
@ Lee:
I think his point is that If we are targeting NGDP and inflation gets too far off the mark, then the dynamically time inconsistent central planners will abandon the target to protect the central bank from political attack.
26. October 2010 at 14:28
Lee,
1. For the love of those who love money. It is rule #1 in capital formation. Guarantee those who hold it – you tax them only 2% to use it. It is the user fee, it is not a lever.
2. Forgetting the truth of #1, it is reality. It is what the Fed KEEPS saying, its the best estimation of where their Head is… and jawboning from the peanut gallery is unproductive.
3. It FORCES the Government to find Productivity Gains (austerity), which free up resources for other things (including paying down debt).
4. It doesn’t have to be 2%, it can be level targeting 2%, which means if we get up to 2.5% – the hawks now KNOW we’re going to dip back down and make it up. Which is the real power of level targeting – booms get pissed on.
—–
To me all of this is structural. We are able to have perfect employment, and we are able to keep inflation at 2% – but to do it the variable thing – must be government, it must light weight enough to change on whim and spin on a dime.
Structurally, Government should not be able to spend more than 19% of GDP. Public employees should not be able to unionize. Laws should encourage wage flexibility. Tax policy should be set to maximize growth (consumption based). And the Fed should live in ABJECT FEAR of allowing inflation to run over 2%.
26. October 2010 at 15:02
Here’s a way we could make sure NGDP grew without having to depend on the Fed:
Find a parter. Buy one second of quality conversation from him for $1. Then, he buys one second of QCon from you for $1. Repeat until NGDP is at the desired level. Then, recognize the pointlessness of this metric (optional).
Btw, why not 6%?
26. October 2010 at 15:09
@ Silas:
This is a problem with RGDP as well.
26. October 2010 at 15:12
A 5% NGDP target would undoubtedly be a step in the right direction, though I am not optimistic that such is widely popular within the Fed. I would prefer targeting a level of NGDP based on maintaining a 5% growth trend. (In other words, right now they should be trying to play catch-up.) Still, progress.
26. October 2010 at 15:20
It should be “or”, not “and”, in order to comply with the dual mandate. The way I’m reading this at least, he’s giving a sufficient condition for the fed to want to “exit”, not a necessary one. If unemployment got to 9% and inflation somehow found 10% at the same time, or if unemployment got to 5% before inflation got above 1.7%, the dual mandate would require that the fed act.
26. October 2010 at 15:21
OT: Should I withdraw all my money from the Pimco Total Return Fund in my 401k due to this from Pimco’s El-Arian:
http://noir.bloomberg.com/apps/news?pid=20601087&sid=a.c.wMdiaY50
26. October 2010 at 15:23
Oops, wrong link…
http://www.cnbc.com/id/39853052
26. October 2010 at 15:55
Parts two on Dudley’s take on the recession and part three on his public comments are up now too.
My understanding was “or” and I can actually think of one good reason for an or: if the Fed printed out a bunch of money and unemployment did NOT go down but inflation DID go up, I would begin to believe that the solution isn’t monetary and it would be a good idea to halt.
Then I read the transcript of his public comments (part 3) and he clearly says “and”:
“I said that I thought further Fed action was likely to be warranted unless the economic outlook were to evolve in a way that made me more confident we would see better outcomes for both employment and inflation before too long.”
But that isn’t exit strategy, that’s entry strategy.
26. October 2010 at 15:59
Again on Fed communication:
http://modelsagents.blogspot.com/2010/10/what-do-feds-policy-and-poker-have-in.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+ModelsAgents+(Models+%26+Agents)
26. October 2010 at 16:38
Silas, altho I want to target 2% CPI because zero is a political impossibility…
I am now selling quality conversation for $.99 per minute, until someone else undercuts me at which point I will drop the price to $.01 in a dumping scheme… which reduces NGDP to nil… as I’m using my $.02 to achieve it.
Altho, this does remind me of the early days online when companies bought increasing amounts of advertising from each other in order to show revenue growth…
Said madness also hopped over into publicly traded companies who began to preach “synergy” which meant they all only did businesses with their own sister companies, this practice kind hit with wall with AOL / Time Warner.
26. October 2010 at 17:15
[…] This is good news – it means that investors believe the Fed will really follow through and print enough money to reflate the economy. Other Fed presidents are reinforcing that perception (via): […]
26. October 2010 at 17:59
I was in a panic tonight until my brother pointed out to me this great fact:
“The American people will always, in their great wisdom, pick the worst candidate. Get used to it!”
26. October 2010 at 18:34
Mark, what were you panicking over?
26. October 2010 at 23:25
Scott: lots of people think they know what the Fed’s dual mandate means, but I’m not sure that’s what the Fed thinks it means. My reading of the tea leaves, particularly in regards to inflation targeting is that the mandate is interpreted as:
Stable Prices mean as close to zero as possible, without being so low as to lose control of the business cycle. The FED has determined that that threshold is X rate today–could be a different rate in the future and used to be a much higher rate in the past. Consequently after determining a target inflation rate, there are not twp objectives to consider only one. The only focus is the inflation target.
In control theory this is referred to as inner and outer loop control.
26. October 2010 at 23:56
I think the de facto mandate depends on who the head is.
Under Bernanke, its helping the member banks. Under Greenspan it was de-facto gold stability and ngdp growth rate stability.
27. October 2010 at 04:33
[…] Make it all seem worthwhile: “” “If we could guarantee 5 percent NGDP growth for several years, it would be great.” […]
27. October 2010 at 06:29
I think the value of having a gold standard in times like these is underestimated. Not because the gold standard guarantees tight money, but because the gold standard allows a managed, credible, self-limiting devaluation of the currency. In a world of freely-floating fiat currencies, it is by definition impossible to manage a devaluation, and it is by definition impossible to have a self-limiting devaluation of the currency.
If the US were on a gold standard, many of us would probably be advocating a devaluation to reduce the burden of historically high debt levels, and to goose employment. But with the US trading freely as a fiat currency, how do we *ensure* an appropriate devaluation? Only via some novel approach that involves targeting something other than gold. But underlying each of these targeting schemes, whether it is to the price of gold, or to the price of a futures contract, in order to implement the targeting scheme the Fed would have to be willing to buy non-interest bearing assets, such as gold or futures contracts. And it would have to stop paying interest on reserves, as such payments are a de facto targeting scheme in themselves: for targeting short-term interest rates. And I do not think the Fed can target more than one related variable at a time with reasonable success.
As I try to work through the theory, the math, and the available data related to Quantitative Easing, I keep coming around the circle back to the same place — that so long as the Fed targets short-term interest rates, whether via IOR or other means, all that QE accomplishes is a market substitution of short-term gov’t debt for longer-term gov’t debt. And I don’t think this will goose the economy when the underlying reason for our stagnation is a debt trap resulting from historically high indebtedness ratios.
Right now the only effective policy lever that the Fed is using is its IOR policy. If the IOR rate is too high for the appropriate amount of economic expansion, I don’t think anything else matters. Given the sub-par economic growth and the sub-par y-o-y growth in MZM, I think it is clear the IOR rate is too high.
27. October 2010 at 06:37
[…] Make it all seem worthwhile: “”“If we could guarantee 5 percent NGDP growth for several years, it would be great.” […]
27. October 2010 at 08:18
It would also substantially improve the Current Account deficit. Arguments about savings aside, the margin compression I commented about in the past is finally hitting home.
http://finance.yahoo.com/news/China-official-dollar-apf-1263355013.html
Unless the rest of the world shares China’s taste for keeping the dollar propped up (by buying more and more dollar-denominated investments and reserves), China will find itself facing domestic inflation and input/commodity inflation, which will squeeze margins. China is now demanding the US stop printing dollars… The US has no incentive to comply, particularly when China continues with its exchange rate controls.
Everyone is now loudly complaining the Fed is “exporting inflation”. Not at all. China, and others who peg currencies to the dollar, are importing inflation, just as they’ve been importing dollars for years to sustain a trade imbalance that has gutted US manufacturing, and left the FIRE sector (finance, insurance, real estate) accounting for 40% of US corporate profits in 2006.
Payback is a four legged female canine, isn’t it?
Unfortunately, US bargaining power remains limited by three things – structural dependence on imports (to sustain overdeveloped structural consumption, like housing stock upkeep), oil dependence (courtesy of zero progress between 2000 and 2009 in energy policy), and structural fiscal deficits.
27. October 2010 at 10:07
Lee, You are probably right.
Morgan, I feel like I need to keep my shades drawn so that a nutty inflation hawk doesn’t take a pot shot at me when gold prices fall. 🙂
patrick, That also confused me. What did he mean?
Marcus, Yes, I left a post there yesterday.
Bill, I agree.
123, I recall the fed funds rate being frequently below the target. Can you produce a graph for Sept/October that shows otherwise?
Silas, In a more recent post comment section I advocated a 6-6-6 solution: 6% NGDP growth for three years to catch up, then 5% thereafter. It was in response to Hoenig’s devil worship statement.
dbeach, Yes, I’ve been advocating level targeting of NGDP here for 2 years. And 24 years if you count journal articles.
more to come . . .
27. October 2010 at 10:53
Wait! When exactly do you expect to see Gold Prices fall?
27. October 2010 at 11:37
Scott, you said:
“I recall the fed funds rate being frequently below the target. Can you produce a graph for Sept/October that shows otherwise?”
I also recall that the fed funds rate was frequently below the target, those where the seconds when I was very happy and relaxed. The problem was that on the same day the fed funds rate was frequently above target. The Fed did not lose credibility because the rate was frequently below the target. The Fed lost credibility because the rate was frequently above the target.
I’ll try to produce a graph later when I have more time.
27. October 2010 at 12:54
@Morgan_Warstler: I’m not sure what point you were arguing for, but there’s no physical law that requires sellers to price their goods competitively — and if people are willing to take a big loss, they could keep purchasing overpriced conversation.
Heck, academia and government have overpaid for economic advice for ****in’ years!
27. October 2010 at 14:58
dWj, You may be right, I couldn’t quite tell.
Liberal Roman, I think many of his comments are reasonable.
D. Watson, Thanks for the links. Yes, ‘and’ is better.
JimP, I think he underrates what the Fed can do w/o fiscal policy. Indeed his model can’t explain why the dollar has recently depreciated.
Jon, The Fed has made it pretty clear that zero=1.7% to 2%. Of course their actual policy has targeted inflation at slightly above 2%, so I don’t see any reason to suddenly shoot for zero in the midst of a financial crisis.
Doug, Those are all good points about the gold standard, but on the other side it is very difficult (politically) to actually raise the price of gold. The government did it only once between 1879 and 1968. That’s a really long time, which means there were some deflationary crises where they refrained from raising gold prices.
Stasguy, I agree that the charges we are exporting inflation are bogus, but I’m not sure about the CA deficit improving. If we actually had a robust recovery, and didn’t do anything to fix the root cause of our under-saving, why wouldn’t the CA deficit rise back to pre-recession levels?
Morgan, I don’t do forecasting (EMH), but my hunch is that gold will not be a good investment over the long term. My official position is that the market is always right.
123, I don’t know for sure, it’s just that I recall people saying “so what if the ff target is 2%, actual rates are much lower.”
27. October 2010 at 21:23
Scott writes:
I didn’t mean otherwise. I meant that zero=about 2% because of the full employment mandate. Otherwise zero would mean zero.
Price stability and Full-Employment is the closest they can get to price stability while smoothing the business cycle.
I was targeting but neglected to quote your remark:
So to summarize: I do not agree that the Fed views tightening with unemployment at 7.5% is a violation of their mandate. I think they view themselves as having met their mandate by accepting a 1.5-2% inflation target.
28. October 2010 at 02:40
Scott, you said:
“123, I don’t know for sure, it’s just that I recall people saying “so what if the ff target is 2%, actual rates are much lower.””
I bet those people were Hamilton and Beckworth, and not the people who were paying 10% for fed funds on 09/30/2008.
28. October 2010 at 04:07
“If we actually had a robust recovery, and didn’t do anything to fix the root cause of our under-saving, why wouldn’t the CA deficit rise back to pre-recession levels?”
That’s a very good question. The answers necessarily go beyond comparative statics.
1) savings rate is not truly exogenous
2) certain industries have greater positive externalities and effects on future growth than, for example, the FIRE sectors – a lot of research from the 90s suggested that skill generation was largely endogenous
Most importantly:
3) I am hypothesizing that one of the major reasons that we have a deficit is because of demand for the dollar itself as a reserve currency. This encouraged central banks and private players to hold/use/accumulate dollars in excess of the level that is required to maintain a currency valuation consistent with trade balance.
I am hypothesizing that devaluation of the currency could affect the preference of central banks and other private players to hold/use the dollar, which would lower the equillibrium dollar value and shift US activities into exports and away from imports. Note the dollar is valued at the margin, so maintaining the undervaluation of the dollar required a continuing _excess accumulation_.
In other words, the PBOC and others provided the “savings” necessary to sustain US imports of trade good (which were exported by our trade partners).
This seems to have ended/be ending, and may reverse to disgorging, such that entities like PBOC are limiting/selling dollar denominated assets even as private US players increase liquidity holdings and/or the trade gap shrinks. Perhaps this is merely a structural change in preference for savings. I think it’s more.
28. October 2010 at 10:18
@123: Oh no!!!!! Horrors! 10% for ultra-short-term interbank loans! Why, that would mean paying 0.367% of the loan toward interest rather than the normal 0.151% they would pay if the interest rate were 4%, the rate bankers are entitled to.
That OBVIOUSLY means economic apocalypse was imminent. Paying 0.21 more bps total interest on a loan is a _clear_ sign of panic. Imagine what the Fed would have to do if workers starting taking out payday loans at 20%!!!
God I hate people like you.
28. October 2010 at 10:20
Note: The above numbers assume a two week loan.
Fed funds loans are normally overnight, which makes the kvetching about 10% rather than 4% all the more pathetic.
28. October 2010 at 12:32
@Silas
For want of a nail, the kingdom was lost.
Those overnight loans were what kept the nominal anchor anchored.
When the fed funds market spiraled out of control, inflation expectations took a dive way below the Fed’s 2% target.
Opportunity cost of reserves skyrocketed, everybody started hoarding dollars.
28. October 2010 at 21:51
@123
I think it was more fear of your debtor defaulting than low inflation expectations.
29. October 2010 at 02:31
@Doc Merlin
Yes, fear of default has caused significant daily upward breaches of 2% fed funds rate target set by FOMC. In turn, breakdown of fed funds rate market has caused the unanchoring of inflation expectations.
29. October 2010 at 06:55
@123: Well, to be frank, I don’t care about any economy that can collapse because someone has to pay 0.21 bps more interest than he’s entitled to. If the economy has that failure mode, our first priority should be how to get one that’s robust against that. There seem to be plenty such economies in history, so it shouldn’t be too hard.
29. October 2010 at 07:55
Silas,
Neither do I. You are right that robustness is the main priority. Not so sure about history though. If it is history, it was not robust enough. We have to choose between current robust real world examples (such as 3 month LIBOR targeting in Switzerland), and theoretical models (such as Bill Woolsey’s monetary freedom).
29. October 2010 at 08:05
@silas:
Bill’s model was actually tried in Scotland and in Canada and was fairly robust. It went away because the state wanted monopoly over money issuance, but not because it didn’t work.
4. November 2010 at 16:52
Jon, If inflation is below 2% and unemployment is high, why would they tighten?
Statsguy, I don’t see what the reserve currency issue has to do with the deficit, I think it’s all about low savings rate. If the PBOC sold dollars for euros, the former holders of euro government bonds would just hold dollar bonds instead. The US CA deficit would be unchanged. They are close substitutes.