Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Wednesday, September 4, 2013

A reply to Sumner

I figured that my previous post might stimulate an interesting debate on the relative merits of NGDP targeting. So far, I've only heard from Scott Sumner (see here). Scott thinks I'm wrong for many reasons. He lists 4, which I reply to here.

1. Government price indices don’t measure the prices that are of macroeconomic interest. For instance in the 6 years after the housing bubble peaked the US, BLS data shows housing prices rising by about 10%, while Case-Shiller showed a 35% decline. Housing is 39% of the core CPI. That’s a big deal.

The BLS data show housing prices rising by 10% after housing prices peaked? Not sure I understand this claim. I thought that the price of housing services entered into the CPI, not house prices directly. In any case, it would have been nice to have been provided with an alternative price index.

2. But even if the data were accurate, prices are the wrong variable, and models that suggest PLT is equivalent to NGDPLT are simply wrong. Indeed one of the strongest arguments for NGDPLT is that it does better when productivity growth is unstable. And productivity growth in America is unstable.

Scott, I hate to break this to you but: all models are wrong in the sense that they are abstract representations of reality. Perhaps you mean "wrong" in the sense that any model that displays such an equivalence necessarily does not fit the data? If so, what evidence do you have that supports this claim?

By the way, Miles Kimball, who has some kind words to offer your crowd, claims here that the NGDP target has to be adjusted for changes in productivity growth. But maybe you have some different model in mind? Where does this model live?

3. It’s also a mistake to draw a trend line on the assumption that the Fed is doing PLT at 2.09%, if it is not in fact doing PLT at 2.09%. Fitted trend lines trick the human eye, as I’ve discussed in previous posts. Do I have evidence that they were not doing PLT at 2.09%? Sure, lots of evidence. The Fed called for fiscal stimulus in late 2008 and early 2009, which would have been sheer madness if they had been doing PLT at 2.09%. As you can see from the graph, the price level was actually above target in 2008, suggesting an overheating economy. That strongly suggests the trend line is in the wrong place.

I am not sure why a call for "fiscal stimulus" in late 2008 and early 2009 would have been "madness." The PCE price-level peaked in July 2008 and fell sharply in late 2008 and early 2009 (largely reflecting the collapse in energy prices).

4. You might respond that the trend line sure looks accurate. Yes, but I could draw a different trend line that would look equally accurate from 1990 to 2008, and then show the price level below target after 2008. Who’s to say that’s not right? Indeed that trend line would be far more consistent with the Fed’s calls for fiscal stimulus, and complaints from Fed officials that demand has fallen short of their goals.

Unfortunately I don’t know how to add trend lines to St Louis Fred graphs. But here’s the graph I’m thinking of, from January 1990 to September 2008. If you assume the Fed was doing PLT during that period, and fit a trend line, I claim that the period after September 2008 would entirely lie below the trend line. That would be partly because the slope would be steeper, and partly because the trend PL would be higher in September 2008 than on Andolfatto’s graph.

Scott: here is the graph. First, I logged the data (natural log). Then I drew a trend line through the data beginning in Jan 2009 and ending in Jul 2008 (not Sep 2008 as you suggest, because I'm sure you meant Jul 2008, the month in which the PCE price level peaked). I then projected this trend line through the rest of the sample. Here is the result:

I can hardly see any difference.

If PLT and NGDPLT really were similar policies, then why does NGDP look far below trend since 2008, while the price level (according to Andolfatto, but I have my doubts) is right on trend?

That would be because the RGDP is below trend. And there are many reasons why RGDP may be below trend that are independent of the conduct of monetary policy.


  1. "Miles Kimball, who has some kind words to offer your crowd, claims here that the NGDP target has to be adjusted for changes in productivity growth." Well, if he does so because he doesn't like variations in the inflation rate that productivity growth fluctuations would otherwise bring about, then of course he misses the point of targeting NGDP, which is that stability of spending isn't the same as stability of prices, and that the former is what's really conducive to overall macroeconomic stability.

  2. Yes,

    there's a obvious answer that doesn't assume changing the target.

    Under NGDPLT in 2005, we would have started raising rates. Under 4.5% we would have even sooner. At 5% in 2005, we start tapping the breaks month to month, and if anyone (in housing) fights us, the next month we are jacking rates again.

    NGDPLT solves the housing crisis, bc it never gets started, which is why discussion around the Fed encouraging stimulus in 2008 during crisis are so bogus.

    In a fin crisis, the Fed stops worrying about either of its mandates, and starts worrying first, primarily, and nearly exclusively about the banks.


    The glory of NGDPLT is that the banks would have gotten stick'd over and over in 2005, so they didn't get to start a fin crisis at all.

  3. Miles Kimball is wrong, David.

    This is exasperating to us market monetarists. The idea that the inflation rate has to be kept steady is a wrong idea. One of the attractions of an NGDP target is that it strips out supply side considerations. So if there is a positive supply shock, lets say a super battery, or quantum computers, or 3-D printing that manages alchemical tasks at the molecular level, than RGDP is going to go up regardless of NGDP. Assume a target of 5%. The epic productivity blast pushes output above that level to 12% real growth, if the NGD{P target is kept stable, that would mean 7% deflation. Unlike demand side credit contraction deflation, this deflation is good, similar to what happens in industries like the computer industry. People wont be hoarding money in anticipation of further lower prices because the economy is growing not contracting. So a constant NGDP target, unadjusted for supply is a feature, not a bug.

    Fed "traditionalists" have to stop thinking that a steady inflation rate is such a good idea. Its not. Akerlof, Dickens, and Perry showed that

  4. Unknown:

    I thought that one of the main arguments underlying the NGDP target idea was that nominal debt is not indexed to the price-level. A negative price level shock increase the real debt burden among debtors, and that these redistributional consequences can (through a variety of channels) have bad macro consequences.

    I wrote down an explicit model where a "bad news shock" led to a downward revision in the expected productivity of capital, which subsequently lead to a portfolio substitution (flight to quality) into government debt (money), which causes a surprise price level decline. Stabilizing the price level turned out to be the right thing to do, in this model. Targeting the NGDP (which was expected to fall in any case, because of the expected decline in RGDP) would have meant raising the price-level and causing the redistribution of income to go the other way. It was not the right thing to.

    So, I'm not really sure what you're talking about. You may have *a* model that supports your a priori notions, but you are sadly mistaken if you believe to be possession of some unquestionable truth.

    My 2 cents worth.

    1. "Targeting the NGDP (which was expected to fall in any case, because of the expected decline in RGDP)"

      This is confusing.

      Say we're at 2% inflation and 2.5% RGDP in mid 2004, and we get a boom of housing starts that push RGDP to 3%, the Fed starts selling until it drives the overall level target of inflation to 1.5%.

      If some other time we're at 2% inflation and 2.5% RGDP and there's a shock to RGDP, we do exactly the same thing.

      The larger point is that IF we can predict TO THE DOLLAR exactly what GDP will be for Nov. 2020, there is FAR LESS chance to have negative positive shocks.

  5. David,
    Perhaps the difference is that MM's treat productivity shocks as transient deviations from trend. I think in your model the productivity shock was a permanent downward adjustment.

    How would the Fed handle a permanent trend change under NGDPLT? Presumably, they would have to 1) identify the change in a timely manner; and 2) correctly adjust the level target.

    Of course, the Fed could also choose to label the trend change "excess safe asset demand".

    1. Diego, that may indeed go a long way in explaining the difference. I was thinking in terms of persistent regime shifts: periods of rapid and less rapid growth.

      Not sure about your last remark. In my view, it is the Treasury that has prevented a massive deflation. The Fed has been *removing* these safe assets from the market (albeit, replacing them with reserves, but who cares.)

    2. That last remark was sarcasm!

  6. "Targeting the NGDP (which was expected to fall in any case, because of the expected decline in RGDP) would have meant raising the price-level and causing the redistribution of income to go the other way. It was not the right thing to."

    I'm not sure what YOU"RE talking about. :-) NGDP level targeting would have focused on the variable that matters, nominal income, rather than prices. Besides, WHAT are we really trying to do here? Are we trying to raise the cost of living for debtors, or are we trying to raise their income?

    "A negative price level shock increase the real debt burden among debtors, and that these redistributional consequences can (through a variety of channels) have bad macro consequences. "

    NOT if the price level decline comes from a gain in productivity rather than a credit contraction. (Read George Selgin!)Incomes among debtors are held unchanged if the Fed keeps NGDP steady. All that happens is the real money supply expands.

    "So, I'm not really sure what you're talking about. You may have *a* model that supports your a priori notions, but you are sadly mistaken if you believe to be possession of some unquestionable truth. "

    it isnt just priori. Look at us and uk history from 1873-1896. There was demand side (bad deflation) during recessions, but not all those years were recessionary, there were some positive years of NGNP growth, combined with decrease in the CPI for those years. Debtors only suffered during financial panics, not in productivity gains during recoveries in the second half of the Industrial Revolution.

    Look at Japan, the CPI is edging up in response to Abenomics, but you can find a few quarters of positive NGDP growth coupled with a mild decline of -0.5 in their CPI before now

    look at specific industries in the United States! The computer industry! Clothing. Productivity gains from technology and free trade lead to a very different outcome than deflation from a financial panic. Computer companies who borrowed to expand didn't suffer, they sold more units at higher incomes!

    It also stands to reason that if the 1970's showed us that we could have high inflation and slow growth due to oil shocks, (negative supply shocks) then the reciprocal, positive supply shocks, can lead to real, fast growth and falling prices.

    Bottom line, productivity growth holding MV/NGDP positive and constant, can result in falling prices without all the bad stuff that we usually think of we we think about deflation. I'm sorry if it wasn't clear before.


    1. Thanks, Edward.

      Please don't tell me to "read George Selgin." I don't have that many years remaining in my life. ;-)

      But seriously, if you could point me to what you consider to be a solid theoretical piece on the subject, I would appreciate it. (I don't want to see Woodford, Hall, Mankiw.)

  7. I'm reminded of the old joke,
    "i know it works in practice! But does it work in theory?" :-)

    The problem is David, is that this is generally considered a very minority view, new, among market monetarists. There hasn't been that much theoretical work done on the subject, with some exceptions, George Selgin, and David Beckworth, who has some good papers up on the subject in his blog.

    Besides, theory isnt my strong suit. I look at historical examples and data.

    1. Fair enough, Edward.

      I like reading George and David. I'm sure they will convince me eventually.

      Looking at historical examples and the data is extremely useful. But I hope you don't fall into the trap of thinking that the data "speaks for itself." Data needs to be interpreted. Interpretation requires theory. I like to make my theories explicit.


  8. I "chipped in" with:

  9. David, you may already have read it, and besides it may not meet your standard of "solid" economics (as you know, I favor informal and intuitive arguments over the usual fully-articulated macro-modeling), but I offer my case for letting P (or, translated into a dynamic setting in which there's an established positive trend rate of NGDP growth)the inflation rate vary with changes in productivity in Less Than Zero. The pamphlet (yes, it's a pamphlet, but it will take no more of your life away than the usual more dense article) is aviailable online through the Institute of Economic Affairs and also as a Mises Institute (well, not everything from them is bad!) reprint. It addresses all the usual arguments for stabilizing P, showing why they don't go through when changes in P are supply (and especially productivity) rather than demand driven.

    1. George: I am not opposed to "informal" or "intuitive" approaches; in fact, I welcome them. I just don't feel comfortable relying on just one approach, including formal methods. There's room for everyone here (including empiricists and historians) and I think different approaches should be complementary. So, looking forward to reading your pamphlet! But where the heck can I find it?

    2. Ah, a fellow eclectic! I might have known. Here's the link to the Mises Institute reprint:

      Should the history of thought on the topic be of interest, here are (gated) links to two follow-up articles on that:

  10. Oh, here is the IEA version, which seems a bit easier to download and to read:


    Here is a formal paper that comes to the opposite conclusion of your model.

    There have been some other papers along the same lines. I will send you links.

    I did look at your model. It didn't seem very insightful to me.

    1. Thank you Bill, the Koenig paper looks interesting.


      Here is another along the same lines.

      Your model focused on the utility implications of shifts between the generations. Market Monetarists have had relatively little interest in this, rather focusing on sticky prices (including wages.)

      I think your model effectively had one creditor and debtor, and shielding the creditor from all loss turned out to generate more utility than sharing it. While possible, of course, doesn't it seem likely that sharing the risk is better? And that is what these models that transition from complete to incomplete markets show.