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Saturday, September 7, 2013

Like a Good Neighbor: Evan Koenig on NGDP targeting

Bill Woolsey points me to a nice paper by Evan Koenig that provides a theoretical foundation for NGDP targeting: Like a Good Neighbor.

I like this paper a lot. Koenig is a lucid writer. The theory is sound and easy to understand. It provides a solid basis from which we can progress in our thinking about the subject.

The formal framework of analysis is a DSGE model. The model is "dynamic" in that it has 2 periods (current and future periods). The baseline model is an endowment economy (he later extends the model to a production economy). Future output is subject to a productivity (TFP) shock. The model agents are heterogeneous: there are debtors and creditors. Creditors have their income front-loaded; debtors have their income back-loaded. Because there is uncertainty over future income (RGDP), debtors are subject to income risk. In an ideal arrangement (e.g., the outcome of Arrow-Debreu securities exchange, or some cooperative arrangement), there is perfect risk-sharing between creditors and debtors. What this means is that creditors and debtors share in future good times and in future bad times -- just the way good neighbors should.

Koenig then assumes that markets are "incomplete" in the sense that private state-contingent contracts (insurance markets) do not exist. The only financial instrument is nominal debt. (This is a "cashless" economy -- "money" is just a numeraire -- but as in the Woodford analysis, the numeraire has real consequences, given the assumed nominal rigidity.) The monetary authority is assumed to have perfect control over the inflation rate.

For a given inflation rate (interpreted as a strict inflation target), the equilibrium allocation sucks. How so? Given that this is an endowment economy, monetary policy has absolutely no control over the RGDP. The problem turns out to be how the future RGDP is distributed ex post, relative to how it should have been allocated if an ex ante insurance market was available. Risk is misallocated under an inflation target.

What is the intuition for this? To try to map things into contemporary events, let's examine what happens in his model economy when it falls into recession. In that event, the future RGDP turns out to be low (and there is nothing anyone can do about it). But with a fixed nominal interest rate and a fixed inflation rate, the real rate of return on debt is fixed. If debtors make good on their obligations, then creditors do not share any of the recessionary burden--they are not being good neighbors, the way an optimal risk-sharing arrangement would have recommended. [Note: attempts to lower the nominal interest will help alleviate the debt burden to the extent that indebted households are permitted to refinance. So, even if Sumner et. al. do not consider such policy as "easing," I think it clearly would be in the present context.]

As usual, there is a state-contingent fiscal policy that rectifies this situation (by redistributing income appropriately). But alternatively--and perhaps more simply--why not follow a policy that causes the price-level to move countercyclically with the productivity shock? (See also this paper by Henry Siu). The effect of this policy would be to deflate the real debt burden of debtors during a cyclical downturn--redistributing some of the burden back to creditors--just as a good neighbor policy would have dictated. As it turns out in this simple version of the model, a NGDP target exactly replicates the efficient allocation (even it if does not prevent or even mitigate the downturn in RGDP). The Fed should permit a period of higher-than-normal inflation when the economy falls into recession owing to a negative productivity shock. After all, it's what people would have wanted ex ante (even if all do not agree with the policy ex post).

What to make of this? Well, there's definitely something here that rings true. But now let's ask a few questions. What triggers a recession in this economy? The event is a negative productivity shock -- some sort of negative "aggregate supply shock." Is this what we think triggered the 2008 recession? Maybe. In a richer model with productivity growth, a slowdown in growth could generate a decline in asset prices, a contraction in economic activity, followed by slower growth (if the event was a persistent regime shift, for example).

Alternatively, some people point to the sharp increase in food and energy prices in early 2008 as type of adverse supply shock; see here. Scott Sumner offers this type of interpretation for Canada here. The idea here is that the negative supply shock contracted real economic activity. An "accommodating" central bank would have let inflation rise. But the hard-headed inflation targeters prevented this from happening -- resulting in a contraction in aggregate demand, which further exacerbated the decline in real income. [Actually, I'm not sure what prevents the central bank from stabilizing RGDP in his model -- just crank the AD curve up along the the SRAS curve -- no?]

Well, that's all fine and good as far as it goes, but almost all none of this story can be supported by Koenig's baseline model which is, after all, an endowment economy (with market clearing). Koenig does extend his model to include production: future output is a function of current investment (provided creditors) and future labor (provided by debtors). The qualitative nature of the results reported above are not changed. However, a strict NGDP target is no longer optimal--instead, policy should stabilize nominal consumer spending.

But not everything smells quite right in this extended version: it has some annoying "neoclassical" properties. So, for example, when productivity turns out to be low in the future, the high debt burden faced by the worker-debtors induces them  to work harder (via a negative wealth effect) . Although the real wage declines owing to lower productivity, the offsetting wealth effect is not likely to generate a significant decline in employment. Indeed, employment may even boom in the model if debtors value consumption highly and if they are motivated to work hard to pay off their obligations. On the other hand, the ability to default on debt could make things work the other way. Unfortunately (from the perspective of the model), if workers default on their debt, they may work less, but they can now afford to consume more. The idea of a consumption boom driven by distressed households seems hard to swallow. So there are still some bugs to work out.

Overall, I'd say that the Koenig model is a good place to start thinking about monetary policy in a world of nominal debt and risk-sharing motives. I am not entirely convinced, however, that the type of shock modeled by Koenig is entirely relevant for understanding present circumstances. And even if we believe that the shock + nominal rigidity highlighted by Koenig played some part in the recession, can it plausibly account for what is happening now five years after?

Don't get me wrong: I think that the redistributive consequences of macroeconomic shocks are too often downplayed (that's one reason why I like the OLG model I talked about here -- the one that Bill Woolsey did not find insightful, for reasons he felt best to leave private). But in macroeconomics, we are also interested in the transmission mechanism by which redistributive shocks can have aggregate effects. This transmission mechanism is absent from Koenig's model. His reference to Mian and Sufi (2011) suggests that he has in mind depressed consumption demand originating with the distressed worker/households of his model. But this line of reasoning does not take adequate account of the "winners" in his model (and in reality). Shouldn't they be embarking on a consumption spree with their windfall gain, largely offsetting the depressed spending from the "losers?" [Moreover, in his extended model, where creditors (winners) are also the investors, his model likely predicts an impending investment boom.]

I'll repeat the question I've asked the NGDP crowd before. Let me grant that adopting a NGDP target may be a good idea at some point in the near future, say, to guard against future recessions. But what about right now? Should the Fed immediately adopt a policy designed to take NGDP back to its original trend path, and would doing so immediately help the real economy (and if so, by what mechanism exactly?).  Keep in mind that we are talking now 5 years out from 2008 -- much, if not most of the household deleveraging process is likely complete.

If the answer is "no," then why is NGDP (RGDP) still below its original trend level? If the answer is "yes," then what is the mechanism? If you were to explain it to me in plain simple Koenig-like language, it would be greatly appreciated. 



    Here is another paper along the same lines.

    I will comment on your model later. Sorry for the passing criticism.

    1. Nice to see that Sheedy, like me, uses an OLG model.

  2. By the way, Market Monetarists don't see nominal GDP level targeting as a one time policy to raise nominal GDP to the Great Moderation trend. It is rather a regime that is better than inflation targeting. As time has passed, there has been more and more divergence among Market Monetarists on what to do now. My own view is a Reagan/Volcker, nominal recovery (a year of 10% nominal growth) and then a 3% growth path form then on out. Sumner favors two years of 7% growth and then 5% from then on out.

    What is the best growth rate for the target growth path? Subject to debate among Market Monetarists.

    What is the proper level to start the new growth path compared to today? Subject to debate.

    And how fast should we aim to get to the new growth path? (one year, two years?) Subject to debate.

    Going back to the Great Moderation path does have some advantages--as a Schelling point.

    Market Monetarists definitely see nominal GDP itself as a Schelling point relative to some kind of optimized function of inflation and output.

    Keeping spending on output growing at a slow steady rate has a simplicity that will allow for more accountability. it is all about a rule.

    The Taylor rule, tying a target for the federal funds rate to deviations of inflation from target and an output gap is a bad rule.

    We need a better rule. Having the Fed maximize total utility isn't a very good one either.

    1. Fine, there is disagreement. But you did not answer my question. Consider your preferred policy. What is the mechanism that helps us recover now?

    2. More spending on output, firms respond by expanding production. Output grows more rapidly, shifting to a higher growth path. Output today is below the growth path of potential output. The output gap closes (perhaps partially, perhaps fully, perhaps there is some overshooting.)

    3. Forgive me for being slow. Can you please walk me through this?

      Consider the US economy right now. What is the friction holding back recovery? What is your proposed policy? And what is the mechanism? (Please do not tell me "more spending on output" -- I'd like to know how this happens.) Thanks for your patience.

  3. Why didn't I like your model?

    If the expected productivity of capital should fall, then what should happen is that the nominal interest rate fall to appoint where saving and investment remain equal. The demand for investment deceases, but the lower interest rate increases the quantity of investment demanded. Meanwhile, the quantity of saving supply rises, which is an increase in current consumption.

    To the degree the lower nominal interest rate raises the demand to hold hand-to-hand currency, then its quantity should rise. Otherwise, the nominal interest rate on money should fall with other interest rates. This change in expectations should occur with no monetary disturbance at all.

    Both the price level and total spending on output should stay the same.

    Your model seemed entirely innocent of these basics.

    Money is treated as the same as government bonds. The interest rate and quantity are policy variables. The increase in the demand for money causes deflation.

    Further, money/government bonds are the only debt instruments.

    The whole point of money/government bonds/debt instruments is to fund retirement.

    Still further, the vast majority of people who earn labor income and consume nearly all of it now are ignored. (People only consume in retirement. People only work to retire.)

    And in the end, you are using the monetary regime to somehow come up with a result where a social security program is more beneficial than saving and investment.

    You even discuss who should be taxed to fund the government bonds!

    Isn't kind of obvious that if you really believe that a discretionary government policy is desirable to help with retirement, the monetary regime is the wrong place to deal with it?

    1. like usual.. messed up.

      lower interest rate, lower quantity of saving supplied and more consumptoin

    2. If the expected productivity of capital should fall, then what should happen is that the nominal interest rate fall to appoint where saving and investment remain equal.

      Why do you say that? Policy picks the nominal interest rate and inflation, so both are fixed at the time of the shock. This is similar to the Koenig paper where the nominal interest rate is fixed and inflation is fixed (under an IT regime). You didn't seem to mind when he made this assumption.

      Both the price level and total spending on output should stay the same.

      They do not in the equilibrium of the model I consider. Bad news causes investment to plummet, there is a flight to safety, and the excess demand for government securities is deflationary. Not sure what part of this story you find implausible. It seems to describe reality quite well to me.

      Your final comments reveal to me that you are taking the OLG structure too literally. You should read this to cure yourself of that notion: Stationary Sunspot Equilibria in a Finance Constrained Economy (Woodford, Journal of Economic Theory, 1986).

      Moreover, note that there is an easy -- very easy -- fiscal fix in the Koenig paper as well. But somehow, once again, that doesn't seem to bother you? Isn't it kind of obvious that if you really believe that discretionary government policy is desirable to help with redistribution (the Koenig model), the monetary regime is the wrong place to deal with it?

  4. According to Market Monetarists, the primary benefit of nominal GDP targeting is that when successful, it previous deviations of output from potential. It is based on the notion that some prices and wages are sticky.

    Preventing deviations is best, and level targeting helps avoid and dampen any deviations that occur.

    This is no different from price level targeting.

    However, price level targeting requires monetary disturbances when there is a shift in relative prices. For example, oil prices rise. Other prices, and nominal wages, must fall to keep the price level on target.

    A "rule" that says stabilize the price level except when it is a bad idea is no rule at all.

    If wages are especially sticky, then even broad shifts in productivity growth are handled better by nominal GDP level targeting. More flexible product prices rise more slowly or more rapidly.

    With inflation targeting, unanticipated changes in the prices of goods are allowed. That is why it is better than price level targeting. But what about anticipated changes in prices?

    For example, the Chinese economy is really going places, and oil prices will rise significantly. We see this happening over the next 5 years. Is the expected inflation blocked? Or do we allow it to happen?

    But what about creditors and debtors? When productivity shifts, say due to a change in the price of oil or some broad based shift in productivity growth, then nominal GDP targeting makes debt contracts share risk more efficiently. Shielding all the creditors from higher oil prices and putting all the burden on debtors (and wage earners) is not efficient.

    This is an artifact of price level targeting. It was not a characteristic of the gold standard. With a gold standard, a disruption in oil production made creditors worse off along with everyone else. Only the "improvement" of price level targeting would shield them.

    Now, think again about your model. People only care about consumption in retirement. If retirees are creditors, then shielding them from any adverse productivity shock would be beneficial to them.

    But your focus was on the workers of today who expected low returns. They shift to government bonds/money. If the real returns on capital are low, and output low when they retire, then prices will be high. They suffer doubly!

    So, nominal GDP targeting would be counterproductive. It takes away from the ability to shift to government bonds and have a decent return on saving when capital productivity is low.

    OK, the real answer is that when productivity is low and so equilibrium interest rates are low, the government should cut taxes on the working people and run budget deficits and have the working people buy the bonds. They get higher real returns on their labor. And then, the government runs budget surpluses when productivity of capital is high. It pays down the national debt, lowering equilibrium interest rates. The government is smoothing fluctuations in productivity of capital, smooth returns from saving. If you are in a generation where productivity is low, then you get subsidized by taxes on people who live when expected productivity is high.

    What does this have to do with nominal GDP targeting? I that that if the price level is going to be higher in the future (due to the low output) that will make nominal interest rates higher than otherwise. The savers today are compensated for that.

    Of course, the real interest rate is lower today because of the lower productivity. And that is why you need the government deficit spending to smooth the returns on saving.

    By the way, I don't favor having government try to run deficits when real interest rates are low in order to provide savers with a higher real return and then pay down the national debt when real returns are high. I have no trust that politicians and voters would follow through.

    And, more to the point today, balling this up with price level vs. nominal GDP level targeting just confuses matters.

  5. You asked for formal papers.

    You mentioned your post including the model from some months ago.

    I remembered reading your post and not being impressed. That is, I didn't think it had much to do with why nominal GDP targeting relative to price level or inflation targeting.

    Still, I was aware of two papers that abstracted away from short run price stickiness and focused on the distribution between debtors and creditors. I gave you links.

    I didn't endorse either paper.

    Nor do I think that they show how a return of nominal GDP to target (or trend) will cause a recovery of real output and employment.

    It is rather that stabilizing the price level (and to a lesser degree, inflation) puts all of the risk of productivity shocks on debtors. Why is that a good idea?

    David Eagle has some formal papers on this too, but I haven't found links to online versions.

    As George Selgin mentioned, he discusses the justice between creditors and debtors issue in Less Than Zero, pointing to earlier literature on the matter.

  6. Alright, Bill. If I understand you correctly, your view is that adopting a NGDP target right now for the U.S. will do nothing measurably to improve matters now, but is a good policy to have in place to mitigate the adverse consequences of negative productivity shocks in the future. Correct?

    But if so, I am still wondering what your explanation might be for why we are still so far below our historical NGDP path?

    It is rather that stabilizing the price level (and to a lesser degree, inflation) puts all of the risk of productivity shocks on debtors. Why is that a good idea?

    That is a good question. Here is another question: why does debt exist? What role does it play? And if it is playing some economic role (say, to align incentives in a second-best world), what are the implications of a policy that undoes what debt is trying to accomplish? I don't see many people asking this question. Most people just take the existence of debt as exogenous. Is this a good idea?

    1. Debt contracts exist to share risk.

      Align incentives? That is firm specific. Smith lends money to fund Farmer Jones, and it is a debt contract so that Smith doesn't have to supervise Jones.

      It might be that entrepreneurs specializing in production particular goods are better able to forecast outcomes. That will be good specific. Note--specialize.

      Farmer Jones should be the one to try to figure out what is going to happen to corn prices next year. Smith just makes a loan.

      Now, why should the entrepreneur producing cell phones compensate his creditors for losses in real income due to higher gasoline prices because of political unrest in Syria?

      Every entrepreneur must forecast everything?

      Nominal GDP targeting, like a gold standard or a quantity of money rule means that a nominal debt contract by a single firm producing one or a few goods is not a speculation on changes in the supplies of other goods.

      Sure, if corn prices fall, or Farmer Jones slacks off, or there is a flood in his fields, his creditor is shielded from loss short of bankruptcy.

      But if oil prices rise, the creditor is not shielded. Farmer Jones has to figure out how much he is going to work, take a chance on bad weather in his location, and worry about what will happen to his product price. He does not have to worry about strikes in the cell phone industry.

      The problem with a gold standard or quantity of money rule is that all nominal contracts are speculations on the demand for gold or money. (Well, there could be changes in gold supplies too.) Nominal GDP targeting avoids that risk. But unlike price level targeting, it doesn't add the risk of shifts in the supplies of other goods.

      If there is only one good, or worse, a representative agent, this entire issue is invisible.

      The representative agent slacks off and produces less. Nominal GDP targeting causes the price level to rise so that his nominal earnings are the same. The debt contract fails to share risk as it was supposed to.

      In reality, Farmer Jones slacks off. This has almost no effect on the price level or real output. Farmer Jones takes almost all of the loss with nominal GDP targeting. Contracts align incentives.

      There is a flood on Jones' farm. This has next to no impact on the price level or real output. Contracts share the risk as contracted. And if Jones can forecast the weather, it aligns incentives.

      You need multiple goods and firms to see that you are not aligning incentives or sharing any risk Farmer Jones is better situated to forecast when you make Farmer Jones compensate his creditors for higher prices for unrelated goods. With one good, there are no unrelated goods.

      This was not a characteristic of the evolved monetary systems we had. It is a new characteristic added by price level targeting.

      It is an intervention--invented by economists really. Leave gold and go to a composite commodity. Well, that fixes the problem of shifts in the demand for gold causing massive disruption in contracts that have nothing to do with sensible risk sharing or alignment of incentives. But it adds risk from other, unrelated goods.

      Nominal GDP targeting is the better approach. Avoids changes in the price level needed to clear the gold market, just like a price level target. But it doesn't add the risk of shifts in the supplies of other goods to every nominal contract. Nominal GDP targeting solves the same problem with the gold standard that price level targeting solved, but it does so without adding this additional problem the gold standard did not have.

  7. I think a nominal GDP level target, starting at a significantly higher growth path would help now. It would raise both real output and employment.

    To the degree it results in higher inflation, that is a bad thing.

    That the debtors will have more nominal income to pay their debts is a good thing.

    I think output is below capacity and the unemployment is above the natural rate. Firms can expand production and will in response to increased demand.

    I think firms have kept on raising prices because costs, especially wages continue to rise. I think wage increases have only slowed slightly is because firms continue to expect the Fed to eventually generate a nominal recovery and they want to protect their reputations as good and fair employers.

    Eventually the slower growth rate of wages and prices will get them down to lower growth paths consistent with the new growth path of nominal GDP.

    When that happens, nominal wages and prices will go back to growing slightly faster, consistent with growth rate of nominal GDP.

    If nominal GDP shifted up to a higher growth path, it would hasten this process.

    While I think higher inflation is always a bad thing, I think the central bank should ignore it. Focus on the level target for spending. Increased spending unless inflation rises too high provides less motivation for firms and households to spend. Increased spending regardless of whether it generates more output or higher prices motivates spending now better than the conditional approach.

    1. I appreciate the thoughtful critique of my model, Bill.

      In terms of your current policy recommendation:

      I think a nominal GDP level target, starting at a significantly higher growth path would help now. It would raise both real output and employment.

      I still have trouble wrapping my head around how this is supposed to happen, but let me think about it a little more. Thanks.

  8. "Should the Fed immediately adopt a policy designed to take NGDP back to its original trend path, and would doing so immediately help the real economy (and if so, by what mechanism exactly?)."

    OK, this is a completely different question than the question of whether NGDP targeting is a good idea in general. Christina Romer, for example, argues that an immediate shift to NGDP targeting would be helpful because it would be perceived as a regime shift and thereby change expectations in ways that no incremental policy change could. This doesn't necessarily imply that she thinks NGDP targeting is an inherently better regime. (I would also note that, unlike Christina Romer, market monetarists, for the most part, don't argue for taking NGDP all the way back to its original trend path. There are really two different schools advocating NGDP targeting for largely different reasons, and your question applies more to the "regime shift" school rather than the "market monetarist" school.)

    The mechanism by which this would help the real economy, I would argue, is a combination of nominal price/wage rigidity and multiple equilibria. I believe the real economy is depressed by a couple of factors (among others, some which monetary policy would not be able to address): (1) downward-sticky nominal wages that have caused a downward shock in equilibrium real wages to have a persistent impact on employment and (2) a self-fulfilling prophecy in which expectations of low real growth lead households and businesses to spend less. If you promise a big jump in NGDP over the next several years, and if the promise is credible, it implies that one of two things will be the case: (1) there will be a jump in RGDP (which, if it's anticipated, would raise both growth expectations and equilibrium real wages, thus solving the two problems) or (2) there will be more inflation than previously anticipated, so that the real interest rate will be extremely low (which, if it's anticipated, would shift demand from the future to the present, thus raising equilibrium nominal wages and increasing output).

    This explanation is already too complicated for me to make rigorous without a lot of work (which I'm sure others have already done), and I've even simplified it already by ignoring price rigidity, and I haven't even gotten to the issue of hysteresis (and the reversal thereof, which I think requires price rigidity, because it basically means getting monopolistic competitors to produce more than their optimum so that their demand for labor rises and they are willing to pay higher real wages and/or pay for training to draw people back into the productive labor force). Making this stuff both simple and rigorous while covering the important points is quite a tall order, especially in a blog comment.

  9. Koenig's paper resurrects an old point that I've elsewhere traced back as far as Samuel Bailey's writings of the 1830s. As this pedigree might suggest, the intutition is actually very straightforward, but (I sigh in having to say so) of course one need's a fancy formal model to make it "officially acceptable." I had a similar reaction to Kevin Sheedy's paper, which he was kind enough to send to me some months ago, and in which he cites my paper tracing the history of thought on the topic, but not my own, previous positive but informal statement of the same argument.

    I was, I hasten to say, very impressed by the ingenuity displayed in Kevin's paper, and don't doubt that I would form a similar impression of Koenig's were I to delve into it. But I remain unconvinced that the elaborate proofs offered in these papers really "prove" anything that wasn't at least equally well proven by Bailey and other writers since, unless it is that one can, with a great deal of effort, write down plausible formal models that for all their artificiality manage nonetheless to yield insights we might just as surely arrive at in less ingenious ways. Is it really necessary, for instance, to employ a DSGE or OLG model to show, for example, that one doesn't make fixed nominal debt contracts less troublesome by having the monetary authority keep P stable in the face of and _adverse_ supply shock? And if it isn't, is it such stretch to suppose that one can also make the opposite point without such models?

    1. George:

      DSGE/OLG models are just tools. The mathematics used to build these tools is just a language. As with most languages, there is a one-to-one mapping between them (translation). But different languages have their strengths and weaknesses. Just because an idea is expressed in one language does not mean that one may not learn something new trying to express it in another.

      I like the methodology I use because it forces me to be explicit and upfront about the assumptions I am making. Most verbal arguments have a plethora of implicit assumptions that can lead to endless and futile debate. For example, no one has ever written a book on "What did Debreu Really Mean?" And you know that there are endless books on the question of "What did Keynes Really Mean?"

      Koenig lays out an argument that is clear and *easy* to criticize. In fact, I did criticize it in terms of providing a plausible interpretation of what happened since 2008. His "intuitive" argument in fact implies some very strange predictions along other dimensions. I don't think anyone could have readily picked these up if he hadn't been explicit in his assumptions and logic.

      Finally, I notice that Koenig in fact finds that targeting nominal consumption spending is optimal (in his more general and realistic environment). Did you, with your "straightforward intuition" manage to deduce this as well? If you did, I will be mightily impressed! :)

    2. I can't speak on that last point about Koenig's article, as I hadn't read it carefully, ad I don't deny either that formal models can reveal things that informal arguments don't or that that grappling with models such as his can be stimulating and informative. But the notion that every proposition, to be established "rigorously," must be derived from a full-fledged model, is one I'm unable to accept, in part because, as your own comment on Koenig's article illustrates, such derivations are often only achieved at the cost of making, for the sake of tractability, assumptions (some of which are in fact not all that transparent) that are either themselves unrealistic, and unrealistic in a manner that causes the models to yield some very counterintuitive results. It then becomes a major challenge to untangle the trustworthy from the untrustworthy implications of the model, and for that purpose one falls back after all on the very "intuitive," informal reasoning that one hoped to dispense with.

      But I don't want to stake out an extreme view. My position is that it takes all kinds of approaches to get to the bottom of things. But I also think that the profession generally has embraced an extreme view favoring the formal modeling approach over others, at least when it comes to what goes in the more prestigious journals. The blogosphere has become important as a forum for macroeconomic debate in part, I believe, owing to the fact that it allows for arguments of a kind that, though reasonable, tended to be set aside by journal editors and referees who insist that everything must be done using the latest set of fashionable models.

    3. But the notion that every proposition, to be established "rigorously," must be derived from a full-fledged model, is one I'm unable to accept...

      First of all, I can not ever recall saying that.

      Second of all, are you able to provide a set of guidelines that will help us establish when a proposition needs to be established "rigorously" and when it can be left "unproven?"

      such derivations are often only achieved at the cost of making, for the sake of tractability, assumptions (some of which are in fact not all that transparent) that are either themselves unrealistic, and unrealistic in a manner that causes the models to yield some very counterintuitive results.

      You write as if an "intuitive" argument never relies on unrealistic assumptions for the sake of tractability! My own view is that verbal arguments frequently rely on hidden assumptions that, if they were made explicit, would suddenly render and "intuitive" explanation counterintuitive.

      It then becomes a major challenge to untangle the trustworthy from the untrustworthy implications of the model, and for that purpose one falls back after all on the very "intuitive," informal reasoning that one hoped to dispense with.

      You speak as if it is not a major challenge to untangle the trustworthy from the untrustworthy in informal, intuitive, verbal arguments. And I think few people would suggest "dispensing" with "intuitive" reasoning, although, to be honest, I'm not entirely sure why. Partly it is because I have a hard time coming up with a definition for "intuitive reasoning." Do you have one?

      George, I heartily agree with your concluding paragraph. But I'm really not sure what motivated you to begin this discussion here, in regard to this post. You seemed to suggest that "we already knew all this a long time ago." Well, that may be true. But like I said earlier, I think there is value in this approach. And the proposition of nominal consumption targeting derived by Koenig pssibly sounds a lot more "intuitive" to me that nominal income targeting. That this result has me now thinking about the possibility is just one of the fruits of his formal approach to the question at hand.

    4. David, you misread me in thinking that the position I'm critical of is one I think you hold. I'm merely criticizing what I believe to be a common view in the profession. I recognize your own views as being much closer to my own than that, and am sorry to have given any different impression.

      It would of course be futile for me to try to define precisely what constitutes an informal (I prefer this to "intuitive") as opposed to formal argument. But in practice I mean almost any sort of argument that doesn't resort to some currently de rigueur sort of macro model. Some years back, I well remember, no one could dare to say a thing about monetary economics unless it was said using an OLG model; today the nod often goes to DSGE.

      It's this insistence on couching things in terms of one of a rather small set of currently popular models that I object to, and especially so given my belief that, whatever merits these models may have, they seldom do what people pretend that they do. If someone "gets" an NGDP stability argument out of, say, a DSGE model, one can be sure that he constructed the model for the purpose, just as one can be sure that no magician is actually ever surprised to find a rabbit in his hat. This doesn't mean that such models yield no surprises to their authors at all--they do, and especially in the process of trying to get them working. What's more the surprises may themselves say something about how real economies work. But that doesn't itself mean that there isn't a great deal of hocus pocus involved in the professions' obsessive preference for formal over informal analysis. There is, in short, a mythology of formal modelling that embodies a highly misleading view of how our discipline really works, or ought to work. I don't believe you to subscribe to it--and your remarks suggest that you don't. But many economists do, and I think that's too bad.

    5. It was a good discussion, George, and I appreciate you sharing your thoughts here! We are not far apart on this issue, and there's plenty of room for all sorts of methodologies.

  10. If money is neutral why not just target a neutral price level? (e.g. 0% inflation or stable prices)

    1. If money is neutral, then we can just stop talking about money and monetary policy. Most economists believe that money is not neutral in the "short-run," but that it is in the "long-run." Moreover, even if money is neutral, there is still the possibility that it is not "superneutral." (Google that last term if you are unfamiliar with it.)

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  12. David,
    From a non-economists' perspective, it seems the general response to your question follows a progression:

    1) Wages are sticky. What accounts for the persistence of stickiness? Not clear, therefore proceed to...

    2) Prices are sticky. Again, what explains persistence? Not clear, therefore proceed to...

    3) Shortage of safe assets. Persistence here is easier to describe: private safe asset supply shrunk with shadow banking. The supply of public safe assets is insufficient. However, why does the private sector persist in its inability to manufacture safe assets? Here the answer is "excessive pessimism". What is the source of "excessive pessimism", and why is it that pessimism not evident in risk asset prices? Not clear, therefore proceed to...

    4) There is an AD shortfall.

    1. Diego,

      With respect to 3), you overlook one critical thing. One can be perfectly sure that we are all going to hell. That is being pessimistic. And there is no risk associated with the venture either!

  13. I think you mean "there is no uncertainty associated with the venture." The known risk of personal suffering (100%) would doubtless feed into equity valuations. Just "animal spirits"!

  14. Diego: if you knew with 100% certainty that you are to die tomorrow, there is no risk, and hence no risk premium associated with the venture. Of course, the prospect of dying will feed into the asset price. That's my point. Even in the absence of risk, there can be a flight to safety. What matters is the first moment, not higher moments. :)

  15. I see what you mean. However, the "safe asset" thesis doesn't explain why risk assets have boomed. "Pessimism" would have affected their price during a "flight to safety". The problem implied by "excess safe asset demand" is "surplus risk asset supply".

    BTW, today's FT article is an excellent review of the structural issues affecting safe asset (i.e. private liquidity) supply: