NGDP Targeting: Some Answers

I want to thank everyone who replied to my previous blog post NGDP Targeting: Some Questions. It will take me some time to digest all of the information sent to me. In the meantime, let me report on a few of the answers I received.

First, some background information. I do not believe that sticky nominal prices or wages matter (at least as far as explaining years of sub par recovery dynamics). I explain why here: The Sticky Price Hypothesis: A Critique. Consequently, Nick Rowe's reply to my post does nothing for me (although I still love the man and his blog!). On the other hand, I am not so sure about "sticky" nominal debt. I am more sympathetic to Evan Koenig's view:

The analysis presented here is completely orthogonal to the literature. It does not involve goods-market or labor-market pricing frictions in any way. As our most severe economic downturns have been characterized by widespread default on financial obligations and disastrous breakdowns or near breakdowns in lending, an analytical framework that puts debt and the distribution of risk at center stage arguably has something to say about optimal policy. 

One of the main proponents of NGDP targeting sent me this article, so I took it to represent a main theoretical justification for NGDP targeting. And indeed, a lot of people seem to be talking about a "debt overhang" problem and a "balance sheet recession." I sort of figured (perhaps incorrectly) that the idea of getting the Fed to commit immediately to (say) a 5% NGDP target was to generate a credible temporary inflation to reverse the effect of the unanticipated and sharp decline in the price-level path (in 2008).  The mechanism people have in mind, I think, is essentially to reduce the real debt burden of debt-constrained households, to get them to start spending, and to increase aggregate demand.

In my previous point, I raised the question of how strong and how desirable this mechanism might be now that we are 3 years out from the 2008 price level shock. Surely, a lot of the debt negotiated prior to the shock has been either reneged, renegotiated, or retired. At the same time, a lot of new debt has presumably been issued under the expectation of the new price-level path (given that people generally believe that the Fed will stick to its 2% inflation target). If the "turnover" rate is high (i.e., if there are large gross flows of debt being created and destroyed), and if the economy remains under "potential" for a long time, then one would have to question the quantitative importance of this mechanism; and also, the desirability of reversing the price-level path.

Well, I have to thank Mark Sadowski for taking the time to dig up some statistics for us. You can refer to the comments section of my previous post for details, but Mark's back of the envelope calculation is summarized here:

At the end of 2011, there was some $13.2 trillion in household debt outstanding. Of that nearly three quarters, or about $9.8 trillion, consisted of home mortgages  

... 

Thus a total of perhaps $5 trillion in debt has been originated/refinanced since the new NGDP trend has been established. Which means that about $8.2 trillion or approximately 64% was negotiated before the new trend was established. 

Assuming that the rate of origination/refinancing is linear (dubious) then it will take a least another five years before all household debt conforms to current NGDP growth expectations. 

So, it seems that there is still a lot of "old" debt out there, negotiated under the old price-level path. But there is also $5 trillion in new debt, negotiated under a new price-level path. And the longer we wait, the more this number will grow. Granted, this problem may have been avoided if the Fed went into the crisis with a credible NGDP target. But this is not the world we live in. What would Scott Sumner do right now? Who is he willing to make angry and why? Scott offers a hint here: Can we confident about the benefits of more NGDP?  

2. But does it still make sense to go back to the pre-2008 trend line? Probably not, recently I’ve been calling on the Fed to go about 1/3 of the way back to that trend line, and then start a new policy trajectory (hopefully explicit in this case.)

In any case, it seems that Scott believes that "more NGDP right now would modestly reduce the unemployment rate."  I confess that I am not entirely sure what mechanism he has in mind here. I really do need to read his 1000 blog posts on the subject one day!

I still have a lot of reading to do before forming an opinion on this subject. There were a lot of really good comments on my post that I haven't mentioned here--I need some time to think them through. Before I sign off though, some of you may be interested in these two links (h/t Prof J):

First, here is George Selgin: Wide off the mark, or, Nonsense about NGDP targeting. This seems like an extreme view, but I think it deserves some attention. 

Second, we have Mark Carney (Governor of the Bank of Canada) speaking here on why he believes a "flexible inflation target" is superior to an NGDP target. 

NGDP Targeting: Some Questions

Let me start by saying that the idea of a NGDP target does not sound outlandish to me. But I feel the same way about price-level and inflation targeting. The first order of business for a central bank is, in my view, is to provide a credible nominal anchor. Probably not  much disagreement about this out there.

  

Proponents of NGDP targeting, however, like Scott Sumner and David Beckworth, for example, seem to believe very strongly in the vast superiority of a NGDP target--not just as a policy that would mitigate the effects of future business cycles--but also as a policy that should be adopted right now by the Fed to cure (what they and many others perceive to be) an ongoing "aggregate demand deficiency." 

What I am curious about is not that they believe this, but how strongly they believe in it. I respect both of these writers a lot, so naturally I am led to ask myself how they came to hold such a strong belief in the matter. What is the theoretical underpinning for NGDP targeting? And what is the empirical evidence that leads them to believe that an NGDP target right now is a cure for whatever ails us right now?

One way to seek answers to these questions is to spend hours perusing their past blog posts. I'm sure they must have answered these questions somewhere. But I figure it will be more efficient for me to just state my questions and have them (or somebody else) point me in the right direction for answers.

First, let us consider the (or a) theoretical justification for NGDP targeting in general. Actually, David was kind enough to point me a nice paper on the subject: Monetary Policy, Financial Stability, and the Distribution of Risk (Evan F. Koenig). Here is the abstract:

In an economy in which debt obligations are fixed in nominal terms, but there are otherwise no nominal rigidities, a monetary policy that targets inflation inefficiently concentrates risk, tending to increase the financial distress that accompanies adverse real shocks. Nominal-income targeting spreads risk more evenly across borrowers and lenders, reproducing the equilibrium that one would observe if there were perfect capital markets. Empirically, inflation surprises have no independent influence on measures of financial strain once one controls for shocks to nominal GDP.

Alright, fine. The argument hinges on the existence of nominal debt obligations. Well, not just debt that is stated in nominal terms, but debt that is fixed in nominal terms (renegotiation is ruled out). This is, of course, a story that goes back at least to Irving Fisher (1933): The Debt-Deflation Theory of Great Depressions.

I've always liked the Fisher story. And it obviously has an element of truth to it. But admitting this is different than asserting that the mechanism is quantitatively important, especially for generating decade-long recessionary episodes.

First of all, as I alluded to above, people can and do renegotiate the terms of nominal debt obligations if things get too far out of whack. True, renegotiation (including outright default) is costly and imperfect, but it happens nevertheless. And to the extent it does, nominal debt is not as "fixed" as some make it out to be. It would be good to know how much renegotiation does or does not happen out there.

Second, even if renegotiation is quantitatively unimportant, we should consider the dynamics of debt creation and retirement. At any point in time there is an outstanding stock of nominal debt, with terms negotiated in the past on the basis of future price level paths (among other things, of course). We should also keep in mind that new debt agreements are being formed, and old agreements are being retired and modified (refinanced) continuously throughout time. How big are these flows relative to the outstanding stock of debt?

I think the answer to the previous question is important for understanding how long the real effects of a "negative price-level shock" can be expected to last. If "debt turnover" is high, then such a shock cannot reasonably be expected to generate a decade of subnormal economic performance.

We are presently more than 3 years out from the sharp decline in the price-level that occurred in the fall of 2008. How much new nominal debt has been issued since then--debt that would have presumably been negotiated with expectations of a new price-level path? Does anybody know?  In particular, if one is advocating a return to the old price-level path right now, what does this mean for the creditors who have extended loans over the past 3 years? Should we care? Why or why not?

I have not even touched upon the practical feasibility of NGDP targeting--I'll save this for another day. But for now, I'd like to know the answers to my questions above. Who knows, I too may become one of the faithful! 

A good weekend to all. 

The income tax, then and now

Mark Perry entertains us with a comparison of the U.S. income tax form that filers were required to fill out in 1913: see all 4 pages here.  

Almost 100 years later, the instructions alone (1040 in total) take up 189 pages.

How will it look, I wonder, 100 years from now? 

What really constrains bank lending

Thought I would share an interesting article by John Carney: What Really Constrains Bank Lending. If anyone out there has worked in the business, I'd be interested to hear your thoughts.

Also, another interesting story today: Lenders Again Dealing Credit to Risky Clients.

Annette Alejandro just emerged from bankruptcy protection and doesn’t have a job, and her car was repossessed last year. Still, after spending her days job hunting, she returns to her apartment in Brooklyn where, in disbelief, she sorts through the piles of credit card and auto loan offers that have come in the mail. 

“Even I wouldn’t make a loan to me at this point,” Ms. Alejandro said.

Here we go again...

Labour Market Mismatch (Canadiana)

A reader of mine passed along a link to an article discussing some issues that firms and workers are facing in the Canadian labor market; see The widening gap in Canada's labour market.

A fault line is splintering Canada’s labour market into those who can’t find work and those who can’t find workers. 

There’s no shortage of people looking for work. Some 1.4 million Canadians are unemployed, the jobless rate is still above pre-recession levels and youth unemployment is nearly 14 per cent. Despite this, employers across the country say they can’t find the right workers for all kinds of available jobs.

... 

At the same time, employers from Newfoundland and Labrador to the Prairies say shortages are constraining their ability to grow, innovate and compete. The Canadian Chamber of Commerce cites a shortage of highly skilled labour as the top barrier for businesses, and the mismatch has recently landed on the radar of policy makers, including central bank Governor Mark Carney.

Structural shifts in the labour market mean “workers in declining industries may not have the skills or experience to match immediately the needs of employers in expanding industries,” Mr. Carney said in a speech last week. 

Unemployment is high, even as the number of job vacancies continues to rise, he noted. Indeed, as of December there were 222,000 vacancies across the country, according to Statistics Canada. The Bank of Canada’s business outlook survey, released Monday, showed a slew of employers are struggling to fill positions. The survey showed 27 per cent of firms reported a labour shortage this spring, near a three-year high, though below levels seen last decade.

This last sentence suggests that we've been here before. Ten years ago, Canada was emerging from a mild recession; see here: Cyclical asymmetry in the unemployment rate (a comparison of Canadian and U.S. unemployment rate dynamics). But is it really more of the same, or are things a little different this time?

In the tech hub of Waterloo, Ont., plenty of companies are expanding – or trying to. 

“It has always been difficult finding highly qualified scientific and technical personnel,” but the problem has become more acute in recent years, says Brian Doody, CEO of electronics firm Teledyne Dalsa Inc., a company that started as a spinoff from the University of Waterloo. 

“The lack of young people pursuing further education in engineering and science and technology, is definitely a strain on our ability to grow,” he said. There are some jobs in some microelectronics disciplines where “we have been looking for people for more than a year.”

It is interesting to see this employer suggesting that the problem has become more acute in recent years. Is this a cyclical or secular phenomenon? Maybe a bit of both?

“The lack of young people pursuing further education in engineering and science and technology, is definitely a strain on our ability to grow,” he said. There are some jobs in some microelectronics disciplines where “we have been looking for people for more than a year.” 

Other employers, such as Scott Calver, CFO of trucking firm Trimac Transportation Ltd., say the shortage is serious and getting worse. 

Young workers are not as motivated by money as older ones, Mr. Calver said. “The older generation considered that their success was based on the number of hours a week you worked, and how much money you made. The people in their 20s and 30s are not as motivated by money, and they value success on working fewer hours, not longer hours.” 

Trimac and other trucking firms are having trouble getting unemployed drivers to move to places where there are jobs. “What is disappointing is how limited Canadians are in their ability to relocate,” Mr. Calver said.

Their ability to relocate? Or their willingness to relocate? If the former, might some policy designed to facilitate mobility be in order?

In any case, does this sound like a problem that can be resolved by an increase in G?

PS. Prakash Loungani has an interesting post here pertaining to the U.S. labor market: Manufacturers Struggling to Find Skilled Workers. Oh, and here's David Altig with a good post on the subject: The structure of the structural unemployment question.

The Trend is the Cycle

Nir Jaimovich (Duke University) and Henry Siu (University of British Columbia) appear to have made a very interesting discovery. Evidently, there appears to be a very strong link between two much talked about phenomena: job polarization and jobless recoveries. Their paper is available here:  The Trend is the Cycle: Job Polarization and Jobless Recoveries. 

 

Job Polarization

 

Job polarization refers to the recent disappearance of employment in occupations in the middle of the skill distribution. To display this phenomenon, the authors decompose employment into occupational groups and then delineate occupations across two dimensions: cognitive vs. manual, and routine vs. non-routine. (These labels are largely self-explanatory, but refer to the paper for details.) 

 

Evidently, these classifications correspond to rankings in the occupational income distribution. Non-routine cognitive occupations tend to be high-skill jobs, and non-routine manual occupations tend to be low-skill jobs. Routine occupations--both cognitive and non-cognitive--tend to be middle-skill occupations. Here is what has been happening to employment shares across these categories:

Percent Change in Employment Shares by Occupation Group 

The figure above shows that across three decades, the share of employment in the middle of the skill distribution appears to be disappearing. Prime suspect: routine biased technological change (e.g., think of ATMs replacing bank tellers). 

 

Jobless Recoveries

 

Jobless recoveries refer to the unusually slow rebound in the employment dynamic following the end of a recession (when GDP is growing). Here is the typical pattern one would have observed 30 years ago (and before): 

The x-axis is centered at "0," which represents the trough of the recession (using NBER dating). The data is plotted for 2 years around the trough date. The shaded region represents peak-to-trough. The y-axis plots the percent change in employment relative to its value in the trough. The figure above shows the rapid recovery in employment following the trough of the recession.

The dynamic above is to be contrasted with what has happened in the previous 3 recessions (early 90s, early 00s, and most recent). Here is what the picture looks like following the most recent recession:

Yes, but what's the link?

 

So far, this all very interesting, but not very new. What is new is how the authors link the two phenomena. 

 

The following diagram depicts the same employment dynamic, except with employment decomposed along three dimensions: [1] non-routine cognitive, [2] routine, and [3] non-routine manual (same as the polarization graph above). Here is what we see for the 1982 recession:

 

In this episode, the recovery in employment was strong across all occupation groups. In fact, the non-routine  occupations appear to have grown throughout the recession! The key is the strong recovery in the non-routine class of occupations. Roughly the same pattern is evident in the 1970 and 1975 recession as well. 

 

But now let's take a look at the more recent employment dynamic: 

 

 

Here, we  see hardly any movement at all in the non-routine occupations, but a significant and persistent decline in routine occupations. The relative weakness in routine occupations is evident in the 1991 and 2001 recessions as well. 

 

The conclusion is that jobless recoveries are due entirely to jobless recoveries in routine occupations. In this group, employment never recovers beyond its trough level, nor does it come anywhere near its pre-recession peak. This is in stark contrast to earlier recessions. 

 

The Trend is the Cycle

 

Consider now how the employment ratio behaves across these 3 occupational groups over the sample period 1967-2011. Here is the non-routine cognitive group:

 

 Here is the non-routine manual group:

And here is the routine group:

 

This last figure is quite dramatic. It shows how, prior to 1990, routine employment rebounded strongly following a recession. But since 1990, it appears not to rebound at all. Indeed, the pattern appears to be one of a precipitous decline in recession, followed by a period of relative stability in the subsequent expansion. 

 

Moreover, because these routine jobs are associated with the middle of the income distribution, the data here suggest that job polarization is not a slow, secular phenomenon--it is intimately tied with the business cycle. 

 

Theory

 

The authors employ a Diamond-Mortensen-Pissarides model to show how routine biased technological change can lead to job polarization, and how recessions can accelerate this process. The modeling framework is a good choice, in my view. (In particular, I have a hard time imagining how an IS-LM or NK model can be used to understand this phenomenon--but maybe I just lack imagination!) 

The work here is still very preliminary, of course, but the results look promising. Needless to say, it is hardly the last word on the subject. But I am confident that talented young economists, like Nir and Henry, will continue to shed light on the matter. Well done, gentlemen. Keep up the good work!