NGDP Targeting: Macroeconomic Panacea?

0:00Well the paper is, my paper is entitled Nominal GDP Targeting Macroeconomic Panacea? We can say the short answer is no. When I started researching this, I didn't realize this, but the idea of nominal income targeting was alive in the mainstream literature at least as early as the late 70s and early 80s. They kicked it around, nothing really happened much, didn't received much traction. It was talked about a little bit again by Martin Feldstein and Mankiw in the 90s. And again, it didn't really take hold very strongly. Most recently, of course, it's been taken up by a relatively small group of economists identified as market monetarists.

0:49They are a group that be like Scott Sumner, David Betworth, Lars Christiansen. They see what they call monetary disorder as the cause of the 2008 financial meltdown and subsequent recession. And in doing so, they explicitly reject the notion of capital malinvestment as a source of the business cycle. However, they also claim to believe in markets, assuming them to, quote, to be efficient and forward-looking, end of quote. They stress the forward-looking nature of markets because for market monetarists, expectations seem to trump all other considerations. as such, they view expected nominal GDP growth as a better indicator of monetary policy than either interest rates or the actual money supply.

1:36They view interest rates as the price of loanable funds, but they do not recognize that the interest rate is actually a ratio of the prices of present goods over the prices of future goods, or that the time transaction where present money is exchanged for future money occurs not only in the loanable funds market, at the same time, it is argued that the current price level and the nominal GDP are more dependent upon current expectations about the future money supply than they are on the current money supply. Because markets are forward-looking, successful monetary policy would then be one that stabilizes expected nominal GDP because sudden changes in expected nominal GDP are what cause macroeconomic disturbances.

2:33The supremacy of expectations in their analysis can be seen in their explanation of the Great Recession. It is claimed that the source of the 2008 financial meltdown was contractionary Federal Reserve policy resulting in investors realizing that the Fed either could not or would not prevent a decline in nominal GDP. Anomalous EDP targeting supposedly would temper recessions when the economy is faced with negative supply shocks by sustaining aggregate demand when real output falls. Given their focus on aggregate spending, it is not surprising that the market monetarists have often been criticized for adopting a Keynesian vision of the macroeconomy. They do not accept this claim at all. Their advocating monetary stimulus, they say, is not due to any desire for a Keynesian-style They reject returning to a rigorous gold standard, thinking it would contribute to macroeconomic problems because many prices, it is alleged, are sticky. Additionally, a gold standard cannot prevent irresponsible governments from monetary instability, according to their view of thinking.

3:51Now there are several problems that I see with market monetarism that can be classified under three main categories. It's theoretical framework and vision of economic activity, the form of expectations and the extent to which they enter into economic decision making in their theory, and the actual consequences of their suggested monetary policy. Policy. The most fundamental reason that nominal GDP targeting misses the mark is due to a generally faulty analytical framework that entails an unsatisfactory understanding of economic activity. It misunderstands the nature of price coordination and leaves the intertemporal capital structure completely out of the analysis. While market monitors staunchly reject claims that they are Keynesians, it is understandable why people would think so.

4:41They assert that recessions are due to insufficient aggregate demand. Income is thought to be created by money flows instead of by provision of productive services accounted for in money prices. They ignore, reject or dismiss the importance of the capital structure and monetary injection effects at all. Investment is driven solely by expectations or conventional wisdom about nominal spending and a collapse in investment leads to recession and unemployment because of sticky prices. Decreased aggregate demand and sticky prices and wages combine to result in idle factors of production and unemployment. Monetary policy, however, can serve as the universal cure for persistent price disequilibrium.

5:28And all of this sounds relatively Keynesian. In fact, their entire analysis is predicated on the acceptance of the new New Keynesian Aggregate Supply, Aggregate Demand Framework. Even on its own terms, there are analytical problems with ASAD analysis. Most revelant and troublesome for evaluating nominal GDP targeting is that there is no such thing as an aggregate demand that equates with aggregate supply at a single price level. In fact, the social economy is made up of a vast network of distinct markets that are are integrated into a complex division of labor through intertemporal production structure and the use of a general medium of exchange. Productive activity, therefore, is the result of a vast number of decentralized decisions made by a multitude of different entrepreneurs at different places in the production structure. Capital is not a blob of homogenous shmoo, So investment is not a homogenous I. Sound analysis of macroeconomic discoordination must take these facts into account. Now it is possible for people to decrease their demand

6:38for consumer or producer goods if they increase their demand to hold money. This would only lead to wastefully idle resources, however, if prices for these resources remained above Market Clearing Levels. This will not persist, of course, if prices are allowed to adjust. If the demand for a product falls, the incentive to reap profits and avoid losses will lead both entrepreneurs and workers to reduce their selling prices. Unless frustrated by government edicts or the fear of strike threats, perhaps, entrepreneurs will seek to adjust their selling prices to market clearing levels. Such price reductions and cost cutting encourages continual sales and employment. Real earnings of the firms concerned will stabilize, allowing them to continue production and hence to demand labor, land and higher order capital goods from other firms in the production structure.

7:28Instead of allowing markets to clear via the price adjustments, according to subjective preferences, market monetarists advocate that monetary authorities bring about market stability by increasing the money supply. Such inflation, however, will not necessarily equilibrate the specific demand for and supply of Money on the part of individuals who may be experiencing an excess demand. If prices and wages are that sticky, there would need to be a significantly large increase in nominal GDP to maintain equilibrium. Now this begs the entire question of sticky prices. Several theoretical problems with the theory of sticky wages exist, and I don't have time to go into all of them, but on the one hand, if there is only one or a handful of firms In other words, if all firms that may be charging higher, or maybe paying, shall we say, higher so-called efficiency wages in the labor market, then employment will be restricted in only those industries and employment will expand in other industries, and this would not lead to a general increase in unemployment economy-wide. On the other hand, if all firms pay so-called efficiency wages, why is the higher wage not considered the market wage? Because it's the wage that everybody pays in the market. More importantly, however, to focus on sticky wages is again to focus on the

8:43At best, sticky wages do not explain why a recession begins, they would only explain why a recession is prolonged. Additionally, if markets do not equilibrate due to minimum wage and other price controls, this is hardly a consequence of the free market. The solution would be to eliminate government intervention, not to intervene by arbitrarily increasing the money supply. On the other hand, if markets do not equilibrate due to long-term labor, including union contracts, this results in what we could call a voluntary excess supply of labor, which is not really an excess supply at all. Now in fact, history reveals that prices and wages do adjust downward if allowed.

9:28Even in the case of long-term contracts, workers and employers can and do negotiate new market clearing wages, especially when it becomes apparent to people that if we don't, we're We see this with what, say, performance unions did in their Broadway contracts in the wake of the 9-11 attacks, or even in the most recent case, we have United Auto Workers negotiating two-tier labor agreements that will allow for lower wages to be paid. There are certain symphony orchestras who are sort of caught in the pinch, and their musicians negotiated significant 10% reductions in their wages. So this does happen. Now, it makes it harder, of course, when we pay people not to work, there are people who will take us up on it.

10:14So that sort of makes things, sometimes makes the adjustment process less smooth, shall we say. Now, decreases in demand are always experienced in particular markets, and when there is a decrease in demand or a decrease in supply in the face of elastic demand, total expenditures will drop. Note, however, that spending is the effect of the changes in the preferences of buyers and sellers and not the cause of the decrease in demand and supply. Joe Salerno in his 2006 paper shows how this applies to the broad social economy. Market clearing prices and quantities are determined on every market by the interaction of individuals' value scales on which goods are valued in relation to one another and to money.

11:04It is only after market equilibrium prices and quantities and therefore the value of money have already been determined that then the actual spending occurs. Another particular manifestation of, and this is sort of the second broad set of problems I see, a particular manifestation of market monetarists' unsatisfactory economic framework, is their understanding of the form and of and extent to which expectations enter into their analysis. Certainly no one should dispute that expectations play an important role in economic decision making. All action takes place in the present, while the results of action will be reaped at some point in the future, and consequently all action, including production, is forward-looking. All action must therefore be based on speculations about the expected outcomes of various potential actions.

11:54However, for understanding the nature of macroeconomic fluctuations, it is crucial that we have a proper understanding of the nature of the expectations that affect investment decisions. As indicated earlier, market monetarists seem to believe that actions of investors are determined almost exclusively by expectations of future nominal spending or nominal GDP. The problem with such a perspective is twofold. While sound economic theory recognizes that expectations of outcomes in the future are a prerequisite for action in the present, At present, economics cannot provide insight into the content of these expectations, or how expectations change over time.

12:42Expectations are not autonomous entities, but are bounded by a person's goals, his past experience in attempting to achieve his goals, and his entrepreneurial ability. Hence, expectations are not monolithic, which is why entrepreneurs must incorporate timeology into their decision-making. Treating expectations as universal and monolithic opens the door to grave errors of economic theory. For example, the market monetarists claim that it is expectations about future nominal GDP that solely determines present investment decisions and hence the direction of the economy, fails to recognize that recessions are not merely the result of decreases in aggregate spending following a boom. They are the result of Entrepreneurial Error. It is possible, for example, for entrepreneurs to reap profits even in an environment of declining total spending. What matters is not aggregate spending per se, but the spread between the price of products and the sum of the prices of the factors of production. If the total quantity of all spending in the social economy falls and overall prices fall, firms can still reap profits as long as they identify those projects

13:46at which the factors are underpriced relative to the future price of the product that those Those factors can be used to produce. Additionally, the form of expectations assumed is the source of a particular inconsistency I see in market monetarist literature. This inconsistency in turn is also related to their failure to understand recessions as a result of a cluster of entrepreneurial error. Market monetarists assume that markets are efficient and forward-looking. At the same time, recessions are due to decreases in expected nominal GDP. Now if markets are efficient while forward-looking, how can there be a cluster of entrepreneurial error? It seems that if market participants make efficient adjustments while looking forward, there should not be widespread mistakes made by entrepreneurs. If so, how can there be a recession?

14:33Now perhaps the response might be, as Loris Christensen implies, that although people have expectations that are indeed rational, they're not perfect. And so, if market participants properly forecast that the Fed would not or could not continue to increase nominal GDP through 2008, why should there be a recession? If their forecast was correct, they should have acted accordingly and markets would clear and at the very least, there would not have been widespread persistent unemployment. Market monetarist's affection for nominal GDP targeting once again demonstrates that an unsound theoretical framework will often lead to unsound economic policy. One of the biggest problems with trying to reduce economic fluctuations via nominal GDP targeting is the real effects of monetary policy necessary to stabilize actual or expected nominal GDP.

15:24It is necessarily true that newly created money will enter the economy at particular points. Monetary inflation therefore will reflect demands for certain goods first and then subsequent demands for different goods as the new money is spread throughout the economy. The step-by-step adjustment process during which the new money is absorbed necessarily results in real changes in relative prices and a real redistribution of wealth. Credit expansion, we know, necessarily stimulates malinvestment by encouraging production processes that are too roundabout relative to social time preferences. Without an increase in voluntary savings, longer production processes are not able to be completed. This is the heart of the malinvestment problem. Issuing fiduciary money via credit expansion promotes unsustainable boom activity because because it provides both the incentive and the means for entrepreneurs to undertake projects for which there are insufficient real resources to complete.

16:16The necessary consequence of monetary inflation, even if the desire is to stabilize actual or expected nominal GDP growth, is the boom-bust cycle in which resources are squandered, capital is consumed and society is relatively impoverished. Such an outcome is the exact opposite of the desires of those advocating nominal GDP targeting. Thank you very much.