IT, PLT & NGDP-LT: Is there a story?

In the 1980s and even before, NGDPT was widely discussed, while there was no similar discussion about IT. But as it often happens, circumstances ended up “electing” inflation as the target of monetary policy. The “circumstance” in this case was the desire of the NZ Prime Minister to make government agencies more efficient. To that purpose he required everyone to define goals and targets that would allow objective evaluations. When it came to the Reserve Bank of New Zealand, the Governor put forward the idea of targeting inflation (at the rate set by Parliament).

The idea spread like bush-fire and sequentially several countries adopted “IT”. At that time, early 1990s, Friedman had already convinced (most) of the world that inflation was a monetary phenomenon so there was no better choice than for the Central Bank to conduct monetary policy in such a way as to avoid inflation getting “out of hand”. Even an inflation prone country like Brazil had success with IT which was introduced in early 1999 concurrently with a massive (almost 100%) devaluation of the exchange rate (which had been, for the previous five years, the nominal anchor and responsible for the success of the Real Plan in ending hyperinflation).

A period of low and stable inflation took over, even for many countries that never formally adopted the target. The US, for example, is one such case.

Almost a quarter of a century later “IT” is being questioned. A good summary of the discussion is David Beckworth´s “Inflation Targeting – A Monetary Policy Regime whose time has come and Gone”. The abstract reads:

Inflation targeting emerged in the early 1990s and soon became the dominant monetary-policy regime. It provided a much-needed nominal anchor that had been missing since the collapse of the Bretton Woods system. Its arrival coincided with a rise in macroeconomic stability for numerous countries, and this led many observers to conclude that it is the best way to do monetary policy. Some studies show, however, that inflation targeting got lucky. It is a monetary regime that has a hard time dealing with large supply shocks, and its arrival occurred during a period when they were small. Since this time, supply shocks have become larger, and inflation targeting has struggled to cope with them. Moreover, the recent crisis suggests it has also has a tough time dealing with large demand shocks, and it may even contribute to financial instability. Inflation targeting, therefore, is not a robust monetary-policy regime, and it needs to be replaced.

In many (most?) cases, “IT” is coupled with a rule for the instrument; a central bank determined interest rate (the Fed Funds rate in the US, for example). Because of that quirk, monetary policy has become synonymous with interest rate policy. And if interest rates are very low, as at present, central bankers (and analysts) only talk about the “need” to “normalize” monetary policy, i.e. get interest rates up to more “normal” levels.

The problem associated with low (or very low) policy rate has been discussed for at least 15 years in conferences and papers with titles such as “How to conduct monetary policy in a low inflation environment”, the idea being that if inflation is “low” (or “on target”), interest rates will also be “low”, so that if a shock comes along that requires interest rates to be lowered further, the ZLB will “prevent” monetary policy from being effective, that being the situation which is perceived by many today and why we hear arguments for an increase in the inflation target rate.

Ironically, you also hear the same people saying monetary policy is “easy” (because interest rates are very low). They don´t connect with their stated view that interest rates are low because inflation is low, meaning that monetary policy has been “tight” (to bring inflation down to target). They should reread their Friedman!

One problem with IT, in addition to those discussed by Beckworth is that it is “memoryless” with regards to the price level which is what matters most for economic decisions. For that reason we have also had frequent discussions about the benefits of the central bank adopting a price level target (PLT). See here for an example.

And then there is NGDP-LT (LT=level target) which is the favorite target of market monetarists. Basically, instead of having inflation running at the target rate or the price level evolving at a constant level target rate, NGDP-LT will have the central bank controlling the aggregate nominal spending (NGDP) in the economy evolving along a level target rate.

How to choose among them? You could (and people have) build models that will (hopefully) allow you to evaluate them. Another way is to do an empirical analysis where your “model” is history.

For that I picked four “inflation targeting” countries (in the US “IT” is only implicit) and see how they performed:

  1. As an inflation targeter
  2. As a price-level targeter
  3. As an NGDP-level targeter

The charts show (for (1)) that, with the exception of Australia (which has a target band, not rate) they were either above “target” (US) or below “target” (Sweden and Canada (with Canada showing only a small miss)).

Target Story_1

For (2), the charts show that with the exception of Canada whose price level has remained close to the target path (as inflation has remained close to target), the others show significant divergences from the price level target path, either positive as in the case of Australia and the US or negative as in the case of Sweden.

Target Story_2

It seems that (3) is a clears “winner”. In all cases, irrespective of inflation being a bit above or below target on average or the price level showing positive or negative divergence from the level path, NGDP remains close to the target path all the way up to the crisis. Interestingly, the country that suffered the least pain (in terms of real growth and unemployment) was Australia, not coincidently the only of the countries shown that did not allow aggregate nominal spending to diverge (especially in the downward direction) from the target path.

Target Story_3

While the other countries are trying all sorts of “potions” to try to get back “on their feet”, including dilly-dallying with additional terms in their mandate (like “financial stability” or, in the case of the US additionally enshrine the Taylor-Rule as “policeman” for the Fed´s actions), Australia is back on the original trend level path.

Takeaway: The central bank that best takes care of maintaining NOMINAL (spending) stability does best.

PS This is the RBA´s “mission statement”:

In determining monetary policy, the Bank has a duty to maintain price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve these statutory objectives, the Bank has an ‘inflation target’ and seeks to keep consumer price inflation in the economy to 2–3 per cent, on average, over the medium term. Controlling inflation preserves the value of money and encourages strong and sustainable growth in the economy over the longer term.

But what they really provided was nominal stability!

The idea that central banks “need a financial stability mandate” keeps coming back

Even in Sweden, where 4 years ago the Riksbank decided there was “too much debt” and raised rates to “calm people down”. That, as we know, ended in grief and with the head honcho being outvoted (first time that happens) in the last policy committee meeting, when the policy rate was lowered by 50 basis points to 0.25%.

But there are those that don´t give up. As Lars Svensson writes:

Should the Riksbank have financial stability as an objective besides price stability? According to an op-ed by Carl B. Hamilton in Dagens Industri on July 17, the answer is yes. According to Hamilton, this is even a practice already established by the Riksdag (the Swedish parliament). The Riksbank Act needs to be amended, but only as a formality.

But Hamilton forgets that the Riksbank has no effective policy instruments to affect financial stability, except in connection with the management of financial crises. He also forgets that the government with the support of seven parties in the Riksdag – including Folkpartiet (the Liberal Party) – has decided that the Riksbank will not receive any such instruments. Without the instruments, the Riksbank neither can nor should have financial stability as an objective.

The fact is that Sweden has done a pretty bad job. It´s mandate calls for 2% inflation, nevertheless, since 1994 inflation has averaged only 1.3% per year. And the average is the same including or excluding the post crisis (2008) years!

Pre-crisis, in countries such as the US or Canada, among others, you couldn´t distinguish from the data if the central bank was targeting inflation, the price level or NGDP. All those were observationally equivalent. I´ve shown previously that the only “dog that barked” was NGDP level targeting.

In Sweden, on the other hand, inflation was far below target on average and so was the price level (consistent with 2% inflation). The charts below illustrate.


Nevertheless, completely unwittingly, NGDP remained close to a level trend until the crisis hit. And despite inflation (on average) remaining below target, NGDP was climbing back to the previous trend rate. That is, until 2010 when the Riksbank decided it was time to restrain people´s (and house price) exuberance!


So Sweden provides a good example (evidence?) that what really matters for the central bank is to provide NOMINAL stability. When it does so things work out, even if inflation (or the price level) remains below “target”.

Making inroads

The name Market Monetarism is not yet four years old, although the ideas (which are an extension of monetarism) recently turned 5! Krugman argues that we are “homeless”, but our “crib” is the blogosphere. Maybe soon we´ll be able to “afford a home”.

That may come sooner than expected, given that “the other side”, full of “high-powered brains”, is now unabashedly brandishing the name (MM) about. Initially Krugman, not wanting to “advertise” called us neo-monetarists, but now he´s calling us by the full name!

Over the past month or so there´s been some back and forth (debate). A synopsis:

What annoys me about market monetarists (see links therein)– Simon Wren-Lewis

Good and bad blog debates –(links to several Mark Sadowski posts) – Simon Wren-Lewis

Neomonetarist delusions (Krugman)

Asymetrical doctrines (Krugman)

Neofiscalist delusions (Nick Rowe)

Mr. Krugman´s peculiar post (Scott Sumner)

Update :

Addicted to inflation (Krugman)

Response from Josh Barro Not Everyone is Addicted to Inflation




Japan would be better off depressed!

This can be inferred from a speech by Rintaro Tamaki, Deputy Secretary-General and acting Chief Economist of the OECD, who for 35 years worked for Japan´s Ministry of Finance:

The chief economist of the Organization for Economic Cooperation and Development, Rintaro Tamaki, recently gave a talk that should be heard by all Japanese economists and policy makers. He observed that the aim of Japanese economic policy is still mainly about strengthening growth. However, in Europe, the more recent trends in policy strive for reducing inequality(!).

Unfortunately most of Abe’s policies look more to the past than to the future. Repeated attempts to use inflation to restart the economy have produced momentary jumps in growth.

But those little jumps are less beneficial in the long run than improving education, equality and relations with other economies.

Having been at Japan´s MoF for so long made him addictive to “depression”.

The Dallas Fed: The Gift That Keeps Taking Recession “Conservatively” Cost Each U.S. Household $120,000…and Counting? Oil Spike May Have Triggered Recession, but Not Fed

A guest post by Benjamin Cole

I thought of Marcus Nunes instantly, when I saw the lead to another paper published by the Dallas Federal Reserve Bank. Here’s that lead:

A confluence of factors produced the December 2007–June 2009 Great Recession—bad bank loans, improper credit ratings, lax regulatory policies and misguided government incentives that encouraged reckless borrowing and lending. The worst downturn in the United States since the 1930s was distinctive. Easy credit standards and abundant financing fueled a boom-period expansion that was followed by an epic bust with enormous negative economic spillover.”                                                 

That’s quite a confluence, and totally exonerates…well, the United States Federal Reserve, of course.

Our central bank was part of the solution though, according to the paper, Assessing the Costs and Consequences of the 2007–09 Financial Crisis and Its Aftermath by Dallas Fedsters David Luttrell, Tyler Atkinson and Harvey Rosenblum. The Fed eased monetary policy, and possibly averted a Great Depression, aver the authors.  

The Lost Dollars

The Dallas paper is actually readable and does yeoman work in estimating the painful costs of the 2008 bust-o-rama to the public. 

“There are few estimates of what society gave up due to the crisis: Our conservative estimate is $50,000 to $120,000 for every U.S. household,” report the trio of authors. 

As an aside, there is something off-kilter about this wide-ranging “conservative” estimate of recession losses. It reminds of younger (pre-Internet and image-trading) days, when a blind date might describe her dress size as, “conservatively, you know, somewhere between size 8 and 32.”

That was when blind dating lived up to its name.

Can You See It?

Agonizingly, the Dallas Fedsters come close—oh, so close—to stumbling on the real cause of the 2008 bust, when they ask, “[w]hether an oil-price shock in 2008 might have caused a mild recession anyway.”

What? What! Or in Texas Spanglish, “¡Que?”

They get it? Are they just feigning myopia?

What was the Fed doing in 2008, when higher oil prices were threatening a recession? The Fed was tightening up, fearful of inflation!

As we now know from transcripts of 2008 meetings of the Federal Open Market Committee, the Fed was monomaniacally obsessed with inflation then (as ever, perhaps). The transcripts reveal the word “inflation” (or variants thereof, such as “inflationary”) was used 2,664 times in 2008 FOMC meetings; the word “unemployment” only 275 times. This was the year of worst U.S. economic downturn in postwar history.

So, the 2008 higher oil prices were threatening a mild recession, but the Fed stomps on the money supply. Is it such a leap of faith to conclude that the Fed turned a recession into a rout? That only then—after the Fed starved the economy of money—that the leveraged property markets tumbled down, taking too a fragile banking system?

Looking Forward

Well, that’s gloomy enough, but there is more.

The Dallas central bank economists conclude by asking if U.S. economic output will be permanently crimped by the 2008 bust, ever growing along a lower path in the future. (As it stands, this seems to be the case, btw.) Thus households might continuously accumulate losses compared to what might have been, as time goes by, the trio of authors ponder.

A good question, dudes.

Do you think the Fed should keep its 2 percent inflation noose around the economy’s neck?

Ponder that.

A legislated axiom: The “Taylor-Rule” as the “Reference Policy Rate”

Guest posting at Econbrowser, Alex Nikolsko-Rzhevskyy, David Papell, and Ruksandra Prodan argue pro a legislated Taylor-Rule for the Fed:

While economic performance is always better in rules-based eras than in discretionary eras, the effects of the deviations differ systematically among the rules. The ratio of the loss during discretionary eras to the loss during rules-based eras is reported in Column 3 of Table 1. The loss ratio is largest for the original Taylor rule, next largest for the modified Taylor rule, and smallest for the estimated Taylor rule. The results in Table 1 are robust to deleting the periods when Paul Volcker raised the federal funds rate more than two percentage points above the Taylor rule benchmark in order to bring down inflation and restore Fed credibility, which arguably should not be classified as part of the discretionary eras. Using the original Taylor rule as a benchmark provides the sharpest evidence of the negative effects of deviating from policy rules.

How does this relate to the proposed legislation? Our evidence that, regardless of the policy rule or the loss function, economic performance in rules-based eras is always better than economic performance in discretionary eras supports the concept of a Directive Policy Rule chosen by the Fed. But our results go further. The original Taylor rule provides the strongest delineation between rules-based and discretionary eras, making it, at least according to our metric and class of policy rules, the best choice for the Reference Policy Rule.

Nick Rowe has a very good response to their arguments. The punch-line:

I can’t help thinking that there is something peculiarly American to this question. 1776 and all that. Why don’t they get the distinction between target rules and instrument rules?

And that´s a serious problem as the charts below illustrate.

The price level charts (PCE and PCE-Core) have an estimated 1992-06 trend of 1.9% and 1.8% respectively. The implicit inflation target of 2% was almost perfectly nailed.

TR Legislated_1

The FF target rate chart is next, followed by the chart which includes the “Taylor-counterfactual” indicating the period rates were “too low for too long”.

TR Legislated_2

Although the “instrument rule” was “badly” set, the inflation target was hit. The instability showed up in NGDP, so if we had an NGDP level target rule we would have missed the target!

TR Legislated_3

When the Fed woke up to the miss, monetary policy was adapted by introducing forward guidance. NGDP “dutifully” returned to the trend-level path.

The high price attached to an “instrument rule” showed up a bit later, when the Fed manipulated the instrument (and the “communications”) to counter a rise in inflation (PCE) due to a supply (oil shock). The price came in the form of a quick drop in NGDP. The rest, including Lehmann, is a consequence of not having an NGDP level target rule!

PS John Taylor believes that using his namesake rule as “Reference” would “Spark Another ‘Great Moderation‘”

PPSS Alan Blinder thinks it would be a negative but his reasoning is faulty:

The House Financial Services Committee held a hearing on Federal Reserve reform on July 10. The hearing didn’t get much press attention. But it was remarkable. While the House can’t manage to engage on important issues like tax reform, immigration reform and the minimum wage, it’s more than willing to propose radical “reform” of one of the few national policies that is working well(!).

Another Ode to “financial stability”

Sumerlin and Swagel could not be clearer:

Many monetary experts refer to the 2000 equity crash as a benign event. But the unemployment rate rose by 2½ percentage points after the decline, and the monetary policy response to that rise in unemployment contributed to the housing bubble and the 2008 financial crisis. The Fed will not achieve the stability that it seeks until financial stability concerns are given an equal weight when determining monetary policy.

Central bankers would have to go to a circus and take classes with expert jugglers! A three-piece mandate?

David Beckworth has convincingly argued that by adopting an NGDP level target, i.e. attaining nominal stability, would greatly reduce instances of financial instability (which, like argued here, would likely be the result of bad public policy).

But let´s examine their argument about the monetary response to the 2000 equity crash.

The chart indicates that the long-run “stock story” is mostly a productivity (TFP) story.


The next chart shows that short-run stock fluctuations are closely linked to NGDP fluctuations. In 1998-00, monetary policy was overly expansionary (see here for details). There was an over-correction and monetary policy became excessively contractionary (where the stance of monetary policy is “defined” relative to the NGDP gap and not by the level of the Fed´s policy rate).


Incredibly, between January 2001 and July 2003 the Federal Funds target rate (FFT) was reduced from 6.5% to 1%. Stock prices kept falling, and the NGDP gap widening. Monetary policy only became more expansionary (leading NGDP back to trend) when the FOMC introduced forward guidance in August 2003.

The chart depicting the Gap and unemployment tells the same story.


This is another indication that if the Fed pursues nominal stability, by which I mean focusing on keeping NGDP evolving along a stable trend level path, the market (price system) will function much more efficiently and bad public policy (not monetary policy) will get the blame for any financial instability that arises!

Update: “Everybody´s talking“:

Those who warn of grave dangers if speculative price increases are allowed to continue unimpeded are right to do so, even if they cannot prove that there is any cause for concern. The warnings might help prevent the booms that we are now seeing from continuing much longer and becoming more dangerous.

Two versions of AD

Gotcha! It´s not two meanings, but two versions. One is the Static version and the other the Dynamic version.

In the static version AD is the value of aggregate nominal spending. In the dynamic version AD  is aggregate nominal spending growth.

In both, AD refers to the whole curve, along which either aggregate nominal value or aggregate nominal value growth is the same.

Which combination of price (or inflation) and RGDP (or RGDP growth) will prevail depends on where the AS curve is located.

The charts illustrate.


PS. See Scott Sumner and Tyler Cowen