“Genie in a bottle”

Maybe like others, I was surprised by Larry Kudlow´s nice reference to market monetarism. But what drew my attention was the mid part here:

Interestingly, while the inflation rate has remained subdued, so have market-price indicators, such as gold, the dollar, and commodity indexes. The suggestion here is that Bernanke, rather than mounting a high-inflation policy, has been avoiding deflation.

At the end of the day, the Federal Reserve is not the engine of growth. Low tax rates, light regulation, and limited government spending create the incentives for more rapid economic expansion and prosperity-inducing opportunities.

But if I have this story right, the market monetarists want the central bank to enforce a nominal GDP growth rule, which will avoid both deflation and inflation, and thus give fiscal incentives breathing room for a more rapid job-creating expansion.

Many think MM´s propose the Fed be the “engine of growth”. Big mistake. What we propose, with NGDP level targeting, is that the Fed embraces its role as the “engine of nominal stability” (“avoid both inflation and deflation”).

The “Great Moderation” is our “show case” period. As the panels indicate pretty clearly – by correlating NGDP growth in period t with NGDP growth in period t+1 (and the same for real GDP growth and PCE-Core inflation) – is that during the period the Fed managed to keep “the genie (NGDP) inside the bottle” i.e. attain NOMINAL STABILITY, real stability AND low and stable inflation followed suit.

Genie_1

Genie_2

Genie_3

It is interesting to note, indicating that targeting inflation successfully is not enough, is that while Bernanke has managed (imperfectly) to keep inflation low, by losing nominal stability he also lost real output stability (and keeps being afraid of sliding into deflation).

Update: The NK trade-off is not between inflation and real output (employment/unemployment) as in the original Phillips Curve, but between real output variability and inflation variability. This trade-off is determined by the choice of parameters (for the deviation of inflation from target and output from potential) in the Monetary Policy Rule. Market Monetarists argue that by stabilizing nominal output (NGDP) you “minimize” the variability of both real output and inflation. The “Great Moderation”, characterized by NGDP stability along a level path, provides compelling evidence.

6 thoughts on ““Genie in a bottle”

  1. That’s a great conclusion, Marcus. I’m tempted to say, convincing.

    Interesting graphs, too. I never thought of plotting data against itself with time offset like that.
    Seems to me (first thoughts) that the displacement of the plotted points perpendicular to the 45-degree line is a measure of stability… Displacement of points along the 45-degree line is a measure of stability and economic performance combined.

    I might assume that displacements along the line due to stability (or lack) are about equal to displacements perpendicular to the line due to stability (or lack), and that any additional displacements along the line are due to economic performance, and not to stability.

    If my method of interpreting the graphs is correct, then it is quite clear from your graphs that “performance” had a much greater effect than “stability”. I’m sure you will reject this conclusion. Therefore I figure you must reject my method of interpreting the graphs.

    If you would, then, please explain how you interpret the graphs and what is wrong with my first thoughts on the subject.

    • Art, to tell you the truth I thought you were writing classical greek! It´s simple. The more bunched together are the points, the greater the stability or, alternatively, the lower the volatility. As I commented in your blog the other day, growth is a different animal from stability. I believe stability helps you get better growth (although some believe you get “bubbles”)

      • Yeah, I’m good at that 🙂 On a related subject, your English is so good that I find it difficult to believe it is a second language for you.

        “I believe stability helps you get better growth”
        I don’t understand why you say that, because your graphs with NGDP or RGDP trend lines seem to show above-trend growth before the Great Moderation, and below-trend growth since.

  2. Great post.

    Before the 2012 USA Presidential election, I wondered if after the election, the “right wing” would come to embrace Market Monetarism, after the election.

    In other words, the right-wing wanted Obama to lose, and wanted the Fed to suffocate the economy to get there.

    Now, the election is over. I am finding more and more “right-wingers” seemingly a little more accepting of MM.

    I still think that if Romney had won, and Taylor been appointed Fed Chief, and Romney started a conflict with Iran, then Taylor would have printed money to the moon.

  3. Good post. The inflation genie is very sad these days. The NGDP LT idea genie is getting very happy.

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