A James Alexander post
Market Monetarists have often been a bit frustrated with Simon Wren-Lewis’ Keynesian over-concern with the obstacle of the Zero Lower Bound. Having flirted with NGDP Targeting a few years ago he went off the idea. It is great to see him both attacking the idea of raising rates, in fact suggesting a cut in rates, and also returning to support NGDP Targeting:
“Good policy should not just look at the most likely outcome, but also at risks. At the moment there is a significant risk that we may be losing a huge amount of resources because of a tepid recovery. To cover that risk, we should cut rates now. The worst that can happen if this is done is that rates might have to rise a little more rapidly than otherwise in the future, and inflation might slightly overshoot the 2 per cent target. Inconvenient, but not very costly.
If we fail to cover that risk, there is a non-trivial probability that in three years’ time inflation will still be well below target and we will all be asking why on earth everyone in 2015 was talking about an interest rate increase.”
“If the Bank of England had adopted a NGDP target, as many have recommended, the MPC would be tearing their collective hair out right now trying to stimulate the economy. There would be zero talk of interest rate increases. So there seem to be just two possibilities. Either NGDP targeting is nuts, or monetary policy has slowly gone off the rails by focusing on CPI inflation alone.”
Unfortunately, there is still little room for the UK to cut rates as they are obviously very close to the the ZLB, unless the MPC goes down the negative rate road. Perhaps Wren-Lewis is just paving the way for a reopening of his campaign for more big government fiscal policy – he has never proposed tax cuts as a form of fiscal policy as far as I have read. Is this because his anti-market, anti-supply side, bias blinds him? I don’t know. But this bias needs to be overcome for NGDP Targeting to be really effective.
At or around the ZLB central banks have to be very clear just how far they will go with unconventional monetary policy in order to achieve their targets. But the key issue is how the markets, and thus the wider economy, understand what the central bank is really targeting.
Actual NGDP is a tricky thing to target as the numbers inevitably come out after the event, and accurately many months after the event. It could be too little, too late if central banks only look at incoming data. They must look forward, to set the flight path they want to be on.
Better to work with the market and target the market’s expectations for future NGDP. At the moment these expectations can only be seen indirectly through market implied inflation rates, longer term bond yields, equity markets and exchange rates. Consensus macro forecasts are almost worthless with their constant reversion to mean, usually using the same discredited macro models used by the central bank’s themselves. Market prices are far more reliable as a guide to the future as real money is at stake rather than just the reputations of a lot of rent-a-mouths.
It would be best for central banks to help launch an NGDP Futures market as Scott Sumner has argued. This small but imaginative step by a supply-side macroeconomist brought together Friedman’s classic monetarism with the new insights of rational expectations.
It would be even greater if Wren-Lewis too could make this step and work with rational expectations to achieve successful monetary policy and growth, rather than being so skeptical about the market all the time. For a Keynesian like Wren-Lewis this would be a giant leap, but it is a necessary one.