A James Alexander/Marcus Nunes post
Independent of Brexit, the bigger issue remains that all three currency blocs – USD, Euro and British Pound – are seeing low NGDP growth, too low for comfort. Small real shocks like Brexit (let´s call them, à la Robert Higgs, actual and/or potential institutional discontinuities) cause market mayhem precisely because NGDP growth is too low and thus rather fragile and easily knocked lower.
Why is NGDP level and growth so low? Because central banks seem to like it that way. Their 2% inflation targets dominate their discourse and all their internal projections show them on course to meet their targets in two years’ time – and to hell with NGDP growth. The result is slow monetary strangulation; Brexit is mere noise in this bigger picture.
Nevertheless, given the nature of Brexit, that mixes Supply and Demand shocks, some clarification is in order.
- Brexit caused a (global) fall in velocity (AD shock). This requires an offsetting rise in money supply
- Brexit caused a (less global) fall in trend real growth (AS shock). Given that monetary policy is synonimous with interest rate policy, this requires a fall in interest rate (because the neutral rate has fallen), which at the ZLB is not forthcoming. In that case, a negative AS shock automatically turns into a negative AD shock.
Solution: Forget interest rate targeting and concentrate on nominal stability (NGDP-LT)
If the negative AS shock is permanent, for nominal stability to be maintained you require a lower trend growth in NGDP.
Permanent AS shocks tend to be rare!