Blanchflower Baloney

A Mark Sadowski post

In a recent post James Alexander caught Danny Blanchflower tweeting that he thought “NGDP totally impractical due to data revisions”.

This is a familiar complaint, voiced for example by Goodhart, Baker and Ashworth in January 2013.

There are numerous problems with this line of thinking.

First of all, central banks shouldn’t be targeting past values of economic variables anymore than one should attempt to drive a vehicle on a superhighway by looking in the rearview mirror. Arguably the world’s major central banks tried doing that in 2008, and we are still living with the results. Since central banks should only be targeting the expected values of economic variables, bringing up the issue of data revisions reveals a level of obtuseness that borders on the ridiculous.

And as irrelevant as the issue of data revisions is to the proper conduct of monetary policy, although NGDP levels tend to be revised, that certainly should not imply that inflation rates are not revised. In fact the personal consumption expenditure price index (PCEPI), the inflation rate of which is the official target of the Federal Reserve, often undergoes significant revisions.

There’s two main ways of measuring the size of the revisions of the components of national income and product accounts: 1) Mean Revision (MR) and 2) Mean Absolute Revision (MAR). For rate targeting MAR is the more appropriate measure, and in fact the MAR of inflation is usually smaller than the MAR of NGDP. However, for level targeting MR is more appropriate.

Interestingly, at least in the US (Page 27):

“The MRs for the price indexes for GDP and its major components are generally not smaller than those for real GDP and current-dollar GDP and its major components.”

In fact, over 1983-2009 the MR for the final revision to quarterly NGDP is 0.14, whereas over 1997-2009 the MR for the final revision to the GDP deflator and the PCEPI is 0.20 and 0.12 respectively. And over time the revisions have trended downward.

So I suspect that the MR for NGDP is smaller than the MR for PCEPI over 1997-2009.

Which means the claim you frequently hear that NGDP revisions are larger than inflation revisions is pure grade A horse manure. You will never see any evidence supporting this mindlessly repeated spurious claim, because no such evidence exists.

And, finally, inflation is a totally artificial construct requiring that we come up with an estimate of the extraordinary abstraction known as the “aggregate price level.” To see how preposterous this is imagine equating the aggregate price level between what it is now and what it was in say 14th century England. The goods and services are so different it requires the complete suspension of one’s disbelief.

In particular, PCEPI inflation is the difference between nominal PCE and real PCE, meaning PCEPI inflation is nothing more than the estimated residual between a truly nominal variable, which is relatively straightforward to measure, and a real variable, which is fundamentally an exercise in crude approximation.

It’s high time that central banks moved beyond the near medieval practice of targeting real variables and/or their residuals, and started targeting truly nominal variables, which according to the accepted tenets of monetary theory is their proper domain.

NGDP data revisions means targeting it is “totally impractical”, really?

A James Alexander post

Danny Blanchflower, the enfant terrible of the Bank of England when he was for a time on its rate-setting Monetary Policy Committee, tweeted here that NGDP Targeting was “totally impractical” because it was a figure that was so subject to data revisions.

Well, first off, revisions don’t matter to Market Monetarist advocates as the “Market” bit of MM refers to the theory that you should target expectations for NGDP Growth. Scott Sumner has argued for a market in NGDP Futures so accurate market forecasts of NGDP growth could be used. This proposal is not much of a leap for standard macro theory that argues you control inflation by targeting inflation expectations. So it’s no big deal to target forecasts, every macro-economist should get that bit.

Market Monetarists are highly sceptical of inflation expectations as measured purely in surveys. The public has little understanding of the term inflation. Although the public sees their shopping basket go up and down in cost it has only modest relevance to the central banks that like to target core inflation, i.e. excluding volatile food and energy. On saner days central banks actually target the measure of inflation that gets them from NGDP to RGDP, known as the GDP Deflator. This figure often runs well below measures of consumer inflation. A good discussion on the good reasons why this happens is here.

Consumers would also have little view on NGDP, of course, if that were targeted. They would roughly see one large element though, in aggregate wage or income growth. This is because NGDP (and therefore RGDP) can be measured by adding up all the income in the economy, via the “income method”. The two other ways to measure NGDP are the self-explanatory “expenditure method” and the very tricky “output method”. Of course, I don’t have to explain this to expert economists like Danny Blanchflower.

Second, NGDP should, in theory be more reliable to measure since RGDP is based upon NGDP. Any errors in NGDP will, de facto, be in NGDP. However, RGDP errors are then compounded by errors in the deflator. It is therefore impossible for RGDP to be more reliable than NGDP.

The question is then whether NGDP is more or less prone to error than “inflation” measures. Well, NGDP only has one definition, so that certainly helps, inflation many. The infamous switch in the UK from RPI to CPI as the main method was certainly a major revision to method and certainly sowed huge confusion. It still does cause problems as index-linked bonds are still based on RPI, as are most inflation-protected pensions and other forms of financial income.

Lastly, Blanchflower demanded that I provide some empirical research that NGDP is less prone to error than RGDP or “inflation”. Well, here is a study by the US statistical office, the Bureau for Economic Analysis that demonstrates that NGDP (“Current-dollar GDP” in the table) is at least as reliable as RGDP looking at the period 1993-2013. This can’t actually be true given RGDP’s two sources of error. The resources spent on RGDP are much larger than those spent on NGDP so that may account for the BEA’s result.

Whatever, it at least shows Blanchflower’s “totally impractical” is just wrong in fact as well as theory. He should stop talking nonsense. 

The great benefit of NGDP Targeting is that it means the central bank concerns itself only with nominal stability and doesn’t have to get concerned with the balance between inflation and real growth, or the hard to measure productivity growth that drives the difference. Those issues can be left to real economy experts to sort out. 

In this way of thinking neither inflation nor Real GDP growth should be of any concern to a Nominal GDP Targeting central bank.

Never reason from a liquidity crisis

A James Alexander post

Tony Yates tips his hat with more respect that in previous posts towards NGDP Targeting.

Re-reading his earlier “silly” post I was struck by this comment he made in reply to some of the commenters:

“NGDP targeting would not have helped avoid the financial crisis. That was caused not by bad monetary policy, but by bad financial regulation policy”.

He was picked up on this by both Andy Harless and one other, but Yates kept mum. Why?

I suspect he can’t go there because his long time at the Bank of England turned him into something of an apologist for his alma mater. Benjamin Cole has complained here about the same sort of thing in the US.

Dan Davies, another sometime Bank of England employee and sometime apologist, has written very insightfully about the demarcation lines between the elite macroeconomists at the Bank of England and everyone else, in particular the grubby lot doing banking regulation. [Apologies to readers but I can’t find the link … it may have been an e-mail from when he was a banker]. They were always regarded as second-raters. Yates unconsciously reinforces that in his website bio:

“I worked for 20 years at the Bank of England in its Monetary Analysis directorate, the part of the Bank devoted to the setting of monetary policy.”

He has to make it very clear that it wasn’t in the lower ranked parts of the central bank, inhabited by dumb financial regulators, who failed to control those smart but evil guys at the banks.

But if it weren’t the banks or their regulators who caused the crisis then who was to blame? Yates and the all too numerous academics who move in, out and around the central banks have too much at stake to hold their hands up and take the blame. They can’t face the embarrassment. But it was them.

And this is probably the reason we hear so little criticism of the Bank of England’s monetary policy or that of the Fed or the ECB in precipitating the 2008 and 2011 crises. They really are “all in it together”. And like any good trades union, united they stand divided they fall.

Well paid bankers make easy villains yet the liquidity crisis that brought them low was a central bank failure.

Yates pompously suggests Market Monetarists should stop writing and go and create some mathematical models, but if I were to put in a function for “catastrophic failure by central banks to stick to targeting core CPI and in fact actively tighten policy or threaten to do it in the face of falling NGDP expectations” how would that go down?

I suspect I wouldn’t get much funding from Yates and his cronies who stuff the academic funding bodies or see it published in one of the hundreds of central bank academic journals. It may be wordy to call most modern macro a closed shop, but it’s true.

If Yates can so easily toss off populist comments that it was all caused by evil commercial bankers and useless regulators then there is plenty to argue about over the internet.

One small step for supply-siders, a giant leap for Wren-Lewis?

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.

Australia tries to find “balance”

Being one of the very few countries (two others are Poland and Israel) whose monetary policy managed to avoid a recession on the heels of the 2008-09 crisis, Australia is a natural object of Schadenfreude!

Two recent articles “wish harm” on Australia

1 Is Australia Sliding Into Recession?

Recent data prompt economists to warn Australia may be ripe for first recession in 24 years

2 Goodbye to the lucky country

What if our economic growth stalls altogether? Worse still, what if we slip into recession?

These are not farcical questions. Figures released this week recording just 0.2 per cent growth in Gross Domestic Product for the June quarter, and just 2 per cent for the year to June, were extremely weak. Indeed, without a one-off increase in government defence spending, the quarter would have recorded zero growth.

There´s as usual some luck involved. In the case of Australia, it did no harm that immediately before the crisis hit, it was effecting an “excessively” expansionary monetary policy, as indicated by NGDP growth and it´s level relative to the trend path. The two charts illustrate.

Australia is the prototype commodity exporting country. In such cases, the exchange rate should move to offset commodity price or terms of trade changes. That´s what´s reflected in the next chart, with two notable exceptions. In 2004-07, the exchange rate doesn´t move, while commodity prices are rising. That boils down to an expansionary monetary policy. In the first set of charts that is reflected in the upward trend taken by NGP growth and the rise in NGDP above trend.

In 2001-13, the RBA tightened policy. That is implied by the fact that falling commodity prices were not accompanied by a depreciation (fall) in the A$ relative to the dollar. In the first set of charts, we observe a strong fall in NGDP growth.

We note that NGDP growth has done a lot of “swinging” after the crisis hit. Scott Sumner thinks that the RBA has “chosen” a lower growth rate for NGDP. That may be right, and I put that new trend growth at 4%. If that´s correct, we may soon find Australian NGDP growth settling around that level, implying that NGDP will evolve close to a level path that will be below the previous one.

There´s, however, always the risk that the RBA, if it starts worrying about debt levels and house prices, will make the mistake the Riksbank made in 2010. Let´s hope that doesn´t occur!

Update: In Australia, the post crisis “NGDP growth swings” are reminiscent of the “Volcker NGDP growth swings”. What Volcker was trying to do was find a stable path for NGDP. That was “bequeathed” to Greenspan, and the “Great Moderation” ensued, until Bernanke lost it!

Good-bye, so long, farewell?

In a recent post Scott Sumner muses:

For the past few years I’ve been suggesting that the labor force participation rate is not going to bounce back.  Commenters have insisted that the workers were just “discouraged”, and that they’d come back in and start looking for jobs when the labor market got somewhat better.

Today the unemployment rate fell to 5.1%.  If that’s not the natural rate, it’s pretty close. Close enough so that if you really wanted a job you should at least be looking by now.  And yet the Labor force participation rate is 62.6%, the lowest level since the 1970s. No, I’m afraid the discouraged workers are gone for good.  Indeed the Fed wants to tighten now to prevent the job market from overheating!

In the next post he asks:

What is the total number of months during the Ford, Carter, Reagan and Bush I administrations, plus the first term of Clinton, when the unemployment rate was lower than today?

Answer:  1

(March 1989, when it was 5.0%)

Come on discouraged workers, get out there and start looking!

Nevertheless, taking a longer view, below several instances (many more in the 60s and 90s) of unemployment below 5.1% and the corresponding YoY core pce inflation:

Nov/66: 3.6% – 3.1%

Nov/73: 4.8% – 4.8%

Mar/89: 5.0% – 4.5%

Apr/00: 3.8% – 1.7%

May/07: 4.4% – 2.0%

Now: 5.1% – 1.2%

However, it is disturbing to see, as shown in the chart below, that monetary policy failures (letting NGDP growth drop significantly, or even tank) has permanent real effects, in this case causing a permanent drop in the labor force participation rate (even considering only prime-age workers). And the Fed Borgs think more “tightening” is needed!

Therefore, saying that 5.1% unemployment is indicative of a “tight” labor market is nonsense! What is “tight” and remains “tight” is monetary policy.

The following chart indicates that higher employment growth could be forthcoming with higher nominal spending growth. Unfortunately, the Borgs don´t seem willing to experiment!

Title Song

 

When Milton Friedman Called For 7% Nominal GDP Growth

A Benjamin Cole post

On October 23, 1992, Milton Friedman penned an op-ed for The Wall Street Journal in which he bashed the U.S. Federal Reserve for being too tight.

Although the Fed had cut the federal fund rates from 10% to 3%, Friedman wrote, “It is hard to escape the conclusion that the restrictive monetary policy of the Federal Reserve deserves much of the blame for the slow, and interrupted, recovery from the 1990 recession.”

In 1992, the record shows, core inflation was 3.3%. The GDP grew at 3.4%.

But Friedman thought the Fed should try to bump up one, or both, of those figures.

Thus, Friedman was calling for a 7% NGDPLT, maybe more.

Today

In the years since Friedman in 1992 bashed the Fed for being too tight—which he also did in 1957, and also in his study of the Great Depression—the economics profession became demented, and developed a peevish fixation on inflation, and even a perverted obsession with zero inflation or deflation.

Deflation has not worked in any large modern economy; see Japan. The island growth rate through their deflationary years was 0.5%, below that of statist France, or any place that was not a backwater basket case.

Yet today we see Fed Chair Janet Yellen solemnly administering a monetary policy far tighter than anything Friedman ever proposed. Yellen is evidently targeting inflation below 2%, and appears tolerant of sub-2% real growth. Recent departees from the FOMC wanted the screws even tighter.

Thus, the Fed has a 4% NGDPLT, and maybe not even.

I am sad to say some in the Market Monetarist movement seem to abide by such cramped, microscopic levels of growth and inflation. I do not know why. We are talking about nominal indices of prices, of dubious accuracy. And the U.S. economy is surely capable of many years of at least 3% real growth.

I have proposed a 7% NGDPLT for now. Just like Milton Friedman did.

But then, I think the purpose of macroeconomics is prosperity, not a slavish devotion to a nominal and arbitrary price index. Or a craven appeasement of dogmatic, partisan fantasies of what is macroeconomics.

Can we get back to robust growth and moderate inflation? What was wrong with that outcome?

It´s good when something works both in practice and in theory!

For the past several years, market monetarists have promoted the change from inflation targeting to NGDP level targeting. The analysis was mostly empirical, a fact that made some “wrinkle their nose”. A new model based paper arrives at the same conclusion:

The design of monetary policy has been the subject of a voluminous and influential literature. In spite of widespread discussion in the press and policy circles, the normative properties of nominal GDP targeting have not been subject to scrutiny within the context of the quantitative frameworks commonly used at central banks and among academic macroeconomists.

The objective of this paper has been to analyze the welfare properties of nominal GDP targeting in comparison to other popular policy rules in an empirically realistic New Keynesian model with both price and wage rigidity. We find that nominal GDP targeting performs well in this model. It typically produces small welfare losses and comes close to fully implementing the flexible price and wage allocation. It produces smaller welfare losses than an estimated Taylor rule and significantly outperforms inflation targeting.

It tends to perform best relative to these alternative rules when wages are sticky relative to prices and conditional on supply shocks. While output gap targeting always at least weakly outperforms nominal GDP targeting, the differences in welfare losses associated with the two rules are small.

Nominal GDP targeting may produce lower welfare losses than gap targeting if the central bank has difficulty measuring the output gap in real time. Nominal GDP targeting always supports a determinate equilibrium, whereas output gap targeting may result in indeterminacy if trend inflation is positive.

Overall, our analysis suggests that nominal GDP targeting is a policy alternative that central banks ought to take seriously.

There are a number of possible extensions of our analysis. Two which immediately come to mind are financial frictions and the zero lower bound. Though our medium scale model includes investment shocks, which have been interpreted as a reduced form for financial shocks in Justiniano et al. (2011), it would be interesting to formally model financial frictions and examine how nominal GDP targeting interacts with those.

Second, our analysis abstracts from the zero lower bound on nominal interest rates. It would be interesting to study how a commitment to a nominal GDP target might affect the frequency, duration, and severity of zero lower bound episodes.

On the last sentence, MM´s have little doubt that, when undertaken, the study will also corroborate their view that the frequency, duration and severity of ZLB episodes would essentially disappear!

Will new tools help to “save” the economy?

The BEA has announced the forthcoming release of new analysis tools:

The Bureau of Economic Analysis plans to launch two new statistics that will serve as tools to help businesses, economists, policymakers and the American public better analyze the performance of the U.S. economy. These tools will be available on July 30 and emerge from an annual BEA process where improvements and revisions to GDP data are implemented. BEA created these two new tools in response to demand from our customers.

Average of Gross Domestic Product (GDP) and Gross Domestic Income (GDI)

Final Sales to Private Domestic Purchasers

This new data tool is just one of the ways that BEA is innovating to better measurethe 21st Century economy and provide business and households better tools for understanding that economy. Providing businesses and individuals with new data tools like these is a priority of the Commerce Department’s “Open for Business Agenda.”

Meanwhile the “more government crowd” is strident.

Simon Wren-Lewis:

When we have a recession caused by demand deficiency such that interest rates hit their Zero Lower Bound (ZLB), the obvious response from a macroeconomic point of view is fiscal stimulus. Instead governments have become obsessed by their debt and deficits, and so we have austerity instead.

Brad DeLong:

Arithmetically, the U.S. economy is depressed because residential construction and government purchases are well below previously-expected trend levels…

And governments are not responding to market signals: financial markets are telling them that they have a once-in-a-lifetime opportunity to advantageously pull spending forward from the future into the present and push taxes back from the present into the future. But, because of the ideology of austerity, they are not taking advantage of this opportunity.

Brad calls a spade a spade: “Economy is depressed”, but it´s not because of his GDP components reasons.

Take Final Sales of Domestic Product (FSDP), to remove some of the volatile components of NGDP. The charts below show how it has performed relative to the “Great Moderation” trend. You also see that the 90/91 and 2001 recessions were “overcome” when FSDP growth managed to get FSDP back on trend. Not so following the “Great Recession”, with the result being a depressed economy.

This predicament is not due to “residual seasonality”, “inappropriate tools for analyses” or “ideology of austerity”. It´s wholly due to the Fed constraining the growth of nominal spending at an inadequate level, one that has persisted for 5 years! It´s beyond belief that “growth stability” for that length of time is just a coincidence!

I´m reminded of the wisdom of James Meade, who in his 1977 Nobel Lecture said:

Earlier I spoke of ‘price stability’ as being one of the components of ‘internal balance’. Yet in the outline which I have just given of a possible distribution of responsibilities no one is directly responsible for price stability. To make price stability itself the objective of demand management would be very dangerous.

If there were an upward pressure on prices because the prices of imports had risen or because indirect taxes had been raised, the maintenance of price stability would require an offsetting absolute reduction in domestic money wage costs; and who knows what levels of depression and unemployment it might be necessary consciously to engineer in order to achieve such a result?

The “price stability” obsession is the reason the economy was “knocked down” in 2008!

His “solution”:

I have told this particular story simply to make the point that the choice between fiscal action and monetary action must often depend upon basic policy issues which should certainly be the responsibility of the government rather than of any independent monetary authority. Perhaps the best compromise is an independent monetary authority charged so to manage the money supply and the market rate of interest as to maintain the growth of total money income on its 5-per-cent-per-annum target path, after taking into account whatever fiscal policies the government may adopt.

Unfortunately, the economy has remained depressed for too long. That has certainly “sapped its strength”. Nevertheless, a higher level of spending is certainly achievable. Maybe, for incomprehensible (to me) reasons, it´s not desired!

Recently, Scott Sumner visited the St Louis Fed. It wasn´t for naught!

Today Bullard comes out of the closet with a euphemism:

The Federal Reserve should consider new policy options, including directly targeting a non-inflation-adjusted level of economic growth, after more than six years of sustained monetary easing failed to spur a boom, Federal Reserve Bank of St. Louis PresidentJames Bullard said Thursday.

“It’s time to question the current theory and explore other models about what’s going on at the zero lower bound,” Mr. Bullard said, referring to the Fed’s zero-rates policy that has been in place since December 2008.

Mr. Bullard was presenting new research conducted with three other economiststhat he says shows “the monetary authority may credibly promise to increase the price level…to maintain a smoothly functioning credit market.”

The model could be “broadly viewed as a version of nominal GDP targeting,” the paper says, referring to a policy in which a central bank would set a target for gross domestic product growth without an inflation adjustment. The idea would be to signal to markets and the public that the Fed is serious about generating a recovery, thereby spurring investment and spending.