Arnold Kling Discusses NGDP Transmission Mechanicisms

      This is an issue that never does much but bore Sumner and company. He, Nick Rowe, and company have little but scorn for the "People of the Concrete Steppes." According to Sumner figuring out a transmission mechanism for NGDP is too hard and not very important anyway.

      Arnold Kling does consider this a little. Which is a good thing-Sumner's incuriousity about a transmission mechanism (TM) is for me itself a curiosity.

     http://econlog.econlib.org/archives/2012/05/what_im_reading_19.html

     First Kling quotes from Hetzel's new book:

     "One explanation highlights market disorder resulting from swings in the psychology of financial markets from excessive risk taking to excessive risk aversion. The other explanation highlights monetary disorder based on central bank (Federal Reserve) interference with the operation of the price system."

     So for the Market Monetarist, Hetzel there are those from the-market disorder school and those form the monetary-disorder school.

     Kling says he is from the market-disorder school but with a difference from most in this school:

      "Within this framework, Hetzel is, along with Scott Sumner, an adherent of the monetary-disorder school. I belong to the market-disorder school, although I am not as Keynesian as is the typical market-disorderist."

      Now he gets to the hypothesizing:

      "Consider the following thought experiment. Call what we actually did--the bailouts, the stimulus, the actual path of monetary policy--plan A. Suppose that in March of 2008, when folks were contemplating a bailout of Bear Stearns, the Fed instead had gone with Plan B, in which Ben Bernanke says, "Folks, it looks like there is going to be some heavy weather ahead on Wall Street. A lot of firms are in shaky situations. I want everyone to know that, no matter what happens, (a) we are not going to do anything to assist any individual firm; and (b) we are not going to allow nominal GDP to fall below the path in our forecast, which calls for an increase of 5 percent per year."

       "Would the market response to Bernanke's promise to maintain nominal GDP have resulted in the economy remaining closer to full employment? I can think of three channels.

1. Wage rates. If anything, workers who believed the hypothetical promise to maintain nominal GDP would have been less likely to make wage concessions. Thus, this goes the in the wrong direction.

2. Domestic investment. In theory, investment projects should have looked more promising. But which ones? Not housing or commercial development in the "sand" states. Construction activity elsewhere? Factories? Computers? Maybe we can tell a story in which stock market investors do not sell stocks, Tobin's q does not fall, and so investment does not fall. Or maybe not. Perhaps the declines in the stock prices of financial stocks would have been even worse and more long-lasting.

3. International trade. If domestic demand does not respond to Bernanke, then the only way he can keep his promise is through a large devaluation, resulting in an increase in exports and a decline in imports.

      So he offers three particular channels. Here's his verdict:

       "If you're a market-disorder adherent, what do you think about Plan B vs. Plan A? Again, let's stipulate that there would have been more market disorder without the bailouts. Does that mean, not withstanding the huge currency devaluation, inflation and nominal GDP would have been no higher than under plan A?"

       "My own answer is a bit unusual for a market-disorder person. That is, I think that plan A exacerbated rather than alleviated market disorder. But I don't think plan B would have done much good, either. I would have preferred a "plan B lite" which would have made an effort to keep nominal GDP growth at 5 percent, but without an ironclad commitment. My guess is that real GDP was bound to decline in the latter part of 2008, and the only way to maintain nominal GDP growth of 5 percent over that period would have been to cause a lot of inflation. But I cannot see any harm in 3 percent nominal GDP growth (in fact, it actually declined in the last half of 2008 and the first half of 2009)."

      Interesting. I'm not sure in what way he thinks plan A made things worse but I'd be interested to know. I don't necessarily think that's an outrageous claim. If anything I might be more willing to suspect that it did little good and that the big cost was the opportunity cost of not doing something better.

      I'm not sure why plan B lite is better though if he dislikes an "ironclad commitment" because he wants to maintain discretion then maybe he's right.

      As far as TMs 1, 2, and 3 I don't  know that any of them impress me very much. If NGDPT does work hopefully there are other possible TMs.

      Sumner comments only on the wage rate channel:

      "If workers start making wage concessions then you’ve lost the war. They’ll never be big enough. Get ready to be voted out of office and replaced by another government. Nominal wage concessions are the last thing you want. And I agree with Arnold that nominal wage gains might have actually been slightly higher under 5% NGDP targeting adopted in early 2008—perhaps 4% instead of 3%. But here’s what matters, wages/NGDP would have risen far less in 2008. As it is, the ratio rose by about 7% (3% wage gains and 4% NGDP decline from 2008:2 to 2009:2.) That sudden increase made high unemployment almost inevitable. With a 5% NGDP

      "One of the most important goals of NGDP targeting is to make nominal wage growth stable, so that any needed adjustments in real wages would occur via price level changes."

        Sumner is right that nominal wage cuts are not salvation-Keynes had said that it is actually rational that workers fight much harder to protect their nominal wage than their real wage. Still though, it's yet again clear that when we do touch on TMs, Sumner always suspects that the problem are workers an their unreasonable wage demands. Recall what Keynes said about Classical economists who while on a human level understood the workers' feelings, on the level of economics had to admit that their wages were at the center of the problem.

      Marcus Nunes does make a pretty incisive comment in the comments section.

      "I agree with Arnold’s claim that 3% NGDP growth in 2009 would have been dramatically better than what actually occurred. Why didn’t the Fed do at least that much stimulus?"
      "That´s easy. Because Bernanke thought that by rescuing the financial system he would avoid clogging the credit channel which to him is the most important transmission mechanism."
Unfortunately he had to learn the hard way that his 1983 paper is not very good!"

        http://www.themoneyillusion.com/?p=14157#comments

       To be sure Marcus is always a harsh Bernanke critic but I think it's fair to say that Bernanke way overestimates the credit channel. This is why while I don't know if Kling's plan A makes things worse certainly you can argue that it makes things little better.