NGDP Targeting: Are Expectations Enough?

      Often, it seems this is what they are saying. We have the references to those who are too "hydraulic"-Nick Rowe's "People of the Concrete Steppes."

       A large part of Sumner's dismissal of MMT is that they are "strangely literal." In Macro being literal counts as eccentricity. What matters if what your model says should happen. Ok, I digress.

       Yichuan Wang, who if you haven't read yet I certainly recommend him- however, though a Market Monetarist, believes that expectations aren't enough? There's more to it than Chuck Norris?!

        "Should monetary policy be viewed as a blunt club or a surgeon's scalpel? While we often discuss central banks credible actions to accurately hit a policy target, there is less discussion on whether central banks can precisely hit a target. Because while both blunt clubs and surgeons' scalpels can wound and hurt, a club "beats around the bush" while a scalpel (ideally) targets a specific, well defined area. In the language of monetary policy, we know central banks can raise the level of nominal GDP growth, but can they precisely control the magnitude of the increase? How much of a base injection does the central bank do to make the potatoes hot enough without burning our fingers? This precision problem is at least as important as the accuracy problem because it is a key reason for why explicitly declaring a five percent nominal GDP level target is not sufficient. Because there are real costs of extremely high inflation, the central bank is likely to shy away from policies that might "accidentally" lead to excessively high inflation. If economic variables become more volatile, the lack of monetary policy precision can become a major barrier to monetary policy accuracy."

         http://synthenomics.blogspot.com/2012/07/monetary-policy-blunt-club-or-surgeons.html

        This concern over "bluntness" is important, as it's the kind of thing the FOMC no doubt worries about.

         "The core of my argument starts from a mechanics-credibility theorem, which states that if policy does not have a concrete mechanism, it can not be credible. This theorem means raising nominal GDP can be credible. We know that central banks have an infinite number of ways to inflate: currency depreciation, asset purchases, forward guidance, nominal GDP futures targeting, among other options."

         This is a very interesting and important theorem as it seems to contradict the idea that all you need are expectations. Of the logic of expectations, of Chuck Norris, and of the "market doing the heavy lifting", Yichuan says this:

         "Although this logic is appealing, it is nonetheless circular. According to this line of argument, a precise target is credible because the central bank will inevitably hit the target, but the reason the central bank is precise is because it is credible. Before we can wave the magic wand of expectations, we need to show that there exists a vanilla, "elbow grease" monetary action that can credibly hit a target with both accuracy and precision."

          I'm glad to hear a Market Monetarist say this, because, the expectations are everything argument seems circular to skeptics. Yichuan is also more bearish about the Swiss experiment of a currency floor going forward:

          "In the absence of an expectations mechanic, there is a wide range of uncertainty on the policy response. Other forms of unconventional monetary policy, including currency depreciation or forward guidance, all suffer from this "how much is too much?" problem. Once you inject a few non-linearities into the stories, and have market expectations change at unknown threshold, you realize that prospects for precision are grim."

           "When the monetary policy result is uncertain, central banks are less likely to use the tools to raise nominal GDP. They may fear excessively high inflation or other side-effects of over-expansionary monetary policy, and choose to be "cautious" and live with high levels of unemployment instead. This is the reason why limits in precision can become limits in the accuracy or effectiveness of monetary policy."

           You could question why they are more averse to risking slightly excessive inflation as opposed to way too high unemployment and subpar growth. But this, again, is the blunt vs. precision argument. He also seems somewhat agnostic about what Scott always points too, FDR's gold buying plan. Maybe, Yichuan, suggests, it's not applicable today:

            "A historical counter-example to this theory of uncertainty would be FDR's dollar devaluation program, which Scott and Marcus Nunes have shown to be very effective in restoring both the price level and output during the Great Depression. Yet I don't find their example to contradict my argument about the imprecision of monetary policy at the zero lower bound. Perhaps FDR got lucky. Perhaps the price level was already so depressed that you would have needed hyperinflaiton. Perhaps, back then, finance was not as tightly coupled and the investment effects of getting out of treasuries wouldn't have been as strong. Nonetheless, in our faster, more leveraged, more volatile world, this granularity and imprecision of monetary policy is a bigger impediment."

          So the Swiss currency floor doesn't cinch it, nor does FDR's devaluation... How about Australia? Not entirely. He points out that Australia is different in that they never faced the zero bound:

          "Scott Sumner often uses Australia as another example, pointing out that their monetary base to nominal GDP ratio is much lower than that in the United States. This shows that Australia has not had to inject as much money into their banking system to stabilize nominal GDP, demonstrating that the stabilizing nominal GDP growth should not be very difficult. But Australia is unique in that it never was at risk of the zero lower bound. While part of this may have just been good monetary policy, it still leaves open the possibility of a large, unforecasted


        With all this skepticism, what's next? He seems dangerously close to excommunicating himself. What's left in the Market Monetarist bag of tricks? Turns out there is one more bullet. Yichuan argues that NGDP futures is the answer, it is the silver bullet. It will lead the market do indeed do the heavy lifitng:

         "However, one form of nominal GDP targeting seems to sidestep these problems: nominal GDP futures targeting. This would allow market participants to instantly improve estimates of future inflation by bidding on futures contracts. Their bidding one way or another would immediately translate into changes in central bank open market operations such that nominal GDP always stays on track. This approach sidesteps the non-linearity of expectations because it allows the market to aggregate all the necessary information and automatically has the central bank adapt to the new found information. Even if expectations did shift in response to unforecasted shocks, the policy response would be immediate and taken in decentralized steps as individual investors bid on futures contracts. In this case, mechanics-credibility theorem is satisfied because the mechanic by which the Fed earns its nominal GDP credibility directly interacts with market expectations while avoiding the circularity problem. Market expectations of nominal GDP feed into futures market volumes, which directly changes the monetary base. The market answers the questions of "how much" with the level it thinks is "just right".

      "This is one of the key advantages of an nominal GDP futures targeting regime relative to a conventional "wait-and-see" regime. It cements in credibility, and rolls with the waves of external volatility. In a sense, it floats like a butterfly and stings like a bee. It takes monetary policy from the world of "Bernanke Smash" to "Sumner Slice", and allows for greater accuracy and precision in the control of a central nominal aggregate: nominal GDP."

      So NGDP futures is the key? Meanwhile Mike Sadowski has already posted two parts of his proposed five part takedown of the idea of NGDP futures. Mike is nothing if not confident, he assures us he will have totally discredited  NGDP futures by the time he's done.

      If Yichuan is right that NGDP is that concrete mechanism that would mean that if Mike does successfully repudiate NGDP futures that would be a body blow to Market Monetarism. Again, note this has two contingencies in it, If  Yichuan is right and if  Mike delivers his promise. For the record, Mike claims that he likes the idea of targeting NGDP that it is a major improvement over inflation targeting. It's tough for me to argue there, as I really hate inflation targeting.


      So who knows? One or both of them may be wrong. For his part, I can already imagine Sumner's response to Mike Sadowski's next post knocking NGDP futures. It will come down to saying that Mike needs to read his proposal before he "wastes time" criticizing it.

     Does Mike sound confident enough?

     "dwb, you should find the time to let me know those flawed assumptions, because otherwise NGDP level futures will be a smoldering heap of ash in 2 weeks.

      http://monetaryrealism.com/why-500bn-and-not-500-quadrillion-i-bothered-to-do-the-math/

      In the below link you count how many times Scott complained about people criticizing NGDP futures without reading his proposal. This is typical Scott kvetching. How does he know he didn't read the post? He'll probably answer something like 'well if he did then he doesn't understand it' but wouldn't it be easier just to provide a link that he has in mind?

    I notice he has this thing about not wanting to provide links and sources for things he says. Anyway here's just one instance of Scott's kvetching:

   "Michael still doesn’t seem willing to actually read the proposals; otherwise he would have known that the market would be subsidized, so there is zero risk of no one trading the contracts.  If no one else trades, I will, and I’ll gladly walk away pocketing the entire multi-million dollar subsidy."
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    http://www.themoneyillusion.com/?p=15446

     Ok, here's another one:

      "Mike, I’d suggest you stop talking about my proposal until you actually read it, as what you are talking about has no bearing at all on what I’m proposing. We are talking past each other."

       Again, it's a style point but I think that's cheap on Scott's part I have to admit. Just provide the links and then there can be no doubt we're all on the same page. Rather than taking all these little potshots.