Now It's Scott Sumner vs. Mike Sanowski Time

      You know I like nothing more than a Macro smackdown and that is what we are getting here. Sanowski already had one post questioning the idea of a NGDP futures market, and Sumner had an answer for that.

      Now, Mike has given us a reply to Sumner's reply. He starts out be reiterating he's not opposed to NGDP targeting and thinks it would be a market improvement over the current inflation targeting regime. I was never a fan of it to start. At least superficially it seems a lot better, I'll grant that:

      "Before I get started, I’d once again like to express my support for NGDP level targets. NGDP level targets are superior to our current dual mandate."

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

      Further he is pretty clear about what his critique is and what it isn't:

      "Also, I’d also point out the critique I am making has absolutely nothing to do the quality or usefulness of information which might be given to Central Bankers if NGDP futures existed and traded. Bernanke and Woodford do not address the problems I am raising here. I say there is no possible futures market. I am not saying that if a futures market for NGDP levels existed, the information the CB would get from that futures market would be useless.There is no can opener."

        He quotes Sumner's response:

      "The traders might be so smart that they steal $500 billion from the Fed. I wonder why he didn’t pick $500 quadrillion? Seriously, I’d argue the market need be no larger that $100 million, maybe $10 million. And I’ve published proposals where the Fed would not take a net long or short position. “

        He then quotes dwb from the comments section-dwb, of course, is a regular commentator at Money Illusion and I think it's fair to say a member of the Market Monetarism choir. I don't say this disparagingly, I think it's accurate. For me him and Satuoros are probabaly the best commentators among the "ditto heads" as it were.

      
      "Here is commenter dwb with a version of the same concern:

      “err, 500 BN or 3% of nominal GDP? some faulty analysis there. there are a whole lot of flawed assumptions in your analysis, i don’t have time to go through them all, but 3% of gdp does not even pass the smell test. “

         Give Mike this: no one can claim he isn't confident as shown this reply to dwb:

         "And 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."

          Ok then! It is on! Sumner's own response to Sanowski's original post was typically a summary dismissal-which is typtical for Sumner. Yet, it isn't fun for someone to question an aspect of an idea you've put a lot of work into, but Sumner's bedside manner as I've often suggested, needs work:

          "I wish Michael hadn’t written that post, as I don’t like having to keep replying to criticism by people who have never even studied the proposal."

           "Noah Smith pointed out that if NGDP futures traders were much dumber than the Fed, they might inject extra volatility into NGDP. I pointed out that I’d have no objection to the Fed doing its own trading to offset suspicious trades."

            "Now Michael raises the opposite concern. The traders might be so smart that they steal $500 billion from the Fed. I wonder why he didn’t pick $500 quadrillion? Seriously, I’d argue the market need be no larger that $100 million, maybe $10 million. And I’ve published proposals where the Fed would not take a net long or short position. So under those versions any $500 billion earned by GS would be offset by losses to other traders. And I don’t care if no one trades the contracts, as long as the central bank ensures liquidity and a low cost of trades."

            http://www.themoneyillusion.com/?p=15322

            To peevishly accuse him of not reading the proposal is not necessary. Say this for Nick Rowe, he usually manages to maintain civility when dealing with objections as certainly does David Glasner.

            Ok, let's go to Mike. He makes it clear that the $500 billion number is not out of a hat:

            "$500bn is a decent estimate for how large of a payment the fed would have made to Goldman Sachs and hedge funds on January 30th, 2009."

             Yes, very specific. Have to give him that on January 30th, 2009 the fed would have had to make a $500 billion dollar payment to Goldman Sachs and the hedge funds-basically all large market participant who play futures. Although I'm kind of jumping ahead, I can't resist quoting an answer to this Brito wrote in the comments section:

              "So the fed will give huge sums of money to banks as soon as NGDP dips? So an immediate bailout essentially? Couldn’t that potentially be stabilizing? "

               Hmm. A quicker way to get liquidity into the system? A kind of real time TARP? Here though I'm thinking of the criticisms of MMTers like Dan Kervick, et al.-Mike is MR rather than MMT-that part of the problem of NGDPT through the central bank is it leaves all questions up to unelected central bankers. I've never been totally sure about such criticism but can you imagine the political blowback if the Fed were able to do TARP in one day without even having to consult Congress?

           NGDP. There is wide presumtion that BOE has long targeted NGDP, and it had achieved a 5.3% rate. In the US too we've roughly seen NGDP near a 5% target prior to the 2008 crash, Sumner often points this out to lend the idea historical support. However, Sanowki sees this as a major problem for NGDP futures in terms of the leverage that would be required to make it worth the while for market particpants to use it for hedges and speculation:

           "First, here is some background information about NGDP levels. David Beckworth’s chart shows the Bank of England (BoE) was extremely successful in targeting 5.3% NGDP for decades – until The Event. The BoE missed by about 10% during The Event. It’s pretty clear a central bank can be extremely successful in targeting NGDP."

           "The U.S. federal reserve isn’t targeting NGDP, but here is a similar chart for the U.S. Not too shabby for a CB not even trying to hit a nominal NGDP target."

           "But something to notice about both of these charts is the difference between success and failure. There are very few “slight misses”. The series is binary – either extremely close to the NGDP target, or huge misses of 10%."

            "The success of the Central Bank in hitting the NGDP target during normal times is the source of the $500bn."

             The crux of what the problem is this:

            "We want to create an NGDP level futures contract with specifications economically useful to end users during nonrecessionary periods. If the Central Bank is to get useful information from this the NGDP level futures, somebody must trade the contract."

            "Economically useful contracts apply to every possible futures contract design. If the contracts aren’t economically useful, nobody trades them. This means the Central Bank does not get private sector forecasts from NGDP level futures."

            

             Sumner tends to get dismissive about these types of discussions:

             "Scott Sumner says in his response:

              “I would add that the “futures” market being proposed is unlike any real world futures market.”

               "I think he’s implying I wouldn’t understand a futures market with an unusual design. Hmmm. He’s also implying he’s discovered some special new futures market which the real world futures markets didn’t feel worthy of launching over the last 175 years. Hmmm"

               See, this is where he and Nick Rowe normally evoke talk of The People of the Concrete Steppes. There's always the sense that he doesn't think any of this kind of analysis of transmission mechanisms matters. These kinds of stylized facts he tends to give short thrift.

             "But every futures market, of any structure, must be economically useful to the participants. There are no special designs, no magic tricks, and no special “designed by an economist, not that dumbass Mike Sankowski” exemptions to being economically useful to the participants. The contract must make economic sense for the participants, or they don’t use it, and the fed doesn’t get information."

             "This means the leverage on the contract is above 50 to 1, most likely above 80:1, and perhaps as high as 100:1"

              This is because of the success during normal times of NGDP stability. The very success if the problem, Mike is saying.

               "So, we are puttering along with economic good times, and people are using this contract with 100 to 1 leverage."

               "Then, something like 2008 happens. If the fed is the market maker at the target NGDP level (so the fed can judge hpw much OMO the need to do to push NGDP to target), when the fed makes its 2008 mistake, somebody makes $500bn."

                So because of the leverage required to make this futures market economically useful to market participants requires huge leverage that will when we finally do see NGDP miss its target, huge losses the Fed has to pay Goldman and company. The problem as Mike sees it is that NGDP is historically stable but when it misses the mark the miss is huge, ,there aren't many small misses. So there would be big money in shorting NGDP futures at this point. Basically a month after the end of Q4 of 2008 for instance.

                He argues that the number would likely be higher even than $500 billion as-he thinks-the 5% target is too high. This is interesting that he says that. I feel like it's too low a target too, though among Market Monetarists, Scott's 5% rate is actually the highest. You have those like Lars Christensen and Bill Woolsey who argue for much lower targets of 3% or even 2.5%. George Selgin has talked about 0%! He to be sure is not really a Market Monetarist but some sort of Austrian-I know he says he no longer answers to the label but it gives you an idea where he's coming from.

               "I think 5% is a low NGDP level target. A reasonable NGDP target really needs to be a “NGDP per capita target” and should include population growth. The U.S. population is growing at .98% per year."
          
              "This means NGDP levels should grow at 6.0% annually to hit 2% inflation and 3% per capita real GDP growth. 6% annual NGDP growth translates to 1.47% growth per quarter."

                While this is not the main point of the post, of course, the point is well taken. 5% is too low to achieve historical numbers. I've often felt that I'd like a higher rate. Any way, this is a good piece with a lot to chew on. Sanowski plans more. Will be looking forward to it. Let's finish by quoting his summation:

                 "In his response to Noah Smith, Scott proposes the market for NGDP level futures does not need to be very large. He also proposes alternative contracts where the Fed is not the market maker at a set NGDP target level. Instead this alternative contract design has a floating price level set by market participants."

                 "Before we go on, I think Scott entirely misses how damaging the correlation issue is for NGDP level futures."