NGDP targeting: wither monetarism?

Monetarism is like a Zombie: it can be found theoretically wanting, empirically false and technically infeasible but in one form or another it just soldiers on.  In some ways the hype surrounding the conversation about the possibility of moving from an inflation based paradigm to targeting NGDP could be read as the end of monetarism.  But viewed from another angle it (NGDP targeting) can also be read as the latest reincarnation of monetarism.

Purists will of course bulk: monetarism died along time ago as central banks realized they did not control the money supply as private banks also create money all the time in the form of credit.  But if in narrow technical terms monetarism died soon after its birth, in broader political terms it came of age in the ensuing years.  As I see it there were three initial pillars to monetarism only one of which technical.  First, the CB can control the money supply (false) and thereby inflation; second, the CB should be independent (from democratic influence) to pursue price stability (not amenable to boolean operators); third, monetary policy is the preferred technocratic as opposed to democratic policy (fiscal) lever.  Even though the first be dead the second and third live on.

My problem with NGDP targeting is threefold.

First, proponents of of inflation targeting like the quasi monetarists are want to argue that the last twenty years of  inflation targeting has been a dizzying success.  As per Nick Rowe:

 We have 20 years of empirical evidence showing how inflation targeting works to stabilise expected and actual inflation.

Not so fast.  We have twenty years in which many things were happening: a move across the advanced capitalist zone to flexibilise labour markets and the incorporation of broad swaths of eastern European and Asian, and south Asian labour reserves into the global market; and increasing trade liberalisation and capital mobility. So I am not sure the CB’s should get all or even most of the credit for price stability over the last twenty years.  Although they may warrant some of the blame for higher average unemployment than the pre-monetarist CB regime.

Second, I remain to be convinced that the CB’s can actually target NGDP.  They, the CB,s, have a limited range of arrows in their tactical quiver.  If anything the present crisis has taught us (like the crisis of Keynesianism) at such periods in the micro-economic motivations swamp the thinking of businesses.  I suspect the BOC could announce tomorrow that it had raised its inflation target to 6% and not much would happen in real or nominal terms.  Defeating inflation was a rather simple exercise even if politically difficult.  All the CBs had to do was to put interest rates through the roof and kill off every marginal producer of goods and services.  Similarly keeping inflation in check (on target) was and is a relatively easy affair when one simply has to throw sand in the financial gears.  It becomes a problem of second order magnitude to target NGDP growth when everyone who counts knows you do not really have the ability to independently bring it about.

Nominal growth targeting means nominal investment targeting and in the context of already hyper low interests rates it is hard to see where the CB has a viable policy lever.  They can play around with quantitative easing (as they have already done) but all that appears to have done is set a soft floor on some classes of asset values.  And it is an open question as to whether or not this is a good thing.  On what rational basis was it decided that some asset values were worth preserving and others not?  More importantly putting a soft floor under some classes of asset values has done next to nothing for investment rates which is after all how you target underlying economic growth even when not discounted by inflation.

Third NGDP targeting is opaque in a way that inflation targeting is not.  There is a relatively decent link between the credible threat of high real interest rates and the threat of low real interest rates.  The former pushes noun against a verb the latter not so much.  Without the direct ability to determine aggregate investment rates the CBs are forced into much more cloistered channels with little to no capacity to sanction the relevant actors should it not get what it wants.

My critique probably boils down to the following.  It is only under a supremely unique set of circumstances that CBs found their targeting regime and interest rates to have such a profound positive influence on the level of economic activity.  In capitalist economies it is businesses that invest and hire (something both liberal and Marxist economists agree on) interest rates and asset valuations play only a small part of the calculus to invest.  The government on the other hand can use fiscal policy to indirectly stimulate investment through tax policy and directly control aggregate investment and thus employment via direct spending.

Ironically if the government was to monetize the debt by putting Peter in bed with Paul (the CB and the treasury) it would inadvertently give some real teeth to the CB’s ability to prove to the relevant economic actors that it was serious about targeting NGDP growth.  But I suspect Tory New-Keynesians like Rowe and Sumner would not abide.  For once you show that fiscal policy is in fact a powerful force for economic regulation the last two pillars of monetarism come a tumbling down.  Some version of industrial democracy would be back on the table.

Hardly what a Tory goes shooting for when they wake up early in the morning.

What is causing inflation?

It must be the generosity of EI: no. It must be the generosity of welfare: no. It must be that women are entering the labour market in record numbers: no. It must be militant unions: no. It must be Canada post workers: no. It must be a wage price spiral: no. It must be inflexible labour markets: no. It must be tight labour markets: no. It must be capacity utilization is maxed: no.

It must be factors that almost nothing to do with the domestic economy: Bingo!

What is the solution. Austerity, further deregulation and privatization, punitive labour market policies, more free trade and increased interest rates.

I am so not looking forward to the next four years.

Extend and pretend

It is bad when the most pertinent of commentaries gets no response. What is ironic here is that at the micro level banks are telling their public stop pretending we are not extending even though they face near zero costs or in the case of the US negative costs.

You leave out an important scenario: in a zero interest rate environment, no bank is bad. This is why otherwise insolvent banks like Bank of America or Citi can stay solvent. It doesn’t matter the proportion of non-performing loans on the asset side as long as its cost of funds is minimal. Banks are thus engaged in a race with time to capture a positive return to recapitalize before interest rates rise.

Posted by: Guillaume | November 08, 2010 at 10:48 PM

Yep extend and pretend. That is the future but it is not as yet the present.

Carney and the likely path of inflation and interest rates

I find the notion that we are transitioning to a significantly higher interest rate regime a little unconvincing for several reasons.

First, the appreciation of the CDN dollar should have a deflationary effects. To the extent that increasing interest rates in Canada will provoke a higher FX (assuming the US remains stuck in a liquidity trap alongside a moribund political discourse surrounding budget deficits and thus near zero interest rates) there will be a 2 for 1 punch against inflationary pressures.

Second, there are several indications that China is moving towards a tighter monetary regime.

Third, the world is awash in excess capacity with the European and American consumers on the sidelines. How do you get inflation in a world where everyone is trying to either export or austere themselves back to economic health?

Fourth, on the subject of unions, workers and wage growth, there is not going to be significant wage-push component inflation in the near to medium term. The public sector (understood in its broadest sense) is being hammered; and workers in the private sector have little collective bargaining power. All of this is in the context of slack labour markets: neither bodes well for rapid consumption growth nor inflation.

So, where Carney conjures his present of near to medium-term inflation bogeyman from I do not know.

I should also say I have material reasons to WANT to believe we are headed into a higher inflation / higher interest rate regime as the performance of my pension fund depends on it. But unlike my union executive I won’t be engaging in magical thinking.

It should also be said that, at least, Carney acknowledged that growth was going to be much less robust than the Conservatives have budgeted on. That said, it makes the commitment not to commit to low rates rather odd.

It could be that Carney is trying to jaw-down the property market (bubble?). Throwing uncertainty into the likely future path of interest rates is an important part of altering home-buyer confidence.

Or it could be that Carney knows his models are junk, at this time, and his gut tells him that this is an extremely difficult market to call so he his battening-down the hatches and leaving the widest range of policy options on the table.

For further analysis see Erin Weir”s post over at the PEF