Optimal Control approach

NGDP level targeting: Yellen it from the rooftops, but nobody heard by Cardiff Garcia

(via Thoma)

Yellen Supports Explicit Guideposts by Tim Duy

Robin Harding in the "Financial Times" "Central Bankers give voice to a Revolution."

Search for the title with Google and you can bypass the paywall.

(via DeLong)

The chairman of the US Federal Reserve had reason for cheer and for a little pride: his committee had just said it would keep interest rates close to zero until the US unemployment rate falls below 6.5 per cent (it is 7.7 per cent today). For a central bank, let alone the Fed, to tie rates to the economy in this way was without precedent. 

The move speaks of a quiet revolution that is sweeping over central banks. A day earlier, Mark Carney, currently governor of the Bank of Canada, soon-to-be governor of the Bank of England, became the most senior central banker to praise an even more radical policy: targeting the level of nominal gross domestic product. Instead of having apoplexy, Britain’s chancellor said he wanted a debate. 

Like most revolutions, it seems to come from nowhere but has deep roots. Like most revolutions, it holds the promise of great good but has the potential for harm. It is crucial that politicians and the public understand what this revolution in central bank thinking is and is not about. 

“A revolution is impossible without a revolutionary situation,” said Vladimir Lenin, something of an authority in these matters. (A view from Lenin on recent monetary innovations would be interesting. “The best way to destroy the capitalist system is to debauch the currency” is another of his dainty little remarks.) 

The past five years have led central banks to a revolutionary situation. When the crisis hit, they played their best moves, but to modest effect. Quantitative easing – the ugly term for buying long-term assets in order to drive down long-term interest rates – looks radical thanks to the many-zeroed numbers involved. In reality it is just another way to cut interest rates. 

Monetary policy, and every other kind of policy, failed to engineer a strong recovery in advanced economies. Dissatisfaction with that outcome has led central bankers, spurred on by a healthy dose of external criticism, towards ideas that have been percolating in academia since Japan’s bubble burst in 1990. 

Japan’s long slump drew attention to the vexing problem of what to do if you cut interest rates to zero and the economy remains in the doldrums. Mr Bernanke was vocal in that debate, along with economists such as Paul Krugman, Lars Svensson and Michael Woodford. 

One option is quantitative easing. But there is another option: tell people that you will keep interest rates low in the future. If they believe you then it makes sense for them to borrow now. If rates are to stay low even after the economy recovers then why would they not? 

Central banks are now pursuing that basic insight. The Fed’s new 6.5 per cent unemployment condition is a way to tell everybody that rates will stay low until the economy gets better. The nominal GDP target is a more drastic version of the same thing. In essence it combines growth and inflation into one number. Targeting this not only puts more weight on growth, it means promising to make up for low inflation now with more in the future – another way of saying the central bank will keep interest rates low.

12/12/12 Paradigm Shift

Bernanke's Non-Stupidity Pact by Krugman

Lost Decade Watch by Krugman

THE FEDERAL RESERVE'S SHIFT FROM A TIME- TO A STATE-BASED POLICY RULE: WILL IT END OUR "LOST DECADE"? by DeLong

A Fed Bank President's Idea Comes to Life by Michael S. Derby

Mark Carney - the current Governor of the Bank of Canada and new Governor of the Bank of England - is advocating NGDP level targeting.

FOMC Adopts Game-Changing Conditional Inflation Targeting Rule by Yglesias

More Bond Buying and Thresholds by Tim Duy

THE FEDERAL RESERVE: THREE YEARS LATE--BUT THEY DID IT!! by DeLong

Clearer Policy by Ryan Avent

Fed shifts approach in how it gauges U.S. economy by Thoma

Obamanomics: A Counterhistory by David Leonhardt

The Problem is a Collapsed Housing Bubble, Not a Financial Crisis #4306 by Dean Baker

However, contrary to what is widely asserted, for example by David Leonhardt in hiscolumn today, consumption remains high, not low. The saving rate averaged more than 8.0 percent of disposable income in the years prior to the rise of the stock bubble in the 90s. Currently, it is between 4 and 5 percent of disposable income. If anything, we should be asking why consumption is so high, not why it is low. 

It would be to absurd to expect bubble levels of consumption in the absence of the bubble. However this is what proponents of the financial crisis theory seem to be arguing. In short, the collapse of the bubble led to a gap of more than $1 trillion in lost demand due to the plunge in construction and the falloff in consumption. What if any part of this requires a story about the financial crisis?

This is a bit tricky for me. One way to think of the issue is to imagine an alternate timeline where there had not been a housing bubble.

Could there have been a bubble without the shenanigans in the financial industry?

NGDP (or short run versus long run)

The Short Run Is Short by Eli Duardo

The bottleneck by Ryan Avent

Oh NGDP, is there anything you can't do? by Angus

NGDP in the Long Run and Economic Plasticity by Karl Smith

The NGDP Dilemma Is a Good Dilemma by Yglesias

Economy, Heal Thyself by David Glasner

Bernankeapalooza

An Internet Success Story. Chicago Fed President Charles Evans should feel vindicated for all of his hard work and for sticking his neck out.

A Quick Note on the Fed by Krugman

In effect, the Fed seems to be trying to “credibly promise to be irresponsible”, which is what I advocated way back when in this kind of situation. 

3. That’s all good. However, it’s kind of vague. No clear target, whether nominal GDP or some kind of inflation/unemployment mix. Put it this way: you could imagine a future Fed chairman tightening policy in line with the same Taylor rule that seemed to describe policy before the crisis — a rule that suggests that interest rates wouldn’t start to go up until unemployment was below, say, 7 percent — and still being able to claim that he had not violated any promise Bernanke made. In other words, it’s not totally clear that we really do have a shift in future policy. And since the whole point is to move expectations, leaving this kind of wiggle room is not a good thing. 

To paraphrase an old joke: what do you get when you cross a Godfather with a central banker? Someone who makes you an offer you can’t understand. 

4. Romney is talking destructive nonsense.

The Scott Summer Rally by Yglesias

It Is What It Is by Scott Sumner

On a lighter note, yesterday was “Scott Sumner day” and yet I had to go to work.  That doesn’t seem fair!  I’d also note that Cardiff Garcia at FT Alphavillementioned David Beckworth and I (along with Woodford), in their discussion of economists who had played a role in the debate. Don’t get me wrong, I realize that Woodford’s 100 times more influential than I am.  But I also think we’ve had some impact, mostly by putting out ideas that other more famous people have discussed and/or advocated (Christy Romer, Krugman, DeLong, Jeffrey Frankel, Jan Hatzius, etc.)  So it’s a good day for market monetarism.

Why QE3 Matters by Yglesias

Federal Reserve Finally Working Expectations Channel With Open-Ended QE by Yglesias

The Fed Announces Additional Easing by Mark Thoma

Ben Bernanke rescues the US economy from the nihilism of the right by Robin Wells

Two Cheers for Ben by David Glasner

Fed Ties New Aid to Job Recovery in Forceful Move by Binyamin Appelbaum

Something new by Ryan Avent

AND QE III HAS LANDED: EXPANSIONARY MONETARY POLICY EDITION... by DeLong

Daddy, Where Do Jobs Come From? by Jared Bernstein

Other fiscal measures have more reliable job-creation chains.  Increasing unemployment benefits or food stamps helps because those folks typically spend the money.  And new infrastructure is a pretty direct way to go.  Same with state fiscal relief.  I remember during the Recovery Act, mayors cancelling planned layoffs the day they received Recovery Act funds.

The punch line is a simple one, but it’s one that seems to have been forgotten amidst our increasing love affair in America with laissez-faire economics: the more direct the policy measure—i.e., the fewer links in the chain between the policy and the job—the better it will work.

A Critique of Fed Policy by Binyamin Appelbaum

Michael Woodford may have written the year’s most important academic paper. Here’s why. by Dylan Matthews

Self-Induced Paralysis and "Rooseveltian Resolve"

Fed Watch: Bernanke at Jackson Hole by Tim Duy

Michael Woodford Makes The Case For NGDP Targeting by Yglesias

Bill Clinton: overrated

Toff Doctrine Monetary Policy From Alan Greenspan to Mario Draghi by Yglesias

Read the whole thing. Specifically about Clinton, Yglesias writes

A dangerous and telling precedent comes from the United States where it's widely believed that Alan Greenspan communicated to the Clinton administration that an agenda of deficit reduction would be rewarded with loose monetary policy while a non-approved agenda would be punished with tight money. This worked out well enough in the end because Clinton committed himself to Greenspanism, congressional Democrats more or less went along, and then Greenspan delivered the goods. As a result, Greenspan got to become the "maestro" and we enjoyed solid growth years. But imagine congress had balked, the deficit reduction package had failed, and then Greenspan tried to punish Congress with tight money. How would that have helped...

If Clinton's Economic Record Is Viewed Positively, Then It Speaks to the Horrible State of Economic Reporting by Dean Baker

The Post told readers that Bill Clinton is an effective spokesperson for President Obama in part because:

"Clinton himself presided over an economic boom and a balanced budget gives him credibility to make the case against Romney and the Republicans."

Actually, the seeds of the current disaster were put in place by the policies of the Clinton administration. President Clinton did nothing to try to check the rise of the stock bubble. Its collapse in 2000-2002 led to the longest period without job creation since the Great Depression, until the current downturn.
The economy only recovered from this downturn and began creating jobs again with the rise of the housing bubble. The burst of that bubble of course gave us our current downturn.

The Output Gap versus the "Wealth Shock"

Missouri gets two Federal Reserve Banks. One is in St. Louis, the other in Kansas City. James Bullard is the President of the St. Louis Bank. (Pizzaman and Lothario Herman Cain had worked at the Kansas City one.) Via Yglesias, Cowen, Thoma, and MacroMania, here is a speech Bullard gave in Chicago on inflation targeting.

The key to the large output gap story is the use of the fourth quarter of 2007 as a benchmark for where we expect the economy to be today. The idea is to take that level of real output, assume the real GDP growth rate that prevailed in the yearsprior to 2007, and project out where the “potential” output of the U.S. should be. By that type of calculation, we are indeed stunningly far below where we should be, perhaps 5.5 percent below, using data through the fourth quarter of 2011.

Is this really the right way to think about where the U.S. economy should be? I do not think it is a defensible point of view. Let me give you some of my perspectives. What is more, we have made little progress in closing the gap defined in this way, because real GDP has only grown at modest rates since the recession ended in the summer of 2009. And furthermore, using current GDP forecasts from, say, the Blue Chip consensus, we have little prospect for closing the gap any time soon.

As I understand it, the trend growth rate used by the Fed, the CBO and Blue Chip private forecaster consensus DOES NOT start in 2007 but starts back many years and even decades. If this is true the economic illiteracy demonstrated by Bullard is both shocking and galling. Or is he a fraud?

Most analysts seem to agree that the middle part of the 2000s was characterized by a “bubble” in the housing sector. Housing prices were high and rising fast compared to nominal GDP. It is not prudent to extrapolate a bubble into the indefinite future and claim that such a calculation provides a good benchmark. Yet, that is what we are doing when we extrapolate fourth quarter 2007 real GDP. Furthermore, we normally have the good sense not to do this in other economic situations.

But they aren't extrapolating from the bubble are they?

For those who take the “large output gap” view, the expectation is for real GDP to grow rapidly after the recession comes to an end, as the economy catches up to its potential. It is like a rubber band, there is supposed to be a bounce back period of rapid growth. In fact, most analysts have been looking for exactly this effect since the summer of 2009. It has not happened. This has led to a lot of analysis concerning special factors and headwinds that might be inhibiting the “bounce back” effect.

The wealth shock view puts a different expectation in play. The negative wealth shock lowers consumption and output. But after the recession ends, the economy simply grows from that point at an ordinary rate, neither faster nor slower than in ordinary times. It is more like an earthquake which has left one part of the land higher than another part. There is no expectation of a “bounce back” to a higher level of output after the recession ends. This is closer to what has actually happened since mid-2009. Output has grown at a moderate rate, but not a rapid rate, since the recession ended.

In the wealth shock view, there is no “large output gap” rationale for keeping interest rates near zero. There is only an economy growing at normal rates following a large shock to wealth.

The growth rates are determined by government policy. They're a political decision. The long term potential growth rate is not a political decision. It's a function of technology, organization, population growth, etc.

But the government determines credit conditions, fiscal stimulus, monetary stimulus, inflation rate, etc. They can bring us to our full potential growth rate more quickly or they can stagnate us at a lower equilibrium.

[I have to take a break. I can't keep reading Bullard's tripe right now.]

John Quiggin for NGDP level targeting

(via Yglesias)

Why the Global Shortage of Safe Assets Matters by David Beckworth

In the early-to-mid 2000s, the Fed exacerbated the asset-shortage problem as its loose monetary policy got exported via fixed exchange rates to much of the emerging market world which in turn recycled it back to the U.S. economy via the "global saving glut" demand for safe assets. (For more on this point see this post and my paper with Chris Crowe.) Since late 2008, both the Fed and the ECB have worsened the asset-shortage problem by failing to first prevent and then restore nominal income in each region to its expected path. In other words, since 2008 both the Fed and the ECB have passively tightened monetary policy and this has caused some of the AAA-rated securities to disappear. (Yes, some of the AAA-rated MBS and sovereign debt would have defaulted on their own, but some of them like French sovereigns would have maintained their safe asset status were it not for insufficient aggregate demand caused by passively tight monetary policy.)

I would look into the "loose monetary policy" and the context of it.

Time magazine columnist and assistant managing editor for business and economics Fara Foroorah has a column on the Case for Inflation and NGDP level targeting.

Time Warner names online ad exec to run magazines

Federal Reserve Rejects NGDP Targeting by Yglesias

Department of "Huh?!": John Taylor and Milton Friedman's Monetary Policy Edition by DeLong

John Taylor, Allan Meltzer, and Amity Shlaes, welcome to my rogues gallery!

 

Back in Sept. 2008 I thought this cartoon was clever how it melded news  from the hard sciences over apocalyptic concerns that the super collider would create tiny black holes with news from the economy that the swirling mortgage crisis had sucked down Lehman brothers.

Today you have the strange world of economics when you're near the zero bound / stuck in a liquidity trap and in the world of hard sciences:

The team which found that neutrinos may travel faster than light has carried out an improved version of their experiment - and confirmed the result.

In my previous post I quoted Glasner as writing:

I don’t think that his comment that I have been rehashing Krugman’s ideas without attribution is correct. What I am trying to do is to show how to apply the Fisher equation in a somewhat novel way and to come up with a result that fits in with Keynes. In the process, I think that I am shedding some light on both Fisher and Keynes. It is also not true that Krugman is the first one to understand the possibility of an equilibrium negative real rate. Pigou discussed the possibility in his review of the General Theory in 1936. But instead of introducing a positive rate of inflation to resolve the paradox, Pigou invented the Pigou effect as the way out.

I don't know enough about the Fisher equation or Pigou or negative real rates to know if any of this is true or not. Which makes it interesting to me. Glasner's original post was here.

Krugman blogged "I see that David Glasner is worried about what appears to be a need for negative real interest rates, and suggests that this may be close to concerns about the liquidity trap."

And

I suspect that a lot of time and effort has been wasted because smart commentators like Glasner “knew” that Keynesians were crude thinkers using mechanical approaches — I don’t know if that’s actually true for Glasner, but I’ve seen it a lot in others — leading them to spend several years laboriously arriving at the same conclusions people like me, Woodford, Eggertsson, Svensson etc. had already laid out in detail a decade ago.

OK, venting over. Now, what’s the proposal?

So Glasner could have just pointed to Krugman, etc. instead of writing his blog post? Glasner says no, that he is doing something new by pointing to the Fisher equation.

Glasner refers to the Fisher equation. Fisher is mostly known for his conception of a "deflationary spiral" which happened during the Great Depression. It is what Bernanke has been acting to avoid.

In his post on the Fisher equation, Glasner writes:

Although suggestions that weakness in the economy might cause the Fed to resume some form of monetary easing seem to have caused some recovery in inflation expectations, real yields continue to fall. With real yield on capital well into negative territory (the real yield on a constant maturity 5-year TIPS bond is now around -1%, an astonishing circumstance. With real yields that low, 2% expected inflation would almost certainly not be enough to trigger a significant increase in spending. To generate a rebound in spending sufficient to spark a recovery, 3 to 4% inflation (the average rate of inflation in the recovery following the 1981-82 recovery in the golden age of Reagan) is probably the absolute minimum required.

This is what Charlie Evan is saying. Would it be "Keynesian" to advocate getting inflation to 3 or 4 percent? Would this be done by the Fed or fiscal stimulus? I suspect it could be done with a combo.

In Christina Romer's paper on fiscal stimulus she says

When I was in the White House, I used to bristle when people would say I was a Keynesian economist. They acted as if I believed that fiscal stimulus mattered because of some theoretical book written in 1936, or because of what I was taught in graduate school. I used to say that I am not a Keynesian economist, I am an empirical economist. I believe what I do because of the empirical evidence.

Daniel Kuehn blogged

There are lots of people who get it who just have a problem with the whole Keynes packaging and perhaps some of the politics that go along with Keynesianism - many of the NGDP targeters are like this. But I read this post by Glasner, and I know he is worried about the same problem as I am, and that he has basically the same solution.

My all-encompassing theory is Kenyan Socialism, named in honor of our President.

James Pethokoukis at the American Entereprise Instiute's online magazine's* blog asks Romney adviser Glenn Hubbard about NGDP level targeting and it turns out he agrees with Doug Henwood.

It’s certainly something that economists have talked about for years. … Economists routinely look it. Having said that, I’m not sure the Fed would be driven to do much more than it’s doing right now. It already has an amazingly accommodative monetary policy and it’s hard to see how they could make it ever more accommodative. … The Fed is almost pushing on a string right now because the usual housing channel for refinancing is blocked. And on the business side, people are sitting on mountains of cash, but it’s not whether the 10-year yield is 1.9 percent or 2.3 percent that’s going to ignite U.S. investment. … What makes me nervous is anything that looks like temporary increases in inflation because our experience is that’s a genie that’s very hard to put back in the bottle. I would much rather see us do the restructuring in the economy that we need for conventional monetary policy to work, which would mean clearing up the policy uncertainty that is limiting the willingness of business to invest, and help facilitate the deleveraging on the household side. Part of the problem is that the Fed is trying to do the job of the government, too, because the government’s has been sitting on its hands.

Glenn Hubbard in July 2008:

The current policy stance of holding the federal funds rate at 2% will keep monetary stimulus in place. With inflationary expectations not declining, this stimulus will almost surely raise inflationary expectations as the economy improves. This consequence can be seen already in surging commodity prices and the weakness in the foreign-exchange value of the dollar.

It is worrisome that the Fed’s own 2008 projections have risen over the year both for headline inflation (by about 1.5 percentage points) and core inflation (by about 0.2 percentage points). Furthermore, the Fed’s projections of receding inflation in 2009 and 2010 coming true will almost surely require increases in the federal funds rate.

A continuation of a negative real federal funds rate and the increase in money growth accompanying it raises the risk of increasing inflationary expectations, a costly mistake to fix.

This is via David Glasner.  He responded to Kevin Donoghue in his comment section as follows:

Kevin, Yeah, I saw his blog. I thought it was kind of interesting. Even if he was a little annoyed with me, it’s still nice to be noticed. And I also saw your comment on Brad DeLong’s blog post about Krugman’s outburst. Thanks for your kind words. Actually, Peter K, who also commented on DeLong’s post, is probably right that the few blogs that I link to probably create a slightly misleading impression of where I am coming from. I don’t think that his comment that I have been rehashing Krugman’s ideas without attribution is correct. What I am trying to do is to show how to apply the Fisher equation in a somewhat novel way and to come up with a result that fits in with Keynes. In the process, I think that I am shedding some light on both Fisher and Keynes. It is also not true that Krugman is the first one to understand the possibility of an equilibrium negative real rate. Pigou discussed the possibility in his review of the General Theory in 1936. But instead of introducing a positive rate of inflation to resolve the paradox, Pigou invented the Pigou effect as the way out. I discussed this in two of my early posts “Krugman and Sumner on the Zero Interest Lower Bound: Some History of Thought” and “Krugman on Mr. Keynes and the Moderns.”

Well I was wrong. Fascinating stuff.
----------------------------
*The American online magazine contributing editors are Jonah Goldberg, Mark Perry, and Marc Thiessen.

Well Richard Koo agrees with MMTer Dan Kervick that the Fed has "shot its wad" as the President of the United States was wont to say, but Koo has some idiosyncratic views as Krugman has pointed out.

...But even at the best of circumstances, those so-called non-traditional policies achieve very little. I mean, probably better than nothing, but just a little of positive, whereas having the correct fiscal policy can have a huge impact on economy in the current circumstances.  Because so many people are pinning their hope on the federal reserve, there's little discussion on what is the right fiscal policy and that I think is very unfortunate.

And the second part of the problem is that if central banks are viewed in such a way that these guys are going to pump money into the system so that something happens to the nominal GDP, that can cause people to worry that if they're gonna pump that much money into the system, the dollar may collapse. And that can cause another set of problems like foreign investors dumping U.S. treasuries or something because if they know that central bank has limited capacity but are forced to do something to get the nominal GDP going, people might assume that "Well then, the central banks might really do something crazy," and thats not good for the credibility of the dollar or the central bank.

Nick Rowe asks why isn't NGDP targeting a lefty thing?

Yglesias has been pushing it. MMTer Dan Kervick believes it's a ploy to let Obama off the hook. He calls it fadish. He just makes up stuff about QE1 and QE2 not working and then turns around and asserts that runaway inflation will hurt the vulnerable.

The Ur-troll of econoblogs is the one who goes on about inflation when we're facing deflation. My gas and rent is going up!!! The have to be brainless conservative dittoheads.

The Popular Front of NGDP targeting consists of "market monetarists" who don't believe in fiscal policy and Keynesians who do. The output gap is our fascist enemy.

Rightwingers want tax breaks to spur demand. Monetarists want cheaper credit distributed by the Federal Reserve to banks to lend out to businesses.

Leftwingers want the government to bypass banks and invest in infrastructure to create demand.

Or better yet, create a 21st century WPA to create jobs and add demand that way.

Tax breaks don't work well in my opinion and are too unequal in their impact on creating demand. Anything else will do. We need to close that output gap.

No, Paul, No! You Don't Slaughter the Returning Prodigal Son, You Slaughter the Fatted Calf!! by DeLong