Scott Sumner Assumes a Can Opener
It’s possible that I have blogged about this before, but in any event one of the things that bothers me about Scott Sumner’s proposal to have the Fed target nominal GDP (NGDP) is that he often argues almost from definitions, rather than the economics. This is analogous to a Keynesian justifying stimulus spending by pointing out Y = C + I + G + Nx.
Now before we get going, a note on definitions: Nominal GDP is the actual dollar amount of total spending. Real GDP, in contrast, is the amount of spending, after the “price level” has been normalized to some reference year.
So for example, suppose this year total spending is $10 trillion, while the price level is 100. Then next year, total spending is $11 trillion, while the price level rises to 107. NGDP went up 10%, but RGDP only went up about 2.8%. So the actual increase in real output–the increase in the number of cars, iPods, apples, etc. produced in the second year–was only 2.8%. The rest of the measured increase in total spending was simply due to the fact that price tags increased on average by 7%.
OK back to Sumner and his recommendation that the Fed set a target of (say) NGDP growing by 5% per year. I am arguing that Sumner argues from definitions sometimes, and ignores the economics of what he is saying. The most blatant example I’ve seen came in November when Scott (yes, I think we are on a first-name basis) was taking Robert Hall to task.
In one component of the critique, Scott first quoted Hall who had the audacity to write:
The worst financial crisis in the history of the United States and many other countries started in 1929. The Great Depression followed. The second-worst struck in the fall of 2008 and the Great Recession followed. Commentators have dwelt endlessly on the causes of these and other deep financial collapses. Less conspicuous has been the macroeconomists’ concern about why output and employment collapse after a financial crisis and remain at low levels for several or many years after the crisis.
Scott didn’t like this. Instead, he said Hall should have written:
The worst depression in the history of the United States and many other countries started in 1929. The Great Banking Panics followed. The worst recession since the 1930s struck in December 2007, and dramatically worsened in July 2008. The Great Financial crisis of the fall of 2008 followed. Commentators have dwelt endlessly on the causes of these and other deep financial collapses. Less conspicuous has been the macroeconomists’ concern about why output and employment collapse before a financial crisis and remain at low levels for several or many years after the crisis.
Now here’s the important part: Look at the reasoning behind Scott’s suggested alternative paragraph:
We know that severe declines in NGDP are likely to cause severe declines in RGDP. The reasons are murky, although I believe sticky wages are an important transmission mechanism. There is more controversy about what causes NGDP to plunge. But given the recession began in December 2007, and given the severe plunge in NGDP occurred between June and December 2008, it seems a bit hard to believe that the financial crisis of the fall of 2008 was the cause.
First, look at the part I put in bold. Isn’t that a bit like saying, “We know that severe declines in numerators are likely to cause severe declines in quotients. The reasons are murky, although I believe sticky denominators are an important transmission mechanism.” ?
Second, look at how Scott is re-writing history to vindicate his theory. In his suggested paragraph, Scott wanted Hall to write that the worst recession since the 1930s “dramatically worsened in July 2008.” If that were true, then it would bolster Scott’s theory, since NGDP started plunging in June 2008.
But actually, I don’t remember people flipping out about the recession in July 2008. In fact, a whole month later, Bryan Caplan–who Scott admits is smarter than him, or at least sounds smarter at a lunch table–was talking about how great central banks were.
No, it was not obvious that the recession had taken a turn for the worse, until September 2008, i.e. exactly when Hall said it happened. I doubt Caplan would have blogged the above post, in late September.
Skip to Scott’s most recent post. Scott is arguing with Arnold Kling, who had said that Scott’s idea of targeting NGDP might lead to “high and variable inflation.” Scott disagreed, saying:
I believe…that inflation would not become high and volatile. In order for inflation to be high (on average), RGDP growth would have to average much less than 3%. Let me repeat; much less, not slightly less. A trend rate of 1% or 2% RGDP growth will not get you high inflation on average, unless you think inflation was still high after Volcker brought it down to low levels.
So there we have it again, the trick of using definitions to defend his policy. Let me paraphrase what Scott is saying, “If my plan doesn’t screw up economic growth, then my plan will be good for the economy.”
Well, yes, I grant you that Scott. But I go you one better: The Murphy plan calls for the Fed to buy and sell RGDP futures contracts, to hit a target of 5% growth per year. Don’t get me wrong, I’m not saying we’ll always get real growth of 5% per year, but that’s what we’ll hit on average. The years when we’re below target, the Fed will do what it has to do with the monetary base, in order to grow extra fast the next year and catch up with it.
Finally, let me simply say that I disagree with Scott when he writes:
Much more importantly, I don’t think high or variable inflation is a problem as long as NGDP growth is on target. All of the problems that are widely believed by economists to flow from high and variable inflation; actually result from high and variable NGDP growth:
1. Excessive taxation of capital in a non-indexed tax system results from high nominal rates of return, associated with high NGDP growth.
2. Unfair borrower/lender redistributions actually result from volatile NGDP, not volatile inflation.
3. Distortions to the labor market (when nominal wages are sticky) are caused by NGDP shocks.
4. Even the “shoe leather” cost of inflation may be better described by NGDP growth, assuming real interest rates and real GDP growth rates are strongly correlated.
I’m not going to bother going into each one. I claim, without proof, that Scott is simply mistaken. For example, if I have a ten-year bond paying me $25,000 per year that I’m supposed to live on, I don’t really care what happens to NGDP. I get killed when P goes up faster than I expected. Yes, it’s true that in most cases, that’s going to happen when NGDP goes up more than I expected, but that’s because of the definitional trick. Notice that I had to DEFINE NGDP in the beginning of this post, since I couldn’t be sure most readers would even know what it was. So Scott really should stop acting is if everybody “really” cares about NGDP, not P.
Last point: This post should not be construed as me saying Scott’s idea is dumb. It is actually elegant, from a theoretical perspective, and for all I know it might be better than some other rule-of-thumb we could give the Fed, like a Taylor Rule.
All I am saying is that Scott often retreats to an argument from definitions, when he seems to think he is appealing to economic analysis.
I didn’t read the entire post as carefully I should before commenting, but it’s late—excuse any obvious discrepancies on my part (if I don’t take into consideration something you’ve already said). Are you saying that Sumner is wrong in the part of his justification that you bold? What Sumner means when he says that is that a fall in nominal expenditure, or what amounts to a fall in the amount of money in circulation (or being spent), will cause real falls in productivity. I don’t think Sumner is wrong, although I do think his “solution” (nominal income targeting) is erroneous.
In fact, it is completely in line with Austrian theory. The preceding over issue of fiduciary media will cause an industrial fluctuation, and one of the secondary effects of said fluctuations is a fall in the circulation of fiduciary media (a fall in supply and an increase in demand; but I think the former has a far greater impact than the latter, and I think the latter cushions the fall of the former). This fall in nominal spending, especially in capital goods, is bound to cause chaos in the structure of production.
Or, did I miss something (it’s late)?
“We know that severe declines in numerators are likely to cause severe declines in quotients. The reasons are murky, although I believe sticky denominators are an important transmission mechanism.”
GOD, I wish I had written that.
Are you praying?!
The entire debate about targeting nominal GDP strikes me as akin to speculating about angles and heads of pins, frankly.
Asking the Fed to target anything but the rate of inflation is asking the Fed to do something it has no ability to do whatsoever. Last time I looked, the Fed doesn’t produce much in the way of real stuff. Nor does the Fed have any ability to induce others to produce real stuff.
If we had 100% reserve commercial banking, separated utterly from investment banking, and if we had a constant rate of growth of newly injected reserves — 3% per year looks reasonable, based on experience — we would achieve the best of all possible worlds within human capabilities. That’s because producers and consumers would know exactly what to expect due to whatever effects money is believed to have on economic aggregates.
Milton Friedman made the case well long ago. Asking the Fed to to target anything is simply an invitation for greater uncertainty and variation in matters economic. If there were reliable relationships available for policy manipulation to induce stable economic growth by targeting something, why have those relationships remained so ambiguous and elusive? It’s certainly not for lack of theorizing or trying one manipulation or another.
David
You are arguing with straw men. Good job on that. However, controlling nominal GDP is easily done by the central bank – its NOMINAL after all – it depends on the demand and supply of money. The Fed could not control real growth at all. And saying that it can target inflation but not NGDP is to completely not-understand what nominal GDP is – its simply the amount of total spending in the currency, this obviously includes inflation.
Bob, I’m afraid you are 0 for 4 today:
1. There are many reasons why sharp declines in NGDP could cause a fall in RGDP. Sticky prices are just one of those reasons. So I’m not asserting some sort of tautology.
2. The comment about July 2008 has nothing to do with my criticism of Hall. I didn’t say I noticed a fall in NGDP in July 2008, I said a fall in NGDP OCCURRED after June 2008. There are data lags. A fall in NGDP will hurt banking whether people notice it at the time, or somewhat later. One thing for sure, the markets seemed to have noticed it.
3. I said it’s highly implausible that trend RGDP growth in America would fall signficantly more that 1% or 2%. Do disagree? Remember, we are talking about trend growth, not cyclical growth.
4. Regarding the effect on creditors, recall that demand shocks will have the same effects in either case. So the only case we need to consider is supply shocks, such as an oil embargo, which lowers real growth and raises inflation. You are right that a creditor would do a little bit worse under that case (as compared to inflation targeting). On the other hand creditors would do better with NGDP targeting during positive supply shocks, like the tech boom. In both cases it is entirely fair that the gains and losses to society be shared by borrowers and lenders. Lender should lose a bit of real purchasing power when a supply shock makes the country poorer. If they don’t want to take that risk, there’s a very easy solution, buy indexed bonds.