Wednesday, May 2, 2012

Nick Rowe and NGDP Targeting

I don't care what you want to target. NGDP LT? Hot item these days. I don't care. Let me look at Nick Rowe's response to David Andolfatto on the subject, at a theme that runs through Rowe's post.

1. "NGDP targeting provides a 50-50 aggregate sharing of aggregate risk between creditors and debtors. If real GDP falls 10% below what was expected, the price level rises 10% above what was expected..."

Rowe is talking about the effects of inflation on debt -- the erosion thing. What he points out, however, is that NGDP targeting offers no assurance of growth.

If real output turns out 10% low, then inflation just goes 10% high. If real output goes 50% low, then inflation goes 50% high. NGDP targeting does nothing for growth.

2. "Many New Keynesian models assume Divine Coincidence. They assume that if monetary policy is successful in keeping P on target it will also, as a happy side-effect, keep Y on target too."

P is the price level; Y is real output. Nick Rowe says these models assume that if policy keeps prices on target, real output growth will stay on target too.

That's a criticism of inflation-targeting, not NGDP targeting. But the same logic applies to both; NGDP targeting does nothing for growth. NGDP targeting is policymakers telling us: If you don't want inflation, then make sure you generate real growth.

But that's not how you get real growth.

NGDP targeting is a policy choice that finds inflation and real growth to be equally acceptable alternatives. As Rowe says, "An unchanged target P.Y will allow P to rise so Y won't fall as much." If real growth falters, an unchanged NGDP target will allow prices to rise so real growth won't fall as much.

Of course I am sure that no economist, and no one else either, would say inflation and real growth are equally acceptable. But that is what NGDP targeting (the policy) says.

3. "When a negative AD shock hits, both P and Y will fall. When AD recovers both P and Y will rise. But we know very little about how that rise in AD will be divided into a rise in P and a rise in Y."

Nick Rowe says that we have little control over the outcome of an NGDP-targeting stimulus. If aggregate demand (AD) falls below target and policy provides stimulus, "we know very little" about how that stimulus will be split up between real growth and mere inflation. This theme runs all through Rowe's post.

Actually, I think we know quite a lot about that. Knowing nothing, I think we can assume that everything will go to inflation and nothing will go to growth.

Nick Rowe is arguing that, given all of the unknowns, NGDP targeting would give better results than inflation targeting. I'm not disputing that.

I'm pretty sure the argument is that inflation is an inducement to spend, and spending boosts aggregate demand, and higher AD leads to growth. Well, I'm no economist and it is beyond my abilities to out-argue economists about such things. Anyway, I think it's probably at least half true.

So where's the problem? The problem is the problem you already know: The growth we get is inadequate. Same problem we've had since before Reagan:

"Reaganomics" was the most serious attempt to change the course of U.S. economic policy of any administration since the New Deal. "Only by reducing the growth of government," said Ronald Reagan, "can we increase the growth of the economy."

Reagan was wrong about the need to reduce the growth of government, and anyway his policies proved unsustainable. But the point is, his objective was to increase the growth of the economy. Because growth was inadequate.

That was the problem then, and it is still the problem now. That's why we have the George W. Bush tax cuts. It's why we have people calling for austerity. It's why we have people calling for inflation. And it's why we have people calling for NGDP targeting. But NGDP targeting can do little or nothing to boost real growth, as Nick Rowe points out.

Why do we have trouble getting adequate economic growth? Is growth hindered by the fact that we don't use NGDP targeting? No. NGDP targeting is an approach that attempts to get the desired results without bothering to analyze the cause of the problem.

NGDP targeting is a manipulative policy. It uses people's reactions to inflation to induce spending and extort growth from the economy. Would it work?

Does it solve the problem? Well... Of course not. The problem is not simply that we don't get adequate growth. The underlying reason we don't get growth -- that is the problem. But NGDP targeting does not bother to investigate such things.


Nick Rowe said...

Arthur: See where I say:

"The Old Keynesians wanted to target real GDP. They wanted monetary (and/or fiscal) policy to target "full-employment output". It sounded like a good idea at the time. After all, real Y is what really matters. P doesn't matter at all. The rate of change of P (the inflation rate) only matters a little (unless it gets very big or very negative). But Friedman and Phelps, and the policy failures of the 1970's, taught us it couldn't work. A Y target lacks a nominal anchor."

That's the bit you need to address if you want to target real growth.

The Arthurian said...

Failures and Friedman and Phelps, oh my! But yes: that last sentence you quote stood out when I read your post, as something I don't understand.

Thank you, Nick.

Nick Rowe said...

Arthur: But David Andolfatto would know what I was talking about.

This article is the first of the three things I was referring to:

The Arthurian said...

PERfect! Figure I need a week to get through it, but I am most interested in what Milton Friedman had to say. Thank you.

RE your post & mine: I was extremely happy to find that I am not the only one who questions the ability of NGDP targeting to induce growth.

The Arthurian said...

My post emphasizes the idea that "NGDP targeting does nothing for growth."

To make my case I quote three times from Nick Rowe's post.

David Andolfatto makes a similar argument: "Adopting a NGDP target implies that policymakers can commit to (say) a 5% NGDP growth rate. But what if inflation turns out to be 4% and RDGP growth turns out to be 1%? (Or how about 7% inflation and -2% RGDP growth?)"

NGDP targeting does nothing for growth.