WEBVTT NOTE NGDP Targeting: Macroeconomic Panacea? 1 00:00:00.000 --> 00:00:08.560 Well the paper is, my paper is entitled Nominal GDP Targeting Macroeconomic Panacea? We can 2 00:00:08.560 --> 00:00:14.960 say the short answer is no. When I started researching this, I didn't realize this, but 3 00:00:14.960 --> 00:00:24.600 the idea of nominal income targeting was alive in the mainstream literature at least as early 4 00:00:24.600 --> 00:00:29.480 as the late 70s and early 80s. They kicked it around, nothing really happened much, didn't 5 00:00:29.480 --> 00:00:30.720 received much traction. 6 00:00:30.720 --> 00:00:34.280 It was talked about a little bit again by Martin Feldstein 7 00:00:34.280 --> 00:00:35.880 and Mankiw in the 90s. 8 00:00:35.880 --> 00:00:42.440 And again, it didn't really take hold very strongly. 9 00:00:42.440 --> 00:00:44.800 Most recently, of course, it's been taken up 10 00:00:44.800 --> 00:00:47.120 by a relatively small group of economists identified 11 00:00:47.120 --> 00:00:49.640 as market monetarists. 12 00:00:49.640 --> 00:00:54.360 They are a group that be like Scott Sumner, David Betworth, 13 00:00:54.360 --> 00:00:55.960 Lars Christiansen. 14 00:00:55.960 --> 00:00:59.040 They see what they call monetary disorder 15 00:00:59.040 --> 00:01:01.520 as the cause of the 2008 financial meltdown 16 00:01:01.520 --> 00:01:03.280 and subsequent recession. 17 00:01:03.280 --> 00:01:05.840 And in doing so, they explicitly reject 18 00:01:05.840 --> 00:01:07.920 the notion of capital malinvestment 19 00:01:07.920 --> 00:01:10.080 as a source of the business cycle. 20 00:01:10.080 --> 00:01:12.360 However, they also claim to believe in markets, 21 00:01:12.360 --> 00:01:16.280 assuming them to, quote, to be efficient and forward-looking, 22 00:01:16.280 --> 00:01:17.480 end of quote. 23 00:01:17.480 --> 00:01:19.520 They stress the forward-looking nature of markets 24 00:01:19.520 --> 00:01:22.960 because for market monetarists, expectations 25 00:01:22.960 --> 00:01:25.920 seem to trump all other considerations. 26 00:01:25.920 --> 00:01:29.760 as such, they view expected nominal GDP growth 27 00:01:29.760 --> 00:01:32.480 as a better indicator of monetary policy 28 00:01:32.480 --> 00:01:36.240 than either interest rates or the actual money supply. 29 00:01:36.240 --> 00:01:39.160 They view interest rates as the price of loanable funds, 30 00:01:39.160 --> 00:01:41.340 but they do not recognize that the interest rate 31 00:01:41.340 --> 00:01:43.980 is actually a ratio of the prices of present goods 32 00:01:43.980 --> 00:01:45.840 over the prices of future goods, 33 00:01:45.840 --> 00:01:49.800 or that the time transaction 34 00:01:49.800 --> 00:01:51.820 where present money is exchanged for future money 35 00:01:51.820 --> 00:01:53.880 occurs not only in the loanable funds market, 36 00:01:53.880 --> 00:02:09.240 at the same time, it is argued that the current price level and the nominal GDP are more dependent 37 00:02:09.240 --> 00:02:16.200 upon current expectations about the future money supply than they are on the current 38 00:02:16.200 --> 00:02:18.160 money supply. 39 00:02:18.160 --> 00:02:23.600 Because markets are forward-looking, successful monetary policy would then be one that stabilizes 40 00:02:23.600 --> 00:02:31.120 expected nominal GDP because sudden changes in expected nominal GDP are what cause macroeconomic 41 00:02:31.120 --> 00:02:33.280 disturbances. 42 00:02:33.280 --> 00:02:36.880 The supremacy of expectations in their analysis can be seen in their explanation of the Great 43 00:02:36.880 --> 00:02:38.440 Recession. 44 00:02:38.440 --> 00:02:43.080 It is claimed that the source of the 2008 financial meltdown was contractionary Federal 45 00:02:43.080 --> 00:02:49.240 Reserve policy resulting in investors realizing that the Fed either could not or would not 46 00:02:49.240 --> 00:02:52.360 prevent a decline in nominal GDP. 47 00:02:52.360 --> 00:02:57.040 Anomalous EDP targeting supposedly would temper recessions when the economy is faced with 48 00:02:57.040 --> 00:03:03.800 negative supply shocks by sustaining aggregate demand when real output falls. 49 00:03:03.800 --> 00:03:08.280 Given their focus on aggregate spending, it is not surprising that the market monetarists 50 00:03:08.280 --> 00:03:13.640 have often been criticized for adopting a Keynesian vision of the macroeconomy. 51 00:03:13.640 --> 00:03:16.640 They do not accept this claim at all. 52 00:03:16.640 --> 00:03:22.260 Their advocating monetary stimulus, they say, is not due to any desire for a Keynesian-style 53 00:03:22.260 --> 00:03:51.260 They reject returning to a rigorous gold standard, thinking it would contribute to macroeconomic problems because many prices, it is alleged, are sticky. Additionally, a gold standard cannot prevent irresponsible governments from monetary instability, according to their view of thinking. 54 00:03:51.260 --> 00:03:58.260 Now there are several problems that I see with market monetarism that can be classified under three main categories. 55 00:03:58.260 --> 00:04:09.260 It's theoretical framework and vision of economic activity, the form of expectations and the extent to which they enter into economic decision making in their theory, 56 00:04:09.260 --> 00:04:13.260 and the actual consequences of their suggested monetary policy. 57 00:04:13.260 --> 00:04:14.820 Policy. 58 00:04:14.820 --> 00:04:20.200 The most fundamental reason that nominal GDP targeting misses the mark is due to a generally 59 00:04:20.200 --> 00:04:27.660 faulty analytical framework that entails an unsatisfactory understanding of economic activity. 60 00:04:27.660 --> 00:04:32.700 It misunderstands the nature of price coordination and leaves the intertemporal capital structure 61 00:04:32.700 --> 00:04:34.540 completely out of the analysis. 62 00:04:34.540 --> 00:04:39.660 While market monitors staunchly reject claims that they are Keynesians, it is understandable 63 00:04:39.660 --> 00:04:41.700 why people would think so. 64 00:04:41.700 --> 00:04:45.600 They assert that recessions are due to insufficient aggregate demand. 65 00:04:45.600 --> 00:04:50.460 Income is thought to be created by money flows instead of by provision of productive services 66 00:04:50.460 --> 00:04:53.000 accounted for in money prices. 67 00:04:53.000 --> 00:04:59.840 They ignore, reject or dismiss the importance of the capital structure and monetary injection 68 00:04:59.840 --> 00:05:03.180 effects at all. 69 00:05:03.180 --> 00:05:09.220 Investment is driven solely by expectations or conventional wisdom about nominal spending 70 00:05:09.220 --> 00:05:12.780 and a collapse in investment leads to recession and unemployment because of 71 00:05:12.780 --> 00:05:14.600 sticky prices. 72 00:05:14.600 --> 00:05:18.640 Decreased aggregate demand and sticky prices and wages combine 73 00:05:18.640 --> 00:05:22.520 to result in idle factors of production and unemployment. 74 00:05:22.520 --> 00:05:25.100 Monetary policy, however, can serve 75 00:05:25.100 --> 00:05:28.860 as the universal cure for persistent price disequilibrium. 76 00:05:28.860 --> 00:05:33.140 And all of this sounds relatively Keynesian. 77 00:05:33.140 --> 00:05:36.340 In fact, their entire analysis is predicated on the acceptance of the new 78 00:05:36.340 --> 00:05:39.700 New Keynesian Aggregate Supply, Aggregate Demand Framework. 79 00:05:39.700 --> 00:05:44.980 Even on its own terms, there are analytical problems with ASAD analysis. 80 00:05:44.980 --> 00:05:49.580 Most revelant and troublesome for evaluating nominal GDP targeting is that there is no 81 00:05:49.580 --> 00:05:56.660 such thing as an aggregate demand that equates with aggregate supply at a single price level. 82 00:05:56.660 --> 00:06:01.220 In fact, the social economy is made up of a vast network of distinct markets that are 83 00:06:01.220 --> 00:06:06.580 are integrated into a complex division of labor through intertemporal production structure 84 00:06:06.580 --> 00:06:11.540 and the use of a general medium of exchange. Productive activity, therefore, is the result 85 00:06:11.540 --> 00:06:16.500 of a vast number of decentralized decisions made by a multitude of different entrepreneurs 86 00:06:16.500 --> 00:06:23.860 at different places in the production structure. Capital is not a blob of homogenous shmoo, 87 00:06:23.860 --> 00:06:30.820 So investment is not a homogenous I. Sound analysis of macroeconomic discoordination 88 00:06:30.820 --> 00:06:38.540 must take these facts into account. Now it is possible for people to decrease their demand 89 00:06:38.540 --> 00:06:43.960 for consumer or producer goods if they increase their demand to hold money. This would only 90 00:06:43.960 --> 00:06:49.380 lead to wastefully idle resources, however, if prices for these resources remained above 91 00:06:49.380 --> 00:06:50.860 Market Clearing Levels. 92 00:06:50.860 --> 00:06:52.500 This will not persist, of course, 93 00:06:52.500 --> 00:06:56.180 if prices are allowed to adjust. 94 00:06:56.180 --> 00:06:57.540 If the demand for a product falls, 95 00:06:57.540 --> 00:06:59.620 the incentive to reap profits and avoid losses 96 00:06:59.620 --> 00:07:01.460 will lead both entrepreneurs and workers 97 00:07:01.460 --> 00:07:03.220 to reduce their selling prices. 98 00:07:03.220 --> 00:07:05.460 Unless frustrated by government edicts 99 00:07:05.460 --> 00:07:08.460 or the fear of strike threats, perhaps, 100 00:07:08.460 --> 00:07:10.540 entrepreneurs will seek to adjust their selling prices 101 00:07:10.540 --> 00:07:12.020 to market clearing levels. 102 00:07:12.020 --> 00:07:13.940 Such price reductions and cost cutting 103 00:07:13.940 --> 00:07:16.900 encourages continual sales and employment. 104 00:07:16.900 --> 00:07:21.900 Real earnings of the firms concerned will stabilize, allowing them to continue production 105 00:07:21.900 --> 00:07:26.580 and hence to demand labor, land and higher order capital goods from other firms in the 106 00:07:26.580 --> 00:07:28.420 production structure. 107 00:07:28.420 --> 00:07:33.260 Instead of allowing markets to clear via the price adjustments, according to subjective 108 00:07:33.260 --> 00:07:39.260 preferences, market monetarists advocate that monetary authorities bring about market stability 109 00:07:39.260 --> 00:07:41.380 by increasing the money supply. 110 00:07:41.380 --> 00:07:45.260 Such inflation, however, will not necessarily equilibrate the specific demand for and supply 111 00:07:45.260 --> 00:07:50.820 of Money on the part of individuals who may be experiencing an excess demand. 112 00:07:50.820 --> 00:07:56.620 If prices and wages are that sticky, there would need to be a significantly large increase 113 00:07:56.620 --> 00:08:00.380 in nominal GDP to maintain equilibrium. 114 00:08:00.380 --> 00:08:04.360 Now this begs the entire question of sticky prices. 115 00:08:04.360 --> 00:08:09.000 Several theoretical problems with the theory of sticky wages exist, and I don't have time 116 00:08:09.000 --> 00:08:13.680 to go into all of them, but on the one hand, if there is only one or a handful of firms 117 00:08:13.680 --> 00:08:43.680 In other words, if all firms that may be charging higher, or maybe paying, shall we say, higher so-called efficiency wages in the labor market, then employment will be restricted in only those industries and employment will expand in other industries, and this would not lead to a general increase in unemployment economy-wide. On the other hand, if all firms pay so-called efficiency wages, why is the higher wage not considered the market wage? Because it's the wage that everybody pays in the market. More importantly, however, to focus on sticky wages is again to focus on the 118 00:08:43.680 --> 00:08:51.680 At best, sticky wages do not explain why a recession begins, they would only explain why a recession is prolonged. 119 00:08:51.680 --> 00:08:59.680 Additionally, if markets do not equilibrate due to minimum wage and other price controls, this is hardly a consequence of the free market. 120 00:08:59.680 --> 00:09:07.680 The solution would be to eliminate government intervention, not to intervene by arbitrarily increasing the money supply. 121 00:09:07.680 --> 00:09:15.240 On the other hand, if markets do not equilibrate due to long-term labor, including union contracts, 122 00:09:15.240 --> 00:09:20.040 this results in what we could call a voluntary excess supply of labor, which is not really 123 00:09:20.040 --> 00:09:22.960 an excess supply at all. 124 00:09:22.960 --> 00:09:28.800 Now in fact, history reveals that prices and wages do adjust downward if allowed. 125 00:09:28.800 --> 00:09:33.800 Even in the case of long-term contracts, workers and employers can and do negotiate new market 126 00:09:33.800 --> 00:09:37.200 clearing wages, especially when it becomes apparent to people that if we don't, we're 127 00:09:37.200 --> 00:09:57.200 We see this with what, say, performance unions did in their Broadway contracts in the wake of the 9-11 attacks, or even in the most recent case, we have United Auto Workers negotiating two-tier labor agreements that will allow for lower wages to be paid. 128 00:09:57.200 --> 00:10:07.200 There are certain symphony orchestras who are sort of caught in the pinch, and their musicians negotiated significant 10% reductions in their wages. 129 00:10:07.200 --> 00:10:14.200 So this does happen. Now, it makes it harder, of course, when we pay people not to work, there are people who will take us up on it. 130 00:10:14.200 --> 00:10:21.200 So that sort of makes things, sometimes makes the adjustment process less smooth, shall we say. 131 00:10:21.200 --> 00:10:35.200 Now, decreases in demand are always experienced in particular markets, and when there is a decrease in demand or a decrease in supply in the face of elastic demand, total expenditures will drop. 132 00:10:35.200 --> 00:10:45.200 Note, however, that spending is the effect of the changes in the preferences of buyers and sellers and not the cause of the decrease in demand and supply. 133 00:10:45.200 --> 00:10:51.200 Joe Salerno in his 2006 paper shows how this applies to the broad social economy. 134 00:10:51.200 --> 00:11:04.200 Market clearing prices and quantities are determined on every market by the interaction of individuals' value scales on which goods are valued in relation to one another and to money. 135 00:11:04.200 --> 00:11:14.200 It is only after market equilibrium prices and quantities and therefore the value of money have already been determined that then the actual spending occurs. 136 00:11:14.200 --> 00:11:22.800 Another particular manifestation of, and this is sort of the second broad set of problems I see, 137 00:11:22.800 --> 00:11:27.200 a particular manifestation of market monetarists' unsatisfactory economic framework, 138 00:11:27.200 --> 00:11:33.600 is their understanding of the form and of and extent to which expectations enter into their analysis. 139 00:11:33.600 --> 00:11:39.000 Certainly no one should dispute that expectations play an important role in economic decision making. 140 00:11:39.000 --> 00:11:48.000 All action takes place in the present, while the results of action will be reaped at some point in the future, and consequently all action, including production, is forward-looking. 141 00:11:48.000 --> 00:11:54.000 All action must therefore be based on speculations about the expected outcomes of various potential actions. 142 00:11:54.000 --> 00:12:04.000 However, for understanding the nature of macroeconomic fluctuations, it is crucial that we have a proper understanding of the nature of the expectations that affect investment decisions. 143 00:12:04.000 --> 00:12:14.000 As indicated earlier, market monetarists seem to believe that actions of investors are determined almost exclusively by expectations of future nominal spending or nominal GDP. 144 00:12:14.000 --> 00:12:18.000 The problem with such a perspective is twofold. 145 00:12:18.000 --> 00:12:26.000 While sound economic theory recognizes that expectations of outcomes in the future are a prerequisite for action in the present, 146 00:12:26.000 --> 00:12:40.260 At present, economics cannot provide insight into the content of these expectations, or 147 00:12:40.260 --> 00:12:42.980 how expectations change over time. 148 00:12:42.980 --> 00:12:47.340 Expectations are not autonomous entities, but are bounded by a person's goals, his 149 00:12:47.340 --> 00:12:52.580 past experience in attempting to achieve his goals, and his entrepreneurial ability. 150 00:12:52.580 --> 00:12:57.060 Hence, expectations are not monolithic, which is why entrepreneurs must incorporate 151 00:12:57.060 --> 00:13:02.180 timeology into their decision-making. Treating expectations as universal and monolithic opens 152 00:13:02.180 --> 00:13:06.740 the door to grave errors of economic theory. For example, the market monetarists claim 153 00:13:06.740 --> 00:13:12.980 that it is expectations about future nominal GDP that solely determines present investment 154 00:13:12.980 --> 00:13:18.180 decisions and hence the direction of the economy, fails to recognize that recessions are not 155 00:13:18.180 --> 00:13:22.220 merely the result of decreases in aggregate spending following a boom. They are the result 156 00:13:22.220 --> 00:13:26.820 of Entrepreneurial Error. It is possible, for example, for entrepreneurs to reap profits 157 00:13:26.820 --> 00:13:31.980 even in an environment of declining total spending. What matters is not aggregate spending 158 00:13:31.980 --> 00:13:36.300 per se, but the spread between the price of products and the sum of the prices of the 159 00:13:36.300 --> 00:13:40.780 factors of production. If the total quantity of all spending in the social economy falls 160 00:13:40.780 --> 00:13:46.580 and overall prices fall, firms can still reap profits as long as they identify those projects 161 00:13:46.580 --> 00:13:51.420 at which the factors are underpriced relative to the future price of the product that those 162 00:13:51.420 --> 00:13:54.420 Those factors can be used to produce. 163 00:13:54.420 --> 00:14:00.660 Additionally, the form of expectations assumed is the source of a particular inconsistency 164 00:14:00.660 --> 00:14:03.340 I see in market monetarist literature. 165 00:14:03.340 --> 00:14:06.880 This inconsistency in turn is also related to their failure to understand recessions 166 00:14:06.880 --> 00:14:10.160 as a result of a cluster of entrepreneurial error. 167 00:14:10.160 --> 00:14:13.860 Market monetarists assume that markets are efficient and forward-looking. 168 00:14:13.860 --> 00:14:18.980 At the same time, recessions are due to decreases in expected nominal GDP. 169 00:14:18.980 --> 00:14:23.380 Now if markets are efficient while forward-looking, how can there be a cluster of entrepreneurial 170 00:14:23.380 --> 00:14:24.380 error? 171 00:14:24.380 --> 00:14:28.300 It seems that if market participants make efficient adjustments while looking forward, 172 00:14:28.300 --> 00:14:31.380 there should not be widespread mistakes made by entrepreneurs. 173 00:14:31.380 --> 00:14:33.940 If so, how can there be a recession? 174 00:14:33.940 --> 00:14:38.220 Now perhaps the response might be, as Loris Christensen implies, that although people 175 00:14:38.220 --> 00:14:44.460 have expectations that are indeed rational, they're not perfect. 176 00:14:44.460 --> 00:14:50.160 And so, if market participants properly forecast that the Fed would not or could not continue 177 00:14:50.160 --> 00:14:54.620 to increase nominal GDP through 2008, why should there be a recession? 178 00:14:54.620 --> 00:14:58.060 If their forecast was correct, they should have acted accordingly and markets would clear 179 00:14:58.060 --> 00:15:05.180 and at the very least, there would not have been widespread persistent unemployment. 180 00:15:05.180 --> 00:15:08.580 Market monetarist's affection for nominal GDP targeting once again demonstrates that 181 00:15:08.580 --> 00:15:12.060 an unsound theoretical framework will often lead to unsound economic policy. 182 00:15:12.060 --> 00:15:17.100 One of the biggest problems with trying to reduce economic fluctuations via nominal GDP 183 00:15:17.100 --> 00:15:23.660 targeting is the real effects of monetary policy necessary to stabilize actual or expected 184 00:15:23.660 --> 00:15:24.660 nominal GDP. 185 00:15:24.660 --> 00:15:29.460 It is necessarily true that newly created money will enter the economy at particular 186 00:15:29.460 --> 00:15:30.460 points. 187 00:15:30.460 --> 00:15:35.460 Monetary inflation therefore will reflect demands for certain goods first and then subsequent 188 00:15:35.460 --> 00:15:39.360 demands for different goods as the new money is spread throughout the economy. 189 00:15:39.360 --> 00:15:43.200 The step-by-step adjustment process during which the new money is absorbed necessarily 190 00:15:43.200 --> 00:15:48.900 results in real changes in relative prices and a real redistribution of wealth. 191 00:15:48.900 --> 00:15:53.400 Credit expansion, we know, necessarily stimulates malinvestment by encouraging production processes 192 00:15:53.400 --> 00:15:57.120 that are too roundabout relative to social time preferences. 193 00:15:57.120 --> 00:16:00.680 Without an increase in voluntary savings, longer production processes are not able to 194 00:16:00.680 --> 00:16:01.840 be completed. 195 00:16:01.840 --> 00:16:04.360 This is the heart of the malinvestment problem. 196 00:16:04.360 --> 00:16:08.280 Issuing fiduciary money via credit expansion promotes unsustainable boom activity because 197 00:16:08.280 --> 00:16:12.480 because it provides both the incentive and the means for entrepreneurs to undertake projects 198 00:16:12.480 --> 00:16:16.100 for which there are insufficient real resources to complete. 199 00:16:16.100 --> 00:16:21.280 The necessary consequence of monetary inflation, even if the desire is to stabilize actual 200 00:16:21.280 --> 00:16:26.680 or expected nominal GDP growth, is the boom-bust cycle in which resources are squandered, capital 201 00:16:26.680 --> 00:16:30.680 is consumed and society is relatively impoverished. 202 00:16:30.680 --> 00:16:36.680 Such an outcome is the exact opposite of the desires of those advocating nominal GDP targeting. 203 00:16:36.680 --> 00:16:38.680 Thank you very much.