Well the paper is, my paper is entitled Nominal GDP Targeting Macroeconomic Panacea? We can
say the short answer is no. When I started researching this, I didn't realize this, but
the idea of nominal income targeting was alive in the mainstream literature at least as early
as the late 70s and early 80s. They kicked it around, nothing really happened much, didn't
received much traction.
It was talked about a little bit again by Martin Feldstein
and Mankiw in the 90s.
And again, it didn't really take hold very strongly.
Most recently, of course, it's been taken up
by a relatively small group of economists identified
as market monetarists.
They are a group that be like Scott Sumner, David Betworth,
Lars Christiansen.
They see what they call monetary disorder
as the cause of the 2008 financial meltdown
and subsequent recession.
And in doing so, they explicitly reject
the notion of capital malinvestment
as a source of the business cycle.
However, they also claim to believe in markets,
assuming them to, quote, to be efficient and forward-looking,
end of quote.
They stress the forward-looking nature of markets
because for market monetarists, expectations
seem to trump all other considerations.
as such, they view expected nominal GDP growth
as a better indicator of monetary policy
than either interest rates or the actual money supply.
They view interest rates as the price of loanable funds,
but they do not recognize that the interest rate
is actually a ratio of the prices of present goods
over the prices of future goods,
or that the time transaction
where present money is exchanged for future money
occurs not only in the loanable funds market,
at the same time, it is argued that the current price level and the nominal GDP are more dependent
upon current expectations about the future money supply than they are on the current
money supply.
Because markets are forward-looking, successful monetary policy would then be one that stabilizes
expected nominal GDP because sudden changes in expected nominal GDP are what cause macroeconomic
disturbances.
The supremacy of expectations in their analysis can be seen in their explanation of the Great
Recession.
It is claimed that the source of the 2008 financial meltdown was contractionary Federal
Reserve policy resulting in investors realizing that the Fed either could not or would not
prevent a decline in nominal GDP.
Anomalous EDP targeting supposedly would temper recessions when the economy is faced with
negative supply shocks by sustaining aggregate demand when real output falls.
Given their focus on aggregate spending, it is not surprising that the market monetarists
have often been criticized for adopting a Keynesian vision of the macroeconomy.
They do not accept this claim at all.
Their advocating monetary stimulus, they say, is not due to any desire for a Keynesian-style
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.
Now there are several problems that I see with market monetarism that can be classified under three main categories.
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,
and the actual consequences of their suggested monetary policy.
Policy.
The most fundamental reason that nominal GDP targeting misses the mark is due to a generally
faulty analytical framework that entails an unsatisfactory understanding of economic activity.
It misunderstands the nature of price coordination and leaves the intertemporal capital structure
completely out of the analysis.
While market monitors staunchly reject claims that they are Keynesians, it is understandable
why people would think so.
They assert that recessions are due to insufficient aggregate demand.
Income is thought to be created by money flows instead of by provision of productive services
accounted for in money prices.
They ignore, reject or dismiss the importance of the capital structure and monetary injection
effects at all.
Investment is driven solely by expectations or conventional wisdom about nominal spending
and a collapse in investment leads to recession and unemployment because of
sticky prices.
Decreased aggregate demand and sticky prices and wages combine
to result in idle factors of production and unemployment.
Monetary policy, however, can serve
as the universal cure for persistent price disequilibrium.
And all of this sounds relatively Keynesian.
In fact, their entire analysis is predicated on the acceptance of the new
New Keynesian Aggregate Supply, Aggregate Demand Framework.
Even on its own terms, there are analytical problems with ASAD analysis.
Most revelant and troublesome for evaluating nominal GDP targeting is that there is no
such thing as an aggregate demand that equates with aggregate supply at a single price level.
In fact, the social economy is made up of a vast network of distinct markets that are
are integrated into a complex division of labor through intertemporal production structure
and the use of a general medium of exchange. Productive activity, therefore, is the result
of a vast number of decentralized decisions made by a multitude of different entrepreneurs
at different places in the production structure. Capital is not a blob of homogenous shmoo,
So investment is not a homogenous I. Sound analysis of macroeconomic discoordination
must take these facts into account. Now it is possible for people to decrease their demand
for consumer or producer goods if they increase their demand to hold money. This would only
lead to wastefully idle resources, however, if prices for these resources remained above
Market Clearing Levels.
This will not persist, of course,
if prices are allowed to adjust.
If the demand for a product falls,
the incentive to reap profits and avoid losses
will lead both entrepreneurs and workers
to reduce their selling prices.
Unless frustrated by government edicts
or the fear of strike threats, perhaps,
entrepreneurs will seek to adjust their selling prices
to market clearing levels.
Such price reductions and cost cutting
encourages continual sales and employment.
Real earnings of the firms concerned will stabilize, allowing them to continue production
and hence to demand labor, land and higher order capital goods from other firms in the
production structure.
Instead of allowing markets to clear via the price adjustments, according to subjective
preferences, market monetarists advocate that monetary authorities bring about market stability
by increasing the money supply.
Such inflation, however, will not necessarily equilibrate the specific demand for and supply
of Money on the part of individuals who may be experiencing an excess demand.
If prices and wages are that sticky, there would need to be a significantly large increase
in nominal GDP to maintain equilibrium.
Now this begs the entire question of sticky prices.
Several theoretical problems with the theory of sticky wages exist, and I don't have time
to go into all of them, but on the one hand, if there is only one or a handful of firms
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
At best, sticky wages do not explain why a recession begins, they would only explain why a recession is prolonged.
Additionally, if markets do not equilibrate due to minimum wage and other price controls, this is hardly a consequence of the free market.
The solution would be to eliminate government intervention, not to intervene by arbitrarily increasing the money supply.
On the other hand, if markets do not equilibrate due to long-term labor, including union contracts,
this results in what we could call a voluntary excess supply of labor, which is not really
an excess supply at all.
Now in fact, history reveals that prices and wages do adjust downward if allowed.
Even in the case of long-term contracts, workers and employers can and do negotiate new market
clearing wages, especially when it becomes apparent to people that if we don't, we're
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.
There are certain symphony orchestras who are sort of caught in the pinch, and their musicians negotiated significant 10% reductions in their wages.
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.
So that sort of makes things, sometimes makes the adjustment process less smooth, shall we say.
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.
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.
Joe Salerno in his 2006 paper shows how this applies to the broad social economy.
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.
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.
Another particular manifestation of, and this is sort of the second broad set of problems I see,
a particular manifestation of market monetarists' unsatisfactory economic framework,
is their understanding of the form and of and extent to which expectations enter into their analysis.
Certainly no one should dispute that expectations play an important role in economic decision making.
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.
All action must therefore be based on speculations about the expected outcomes of various potential actions.
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.
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.
The problem with such a perspective is twofold.
While sound economic theory recognizes that expectations of outcomes in the future are a prerequisite for action in the present,
At present, economics cannot provide insight into the content of these expectations, or
how expectations change over time.
Expectations are not autonomous entities, but are bounded by a person's goals, his
past experience in attempting to achieve his goals, and his entrepreneurial ability.
Hence, expectations are not monolithic, which is why entrepreneurs must incorporate
timeology into their decision-making. Treating expectations as universal and monolithic opens
the door to grave errors of economic theory. For example, the market monetarists claim
that it is expectations about future nominal GDP that solely determines present investment
decisions and hence the direction of the economy, fails to recognize that recessions are not
merely the result of decreases in aggregate spending following a boom. They are the result
of Entrepreneurial Error. It is possible, for example, for entrepreneurs to reap profits
even in an environment of declining total spending. What matters is not aggregate spending
per se, but the spread between the price of products and the sum of the prices of the
factors of production. If the total quantity of all spending in the social economy falls
and overall prices fall, firms can still reap profits as long as they identify those projects
at which the factors are underpriced relative to the future price of the product that those
Those factors can be used to produce.
Additionally, the form of expectations assumed is the source of a particular inconsistency
I see in market monetarist literature.
This inconsistency in turn is also related to their failure to understand recessions
as a result of a cluster of entrepreneurial error.
Market monetarists assume that markets are efficient and forward-looking.
At the same time, recessions are due to decreases in expected nominal GDP.
Now if markets are efficient while forward-looking, how can there be a cluster of entrepreneurial
error?
It seems that if market participants make efficient adjustments while looking forward,
there should not be widespread mistakes made by entrepreneurs.
If so, how can there be a recession?
Now perhaps the response might be, as Loris Christensen implies, that although people
have expectations that are indeed rational, they're not perfect.
And so, if market participants properly forecast that the Fed would not or could not continue
to increase nominal GDP through 2008, why should there be a recession?
If their forecast was correct, they should have acted accordingly and markets would clear
and at the very least, there would not have been widespread persistent unemployment.
Market monetarist's affection for nominal GDP targeting once again demonstrates that
an unsound theoretical framework will often lead to unsound economic policy.
One of the biggest problems with trying to reduce economic fluctuations via nominal GDP
targeting is the real effects of monetary policy necessary to stabilize actual or expected
nominal GDP.
It is necessarily true that newly created money will enter the economy at particular
points.
Monetary inflation therefore will reflect demands for certain goods first and then subsequent
demands for different goods as the new money is spread throughout the economy.
The step-by-step adjustment process during which the new money is absorbed necessarily
results in real changes in relative prices and a real redistribution of wealth.
Credit expansion, we know, necessarily stimulates malinvestment by encouraging production processes
that are too roundabout relative to social time preferences.
Without an increase in voluntary savings, longer production processes are not able to
be completed.
This is the heart of the malinvestment problem.
Issuing fiduciary money via credit expansion promotes unsustainable boom activity because
because it provides both the incentive and the means for entrepreneurs to undertake projects
for which there are insufficient real resources to complete.
The necessary consequence of monetary inflation, even if the desire is to stabilize actual
or expected nominal GDP growth, is the boom-bust cycle in which resources are squandered, capital
is consumed and society is relatively impoverished.
Such an outcome is the exact opposite of the desires of those advocating nominal GDP targeting.
Thank you very much.