kitchen table math, the sequel: off-topic (somewhat): Scott Sumner on targeting NGDP

Thursday, November 10, 2011

off-topic (somewhat): Scott Sumner on targeting NGDP

Sumner: Nominal GDP Targeting Can Save the Recovery (video interview with Kelly Evans of the Wall Street Journal)

I can't remember when I first became convinced that the Federal Reserve should stop targeting the CPI PCE and start targeting NGDP (the sum of all current dollar spending in the US).

Maybe a year ago?

I bring it up today because the idea has abruptly broken through to the mainstream, and because the state of the economy will determine whether our kids have decent jobs after college (or any job at all), not to mention whether parents will have the money to pay for college in the first place. So now's the time.

I think about NGDP-targeting this way:

The Federal Reserve has a dual mandate: price stability and full employment. It is required to pursue both.

Since the crash, we have had unusually low core inflation, lower than average inflation during the Great Moderation, which was 2%. Update 1/10/2012: PCE inflation has averaged 1.37% over the four years 2007-2012.

We have also had a catastrophic collapse in employment, which is not becoming any less catastrophic as the years go by:

This chart shows the percent of the civilian population that is employed. Before the crash more than 63% of the civilian population was employed; since the crash we have bounced between 58 and 59%.

The chart above is, literally, an image of a depression. In it we see employment drop off a cliff, hit bottom (let's hope), and stay there. The chart makes it impossible for me to call the situation we are in a "recovery," a "weak recovery," a "faltering recovery," an "anemic recovery," a "limping recovery," a "recovery experiencing strong headwinds," or any other formulation that includes the word recovery. This is not a recovery. In my book, this is a depression: a minor depression, but a depression nonetheless. It's not getting better, and I don't believe that more 20-year olds acquiring STEM degrees will fix things.

More STEM degrees may or may not be a good idea; better K-16 education (I've expanded my horizons) unquestionably is a good idea.

Neither one is going to fix the chart.

Why is that?

Since I'm not an economist, I have to choose which expert(s) to believe. And, after spending probably a year of my life reading the various explanations of the crash, I'm persuaded by Scott Sumner and the market monetarists(pdf file) which is not to say anyone else has to be persuaded, obviously. I'm writing an amateur economics post on an education blog just to let you know about market monetarism if you don't already.

I'm convinced the market monetarists are right, and I want our federal overlords policy elites to stop targeting inflation, and start targeting NGDP, as market monetarists recommend.

Wages are sticky -- sticky meaning wages can go up, but not down. (Wages are sticky in one direction.)

I live in a state, New York, where public sector wages are beyond sticky; here in New York, public sector raises are sticky. I'm tuned in to public sector compensation because I've been dealing with my district's budget crisis for a few years now, but wages are sticky across the board in every sector, public and private.

Sticky wages kill jobs. Period. Sticky wages kill jobs because when profits decline, some employees have to be laid off so other employees can maintain their current salaries. In theory, when profits (or tax revenues) fall, wages could fall, too, and everyone would still have a job. Companies would bring in less money in sales, so they would pay less money in compensation, problem solved.

In reality, when profits (or tax revenues) decline, wages stay put. So people have to be laid off.

I have had a front-row seat watching this process unfold here in my town. Where sticky wages are concerned, I don't need experts to explain the world to me. Sticky wages are real, I've seen them, they take away jobs.

Update 1/10/2012: human employees replaced by wolves....

Which brings me to the Fed.

The Bernanke Fed strongly opposes deflation and will do whatever it takes to prevent it.

The Bernanke Fed also strongly opposes inflation (the cure for deflation), and appears to think that if low inflation is good, lower inflation is better. It's fine to go to 1.5% "core" inflation (CPI minus food and energy). It's fine to go to 1%. Two percent is a ceiling, not a target. Update 1/102012: The new 'ceiling' appears to be 2.5%.

At some point (where?) inflation is bad because it might turn into deflation.

Also, if you go into recession for 18 months, and "lose" all the inflation you would have had during that period, the Bernanke Fed thinks that's fine.

There is no such thing as an inflation shortfall in the Bernanke Fed, it seems.

Real estate.

Housing prices, overall, are at 1990 levels.


The Bernanke Fed is a deflation fighter, and yet the Bernanke Fed has presided over a 25% deflation in house prices in just 3 years time.

Given what we've been through, I conclude that neither real estate nor jobs are coming back as long as the Fed continues to target inflation. If the Fed is targeting 2% (or 1%) inflation, and we need 33% inflation (roughly) just to get back to where we were, then we're looking at the new normal. Since I personally see no way jobs can be decoupled from prices, that means jobs don't come back, either. Not for years and years and years.

Update 1/10/2012: Hamilton Jobs Gap Calculator

So I'd like the Fed to stop targeting inflation and start targeting nominal GDP, which includes inflation but is not limited to inflation. The beauty of NGDP is that it combines inflation and employment in one number. Double mandate, single target.

I'll post links to the market monetarist blogs and the various endorsements and counter-endorsements later on. In the meantime, Scott Sumner began his blog, The Money Illusion, in 2009. Within the past month Goldman Sachs published a report endorsing the idea, and Cristina Romer wrote a column agreeing. Brad DeLong and and Paul Krugman have both endorsed; at National Review, Ramesh Ponnoru was an early adopter and advocate.

Update 1/10/2012: Worthwhile Canadian Initiative has the easiest-to-understand explanation of why inflation targeting has failed -- and why "level" NGDP-targeting would succeed -- that I've seen so far.

* I've just this moment Googled a line from Brad DeLong saying 1% is the new 2%.


SteveH said...

"Sticky wages kill jobs."

Some unions are now forced to choose between benefits and pay for the older workers versus the younger workers; between pay and the number of jobs.

Has there been a growth (as a percent of gross company revenue) in the people cost of companies over the years? That's probably true for public sector jobs, but how about for the private sector?

I suspect that the percent cost of employee benefits has grown by a huge amount over the years. Are companies able to pay more to fewer people and still get the job done? Apparently so. Jobs get lost due to efficiency and automation, but is that the entire story?

It's cheaper for companies to pay workers time-and-a-half rather than open up new positions. It's cheaper to pay consultants $200/hour rather than put them on the payroll and commit to them full time. It seems that jobs are a precious commodity at companies. I don't think it was like that years ago.

However, do existing workers have to give up security or pay to provide more jobs? I assume that economists are paying attention to the size of the pie rather than how the pie is split up.

I remember "stagflation" and Ford's WIN buttons. Also, when we bought our first house, the long-term interest rates were well above 12%. It seems that economists should (by now) have a better grasp or consensus on the importance of different variables.

Catherine Johnson said...

I suspect that the percent cost of employee benefits has grown by a huge amount over the years.

That's my question re: "stagnating wages."

I don't know what variables the number includes.

Are benefits part of "wages"?

If not, have workers actually had stagnating wages or have workers had increasing real wages that are composed differently (i.e. a greater percentage of compensation goes to benefits).

I'm asking -- not implying a judgment one way or the other.

I suppose I could look this up, couldn't I.

Catherine Johnson said...

I suspect that the percent cost of employee benefits has grown by a huge amount over the years.

That seems like it would have to be the case given the inflation in health care costs -- (right?)

For how many years now have we had above-inflation increases in health insurance?

Combine that with annual above-inflation increases in education spending, and...... uh oh.

Presumably, the steady above-inflation rise in cost of benefits makes wages more sticky than they were in the 1950s and 1960s. (I don't know how to factor in the higher level of unionization then.)

Catherine Johnson said...

Just a few minutes ago I read the single clearest explanation of the stagflation period -- and the intellectual developments that preceded and followed it -- in a comment on The Money Illusion: Mark A. Sadowski: history lesson.

I looked at Sadowski's CV: he used to be a high school math teacher!

Wish to heck we'd had him teaching C.

ChemProf said...

Another site you might find interesting:

Also, here is the official description of CPI

How we calculate inflation is the subject of a lot of debate, since right now there's quite a bit of inflation in food/energy prices, and the deflation in home prices isn't evenly distributed across the country.

(For example, in my area we definitely aren't back to 1990 prices. I'm sure of this because we bought our first house in 1995, after the last housing bubble popped, and prices are still about double those values.)

At the risk of getting this thread back into issues of politics, I don't think you can look at this purely monetarily. I think that you have to consider the regulatory environment, particularly the expansion of regulations that center around record keeping that become too complicated for small shops. In 2010, 2439 new regulations were added to the Federal Register, and estimates from government sources suggest these cost the economy billions of dollars.

This is not to say that everything should be unregulated, but adding regulations (and the Federal Reserve is at an all time high of over 81,000 pages) is not without costs.

Anonymous said...

Wages have not been sticky in the PNW. Wages have fallen as people routinely are laid off in the tech industry at least. In the land of Microsoft, Amazon, Google, etc, wages have certainly dropped. I see this trend because so many people (including a LARGE population of H1B-Visa Foreign Nationals) have driven down wages, as has outsourcing (sending whole chunks of jobs over to India, Russia China, etc). In the meantime, benefits have gotten much worse. Yes, I think benefits count in compensation. If you used to get pretty much full coverage health care for free or not much, but now you pay $800/month for a family of four, and then also pay for co-pays, deductibles, etc., that certainly impacts a families bottom line.

Companies routinely count benefits packages in their compensation numbers.

The CPI is a farce since the items that SHOULD impact it the most aren't counted (food and oil). Certainly food has increased hugely since 2008.

BTW, I really like the Blog, Calculated Risk.


Morgan Warstler said...

I want to make sure, you say this out loud, we should adopt all and any policy choices that seek to end the stickiness of wages.

Which means we end public employees unions.

We end the minimum wage.

We end Davis-Bacon.

If you want to argue wages are sticky, you must morally accept those policies that actually use government to end sticky wages.

Catherine Johnson said...

What is PNW?

(ummmm....I could Google it, couldn't I?)

Catherine Johnson said...

anonymous wrote:

The CPI is a farce since the items that SHOULD impact it the most aren't counted (food and oil).

I'm going to stress (and keep on stressing) that I am a newbie to this realm --- BUT that, newbie or not, I have to make a decision who to believe. (I've decided Language Log is right: whom is dead.)

I've read several times - I can probably scare up the cites - that headline inflation converges to core inflation, not vice versa.

I want the Fed to stop targeting inflation in food and oil because whenever the Fed targets inflation in food and oil it is also, by extension, targeting 'inflation' in house prices.

Catherine Johnson said...

chemprof- I've never seen that blog - will look!

I don't know enough about regulation; I'm planning to start learning more by reading about Basel first.

I think you'll probably like the SF letter. Leamer's entire thesis is based on the reality you cite, which is that the Great Recession occurred much more strongly in places that had housing booms.

I wonder, though, whether the areas that were relatively unscathed can carry on being relatively unscathed given the ECB (and the Fed).

Catherine Johnson said...

Hey Morgan - !

I'm not arguing wages are sticky.

I'm saying wages are sticky.

Catherine Johnson said...

I should add that, as a writer specializing in psychology and cognitive science, I don't personally see any way for the government to force wages to become un-sticky.

I believe that the money illusions is likely built into the brain; I believe, equally, that the federal government isn't going to change the brain.

The money illusion underlies phenomenon like unions, minimum wage, and so on.

Therein lies the problem.

Catherine Johnson said...

Without knowing enough about it to have an educated opinion, I suspect I like the German approach to sticky wages.

As I understand it, when recessions hit in Germany, the government makes it possible for companies to lower wages as profits drop by kicking in the amount those wages need to be reduced. Everyone stays on the job, and you don't have the massive disruption of lay-offs, foreclosures, bankruptcies, and on and on and on.

That said, I don't know enough about the German approach and its implications to have an informed opinion.

ChemProf said...

PNW = pacific northwest.

Benjamin said...

Excellent blog. Excellent!

Benjamin said...

The new central banker motto: "Today Japan, tomorrow the world!"

kcab said...

Another vote for calculatedrisk here.

SteveH said...

"We end the minimum wage."

I was waiting for that. As I asked before, are we talking about how we slice the pie or about the size of the pie?

"As I understand it, when recessions hit in Germany, the government makes it possible for companies to lower wages as profits drop by kicking in the amount those wages need to be reduced."

Our state has a program like this. The work week is reduced, nobody is laid off, and the workers get partial workers compensation. This evens out the minor fluctuations, but it isn't a solution to larger problems. The state could be propping up a company until it completely collapses. Besides, that money has to come from someplace else. The pie is not getting larger.

In general, I think that wages should be sticky. There are already enough pressures of supply and demand. Improving the economy shouldn't involve returning to a more pure form of capitalism.

The public sector, however, is another issue. There is no good mechanism here.

Anonymous said...

Another thing companies can do to 'unsticky' wages is to have a chunk (20% in an average year, maybe) of compensation be bonus money tied to company profits. If the company stops being profitable, the bonus money goes away. If the company is profitable, the bonus money comes back.

This effectively lets companies reduce payroll when times are tough.

The company I work for does this to some extent (but not 20%).

-Mark Roulo

Catherine Johnson said...

The new central banker motto: "Today Japan, tomorrow the world!"



Catherine Johnson said...

This evens out the minor fluctuations, but it isn't a solution to larger problems. The state could be propping up a company until it completely collapses.


Catherine Johnson said...

Another thing companies can do to 'unsticky' wages is to have a chunk (20% in an average year, maybe) of compensation be bonus money tied to company profits. If the company stops being profitable, the bonus money goes away.

It will probably come as no surprise that I've wished for some mechanism of this sort here in NY's public schools. Because of the Triborough Amendment, all downturns are dealt with via layoffs, period. There is **no** other way.

Without having thought it through (which means I myself may not agree with my next comment) I feel like: can't we have some mechanism whereby when we taxpayers get poorer, we also pay teachers and administrators less?

Or at least, we get to stop giving them raises negotiated during boom times?

And wouldn't that be better for kids who lose their teachers to layoffs AND for the teachers who don't get laid off?

Basically, older teachers who keep their jobs and their raises benefit while every other constituency loses ground.

Catherine Johnson said...

Actually, Mark - that reminds me....there's a company that's been around since the Depression that has **always** managed to keep people on during downtimes....and they've done it through a formal policy of compensation cuts in hard times **specifically** in service of keeping everyone on.

I wonder if I can find that article. It was int the Wall Street Journal a couple of years ago, I think.

Everyone in the company understood exactly what the situation was, and everyone (apparently) preferred a situation where via shared sacrifice people kept their jobs.

Catherine Johnson said...

Some universities have done the same thing: faculty take across the board freezes or cuts in order to keep everyone working.

Everyone understands that's what's being done, and there's not a lot of grumbling or a lot of 'fear and loathing.'

Catherine Johnson said...

chemprof - PNW = Pacific Northwest


maybe I could have figured that out myself ....


Catherine Johnson said...

I like Calculated Risk, too, although....I don't know it that well.

oh--- just looked at it again -- he focuses on real estate?

Catherine Johnson said...

The other realm of economics I'm trying to figure out is exchange rates, capital account deficits, etc.

I'm very keen on Michael Pettis, but I don't understand that realm well at all.

Nevertheless, I have developed a reasonably firm opinion that the U.S. should stop running current account deficits.

I guess I'm of the view that the deficit that matters is the capital account deficit.

kcab said...

Somewhat OT to the post, but thought you might find one of the recent articles in Science News interesting.

On possibility that financial risk is in general incorrectly modeled:

Yeah - Calculated Risk looks at real estate a lot, though not exclusively. I started reading his blog in 2005, when it was apparent that we were going to be moving at approximately the same time the housing bubble was looking likely to burst. Another financially focused blog that I started subscribing to around the same time and still read is The Big Picture - which is mostly Barry Ritholtz but also other people.