Roger Farmer On NGDP Targeting

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Marcus Nunes directed me to a very interesting post by Roger Farmer (written right after the Brexit vote.) Farmer suggests that the Bank of England needs to do whatever it takes to prevent uncertainty from depressing aggregate demand. Indeed it should consider buying shares in an index fund, if necessary. He then provides a comment from Thomas Hutcheson:

"This is fine so far as it goes, but we should deal as well with the policy response of the ECB and the Fed, as well. Whatever long term damage may occur from slightly less free trade (including investment to trade) cannot be prevented by central banks, but they can prevent the damage that comes from uncertainty about the future course of NGDP. It is expectations about that they should seek to stabilize."

Farmer replies to Hutcheson as follows:

I am in broad agreement with the proposal to stabilize expectations of future NGDP growth and, in the simple models that guide my thinking, stabilizing asset price growth and stabilizing expectations of NGDP growth amount to the same thing. The question is: how to achieve that goal?

If central banks simply substitute NGDP targeting for inflation targeting, and if they continue to try to achieve their objective by adjusting short term interest rates, not much will have been achieved. Scott Sumner has proposed instead, that central banks should trade NGDP futures. Robert Shiller goes further and advocates that national governments finance their borrowing requirements by issuing equity-like instruments that pay a trillionth of GDP: Shiller calls these 'trills'. I wholeheartedly endorse both of these proposals. Creating a market for nominal GDP futures, and actively trading trills for Tbills would have much the same effect as stabilizing asset price growth.

Needless to say, I'm very pleased to see that Farmer is receptive to NGDP futures targeting. We both have a longstanding interest in the relationship between asset prices and macroeconomic stability, which perhaps puts us a bit on the fringe of the mainstream. But Farmer is much better known than I am (he teaches at UCLA) so any support from him is very welcome.

I did find the next paragraph a bit confusing:

I differ from Scott in one important respect. Whereas Scott sees NGDP targeting as a substitute for inflation targeting, for me, it is a complement. Central banks should set interest rates to target inflation, and they should set the growth rate of some other object, be it asset prices, NGDP futures, or the price path for trills, to target the unemployment rate.

I'd need to know more, but here's my initial reaction. Normally economists think that you need two independent tools to hit two distinct policy targets. Farmer would probably say that his plan contemplates two tools (interest rates and NGDP futures.) But I see basically only one tool. The Fed would presumably use standard monetary policies (open market operations, interest on reserves, etc.) to affect both interest rates and NGDP futures. Can slightly different monetary tools have two independent impacts? Buying T-bonds and stocks, for instance? Maybe, but I'm an old school monetarist in the sense that I believe it's the liability side of the balance sheet that really matters, not the asset side. So unless I'm missing something, I'm skeptical of Farmer's claim.

I should add that I am assuming this is a sort of business cycle argument. I take it as a given that monetary policy doesn't affect the long run trend rate of unemployment, and hence you cannot choose independent long run targets for inflation and unemployment. (At least without other tools, beyond monetary policy.)

P.S. Off topic, I greatly enjoyed Tyler Cowen's recent interview at the IEA. There was virtually nothing with which I disagree. That's not to say I could make the same arguments; he's a much better social scientist than I am. I just point this out because I have a habit of mostly responding to posts I disagree with, and so if you want to see where our views agree, that interview is a great example. (Covers the Great Stagnation, Brexit, negative rates, education, a bit on Trump and a few other topics.)

P.P.S. Zachary David responded to my recent post on NGDP futures:

In true Sumnerian fashion, he begins with an off-hand remark about how I ignored/didn't read his proposal. Any long time follower of his, like me, knows that this is Sumner's standard opening move for responding to all criticisms of NGDP targeting. I've read it all; it's still goofy. (though not as goofy as the time he called Arctic Monkeys a one-hit wonder)

I was giving him the benefit of the doubt. If he actually read that paper, and then still wrote his deeply misleading post, then that's much worse.

Let's start here:

He wonders why NGDP futures would be such a good idea, given that the private sector hasn't already created such a market. Perhaps that's because the private sector is not legally allowed to do monetary policy.

Oof. This is embarrassing. Sumner attempts to imply that we haven't seen a private sector futures contract linked to NGDP because it would necessarily "do monetary policy" which the private sector cannot. It's a gross non sequitur and completely ignores my point. In the main piece, you'll see that there are no fundamental or market structure issues preventing the creation of an NGDP futures contract. I use the unpopularity of the former unemployment-linked contracts as an analogous example of why his market might have problems gaining traction. Dressing up a futures contract as "monetary policy" does not make it any less of a futures contract.

The only thing embarrassing is David's failure to understand what I wrote. I never said an NGDP futures market would necessarily do monetary policy, I said that would be the logical motivation for creating such a contract. If the private sector is not doing monetary policy, why would it want to create such a market? Yes, there are no barriers to creating such a market. Indeed I created one. So what's the point?

As far as not gaining traction, why would I care? If monetary policy stabilizes the price of NGDP futures, it really doesn't matter whether there is any trading at all. I explained all this in the paper that he insists he read, but somehow didn't understand. If David's too lazy to read the entire paper, he can try the section entitled "What if No One Trades," which begins on page 18 and goes all the way through page 21. Don't you think it's a bit silly to read that entire section, and then whine that Sumner doesn't realize that no one might trade his contracts?

The rest of his response is more of the same. He quotes me, and then misrepresents what I said. Perhaps the funniest example is where he claims I was advocating a gold price peg:

. . . did an economist really just extol the virtues of gold standard pegging?

Um, no. Why do you ask?