Tuesday, July 10, 2012

Selgin on Monetary Stimulus

George Selgin has been skeptical of arguments that the Fed needs to do more at "this time" for a long time.  Market Monetarists, on the other hand, have been insisting that the Fed "do more" since 2008 and have not stopped.   Selgin brings up the issue here.  (Lars Christensen responds here.   And Scott Sumner responds here.)

However, as time has passed, there have been adjustments in the view as to "how much" more the Fed should do.   Sumner has become very "conservative," on the matter, arguing for a couple of years of 7 percent growth and then 5 percent from then on out.    Beckworth has generally advocated shifting back up to the growth trend of the Great Moderation, which would be very rapid growth in nominal GDP during the adjustment period.   My own, somewhat politicized view, is that we should have a Reagan/Volcker recovery in nominal GDP, and then shift to a 3 percent growth path for a new "Great Moderation," this time with something much closer to the price stability promised last time.

To my reading, by the time the recovery started, Selgin thought it least bad to just accept the new baseline and then allow for slow, steady nominal income growth from there.   Perhaps at his preferred one percent trend.   (I may have been reading too much into his remarks.)     To me, this is the implication of growth rate targeting.

Nominal GDP growth rate targeting would be for nominal GDP to grow the targeted amount from wherever it happens to be.    While level targeting is often characterized in terms of catch up growth (or slowing,) I think this sort of definition makes growth rate targeting somehow fundamental.   To me, level targeting means that the target is a series of levels going out into the future.   Pick a future date, and there is a target level associated with that date.   You can look at the rate of increase in the target levels.  You can calculate a growth rate between some current value of nominal GDP and the targeted level at some future date.   But the target for any future date is the level--not some growth rate from the current value.

From a growth rate targeting perspective, monetary policy isn't doing too bad.   The diagram below shows the growth rate of nominal GDP along with the trend from the beginning of 2005 to the end of 2007.

Sure, things were really bad at the end of 2008, but now growth is close to trend.   For those like Selgin and I, who believe that the trend was too inflationary anyway, this more recent growth rate is better!  In  fact, it is a bit high if anything.

Of course, Market Monetarists focus on the growth path.   And it shows a very different picture.

During the Great Moderation, nominal GDP stayed on a very stable growth path.   And now, it has shifted to a significantly lower growth path with a slightly lower growth rate.  Market Monetarists favor level targeting and so it is natural for us to insist that the Fed should have kept the economy on the trend growth path and reversed any deviation.  The only way to reverse any negative deviation is for nominal GDP to grow faster than trend.

Selgin argues that wages have grown more slowly since the beginning of the recession--not at all at the University of Georgia.     With nominal wages growing so slowly, should the economy recover?

Here are hourly wages for production and nonsupervisory employees.   First the growth rate:

While the average is higher than for the University of Georgia, it is still far below the 3 percent trend and has been since the end of the recession.   So, with nominal GDP growing more than 4 percent and wages growing less than 2 percent, surely the economy should have recovered?   Well, no, the economy should be recovering, and it is.    Employment has been rising--just very slowly.    

Now, if we look at the growth path of hourly wages, then the problem becomes obvious.   

If wages had fallen below their trend as much as nominal GDP did, then wages would have adjusted to the new growth path.    In fact, nominal wages are only about 2.6 percent below the trend of the Great Moderation.   They just have about 12 percent to go.   If nominal GDP grows 5 percent per year, and nominal wages grow 1 percent, then that should take only about 3 years.   With 4 percent nominal GDP growth and 2 percent wage growth, then it could be more like six years.

Inflation, using the GDP chain-type deflator is here:

While inflation has averaged well below trend since the end of the recession, it has had a few quarters slightly above trend.   And the last one, was almost right at the 2 percent target!   The Fed is sure doing a great job of keeping inflation from rising too high!  And there was only one quarter of deflation.

What about the price level relative to trend?

The price level is 2.2 percent below the trend of the Great Recession.  Interestingly, this adjustment is smaller than the adjustment in wages, at least the hourly wages of production and nonsupervisory employees.   

The gaps between current levels and the trend growth path of the Great Moderation are below:

Assuming potential output had continued on the growth path of the Great Moderation, then the price level would need to be approximately 13 percent further below its trend for real expenditure to be equal to potential output given this huge drop.    Wages would need to be approximately that much lower too, relative to trend.   

Market Monetarists are well aware that it is possible that potential output has fallen about 13 percent below the trend of the Great Moderation.   (The CBO estimate of potential output is about 7 percent below the trend of the Great Moderation.)   

And perhaps the equilibrium quantity of labor has fallen some huge amount too.   The supply of labor decreased along with the demand, or the supply of labor is very elastic.   

But I don't believe it.

As I said before, I think a traditional recovery in nominal expenditure, like that of the Reagan-Volcker years, would be appropriate.    And then we should move to a long run, noninflationary growth path for nominal GDP.


  1. Presumably moving to a 3% growth path would have to be announced quite some time in advance so that nominal labour and debt contracts can adjust. How far ahead would it have to be announced so that debt deflation wouldn't become a problem?

  2. My preferred monetary constitution would require involve a 5 year lag on implementation of an adjusted growth rate.

  3. This is very well thought out response that completely makes sense. But since we are already discussing issues with MM, what do you make from the urgument #3 from Scott's response?

    In this article you say that to reach 5,5% growth rate of NGDP the wages need to rise only by 3%. So to simplify things, to reach the NGDP of 3% the wages need to rise on average only by 0,5%

    Given very real zero lower bound for wage contracts, are you not afraid that such low NGDP trend would create permanently higher unemployment given that you have just 0,5% buffer for adjustment of wages?