Monday, July 2, 2012

Williamson on Nominal GDP Targeting

Stephen Williamson has some doubts about Nominal GDP Targeting.

Oddly enough, his first criticism is that because the Fed has allowed substantial variability in nominal GDP in the past, it will never adopt a nominal GDP target because this would admit that it had been doing a poor job.

This is the element of Williamson's post that Thoma found interesting.   

To some degree, I find this horrifying.  The Fed has been doing a bad job, so it will continue to do a bad job.   Nominal GDP targeting would solve economic problems, but it is impossible because the current leadership of the Fed would lose face.

On the other hand, it fits in well with my view that there are two types of monetary economist.   There are those who help central bankers do what they want to do, and those who propose reforms of the monetary regime--reforms that may will compel central bankers to behave in new ways.

In my view, nominal GDP level targeting should not simply be a rule for a central bank, but rather part of a new monetary regime--constitutional monetary reform.  That this might require that the current group of central bankers be replaced is always a possibility.   

Williamson then considers the issue of seasonal adjustments in nominal GDP and believes he has found some telling criticism because nominal GDP has substantial seasonal variation.   Of course, measures of the price level are also seasonally adjusted.   Does that have adverse implications for inflation targeting?

Anyway, the proposals for nominal GDP targeting have been proposals to target seasonally adjusted quarterly nominal GDP.   This implies that the regime would seek to keep actual nominal GDP fluctuating according to past seasonal patterns.

If spending patterns over the year should change, this would result in failure to hit the targets.   These failures would have two effects--changes in the seasonality calculations and "policy" changes in monetary conditions to offset these changes.

Perhaps I am being unfair, but when Stephenson suggests that perhaps there is no more reason to worry about fluctuations in nominal GDP over business cycle periods than over the year--I am puzzled.   Should we worry about fluctuations in nominal GDP over the week?   If spending jumps when people are paid on Friday or the beginning of the month, should efforts be made to smooth spending?    Or perhaps we should go further?   Perhaps we should make sure that spending between the hours of 1 AM and 5 AM is equal to that between 11 am and 3 pm?


But to suggest that the current condition of the U.S. economy (with spending on output about 12% below trend,) is of no more concern than the fact that spending for most of the U.S. is quite low at 3 am in the morning is odd to say the least.

Interestingly, Williamson then explains that the Fed stabilizes financial conditions in the U.S.   He is concerned that targeting nominal GDP futures would interfere with  the Fed's efforts to stabilize interest rates.  

In my view, to the degree that the Fed is adjusting the quantity of money to changes in the demand to hold money, and avoiding disruptions in money market conditions as a side effect of shortages or surpluses of money, then this stabilization of interest rates is a good thing.    On the other hand, to the degree that the Fed is creating excess supplies or demands for money in order to prevent changes in the supply or demand for credit from changing interest rates, then this effort is interfering with the role of the interest rate in coordinating saving and investment.  In other words, the Fed is interfering with the ability of interest rates to smooth expenditures in a way consistent with scarcity constraints.

Would it be a good idea for interest rates to be low in the summer and high during Christmas time?   Do efforts by the Fed to stabilize interest rates over the year encourage people to concentrate expenditures during the Christmas shopping season?  

During the 19th century, increases in the demand for hand-to-hand currency during harvest season were associated with spikes in short term interest rates (in the U.S.)   In my view, a monetary regime that accommodates seasonal shifts in the demand for currency relative to deposits is clearly desirable--which is an advantage of private issue of hand-to-hand currency on the same basis as deposits.   And to the degree that the demand to hold money in general increases during that period, perhaps solely because of the large number of transactions, the quantity of money should adjust to meet the demand.    

But should there have been no increases in interest rates during harvest time?   Would it be better if interest rates were lower and  nominal expenditure on nonagricultural goods higher during the rest of the year, perhaps creating demand for other products and providing employment opportunities for seasonal agricultural workers?

While these are interesting questions, and suggest that the proper seasonal adjustment to nominal GDP would be a policy question with a nominal GDP level targeting regime, as mentioned above, the same issues apply to inflation targeting.   

Williamson has been insisting that under current conditions it is solely the interest rate that the Fed pays on reserve balances that impacts the economy.   While I doubt that this is true, and believe that sufficiently heroic open market operations could raise nominal GDP back to trend without there being any change in the interest rate paid on reserve balances, no Market Monetarist is adverse to lowering the interest rate on reserve balances.   


  1. Why do market monetarists look to open market operations as the mechanism of choice to influence NGDP ?

    This always seems like a rather indirect route - involving forcing up asset prices to reduce the interest rate, plus hoping that people will spend some of the funds they get from asset sales on final goods and services.

    Unfunded fiscal policies like reducing taxes, sales and payroll subsides etc would seem like a much more direct approach - and would in addition cause less distortions to the patterns of demand than OMO might cause.

  2. Why open market operations?

    It gives the monetary authority something to sell when the quantity of money needs to fall again.

    Using tax cuts or spending increases to add to the quantity of money means that when the demand for money falls, new interest bearing government debt must be issued, creating an tax burden to cover the interest or else taxes must be increased or government spending cut.

    In my view, government spending and tax decisions should be made by voters acording to the value of the government programs vs. the private goods that must be sacrificed due to the taxes paid. Whether or not the quantity of money needs to change to match the demand to hold money is not closely related to this issue.

    Fiscal policy has a "job."

    Money is an asset. Monetary policy is about adjusting the quantity of that asset to the demand to hold it. When people choose to hold more assets (save,) this should generate more invesetment. Open market operations make changes in the quantity of money match changes in the demand for other assets, which should signal appropriate investment.

    With fiscal policy, when new money is created, rather than signaling an needed increase in the production of new capital goods, so that there will be future output there when those holding the money want to spend it, instead, there are lower current taxes at best or more current government services.

  3. Thanks for your detailed answer. You give 3 reasons why OMO is preferred to other ways to increase the money supply:

    1. OMO is more easily reversed out of when it is necessary to reduce NGDP.
    My response would be that if one had (say) increased the money supply by unfunded tax cuts then one should logically increase them again when required.

    2. Fiscal policy should be used for political/social purposes and not adjusting the money supply.
    If the re4quired "fix" is increased money supply then all ways of delivering this have some distributional effect, at least in the short-run. Tax reductions would benefit tax payers over non tax-payers. Asset purchases would benefit owners of these assets over non-owners.

    3. OMO will lead to the "correct" amount of investment for long-term equilibrium while fiscal policy will distort this.
    This would seem to be the strongest argument but I'm not sure I understand it. A rise in the demand for money in a world of flexible prices would lead (other things being equal) to a uniform fall in all prices and cash balances increasing proportionally. In a world of sticky prices a perfect monetary solution would be to increase everyone's cash holdings by an equal amount until NGDP reaches its previous level (which is another way of saying that the value of money is reduced to its previous level). Investment levels (again other things being equal) would be the same before and after the change in the money supply. Assuming this view of things is correct I believe a carefully chosen fiscal policy has a greater chance of getting close to this model than OMO. If for example an unfunded subsidy on all transactions (including on asset sales) was introduced then the economy could get back to monetary equilibrium with minimum unfairness/distortions and investment would return to previous levels (though holders of large cash balances who engage in few transactions would lose out). OMO (by design) seems to have a bias towards encouraging investment spending that would need to be reversed out eventually for the economy to return to equilibrium.

    My point is that all ways of increasing the money supply are unfair or distortionary in some ways but appropriately chosen fiscal policy has a greater chance of minimizing them. OMO on the other hand seems to have some in-built distortions that would be better avoided.