NGDP Targeting: Some Answers
I want to thank everyone who replied to my previous blog post NGDP Targeting: Some Questions. It will take me some time to digest all of the information sent to me. In the meantime, let me report on a few of the answers I received.
First, some background information. I do not believe that sticky nominal prices or wages matter (at least as far as explaining years of sub par recovery dynamics). I explain why here: The Sticky Price Hypothesis: A Critique. Consequently, Nick Rowe's reply to my post does nothing for me (although I still love the man and his blog!). On the other hand, I am not so sure about "sticky" nominal debt. I am more sympathetic to Evan Koenig's view:
The analysis presented here is completely orthogonal to the literature. It does not involve goods-market or labor-market pricing frictions in any way. As our most severe economic downturns have been characterized by widespread default on financial obligations and disastrous breakdowns or near breakdowns in lending, an analytical framework that puts debt and the distribution of risk at center stage arguably has something to say about optimal policy.
One of the main proponents of NGDP targeting sent me this article, so I took it to represent a main theoretical justification for NGDP targeting. And indeed, a lot of people seem to be talking about a "debt overhang" problem and a "balance sheet recession." I sort of figured (perhaps incorrectly) that the idea of getting the Fed to commit immediately to (say) a 5% NGDP target was to generate a credible temporary inflation to reverse the effect of the unanticipated and sharp decline in the price-level path (in 2008). The mechanism people have in mind, I think, is essentially to reduce the real debt burden of debt-constrained households, to get them to start spending, and to increase aggregate demand.
In my previous point, I raised the question of how strong and how desirable this mechanism might be now that we are 3 years out from the 2008 price level shock. Surely, a lot of the debt negotiated prior to the shock has been either reneged, renegotiated, or retired. At the same time, a lot of new debt has presumably been issued under the expectation of the new price-level path (given that people generally believe that the Fed will stick to its 2% inflation target). If the "turnover" rate is high (i.e., if there are large gross flows of debt being created and destroyed), and if the economy remains under "potential" for a long time, then one would have to question the quantitative importance of this mechanism; and also, the desirability of reversing the price-level path.
Well, I have to thank Mark Sadowski for taking the time to dig up some statistics for us. You can refer to the comments section of my previous post for details, but Mark's back of the envelope calculation is summarized here:
At the end of 2011, there was some $13.2 trillion in household debt outstanding. Of that nearly three quarters, or about $9.8 trillion, consisted of home mortgages
...
Thus a total of perhaps $5 trillion in debt has been originated/refinanced since the new NGDP trend has been established. Which means that about $8.2 trillion or approximately 64% was negotiated before the new trend was established.
Assuming that the rate of origination/refinancing is linear (dubious) then it will take a least another five years before all household debt conforms to current NGDP growth expectations.
So, it seems that there is still a lot of "old" debt out there, negotiated under the old price-level path. But there is also $5 trillion in new debt, negotiated under a new price-level path. And the longer we wait, the more this number will grow. Granted, this problem may have been avoided if the Fed went into the crisis with a credible NGDP target. But this is not the world we live in. What would Scott Sumner do right now? Who is he willing to make angry and why? Scott offers a hint here: Can we confident about the benefits of more NGDP?
2. But does it still make sense to go back to the pre-2008 trend line? Probably not, recently I’ve been calling on the Fed to go about 1/3 of the way back to that trend line, and then start a new policy trajectory (hopefully explicit in this case.)
In any case, it seems that Scott believes that "more NGDP right now would modestly reduce the unemployment rate." I confess that I am not entirely sure what mechanism he has in mind here. I really do need to read his 1000 blog posts on the subject one day!
I still have a lot of reading to do before forming an opinion on this subject. There were a lot of really good comments on my post that I haven't mentioned here--I need some time to think them through. Before I sign off though, some of you may be interested in these two links (h/t Prof J):
First, here is George Selgin: Wide off the mark, or, Nonsense about NGDP targeting. This seems like an extreme view, but I think it deserves some attention.
Second, we have Mark Carney (Governor of the Bank of Canada) speaking here on why he believes a "flexible inflation target" is superior to an NGDP target.
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