Cardiff Garcia: Hey, everybody. Welcome to the Macro Musings podcast. I am not David Beckworth. My name is Cardiff Garcia, and I'm the co-host of a podcast called The Indicator from Planet Money. I have seized the reigns of the Macro Musings podcast just for this episode, because David himself is going to be in the hot seat. He's here with me in the studio right now. David, welcome to your own podcast, man. David Beckworth: Great to be here. Wow. It feels really hot on the other side of the mic. While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected] Garcia: Yeah. Is it starting to get a little prickly over there? Beckworth: It is. I'm getting a sweat. A little nervous here, so be nice.
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Cardiff Garcia: Hey, everybody. Welcome to the Macro Musings podcast. I am not David Beckworth. My name is Cardiff Garcia, and I'm the co-host of a podcast called The Indicator from Planet Money. I have seized the reigns of the Macro Musings podcast just for this episode, because David himself is going to be in the hot seat. He's here with me in the studio right now. David, welcome to your own podcast, man.
David Beckworth: Great to be here. Wow. It feels really hot on the other side of the mic.
While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
Garcia: Yeah. Is it starting to get a little prickly over there?
Beckworth: It is. I'm getting a sweat. A little nervous here, so be nice.
Garcia: All right. David, there's reason that you are on the other side of the mic today.
Garcia: You've written a new paper. It's called *Facts, Fears, and Functionality of NGDP Level Targeting*. Okay? It's a paper in which you try to allay a lot of fears about NGDP level targeting, which is this idea of central banking that you've been advocating for what, 10 plus years now?
Beckworth: Yes. It's a long journey.
Garcia: I have a couple of competing theories for why you just came out with this paper. Okay?
Garcia: They can't both be right, so here they are. Number one, you're feeling a little exultant right now. You're happy about the pace at which NGDP level targeting has become more acceptable as a possible future framework for central banking. That's theory number one. Theory number two is the exact opposite. You're super annoyed that it hasn't become more acceptable, and you're trying to get the word out there. Which of those is it?
Beckworth: Probably more the latter.
Beckworth: It has had some wide acceptance, some prominent people have accepted it, but what's been going on this year, as you know, is this big review with the Federal Reserve. They're discussing different frameworks for the operating framework, their target. We have inflation target, and thinking of maybe doing average inflation targeting, price level targeting, and way in the back somewhere is nominal GDP level targeting. It gets mentioned, but it's the stepchild ... The red-headed stepchild in the back. It doesn't get the kind of play that I want it to get. This is one attempt to bring it forward into the discussion. It's more of the latter explanation you gave.
Garcia: Yeah. I remember in the aftermath of the financial crisis, NGDP level targeting got a lot of debate. It got a lot discussion. Right? Are you just sad that, to this point, it didn't get much beyond that as a serious possibility?
Beckworth: Yeah. I hoped there'd be more traction by now. My hope is that maybe we can pull out a ninth inning win in this review, though time is running short. You know it ends at the end of this year, and early next year, the Board of Governors, the FOMC will have a report. I think everyone sees the average inflation targeting writing on the wall. That's where we're going. This is my last inning ...
Garcia: Last ditch effort.
Beckworth: It is. It is. I'm doing my best to put it forward. Also, just one other thing. Also, I made this paper in an effort to make it very accessible. I don't know if you could see that. My goal is Jay Powell is going to sit down and read this, and he's going to have all these checklists of concerns. Here they are. I can answer them.
Garcia: These are all the most common responses, retorts to NGDP level targeting?
Garcia: And this was an attempt to assuage everybody's fears about what this framework might mean, or at least respond to the criticisms?
Garcia: Okay. We're going to get to that, and we're going to talk about pretty much everything to do with NGDP level targeting today. I find it hard to believe that someone who listens to Macro Musings wouldn't know what it is. I think just in case you might have a lot of new listeners for this episode ... Who knows, right? You should just lay out, in the simplest possible terms, what exactly is nominal GDP level targeting? How does it differ from the current inflation targeting framework that is used by the Fed?
Beckworth: The current framework, inflation targeting, as the name implies, aims to stabilize the cost of living, the change in prices that people face. It's pretty intuitive. It's one of the great arguments for it. People understand prices. They worry about prices. Nominal GDP level targeting flips that and says we should worry about peoples' incomes. What's going to happen to your average dollar income? Try to stabilize incomes. Take the focus off the cost of living. You focus on stabilizing income growth.
Alternatively, if you're talking maybe to a firm, you say, "Hey, we're trying to stabilize sales." Again, we're not trying to grow it too rapidly, but we're not trying to also avoid shortfalls, as well. Stabilize either sales or income. That's what it's about, stabilize total spending in the economy.
Garcia: Okay. The way I look at nominal GDP level targeting and the debate about it, there seem to be two very broad concerns. Right? One is, does the central bank actually have the tools to hit a nominal GDP level target? Right? The second is, assuming that it does have the tools, that target can be hit consistently and credibly, how would this approach lead to a different world than the world of inflation targeting? I actually want to take those in reverse order. For the time being, let's assume that yes, the central bank can, in fact, hit a nominal GDP level target.
Garcia: Okay? Why would things be better? And start with this, why does nominal GDP level targeting do a better job of incorporating negative supply shocks? If there's war between, I don't know, Iran and Saudi Arabia, and suddenly the production of oil plummets, and the price of oil sky rockets. Why is this framework better than the framework we have in place right now?
Beckworth: Because central bankers have a really hard time not responding to inflation, no matter what the causes. If we have an oil price shock that causes inflation to temporarily go up, and I'm not speaking theoretically here. We have evidence. 2008. Federal Reserve was facing higher commodity prices, driven in large part by oil. The Fed decided to do nothing between April 2008 and October 2008. They were worried about inflation. If you read the minutes, they were actually talking about hiking rates.
Over across the Atlantic, the ECB actually did raise interest rates. 2011, they did it again. What nominal GDP targeting does, it removes that temptation. I call it the siren call of central bankers. They want to respond to every little inflation movement that puts it above their target, or uncomfortably high. Nominal GDP targeting says ignore that. See through it. In fact, central bankers themselves would say they want to see through temporary movements in inflation. They have a hard time doing that. What nominal GDP targeting does, is look at total spending. Don't look at the short-term variation in inflation.
To be clear, it still anchors inflation over the long run. In the short run, you allow more flexibility, more variability, than inflation. You don't get swayed by movements inflation that the central bank should not be responding to.
Garcia: Yeah. I should note that it also responds differently to positive supply shocks.
Garcia: In other words, that if suddenly ... Let's say the frackers come on the scene. All of a sudden, inflation plummets, but real growth goes up. Right? The trajectory for real growth goes up. Nominal GDP level targeting treats that also differently than inflation targeting. How so?
Beckworth: Well, inflation targeting would respond by easing monetary policy. If you have a positive supply shock, the one you just described, inflation would go down. The central bank, the Federal Reserve, would see that. Again, they should see through, but if they don't, it would tend to ease policies. Think of the positive supply shock as adding productive capacity to the economy, making us more robust. That's a good thing. You don't want to add stimulus on top of that, and turn that into a potential boom. In fact, there's been many studies done that look at asset bubbles that have emerged, or big boom periods.
Typically, they start with a true increase in fundamentals. Something good happens to the economy, but then that turns into sustained expansion that's fueled by other developments, particularly easing by the central bank. The temptation, again, is this drop in inflation. I note in the paper, 2003 to 2005 fits this story. It's debatable. One interpretation is the Fed was worried about the low inflation during that time. If you can remember back, it was a big productivity boom period. Again, the idea is avoid that temptation, the siren call of inflation, avoid it in the near term.
Garcia: This is partly a response to the question of whether, or not NGDP level targeting has an effect on financial stability. What you seem to be saying here is that when there is a positive supply shock, when the potential growth rate in the US economy goes up, and let's say real growth goes up, and inflation goes down. That's what a positive supply shock is. If the central bank also then eases policy, it could lead to a credit bubble because things are so good, it's super cheap to borrow money, and it essentially leads to a credit bubble That is what ends up leading to potentially a financial crisis down the line.
Nominal GDP level targeting responds a little differently. It tightens in that scenario, if the overall level of spending goes above the path.
Beckworth: That's absolutely right. Another way of saying this, the more technical, not as sexy as what you just said.
Garcia: Oh, great.
Beckworth: Is thinking-
Garcia: We're already threatening to scare everybody away. All right? This is tough topic to talk about.
Beckworth: It is, and I appreciate you coming in and taking on such a big task. Another way to think about it, in terms of the neutral interest, or the natural interest rate. With an inflation target, if you get a positive productivity shock, the economy gets more productive, like in the early 2000s. That's when the second wave of the information technology boom kicks in. Between 2002, 2004, we see total factor productivity really surge. All else equal higher productivity growth should lead to a higher return on capital. Higher return on capital all else equal should lead to higher interest rates. All else equal.
We didn't see that. We actually saw lower rates. That's because the Fed was pulling down its target rate in response to the low inflation created by the productivity growth. The positive productivity growth, or what you call the positive supply shock, it tends to push the economy in two directions. It pushes real GDP up and pushes inflation down. What nominal GDP targeting would do is say that's fine, just let it be. Run with it. Inflation targeting says, uh oh, we better do something. We can't allow this inflation to go down. As real GDP is going up organically, or naturally, then the central bank is tempted to add on top of that, leading to a potential increase in leverage in the boom that you talked about.
Garcia: Here's a question about the modern framework of the Fed.
Garcia: You're talking about how an inflation targeting framework would respond, but the Fed has a couple of mandates. Technically three mandates, but let's leave aside the interest rate one. Right?
Garcia: It's supposed to pursue two percent inflation. Stable prices, right? And maximum employment. You'd think that even with that two percent target, if you get a negative supply shock, that if inflation goes up, yes, but employment would go down. The Fed would still not overreact. You seem to be saying that maybe psychologically, the Fed will still tend to overreact to the inflation increase, rather than acknowledge that there's a problem with employment.
Beckworth: Absolutely. The dual mandate doesn't say you have to focus on one part of that exclusively, all the time. There's room for trade-offs between the two. It's more of a long run goal. Meaning the long run, we want price stability and then we want full employment. In the near term, there's give and take. The question is, well, how do you get the optimal mix of give and take. I make the case that it's through nominal GDP targeting, or something like it.
Garcia: Okay. I want to talk about how nominal GDP level targeting deals with downturns, especially severe downturns like the one we had in 2008 and 2009.
Garcia: The basic idea here is, if it can hit its target, because we're still on that part of the conversation, where we assume that's possible ...
Beckworth: Right, right.
Garcia: And real growth plummets, that the central bank will still do what it can then to raise inflation in order to still keep nominal GDP on its intended track, right?
Garcia: That resulting inflation during a time of severely weakened real growth will have some useful properties. Is that an accurate way to characterize this?
Beckworth: Absolutely. Another way of saying this is, there's two circumstances under which a rise in inflation would occur with nominal GDP targeting. The one we mentioned earlier, a negative supply shock, you allow that to happen, but what you're talking about is a case where there's a collapse in demand. Spending itself collapsed. The Great Depression, the Great Recession.
In this latter case, something went horribly wrong. Policy failed, something happened. We're in a bind, we're in a mess. To get back to where we were, to restore spending, to restore contracts, arrangements, to where they were before, you're going to have to reflate the economy. There's no way around it. If you and I enter into some kind of financial agreement, there's going to be expectations, a certain amount of inflation in that contract. If suddenly we were way below that, one of us would be better off at the expense of the other.
What this does, is it raises spending, and the dollar value of the economy back to where we thought it would be originally. Yes, in a depressed economy, there will be a temporary overshoot of inflation. If you're targeting two percent over the medium to long term, and you were going to bring nominal GDP back to its path, it would imply higher than two percent inflation.
Garcia: You hit on an issue there, tangentially, that I was getting at, which is that there's this relationship between creditors, and the people that owe them money. If you're in a situation where real growth is hit, the economy is in a really weakened state, there's a huge hit to aggregate demand, that under normal circumstances, in a world without NDGP level targeting, it's going to be really hard for the debtors to pay back the creditors. Right?
Garcia: When inflation is high enough that it lowers the real cost of paying back the creditors, and that helps the debtors.
Beckworth: Mm-hmm (affirmative).
Garcia: Here's my question, though. I understand that, to this point. Right? If in fact people know that nominal GDP level targeting is the framework, won't creditors just design contracts in advance that won't lower the real value of what they get paid back in a downturn?
Beckworth: That's possible. That's a great question. You've got to keep in mind that creditors also benefit from this as well. It's not just the debtors who benefit from this. Maybe I'm getting ahead of your questions here. There's another, a secondary financial stabilizing argument for nominal GDP targeting. You touched on one. It tends to prevent the buildup of excesses. What happens if you get to those excesses and it crashes? That is this: we live in a world with lots and lots of debt. Probably too much debt. Highly-leveraged world. In fact, in the case of the US, even more so, because we're the bankers of the world. We provide safe assets. We are a highly-leveraged economy. For better or for worse, there's arguments both ways.
With that said, it makes us much more susceptible to downswings in the economy when we're highly-leveraged. Nominal GDP targeting deals with this. To get to your question, wouldn't creditors find some way around that if they know they're going to get ... They're all getting a deal?
Garcia: Yeah. Won't they design the contracts a little bit differently?
Beckworth: Well, yeah. Again, one point is, one, they benefit on the upside. But, two ... And I've had this discussion with other folks.
Garcia: Wait, wait, wait. Don't just run by that. When you say they benefit on the upside ...
Beckworth: Okay, on the upside ... Here's the upside. The upside is, during a boom, under nominal GDP targeting, inflation would tend to go down. In general, inflation is what we say is counter cyclical. During a recession, it goes up. During a boom, it goes ...
Garcia: In this framework.
Beckworth: In this ... Under nominal GDP targeting. We talked about how the debtor would benefit because if inflation goes up, real debt payments go down. During a boom ... Let's say there is another productivity boom. Maybe Paul Krugman's aliens land and give us new technology, and AIs overtake the world. Okay? Just imagine that wonderful future.
Garcia: It only took us 20 minutes to get to the alien landing, by the way, of the NGDPLT discussion.
Beckworth: Yeah. You know what's going to happen ... Right, right. Imagine that happens, though. Super productive. Let's say you're the creditor, Cardiff. You lent me, the debtor, money. Maybe you lend it, in this low world of low rates, two percent. And this future world of AI aliens, now there's a 10 percent return on the economy, on average. You feel gypped. You feel left out. I would have put my money in the market, in equity. Something different, had I known that aliens were going to land. How can you benefit? How can you get a piece of the windfall gains? What happens under nominal GDP targeting, because you have a target fixed, if real GDP goes way up, and inflation has to go down, which means my real debt payment I gave to you is going to go up dramatically.
Garcia: The fixed amount you give me is worth more?
Garcia: Inflation is now lower…
Beckworth: The dollar amount is the same, but the value of those dollars have risen dramatically. You're better off.
Garcia: True. Although I guess if there's a lot of risk aversion, they're going to tend to design it to prevent ... Right?
Beckworth: Well, they will ... That's my second answer to your question.
Garcia: Right. Okay. Okay.
Beckworth: The first point is this ...
Garcia: They benefit in a boom.
Beckworth: They do. This is kind of like the whole Irving Fischer debt deflation. Nominal GDP targeting speaks to the debtors, but also speaks to the creditors. It's a more symmetric Irving Fischer's story, if I can say that. Here's the second thing, and I've had this discussion with many people. They say there's just this desire by the bond market, bond holders, to have fixed nominal debt contracts. There's just ... We're wired in some way ... I could ask the question this way: why don't we have more indexing in general? Why do we have so little inflation index bonds in the US and elsewhere? I think the answer is, for some reason, the world, humanity likes fixed nominal debt contracts, whether it's currency, or bonds, there's something about that. As long as we have that, nominal GDP targeting will be fantastic.
If we get to the world that you envisioned, maybe we'll have complete-
Garcia: Wait, which world is that now?
Beckworth: The one where-
Garcia: The alien world or the one where the creditors are ...
Beckworth: The creditors.
Beckworth: In the world where the creditors get real sophisticated, and they adjust everything. That would also be a world, I suspect, where you would have a lot more indexing occurring. We don't see that. Maybe another way of saying this, nominal GDP level targeting is for our second best world that we actually live in.
Garcia: Okay. I guess the other argument for why nominal GDP level targeting might not be as much of a threat to financial stability as some of its detractors worry about, is that it helps keep the economy up off the zero lower bound. In other words, when the economy is in a downturn, and the central bank has to lower interest rates to get it out of the downturn, if interest rates go all the way to zero, then it has to confront a series of really challenging questions about what to do next. Maybe negative rates in some parts of the world. In other parts of the world, like the US, that might not make as much sense, but it's harder then. It has to turn to other tools.
Your argument is that with NDGP level targeting, we're much less likely to get to the zero lower bound in the first place. Why is that?
Beckworth: Because it creates expectations that would incentivize the public, the markets themselves, to do the heavy lifting. Let me explain that. Let me also say, this is predicated on credibility, which is I think the first question we've got to get to at some point.
Garcia: Yeah, yeah, yeah.
Beckworth: Assuming this target is credible ... In other words, assuming you and me, and all our listeners believe that is going to hit five, six, whatever the target is, percent growth, then we are unlikely in the first place to get to the point where we begin to hoard money, begin to want to buy more treasury securities. That's what leads to liquidity traps, and ultimately zero lower bound problems, is the public. Households and firms switching out of riskier assets into safer assets. The amount of spending collapsing.
Garcia: It pushes down interest rates.
Beckworth: Yeah, it pushes down interest rates.
Garcia: There's a shortage of places in which to put all that savings that people want to hoard.
Beckworth: Right. All of us wouldn't be rushing to the treasury market. Instead, we would know, hey, we're not going to get to that point, so there's no need for me to rebalance my portfolio towards safe assets in the first place. As a result, we, the public, tend to do the heavy lifting. It makes the job easier for the Fed, and for government to stabilize the business cycle. Again, all premised on credibility.
Garcia: Yeah, all premised on credibility. One final point about financial stability. You actually did a bit of empirical work on this, about the relationship between NDGP level targeting, and financial stability. You've also pointed to the example of Israel, which has a ... Not formal, but de facto NDGP level targeting ...
Garcia: …and its effect on financial stability. Why don't you take us through that work and what you found?
Beckworth: Yes, I looked at 21 advanced economies for a paper I presented at the Cato Monetary Policy Conference. It's in print now. I asked this question. Given all the arguments we've just made for how nominal GDP targeting advances financial stability, it must be the case that those countries who went through the Great Recession, the great financial crisis, and saw, by luck, their ... Maybe by plan, but many cases, by luck, because no one has targeted NDGP explicitly.
For whatever reasons, their nominal GDP targets stay closest to the trend path through the crisis. This argument about financial stability should imply they had a less severe financial crisis, if one at all. If what I'm saying is true, and those countries that, for whatever reasons, maintained stable total spending should have seen less financial stress. Of course, there's a causality question here. What causes what? I make an effort to deal with that in the paper.
What I find is, yes, that's quite the case. If you look at private credit growth, broad money, housing prices, stock prices, equity premium, non-performing loans, across 21 advanced economies, they tend to be more stable ... They were more stable during the Great Recession. There's some extreme cases. Spain, on one end of the spectrum, massive collapse in nominal income. Of course, largely beyond their control. They don't have their own central bank, some bad austerity policies.
Garcia: Stay on target, David. Stay on target.
Beckworth: Okay. Spain's the one extreme example. The other would be Israel, going to Israel. Israel, it's an amazing story. Since 2008 to the present, if you were to look at nominal GDP, it's practically a straight line going up. This is not, again, by design. This is what falls out of the way they do things there. They actually have an inflation target range, one to three percent. If you look at their inflation, as measured by the GDP deflator, it's almost a mirror opposite of real GDP, which is what a nominal GDP target will look like. They had an amazing run this past decade.
Now, they too were subjected to the great financial crisis, but had a much milder experience. One last example, if I may, on this. Australia ... I think Australia may be even a better case. Australia had large amounts of household debt. They had housing prices through the roof. Still do. You did a show on Australia. I remember this. I was listening to your show on this. There's a lot of things you could contribute. Luck, the export commodity prices, a lot of things going on there. One thing they did right, at least during this period, nominal GDP was stable.
I want to speak to you on the whole commodity point there. It's true Australia had a commodity boom in, I think, 2008. In 2009, it was a commodity collapse.
Garcia: Right, but ... Okay. We probably should get into Australia for this episode.
Garcia: I think the argument for what happened with Australia during the great financial crisis was that, first of all, they had protected their banking system a little bit better than other countries in the west. Right?
Garcia: Second, China was a big source of demand for Australian goods during the great financial crisis and the period after ... Because the Chinese government had stimulated the Chinese economy. Right? They were still buying a lot of Australian products.
Garcia: That's the luck factor. Right? They also had pretty powerful counter-cyclical policy, probably more powerful than in the US, and that is the skill factor, I guess is what you'd call it.
Beckworth: Yeah, yeah. They did some things right and they got lucky. No doubt about it. The point is this. The evidence suggests, collectively, if you have stable spending, stable incomes, you tend to have stabler financial systems.
Garcia: Okay. Last question while we are still assuming the central bank can hit that target.
Garcia: Okay? You make the point that there was a long period of un-anchoring, or essentially, nominal GDP level targeting was not being followed de facto in the United States, where instead, it seemed like there was a long period where it was just going way above the path that could have been followed.
Garcia: In other words, if you assume that the US central bank should have been targeting, I don't know, five percent nominal GDP growth each year, there was a long period ... I forget, of decades heading into the 1980s, where it was just way above that. Right?
Garcia: That was followed by a re-anchoring period, from roughly the mid-1980s until the financial crisis, where I think nominal GDP growth was stabilized at about four percent throughout that period. So far, I'm right, yes?
Beckworth: Yes, yes, yes.
Garcia: You agree with all that?
Beckworth: Yes, absolutely.
Garcia: Okay. That period still ended in a great financial crisis, and one of the arguments, one of many arguments for the causes of the financial crisis, was that long periods of stability are very often followed ... This is the Minsky argument, by a period of mass instability. That period of stability essentially inculcates a lot of behaviors in which people expect that stability will last forever, and so they take bigger and bigger risks. The risks build up in certain ways, and then eventually there's a big collapse.
My question is, if we in fact are successful, and we stabilize nominal GDP growth along some targeted path, won't those risks still build up over time, and then you're still going to have to deal with a big calamity at some point?
Beckworth: Oh, absolutely. There's always that possibility, and for sure, we see ... I see this behavior in my own life. Things go well, I get lazy. I take things for granted. I think that's true collectively as a society. The question is, what monetary policy system is the most robust to handle that buildup of imbalances? Even if we create another problem, another buildup of imbalances, what would you want to have in place to handle it? I wouldn't want inflation targeting around, because it would make it worse. For the arguments we laid out earlier, nominal GDP targeting would actually handle it better.
If we did have a buildup of leverage again, nominal GDP targeting would ensure there would be nominal incomes to maintain the payments on the mortgages, on the debt, but moreover, it would provide that more equitable share of risk between debtors and creditors. I guess I would push back again, against the very premise of that question. It's true, but maybe ... And you know this, I make this story other places, this argument other places, to some extent, it was bad monetary policy in 2008 that made things as bad as they were. We were highly-leveraged, but it took a bad monetary policy on top of it to put us where we were.
Garcia: An excessively tight monetary policy.
Beckworth: Yeah. Yeah. It wasn't the Fed by itself, but it was a combination of bad ... It was a perfect storm, and the Fed was one part of the story, and the ECB.
Garcia: Yeah. I think it was the 2011 rate hikes by the ECB.
Beckworth: Oh, ECB ...
Garcia: It'll probably go down in history as the all-time boneheaded maneuvers.
Beckworth: Oh, yeah, yeah. They are the poster child for bad moves.
Garcia: Okay. Okay. So much for the part of the conversation where we assume that this works, that nominal GDP level targeting, that framework can actually be achieved by a central bank. Let's talk about whether, or not the central bank actually has the tools to do that. Here's where I think some of the more compelling criticisms of NGDPLT arise. Okay?
Let's start with this. You write in your paper, "A credible NGDP level target would lead to the public doing most of the spending adjustments needed to keep NGDP on its target growth path."
In other words, this idea relies on expectations being met, and to some extent, fulfilled by the public. Why don't you just start by explaining how that works?
Beckworth: Yes. It's like I mentioned earlier. If you believed the government, the central bank, had the backstop to all activity in the economy, they weren't out there actually doing it, but they were there threatening, look, if you don't deliver, if the private sector crashes, we're here to step in. If you believed that, and you took it seriously, you wouldn't hoard money, liquid assets, in the first place. That's the main idea. We wouldn't all race to buy treasury securities if we knew the Fed would step in, and push the economy back up.
The key is, it's an incentive idea here, that we will act a certain way, we won't spend too much, we won't spend too little, because we know if we do, big daddy Fed's going to step in.
Garcia: Let me try to take a real world approach to explaining that.
Garcia: In other words, same thing that you said, but fewer references to hoarding liquid assets, and things like that.
Garcia: This is how I interpret your line of thinking on NGDPLT. Right? If it looks like there are storm clouds gathering for the economy, and I'm a business or a household, I might be, if I'm a household, tempted to start saving money because, oh my God, what if I lose my job, and I still need to pay rent, and I still need to send my kids to school. I'm going to stop buying things in the economy. I'm going to start saving money. That's bad for economic growth.
If I'm a business, I might be worried that there aren't going to be people there to buy my products, because the economy's about to take a big hit. I'm not going to invest in the kinds of buildings, and equipment, and research and development needed to make my product, and to make the making of the product more efficient from year to year. It's going to be bad for everything. Right? That's bad for the economy too, because businesses are producing less, and they're saving their money. Okay?
In both cases, business and households, you have people saving money, and that leads to a downturn. What you're saying is, that under NGDP level targeting, if it's a credible framework, if businesses and households believe that the Fed's going to step in, and it's going to keep the economy growing, then households aren't going to be as worried about losing their jobs. They're going to keep spending their money as they were before.
Garcia: Businesses might not be as worried about the possibility that nobody's going to be on the other end waiting to buy their product. They're going to keep making their products, they're going to keep investing in the making of their products, they're going to keep competing with their rivals. Right? That is more or less what NGDP level targeting says.
Beckworth: Thank you for stating that so much more eloquently than I could. Yes.
Garcia: But that's ...
Beckworth: That's it.
Garcia: That's it? Yeah. Okay. Here's where we, I think, we need to start critiquing this a little bit. Okay? I think you can find some pretty good evidence that when the central bank lowers interest rates, when it deploys its tool kit, that it does have an effect on the housing market. Right? It lowers mortgage rates, people find buying houses more attractive. Right? That's one thing. It does seem to have an exchange rate mechanism, where it weakens the value of the dollar.
Garcia: Which makes it easier to export goods, and that's good for the economy. Right? I think those things are true. It does seem to have an effect on the stock market. There might be a wealth effect. People might feel like they're richer, and they'll keep spending money. The question of whether, or not is has an effect on businesses, and on investment, seems a lot more contentious. That seems a lot more debated to me, that this expectations channel can be frustrated when it comes to companies. Right? That when the Fed suggests it might lower interest rates, companies don't necessarily amp up their investment. They still wait for people to say, "Yeah, I want more of your product."
This is a place where I think NGDP level targeting might not work as well as its advocates suggest. What do you say?
Beckworth: I think that's a great question. I think, empirically, we don't know. I think theoretically, I think it would work. You're looking at the past decade. A lot of this evidence comes from the past decade. The Fed tried to stimulate the economy with QE, with lots of programs. That's what you're referencing, right? A lot of the evidence in the past decade?
Garcia: I've seen, for example, I think ... God, I don't have it with me now.
Garcia: Attempts to ask companies how they make their decisions. Right?
Beckworth: Oh, based on interest rates?
Garcia: Exactly. Asking CFOs or other managers. Right?
Beckworth: Right, right.
Garcia: How do you make your decisions? I don't think the responses they give have much to do with monetary policy. They have to do with whether, or not they think people are there to buy their products.
Beckworth: Yeah. I guess I would see nominal GDP targeting actually as a way to reinforce that point. The goal is to get households spending again. The goal is to get spending to where it needs to be, to get robust demand growth, which we haven't seen with inflation targeting. The question is, can the Fed get households to spend, and therefore get businesses to invest?
Garcia: A second order effect, in a sense.
Beckworth: Yes. Yes.
Garcia: Businesses are following the demand, and lowering interest rates has an effect on households, and eventually that will translate into businesses investing.
Beckworth: Right. Right. Interestingly enough, you may recall back during the Great Recession, the year or two after that, the National Federation of Independent Businesses, they track small, medium-sized businesses. They have this survey, what's the number one concern? They look at regulation, taxes, labor. It was sales. They cannot find enough sales. Interestingly, if you look at that series, the sales concern for these small businesses, it's the mirror opposite of the unemployment rate.
The thing is, if you can get households spending, there will be this knock-off effect, I think, on firms’ expectations. You're speaking to the instrument. You adjust the interest rate to get to the goal of nominal GDP targeting. That's where the question is, I think.
Garcia: Yeah. My question, I guess, is whether or not it's the case that these expectations will actually be born out, or will they be frustrated? The idea that if the economy takes a swoon, that businesses will make the rational decision, or even households in some cases, that well, the Fed is there. They'll fix it. They fixed it in the past. I'm good. I can keep going. I don't have to save my money. I can keep spending my money. Right?
It seems possible to me that those expectations can, in fact, be frustrated. At that point, you've got a problem if that's what happens.
Beckworth: Right. Let me go back to what I was saying earlier. I think a lot of the discussion on this particular point relates to the past decade. I would answer the question this way, and I'll come back to this past decade. Above zero lower bound, I think the Fed can use normal monetary policy, if it wanted to, to generate powerful expectations in terms of managing aggregate demand. Below zero, not so much. Above zero, I think the challenge is, the inflation targeting itself. I have made the argument, as you know, the Fed has been effectively too tight this past decade. Part of that-
Garcia: Me too, by the way.
Beckworth: I know, I know. I think part of the problem is, the curse, or the success of inflation targeting, we've built in such low inflation expectations, it's hard for central bankers to see two percent as anything but a ceiling. It's not just the day to day changes in interest rate, it's the expected path, what they're going to do over the medium, the long-term that shapes demand. I think part of maybe the response on these surveys is a symptom of the fact that the Fed doesn't want to run the economy hot. We're confusing interest rate movements with the level of heat, or expansion, the Fed would tolerate.
My argument ... I guess my response to that point is, in a different framework, we would see different responses to the questions, above zero. However, below zero, there is a real question on how effective this would be.
Garcia: Okay. I want to go to the next point here, which is about public understanding of what a nominal GDP level target actually is. It does seem to me that with inflation targeting, at least people can understand, hey, prices are going up. It costs more to buy cereal at the grocery store, or whatever. That's a bad thing if it gets out of hand.
Garcia: And the Fed has to step in, and lower the prices. Or on the other side of that, if the economy's doing really badly ... I know, because I don't have a job, or I'm struggling to find a job, or to get a raise, I can understand then that the Fed has to step in and make things better. The phrase NGDPLT, it sounds like a mild and harmless, but kind of embarrassing rash that needs three weeks of antibiotics ... You know what I mean? To heal.
Garcia: It just sounds weird. Explaining it is not easy. If the public doesn't understand exactly what it is, how is that they're going to align their expectations with a central bank that's trying to follow it?
Beckworth: That is a great question I get all the time, and that's why I actually don't prefer to call this nominal GDP level targeting. I do ...
Garcia: What do you call it? The ninja target? Something easy?
Beckworth: Oh, that would be really cool.
Garcia: I don't know ...
Beckworth: I actually like to call it total spending, or current dollar spending target.
Beckworth: Something that's a little more accessible. In this paper…
Garcia: Yeah, it's already there.
Beckworth: …I have to use a term that the Fed's going to understand, that practitioners will understand. If I explain it to my family, or people in my hometown, I would say, "Look, the Fed's job is to stabilize total spending in the economy. That's the amount of money, how often it's used."
That's how I explain it. If I really have to go beyond that, then I'm smart. I pick my audience. If I'm talking to a labor group, I say, "Hey, the Fed is trying to stabilize your incomes. The average income, not all of ours, but on average."
If you're speaking to a retail group, the manufacturers, the National Federation of Independent Business, "Hey, we're here to stabilize sales."
They key is to speak to them in a language they understand. I think this is an easier argument to make, actually, than inflation. If I may, Ben Bernanke, 2011 ... 2010-11, QE2, before Congress. They're asking him, "Why are you doing QE2?" He goes, "Well, I want to get inflation up. It was one percent. I want to get it to two percent."
What? Why would you want to get inflation up? The economy's taking a hit. You want to further a road with what remaining wealth we have? What he really meant was, I want to get total income up. I want to get total demand up. Had he said that ... I want to get total sales up. Had he said that, it'd be a whole lot easier sell to make. I think that's actually an argument in favor of nominal GDP level targeting without saying nominal GPD level targeting.
Garcia: Every single time. Wish I'd known that 40 minutes ago, before we started chatting.
Beckworth: Right. Right. Right.
Garcia: I would have called it something else. No, I can understand that. By the way, I buy the idea that it's maybe hard to imagine a nominal GDP level target being something that everybody accepts, because it's not there now, but that once you ... If you were to ever introduce the framework. But then, it takes hold, and it's easier to imagine because then it's there.
Garcia: In other words, sometimes acceptability is something that comes over a time, and it's hard to envision before then.
Garcia: It's a psychological thing.
Beckworth: I have been asked good questions along those lines, like people don't know what nominal GDP targeting is, even if you use these terms more ... User-friendly terms, which is fair. Most people don't know what inflation targeting is either. I remember Colin Roach once said on the blog. He goes, "David, you know, I'm not going wake up at 5:00 AM tomorrow morning, and wake up and say, woo-hoo, five percent nominal GDP level target, go to work!"
You know? Most people won't. I agree. Most people do respond to the symptoms and the signs they see around them. The Fed's going a good job, because of this framework, they'll see opportunities for work, opportunities for growth, opportunities for new business formations. For the average person, you may not need to communicate explicitly what this target is. Maybe you do, in some cases. For many people, it's just the sense of optimism in the economy.
Garcia: Okay. Next question, okay? Targeting the forecast. Okay? There is a delay on getting nominal GDP or nominal income numbers for the whole US economy.
Garcia: Sometimes these numbers are revised for years. Years later, they get revised. Sometimes those revisions are not trivial.
Beckworth: Oh, they're huge. Yeah.
Garcia: Okay? They can be. Right? And so, the question is, if the Fed is targeting nominal GDP, how does it know it's doing a good job if, in fact later on, the numbers might change?
Beckworth: One answer is targeting forecast, as you suggested.
Garcia: Yeah, but explain that. I meant that to introduce the topic.
Beckworth: Okay. Okay.
Garcia: Get us there.
Beckworth: You can get forecasts of nominal GDP already. For example, there's the Blue Chip Forecast, a monthly forecast of nominal GDP a year ahead. There's the Survey of Professional Forecasters. I think if the Fed were to adopt it, they would probably put a lot more resources into getting additional forecasts. You could take forecasts of where nominal GDP is going and target that. Instead of trying to target where we are today, target where we think nominal GDP is going to be. If the public is expecting nominal GDP to be at, say, three percent growth and you want five percent growth, then that's a sign to ease.
You can imagine something like a Taylor rule, which for our listeners who don't know, it's a reaction function, a way to set interest rates according to some indicator ...
Garcia: I'm sorry, I'm laughing.
Beckworth: Too technical?
Garcia: The expected wonkiness of your listeners is really impressive. You're like, "It's just sort of a Taylor rule. Don't worry about it."
Beckworth: Yeah, yeah.
Garcia: Right. And then you said, as an explanation, that it's a reaction function. Look, you have to break this down a little bit more for us.
Beckworth: Okay. Okay, so ...
Garcia: What you're saying is that it's following a rule, so that ...
Beckworth: Right, right.
Garcia: If, in fact, there's a deviation from the nominal income trend, the Fed then has to do something that's not automatically triggered. It has some discretion over how it pursues getting it back to target, getting it back on trend.
Beckworth: Right. Right.
Garcia: But it has to try.
Beckworth: Right. It needs to respond, in some systematic manner, to deviations of nominal GDP from its desired forecasting paths. Next year, we want nominal GDP to be five percent higher. It's not looking good. We're going to respond to it.
Garcia: Okay, that's interesting. I want to close this part of the conversation by bringing up something that you suggested some years ago.
Garcia: Where you said that if, in fact, the tools that the central bank has, like lowering interest rates, or buying assets, quantitative easing, are not enough to stabilize NGDP back to target. Okay? In other words, if in fact, in the first place, expectations are frustrated and people don't behave in such a way as to keep NGDP on trend, and if the tools that the central bank has to enforce that credibility are also not enough, that you would be open to the possibility of a fiscal backstop of the Treasury Department being involved, and partnering with the central bank, and basically sending money directly to people. Right?
This suggests that even your faith is a little bit in doubt about this expectations part of NGDP level targeting.
Beckworth: Am I losing my religion, Cardiff?
Beckworth: Yeah. I think the way I can circle this, is to say, ultimately the backstop of the Federal Reserve is the federal government. Think of the Fed's balance sheet. If something were to happen to it, who would bail it out? I would be the US Treasury. Well, who bails out the US Treasury? It's taxpayers. How solvent is the government. Ultimately, the power of the Fed is tied into creation of government liabilities. I still hold that view. In fact, I'm writing a paper right now where I argue we should think about it very seriously. I am concerned with the downward march of interest rates across the world, and some of the legal restrictions the Fed faces now, that it could very well be powerless in the next recession.
If you think of QE, large scale asset purchases, what if the tenured treasury's already at zero percent? Yeah, I could go buy 20 year bonds, but there aren't as many. It can't buy equities, and it's limiting other assets. I think it's something we should be thinking about before we get to this, but even if we don't get to it, yes, the credibility of the rule would be improved if you had a treasury backstop. Let me use an analogy here. This will date me, and you've heard this before. Our friend, Nick Rowe ...
Garcia: You're going to date me now, too. Right.
Beckworth: You're younger than I am. Nick Rowe, our friend from the blogosphere, and he's on Twitter, too. Great Canadian economist. He often compares the central bank to Chuck Norris.
Beckworth: You know, Chuck Norris walks into a room and says, "Get out." You don't argue with Chuck Norris. You get out. He'll kick your hiney in a major way. You walk out. He just says something, you do it. That's his idea of the central bank. The central bank says, "We're going to have five percent nominal GDP growth."
It happens. The public believes it's credible. What you're suggesting is, maybe we think Chuck Norris is getting a little old. We don't trust him as much. Chuck Norris says, "Look, my buddy, Jean Claude Van Damme is outside here." Well, who's he, other than being another old 80s martial arts star? Just imagine them in their prime. This story works better if they're in their prime, okay?
Beckworth: Chuck Norris in his prime, Van Damme in his prime. Van Damme is the treasury. If you got the Fed and the Treasury threatening, you're going to get out of the room quickly. And so, you may never have to use the helicopter drop, but just knowing that it's there makes the Fed's power more effective.
Garcia: It adds to the credibility.
Beckworth: It does. It adds. You've got the full backstop of the consolidated balance sheet of the US government. I think that makes a huge difference. Again, you would probably rarely have to actually tap in to it. It's just the threat of tapping into it.
Garcia: What about distributional issues? It is the case that, right now, the main enforcement mechanisms that the Fed has, and the central banks have, is still just tinkering with interest rates, either the overnight rate, the short rate, or as in QE, buying assets and altering the rates of longer-term assets. Right? If you're tinkering with interest rates, you're trying to incentivize a combination of businesses and households to borrow money, and you're hoping that banks will be confident enough to lend that money because if the economy keeps growing, then they'll know that they'll get paid back. Right?
That's trying to influence actual behavior via tinkering with interest rates is still what the Fed has at its disposal right now. Whereas actually getting money directly to households seems like a much more direct channel, by which to influence economic behavior. It's actual money that people have right away. And so, I guess my question is, within an NGDP level targeting framework, wouldn't it be a lot more credibility-enhancing if there were some way of doing direct transfers to households, rather than the interest rate tinkering that we have right now?
Beckworth: Getting money directly to households, to me, is not the answer for credibility. It does address equitable concerns that you've brought up. I can imagine a scenario where we do helicopter drops directly to households, but it's tied to, say, an inflation target. Helicopter drops wouldn't make much difference in that context. If we send checks to everyone, and the Federal Reserve began to panic when inflation got close to two percent, and hit the brakes ... Let's say the Treasury is sending checks on one hand, and the Fed begins to tighten on the other hand, you get in the problem ... In fact, Japan, 2001, 2006, had a QE program, and massive budget deficits. Did not get out of the stagnation it’s been in.
What is key is to do the helicopter drops and tie them to a level target. Icing on the cake may be it's more equitable, yes. In terms of effectiveness, to me, the key is a level target, which promises a return, a reflation, tied to credibility of the backstop of a helicopter drop. That's the key pieces of the puzzle, in my view.
Garcia: Okay. I have one last question of mine, and then we're going to do a couple of Twitter questions before we close.
Beckworth: Yeah. Okay.
Garcia: My last question is, to go back to the question of how NGDPLT handles negative supply shocks, but not a temporary negative supply shock, and not just a potentially permanent negative supply shock, but a negative supply shock that is both permanent and gradual, so that over time, for example, maybe because of demographic trends, maybe because of things happening elsewhere in the world, right?
Garcia: The potential growth rate of the US economy is gradually shrinking. Okay? Now, you put forth two recommendations from other scholars in your paper. You don't put them forth yourself, you list them. Right?
Garcia: One, which I think came from Jeffry Frieden, is that every five or so years, the Fed would have to change the targeted path. Right? You don't seem to like that very much, because that means there might not be as much credibility for the current path if people know that it might change. Right?
Garcia: The other one, which comes from your occasional co-author, George Selgin, is that it's fine. That it's okay to just accept, for example, lower real growth and slightly higher inflation over time. Which is better, and how should we think about it?
Beckworth: On a practical level, probably the first option is the way to go, because most people do have that concern. In fact, if you'd have asked me what's the biggest concern I hear about nominal GDP targeting, it's either communication or this one. Changing potential real GDP, or these permanent shifts. I think that's a practical matter, if you wanted to get nominal GDP level targeting implemented. Probably some kind of compromise, where we do update the target gradually. I think there's ways to do it ... You can balance credibility with changes. In an ideal world, I probably would go with George Selgin's approach, for this reason: By the time maybe a central bank is certain of the change in trend real GDP, it may have caused change in inflation expectations that have gotten baked into contracts already.
To make this concrete, let's say we're growing at two percent real GDP growth, and next year we hit three percent. Oh, this is great, but is this permanent? Is this another temporary increase? Well then, two years later, three years later, four years later, we still have three percent real growth. It's permanent. By the time we come to that conclusion though, inflation would be significantly lower, people would have adjusted, and now the Fed's going to tinker with the target. That, to me, presents problems.
I don't think the cost of not doing anything is that high. I gave this example in the paper. What if it had done something like this since 1960? Right? We've seen a lot of change in potential real GDP. What if they had done that? What would have happened to inflation? In the short term, yes, inflation would have been more variable, but it wouldn't have seen the huge swings in inflation. 1970s, no great inflation. We would have gone from one percent inflation to about four percent inflation, what we would have seen. On average, about two percent. You would have had, again, over the long run, stable inflation, a little more variability of inflation.
If you take the Selgin approach, variability is allowed, but you still get long run inflation stability. Now, if the AIs come, maybe that's a different story. We get rapid, rapid, rapid real growth, we'll come back and adjust our target.
Garcia: Aliens, not AI. More likely, in my opinion.
Beckworth: Aliens. Okay.
Garcia: Okay, cool. Let's do some Twitter questions real fast.
Beckworth: All right.
Garcia: Okay. These were good. These were harder questions than what I just asked you.
Beckworth: Oh, great.
Garcia: You survived the Garcia first portion of this interrogation.
Beckworth: Buckle my seatbelt here.
Garcia: Exactly. Here we go. Okay. Here is the first one, and this comes from Twitter user, Monetary Wonk. Why would nominal GDP targeting be superior to wage growth targeting, which is what Sam Bell proposed? I should also note that Sam was on Macro Musings, along with Skanda Amarnath.
Garcia: They support a gross labor income growth target, not a nominal GDP level target. In other words, they support targeting the money that goes to rewarding work, to workers only, not national income writ large. Why is NGDPLT better than that?
Beckworth: I'm actually very sympathetic to a labor income target. I think for practical political reasons, nominal GDP targeting is an easier step forward.
Garcia: Easier to explain?
Beckworth: Easier to explain, it's easier to do, I think, to implement. If you go down a labor income target path, there's a whole lot more details to work out, arguments over what measure, and you are leaving out capital income. I do think an easier transition would be nominal GDP targeting. I think you can make a good theoretical argument for a labor income target. Maybe that'd be the long-run goal. Nominal GDP level targeting would be the intermediate.
If you look at actual data, if you followed one or the other, they're very similar. There'd be some deviations, but they're very similar.
Garcia: I thought your response to this was pretty compelling. You basically posted a chart showing that they follow almost exactly the same path.
Garcia: National income follows almost the same path as labor income.
Garcia: I remember that Olivier Blanchard responded by saying they weren't the same thing. Sam Bell said that was basically an AEA president throwing it off the backboard, and dunking on you. Right?
Beckworth: I got the LeBron James dunk on me, yes.
Garcia: And you posted the chart, and that was basically it, as far as I'm concerned. Okay. Interesting. All right. Next one comes from Timothy B. Lee. This was an interesting question. Do you care more about the NGDP part or the LT part of NGDPLT? In other words, if you had to choose between a price level target, or targeting annual NGDP growth, but not the level target, which would you prefer?
Beckworth: That is a hard question. I'm not sure I can give a definite answer. Here's why. You have to ask what is the greater risk? Is it hitting the zero lower bound more often? If that's the case, then any kind of level target will do. Or is the greater chance of having a bunch of supply shocks? If supply shocks are the biggest threat we face, and that's for, again, the aliens, the AI, if that's the case, then we need nominal GDP growth target. That'd be wonderful.
If we were going to be stuck at the zero lower bound a lot, and I think there's good arguments that we may be, if we see the long terms rates trending down, then any level target will do. I'm going to waiver on this and say, let's take it as it comes. Let's see what happens.
Garcia: Okay. Cool. This next question, we actually got a version of this question from two different people on Twitter. Michael Madowitz, and Zach Gross. I'll use the Zach Gross version of the question. In practice, inflation targeters focus on measures of core inflation, as the headline numbers have idiosyncratic noise from non-monetary factors. What would be, if there is one, the equivalent for NGDP level targeting? In other words, is there an underlying NGDP that the central bank would focus on?
Beckworth: Ah, very nice.
Garcia: This is an interesting question, because there are some parts of nominal income that might not be effected by aggregate demand or monetary policy.
Beckworth: Yeah. In the case of the US, it's a question we often disregard because we're a big economy, not as open to the world trade as a small, open economy is. If you look in the literature, there are actually different versions of this, besides the labor income one. Another prominent version of this is final sales. Look at nominal final sales, which excludes exports and imports, and also, I think it takes out inventories. It's a domestic demand measurement. You can do that route.
Where I think this really becomes more consequential, however, because that wouldn't be that much different than nominal GDP for the US. You go to smaller economies. Jeff Frankel, he actually argues a pure nominal GDP target is actually more consequential, more useful for a smaller economy, which I was a little surprised. I thought it'd go the other direction. Scott Sumner actually argues different. I'll mention Scott's position in a minute. Jeff Frankel says, "Look, if you have a small developing economy, medium-size economy, and they've got credibility problems, they can't maybe control a printing press, and they want a rule that does it, and they also face a lot of supply shocks, then you should actually go with a nominal GDP target. He gave the example of India. India's actually a little bit larger.
They have monsoons. They have wars. They literally face a real business cycle environment, more often than not, compared to us. You need a system, a rule, that can deal with that. He would argue they actually would work better. Scott Sumner actually responded to those articles that Jeffery Frankel's written. He's written several that make that argument.
Scott says it's better to target labor income. I'll give an example. I think this would be a really, truly compelling case. Norway. If you look at nominal GDP for Norway, these huge swings, and it's all the external sector. If you look at domestic demand, it's a whole lot stabler. I think you want to target that. Look at labor income. Maybe some kind of domestic demand measure.
Garcia: Okay. David, we're actually out of time, man.
Beckworth: That was fun.
Garcia: Didn’t that go by quickly?
Beckworth: Yeah, yeah.
Garcia: It wasn't that painful, was it?
Beckworth: No, just a few scars here and there, but I'm good. Thank you, Cardiff.
Garcia: Again, this paper is published by the Mercatus Center. It's called *Facts, Fears, and Functionality of NGDP Level Targeting: A Guide to a Popular Framework for Monetary Policy*. I'm telling you, you just need to work on the branding here. You need to work on the titling. Right?
Beckworth: Yeah, yeah.
Garcia: You need something more. Something a little sexier.
Beckworth: Something that my dad would read, right?
Garcia: Yeah. Exactly. David, this was fun.
Beckworth: All right. Thanks.