Friday, December 30, 2011
Thursday, December 29, 2011
As for the Republican nomination, I now support my second choice--Ron Paul. My former third choice, Jon Huntsman, now moves to the number 2 position. The South Carolina primary is coming up fast!
While Ron Paul's foreign policy views are more dovish than my own, unlike most of the other Republican candidates this year, he is pointing in the right direction. The U.S. should have withdrawn from Afghanistan (and Iraq) years ago, and war with Iran would be an expensive mistake.
Paul is calling for cuts in the level of federal government spending. I agree that the U.S. government spends way too much. While I don't think $1 trillion cuts in one year are realistic, the rapid increase in government spending and deficits in the Bush and Obama administrations makes these heavy cuts consistent with my usual rule of thumb. Cutting net federal outlays to what they were at the beginning of the Obama administration (2008,) is a $600 billion cut. Ron Paul's $1 trillion returns spending to where it was in 2006, and still leaves a $300 billion deficit (given 2011 receipts.)
For the most part, I agree with Paul's views on personal liberties issues. For example, like Paul, I think Drug Prohibition is a mistake, for much the same reasons that Alcohol Prohibition was a mistake.
Why was Gary Johnson my first choice? I think his political resume as two-term governor is better than Paul's political resume as U.S. Congress back-bencher. On a more personal note, I think Johnson's resume as entrepreneur and mountain climber is great, but in a very different way, so is Paul's background as a medical doctor and family man.
Like Gary Johnson, I describe myself as "pro-choice" on abortion. In truth, I think government should not restrict early term abortions but that it should restrict late term abortions. Paul is strongly pro-life and favors having government outlaw all abortions. Worse, he emphasizes that issue and has sent glossy brochures to my house (and I presume to thousands of other South Carolinians who have voted in past Republican primaries) emphasizing his opposition to all abortions. It is clearly very important to him. Paul, however, does believe that any government suppression of abortion should take place at the state level. So, he opposes having the Federal government outlaw abortions in states that allow the practice.
Like Gary Johnson, I believe that the U.S. should allow more foreigners to come work in the U.S. (I even liked Gringrich's statement in opposition to deporting illegal immigrants who have been in the U.S. for years.) I think Ron Paul agrees. Like Ron Paul, I don't think the U.S. taxpayers should be forced to provide social services to immigrants. I even oppose "birth right citizenship." In 2008, I was a contributor and volunteer for Ron Paul. Like other South Carolina voters, I received glossy brochures on the immigration issue in the weeks leading up to the election. I didn't like what I saw. Ron Paul did get my vote.
What about monetary policy? As far as I can tell, neither Johnson nor Paul (nor any other Republican candidate nor Obama) have much to offer. I support Paul's proposal to audit the Fed. I support Paul's effort to protect the right of citizens to use alternative monies. (This is the core Hayekian monetary reform.) I even support ending the Fed. However, given our current level of economic knowledge, I would favor replacing it with a monetary authority that I suspect Paul would consider no better than the status quo. Still, I think the Federal Reserve, as an institution, just struck out. Strike one--Great Depression. Strike two--Great Inflation. And now, strike three--Great Recession.
Paul has been able to raise lots of money. He nearly won the Iowa straw poll and has a good chance at the Iowa caucuses. He is doing great! While I like Johnson better, most voters apparently disagree. I have met Ron Paul and he is a good guy. I hope that other South Carolinians will join me in voting for him on January 21st.
Thursday, December 22, 2011
Bernanke and Woodford describe a scenario where the central bank targets the consensus of private forecasters, which comes right out of Hall and Mankiw’s 1994 paper, “Nominal Income Targeting.” However, they cite Dowd (1994) and Sumner (1995) which propose pegging the price of a CPI futures contract. Interestingly, Bernanke and Woodford have little complaint with Svensson’s (1997) proposal.
They see his proposal as:
“the central bank’s internal forecast is prepared with the use of a structural model, but that the model and data on the current state of the economy are used to determine the policy action, that according to the model, should result in a forecast equal to the target.”
And what of private sector forecasts? They also write:
“a central bank can choose a policy that has the effect of keeping private inflation forecasts equal to the targeting without having the form of a “forecast targeting” rule, and it is desirable that it do so.”
Incredibly, they even believe that the central bank can use the private sector’s forecast of inflation shocks and potential output shocks to plug into their structural model, and so keep the private sector’s expectation of inflation on target (pp. 681-2.) They describe this in the context where the private sector is mistaken so that the central bank is sacrificing that element of inflation stabilization that it could provide by ignoring the private sector’s forecast and just using its own better estimate of inflation and potential output shocks.
They go on to explain (p.682):
“A version of the proposal might reduce the extent to which the central bank is required to stabilize incorrect private forecasts rather than inflation would be to simply require the central bank to give public testimony about the motivation of its policy stance, that might well include discussion of its own inflation forecast. Private sector forecasts that disagree with that of the central bank might well be matters that would require comment on the part of the central bank, but one could accept an explanation on the part of the central bank of how its own forecasts are made as sufficient demonstration of a good faith effort to achieve the inflation target.”
The Federal Reserve doesn’t exactly target inflation, but rather inflation and unemployment. After its most recent meeting, the Fed gave its internal forecasts of both, and explained that both would remain below target for an extended period of time. Perhaps Bernanke should review what he wrote four years ago.
Like most market monetarists, I reject inflation and unemployment targeting and instead favor targeting the growth path of nominal GDP. Replacing inflation with the target for nominal GDP, what Bernanke and Woodford wrote would be appropriate. The Fed should set policy instruments so that its internal forecast is on target. However, it should also be just a little bit less arrogant than Bernanke and Woodford imagine, and be willing to make some adjustments based upon what the “wrong” private forecasts suggest.
Is it really true that if the private forecasters plug in their values for inflation and potential output shocks into a “true” model of inflation and report that, the result is that the eigen value is within the unit circle and the inflation rate is indeterminate? (p.671)? I don’t think so.
The fundamental problem with Bernanke and Woodford’s approach is that they assume that all forecasters have one true model and true information. If so, the central bank should just pay one of the forecasters for this information. Or why not hire one of them in place of their current staff?
The reality is that no one, not the central bank’s internal forecasters or any of the private forecasters knows the true model or has all of the needed information. They disagree. The goal should be to somehow combine both the central bank’s own forecast with those of the private forecasters to generate a market expectation that can be utilized to adjust current market conditions such that the market expectation is that nominal GDP will be on a slow, steady growth path.
Saturday, December 17, 2011
Tuesday, November 22, 2011
The Committee also considered policy strategies that would involve the use of an intermediate target such as nominal gross domestic product (GDP) or the price level. The staff presented model simulations that suggested that nominal GDP targeting could, in principle, be helpful in promoting a stronger economic recovery in a context of longer-run price stability. Other simulations suggested that the single-minded pursuit of a price-level target would not be very effective in fostering maximum sustainable employment; it was noted, however, that price-level targeting where the central bank maintained flexibility to stabilize economic activity over the short term could generate economic outcomes that would be more consistent with the dual mandate. More broadly, a number of participants expressed concern that switching to a new policy framework could heighten uncertainty about future monetary policy, risk unmooring longer-term inflation expectations, or fail to address risks to financial stability. Several participants observed that the efficacy of nominal GDP targeting depended crucially on some strong assumptions, including the premise that the Committee could make a credible commitment to maintaining such a strategy over a long time horizon and that policymakers would continue adhering to that strategy even in the face of a significant increase in inflation. In addition, some participants noted that such an approach would involve substantial operational hurdles, including the difficulty of specifying an appropriate target level. In light of the significant challenges associated with the adoption of such frameworks, participants agreed that it would not be advisable to make such a change under present circumstances.
Yes, a price level target is a bad idea--big problems with supply shocks.
Yes, picking a growth path of nominal GDP is difficult.
But nominal GDP targeting results in stable inflation in the long run, so there should be no problem with inflation expectations becoming unanchored. That is the danger of inflation targeting. When the rule is to do nothing about inflation surprises, then there must be a constant worry about inflation expectations.
Not yet? Perhaps one day.
Sunday, November 20, 2011
But it introduces another problem: if an inflation shock takes the price level and thus NGDP above the target NGDP path, then the Fed will have to take sharp tightening action which would cause real GDP to fall much more than with inflation targetting and most likely result in abandoning the NGDP target.
Given the markets’ limited experience with very low interest rates, it is difficult to predict with any degree of certainty how they will react to them. If the types of disruptions described above turn out to be significant, taking steps to lower short-term interest rates could actually make financial conditions tighter rather than looser and thus hinder the economic recovery. To avoid this outcome, policymakers tend to choose policies that keep market interest rates positive.
In other words, the potential for negative interest rates to disrupt financial markets limits the extent to which policymakers can stimulate economic activity by lowering interest rates. This limit is known as the zero lower bound.
Money market funds operate under rules that make it difficult for them to pay negative interest rates to their investors, either directly or by assessing fees. Many of these funds would likely close down if the interest rates they earn on their assets were to fall to zero or below, possibly disrupting the flow of credit to some borrowers.
The auction process for new U.S. Treasury securities does not currently permit participants to submit bids associated with negative interest rates. If market interest rates become negative, new Treasury securities would be issued with a zero interest rate—effectively a below-market price—and bids would be rationed if demand exceeds supply. Such rationing, which has occurred in recent auctions, would generate an incentive for auction participants to bid for more than their true demand, leading to even more rationing. This situation could generate market volatility, as unexpected changes in the amount of rationing in each auction could leave some investors holding either many more or many fewer securities than they desire.
A decrease in the IOR rate would also likely affect the federal funds market, where banks and certain other institutions lend funds to each other overnight. A lower IOR rate would give banks less incentive to borrow in this market, which would likely decrease the amount of activity. When less activity takes place, the market interest rate will be influenced more by idiosyncratic factors, making it a less reliable indicator of current conditions. This decoupling of the federal funds rate from financial conditions could complicate communications for the FOMC, which operates monetary policy in part by setting a target for this rate.
Saturday, November 19, 2011
For this reason, as Amity Shlaes argues in her recent Bloomberg piece, NGDP targeting is not the kind of policy that Milton Friedman would advocate. In Capitalism and Freedom, he argued that this type of targeting procedure is stated in terms of “objectives that the monetary authorities do not have the clear and direct power to achieve by their own actions.” That is why he preferred instrument rules like keeping constant the growth rate of the money supply. It is also why I have preferred instrument rules, either for the money supply, or for the short term interest rate.