I too find Market Monetarism interesting. However, I find the discussion around it bafflingly incomplete.
I live in Britain, where legally the central bank (BoE) is supposed to target inflation at 2%. In actual fact, however, before the economic crisis the central bank had inflation consistently running well above its legal target. What it was doing, however, was keeping NGDP growing at approx 5.5% per year—and it had been doing so for over a decade. It was therefore generally thought that, letter of the law be damned, the BoE was in fact an NGDP level targeter, of exactly the kind recommended by Sumner et al.
Then 2007-8 happened, world financial crisis, bank failures, etc. NGDP collapsed despite (1) the BoE attempting to maintain NGDP and (2) the existence of the target. Moreover, despite the fact that the BoE continued its measures, NGDP did not recover to trend, and shows no sign of doing so. What is more, apart from a brief period in 2009, inflation has been well in excess of the BoE’s legal target throughout the period in question. At the time that NGDP was collapsing most sharply, inflation was over 5%!
This seems like a direct challenge to market monetarism. If the expectations channel is so effective at determining NGDP growth, how did expectations become unmoored? If the central bank really can determine NGDP, how did it lose control—and note that this is not a situation like the US, where MMs can genuinely argue that policy has been too tight. The BoE allowed high inflation rates and a massive devaluation of the currency (the £ lost around 25% of its value), but still could not get NGDP back to trend. Moreover, despite monetary policy in the UK being much more accomodative than in the US, economic recovery has been much poorer. Why has this been the case? Why has base money ballooned here, like in the US, but unlike in Australia?
I am not saying market monetarism is wrong as a theory, necessarily. But it needs to have something to say about this situation, because on the surface it appears to be a case of market monetarist ideas put into practice, and being a complete failure. However, market monetarists do not seem to have much to say about this, instead preferring to talk about cherry-picked examples—Britain pursued a much more market monetarist policy than any of Israel, Sweden or Australia, and has a larger economy than all 3 combined. Moreover, Australia in particular engaged in large-scale fiscal stimulus of the kind market monetarists say is unnecessary. The old joke goes that macroeconomics is the study of the American economy, and it looks particularly the case here. The issue has particular salience for me because I’m British, but even besides that, if a country puts your ideas into practice and it fails, you need to do some explaining.
Yes, I agree it is a good contrary case to consider.
My understanding is that an explicit target really hits it home. It makes things legal. It gives people the ability to plan things around it. Did the BOE draw a line the way the swiss central bank did at 1.2 CHF to EUR and should out “You will not Pass”? If it did and still this happened, I would be quite surprised.
You can check out Lars Christensen and Scott Sumner’s posts on Britain, as I will do the same.
As an aside, I myself live in a country (India) where nominal GDP growth is there, but practically nothing else for a healthy economy is there. I have no illusions that without serious regulatory and fiscal reform, India would not achieve the results of a good economic system—Supply side issues, not so much demand side.
Thanks for your interesting reply. I’ve read lots of Sumner (and to a lesser extent Christensen) but their discussion of Britain is fleeting at best.
How do you draw a line in the sand and say “you shall not cross” when it comes to NGDP? That is the whole question. If you are defending a currency peg, you have a clear policy tool (forex purchases) and you can see the effects of your interventions in an actively traded market. The SNB can check the CHF:EUR exchange rate at any time, and intervene in the market to sell CHFs and buy EURs as necessary, until the price adjusts—and reverse course if necessary. Note by the way that currency pegs are much harder to defend in the opposite direction; the SNB cannot print unlimited quantities of Euros to buy Swiss Francs.
However, when it comes to NGDP targeting, there is no clear tool and no immediate way to see the effect of your interventions. The quarterly GDP numbers are backward-looking and already out of date when they are printed. How can you prevent the line in the sand being crossed, when you can’t see if anyone is coming close to it until 4 months later?
Even this might be superable if there was a clear tool. If you want to keep the CHF:Euro ratio low, you print CHFs and buy Euros. If you want to keep the £:NGDP ratio low, you print £s and buy… NGDP? Except you can’t! You have to buy outstanding government bonds and then hope for various “transmission mechanisms” to take effect. But will this in fact do anything with interest rates at zero? Lots of people say otherwise (e.g. “liquidity trap”, “market segmentation”, “creditism” etc). In point of fact, the BoE was buying government bonds furiously and every quarter the NGDP numbers came in low. Meanwhile we had high inflation and a collapsing £, so it’s not like their asset purchases were doing nothing, it’s just that they weren’t raising NGDP.
This is what people like Cochrane mean when they say that they don’t believe the central bank controls NGDP. It’s not that nominal variables don’t have real effects, it’s that transmission mechanisms matter, and are complicated, and the MMs can’t just feign indifference. Why will these purchases raise NGDP, and not just asset prices? Zen masters like Sumner mock this kind of thinking as “people of the concrete steppes” and say that setting the target is enough? But if transmission mechanisms don’t matter, how do the expectations become unmoored? And if transmission mechanisms do matter, then how can you just blithely ignore them?
Now occasionally you’ll hear MMs respond to this with talk of a Central Bank-created NGDP futures market, which is essentially Hansonian futarchy. This might allow realistic feedback (but unfortunately does nothing to solve the lack of a tool). But you’ll note that none of Sweden, Israel and Australia have any such thing, so if this toy market is necessary to the proposal, then you can’t cite them as existing successes.
Four years ago I was a market monetarist (although in those days we just called it mainstream macro). Now I think that the cause of Britain’s problems is supply side. I am less confident about the US, but I would not be surprised at all if NGDP targeting proved a huge disappointment there too.
I was never in doubt about a determined central bank’s ABILITY to PASS a monetary target, not hit it like a bulls eye, but pass it like a tape at the end of a race. The runners keep running and may need sometime to slow down :)
A central bank can create a depression. Increase the rates to a level where no conceivable investment is feasible.
A central bank can create hyper inflation. Announce that you are willing to buy everything and start buying it. Somewhere along that route, measured nominal GDP would exceed the target laid out for it. So, the central bank can hit the target, by limiting its craziness.
My doubt in regards market monetarism was—is this a good thing to do, in the long run?
For supply side vs demand side issues, I guess the question to ask is if the productivity measurement is correct. If TFP is 1 % and you’re aiming at 6% NGDP growth, you’re just hurting the economy. Maybe, (don’t know for sure), britain was aiming at too high a growth rate.
I too have no doubt that the central bank can cause hyperinflation or severe deflation. The question is, can it thread the needle and get levels where it wants them to be? If during a velocity shock like 2007-8, the only way to get 5% NGDP growth is to alternate between 200% NGDP growth and −47.5% NGDP growth, then it seems like the cure is worse than the disease, in terms of providing the kind of stable monetary expectations that MMs agree are necessary for economic growth, investment, etc.
Suppose we have a patient with a fever (or pneumonia). The doctor is unable to stabilise the patient’s temperature. It’s true that if we throw her in an ice floe she’ll be too cold, and if we throw her in an oven she’ll be too hot, but that doesn’t prove that we can stabilise her temperature, and I sometimes feel that Market Monetarists are coming uncomfortably close to making this argument.
I doubt that there will be that much variation since even if you look at it, you are considering a sale of assets or a purchase. There are thousands of such transactions happening everyday. That range of fluctuations doesn’t happen. I’m not great fan of central planning, but I think that NGDP or nominal wage targets are possible to hit without a 100% variation.
I too find Market Monetarism interesting. However, I find the discussion around it bafflingly incomplete.
I live in Britain, where legally the central bank (BoE) is supposed to target inflation at 2%. In actual fact, however, before the economic crisis the central bank had inflation consistently running well above its legal target. What it was doing, however, was keeping NGDP growing at approx 5.5% per year—and it had been doing so for over a decade. It was therefore generally thought that, letter of the law be damned, the BoE was in fact an NGDP level targeter, of exactly the kind recommended by Sumner et al.
Then 2007-8 happened, world financial crisis, bank failures, etc. NGDP collapsed despite (1) the BoE attempting to maintain NGDP and (2) the existence of the target. Moreover, despite the fact that the BoE continued its measures, NGDP did not recover to trend, and shows no sign of doing so. What is more, apart from a brief period in 2009, inflation has been well in excess of the BoE’s legal target throughout the period in question. At the time that NGDP was collapsing most sharply, inflation was over 5%!
This seems like a direct challenge to market monetarism. If the expectations channel is so effective at determining NGDP growth, how did expectations become unmoored? If the central bank really can determine NGDP, how did it lose control—and note that this is not a situation like the US, where MMs can genuinely argue that policy has been too tight. The BoE allowed high inflation rates and a massive devaluation of the currency (the £ lost around 25% of its value), but still could not get NGDP back to trend. Moreover, despite monetary policy in the UK being much more accomodative than in the US, economic recovery has been much poorer. Why has this been the case? Why has base money ballooned here, like in the US, but unlike in Australia?
I am not saying market monetarism is wrong as a theory, necessarily. But it needs to have something to say about this situation, because on the surface it appears to be a case of market monetarist ideas put into practice, and being a complete failure. However, market monetarists do not seem to have much to say about this, instead preferring to talk about cherry-picked examples—Britain pursued a much more market monetarist policy than any of Israel, Sweden or Australia, and has a larger economy than all 3 combined. Moreover, Australia in particular engaged in large-scale fiscal stimulus of the kind market monetarists say is unnecessary. The old joke goes that macroeconomics is the study of the American economy, and it looks particularly the case here. The issue has particular salience for me because I’m British, but even besides that, if a country puts your ideas into practice and it fails, you need to do some explaining.
Yes, I agree it is a good contrary case to consider.
My understanding is that an explicit target really hits it home. It makes things legal. It gives people the ability to plan things around it. Did the BOE draw a line the way the swiss central bank did at 1.2 CHF to EUR and should out “You will not Pass”? If it did and still this happened, I would be quite surprised.
You can check out Lars Christensen and Scott Sumner’s posts on Britain, as I will do the same.
As an aside, I myself live in a country (India) where nominal GDP growth is there, but practically nothing else for a healthy economy is there. I have no illusions that without serious regulatory and fiscal reform, India would not achieve the results of a good economic system—Supply side issues, not so much demand side.
Thanks for your interesting reply. I’ve read lots of Sumner (and to a lesser extent Christensen) but their discussion of Britain is fleeting at best.
How do you draw a line in the sand and say “you shall not cross” when it comes to NGDP? That is the whole question. If you are defending a currency peg, you have a clear policy tool (forex purchases) and you can see the effects of your interventions in an actively traded market. The SNB can check the CHF:EUR exchange rate at any time, and intervene in the market to sell CHFs and buy EURs as necessary, until the price adjusts—and reverse course if necessary. Note by the way that currency pegs are much harder to defend in the opposite direction; the SNB cannot print unlimited quantities of Euros to buy Swiss Francs.
However, when it comes to NGDP targeting, there is no clear tool and no immediate way to see the effect of your interventions. The quarterly GDP numbers are backward-looking and already out of date when they are printed. How can you prevent the line in the sand being crossed, when you can’t see if anyone is coming close to it until 4 months later?
Even this might be superable if there was a clear tool. If you want to keep the CHF:Euro ratio low, you print CHFs and buy Euros. If you want to keep the £:NGDP ratio low, you print £s and buy… NGDP? Except you can’t! You have to buy outstanding government bonds and then hope for various “transmission mechanisms” to take effect. But will this in fact do anything with interest rates at zero? Lots of people say otherwise (e.g. “liquidity trap”, “market segmentation”, “creditism” etc). In point of fact, the BoE was buying government bonds furiously and every quarter the NGDP numbers came in low. Meanwhile we had high inflation and a collapsing £, so it’s not like their asset purchases were doing nothing, it’s just that they weren’t raising NGDP.
This is what people like Cochrane mean when they say that they don’t believe the central bank controls NGDP. It’s not that nominal variables don’t have real effects, it’s that transmission mechanisms matter, and are complicated, and the MMs can’t just feign indifference. Why will these purchases raise NGDP, and not just asset prices? Zen masters like Sumner mock this kind of thinking as “people of the concrete steppes” and say that setting the target is enough? But if transmission mechanisms don’t matter, how do the expectations become unmoored? And if transmission mechanisms do matter, then how can you just blithely ignore them?
Now occasionally you’ll hear MMs respond to this with talk of a Central Bank-created NGDP futures market, which is essentially Hansonian futarchy. This might allow realistic feedback (but unfortunately does nothing to solve the lack of a tool). But you’ll note that none of Sweden, Israel and Australia have any such thing, so if this toy market is necessary to the proposal, then you can’t cite them as existing successes.
Four years ago I was a market monetarist (although in those days we just called it mainstream macro). Now I think that the cause of Britain’s problems is supply side. I am less confident about the US, but I would not be surprised at all if NGDP targeting proved a huge disappointment there too.
Thanks for your patience and civility.
I was never in doubt about a determined central bank’s ABILITY to PASS a monetary target, not hit it like a bulls eye, but pass it like a tape at the end of a race. The runners keep running and may need sometime to slow down :)
A central bank can create a depression. Increase the rates to a level where no conceivable investment is feasible.
A central bank can create hyper inflation. Announce that you are willing to buy everything and start buying it. Somewhere along that route, measured nominal GDP would exceed the target laid out for it. So, the central bank can hit the target, by limiting its craziness.
My doubt in regards market monetarism was—is this a good thing to do, in the long run?
For supply side vs demand side issues, I guess the question to ask is if the productivity measurement is correct. If TFP is 1 % and you’re aiming at 6% NGDP growth, you’re just hurting the economy. Maybe, (don’t know for sure), britain was aiming at too high a growth rate.
I too have no doubt that the central bank can cause hyperinflation or severe deflation. The question is, can it thread the needle and get levels where it wants them to be? If during a velocity shock like 2007-8, the only way to get 5% NGDP growth is to alternate between 200% NGDP growth and −47.5% NGDP growth, then it seems like the cure is worse than the disease, in terms of providing the kind of stable monetary expectations that MMs agree are necessary for economic growth, investment, etc.
Suppose we have a patient with a fever (or pneumonia). The doctor is unable to stabilise the patient’s temperature. It’s true that if we throw her in an ice floe she’ll be too cold, and if we throw her in an oven she’ll be too hot, but that doesn’t prove that we can stabilise her temperature, and I sometimes feel that Market Monetarists are coming uncomfortably close to making this argument.
I doubt that there will be that much variation since even if you look at it, you are considering a sale of assets or a purchase. There are thousands of such transactions happening everyday. That range of fluctuations doesn’t happen. I’m not great fan of central planning, but I think that NGDP or nominal wage targets are possible to hit without a 100% variation.