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Translating Market Monetarists

September 28, 2012

Angus’ quotes in italics, my responses in plain text.

I fail to understand exactly how the Fed is supposed to precisely target NGDP. They’ve kept the policy rate at zero for multiple years and promised to keep it there for multiple years more. They have flooded the banking system with reserves. But NGDP has not grown fast enough. Now the Fed has promised to keep the pedal to the metal after the economy has recovered, will that get NGDP growth where the MMTers want it?

NGDP is exactly where the Fed wants it to be. I know this is a controversial statement, but if it were really out of control, why is it so incredibly stable? You can’t have a liquidity trap and also perfectly controlled NGDP growth.

There are no long and variable lags and no liquidity traps in market monetarism. The Fed doesn’t promise anything for the future, ever. Because the Fed wouldn’t announce an interest rate target, they would not be constrained by the 0 lower bound. Right now, people’s mental model is that the Fed hits 0% and stops doing OMOs because of the liquidity trap. But what if they just kept buying bonds anyway? Two things could happen:
1. The Fed could become owner of 100% of all Treasury liabilities, lower IOR to 0%, and inflation would not change at all. Market monetarists don’t believe this could happen.
2. Inflation/NGDP would increase despite 0% interest rates. This may seem kind of Green Lanternish for some macroeconomists who think of monetary policy as interest rates, but empirically, it seems like the Fed still has very good control over NGDP even after the crisis.

Market monetarists argue that stable NGDP would be consistent with political popularity, so there’s no time consistency problem.

[Why should the Fed…] Create a futures market for NGDP and target its price?

This idea is founded on the EMH. Markets can predict things better than anyone at the Fed, so if you want to stabilize a variable, you need to know what to shoot for, and prediction markets can help you with that. You might say that we know the past with more certainty, and that’s true, but then you are continually reacting to shocks rather than anticipating them.

NGDP is “the real thing,” whereas P and Y are simply data points pulled out of the air by Washington bureaucrats.

Translation: NGDP is a data point which can be observed unaltered in the real world. When I go to a store and buy 10 apples for $2 each, that’s $20 of NGDP. When someone says “well, how much of that is real GDP?”, you need to say what the price of apples was for the last few years, come up with a consumption bundle, index it to previous consumption bundles, add together what you think is the value of other goods, and do a bunch of calculations to come up with RGDP. NGDP is the starting point of the calculation. Inflation and RGDP are a constructed data element.

Nominal income is not an exogenously imposed constraint on the activities of the private economy. Nominal income is largely created by the actions of the private economy.

The Fed is seen as a purposeful entity (or perhaps market monetarists want it to be a purposeful entity). It has a target and prints money until it hits that target. It makes no sense to a market monetarist for the Fed to forecast nominal variables, just as I don’t forecast what I’m eating for dinner. I just pick something, just as the Fed can pick a level for inflation, NGDP, whatever.

Tyler Cowen has written that the private sector can manufacture its own NGDP. This is true. However, if the Fed is purposeful, and the private sector increases NGDP, the Fed will reduce the money supply until NGDP is where the Fed wants it to be. Hence, the Fed unmakes the unwanted NGDP. So in a sense, they are seen as the ones who are in control. Market monetarists think that for most shocks, the Fed can overpower any other actor in the economy, with the possible exception of a determined Congress.

Concluding Remarks
I feel like a cult member explaining the bizarre logic of our holy writings. Market monetarism is quite foreign to the way of thinking of other schools of economic thought. Interest rates are purposefully ignored as a matter of course. Targets are given high priority and when the central bank misses them, it’s not that it was a big shock, we say that the central bank screwed up. There is no distinction between the central bank doing something and the central bank letting something happen. Once you start to grok market monetarism though, it’s a pretty powerful way of looking at the world.

Further Reading:
Sumner’s FAQ
Beyond Market Monetarism

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