I followed a link from Marcus Nunes’ new post praising Beckworth and Ponnuru for an excellent article about NGDP targeting; and forgetting that the link was to the National Review I ventured down to the comments section without the proper mental preparation or a saltshaker as a commenter posted a rather tortured rebuttal that is signed Andrew Baldwin. It starts out like this:
This is a terrible analysis, giving a cartoon version of inflation targeting (IT), and skating around the huge defects of nominal output targeting. It starts off promisingly, noting that over the long term a central banks can’t determine the productivity of an economy or its growth rate. This is the whole rationale for a central bank targeting the inflation rate, which it can control, and is consistent with the idea that the fundamental duty of a central bank is to protect the purchasing power of a country’s currency. However, the authors instead suggest that the central bank target nominal output, which central banks can also control.
However, in targeting the growth of nominal output the central bank is only targeting the growth rate, which it can’t control and the inflation rate as measured by the GDP deflator, a truly terrible inflation measure.
Apparently, Mr. Baldwin is just a bit confused between RGDP and NGDP. He’s correct that the central bank cannot control real growth. But, he is mistaken that the central bank cannot control the nominal value of output. Because if the central bank has control over inflation and the value of the currency, it can control the nominal value of output.
But, I am not writing about Mr. Baldwin’s comment to necessarily argue each point. I actually prefer the backdoor approach to debunking the inflation nutter thesis with inverse intuition; it paints a much better picture that way. Because if it is the central bank’s fundamental duty to protect the purchasing power of the country’s currency, and that is the duty of the central banks above all else, surely Mr. Baldwin, if he had been alive at the time, would have congratulated the Fed of the 1930’s for a job well done. He isn’t necessarily arguing with Beckworth and Ponnuru, he’s arguing with Freidman’s Monetary History of the United States that pins the blame for severity of the Great Depression squarely on the Fed for allowing deflationary free fall. He’d rather we’d never mind about the law that says the Fed “shall manage monetary and credit aggregates commensurate with the economy’s long run ability to increase production; so as to promote of full employment, stable prices and moderate long term interest rates.” I’m sure if he thought about it, Mr. Baldwin would discover that his entire thesis is illegal, and illegal in large part due to the economic horrors experienced by society during the Great Depression and in recognition that we are no longer a nation of subsistence farmers. Employment is the means of survival for most people today.
Besides being confused about the proper role of the the Federal Reserve and between RGDP and NGDP, he seems to have a bit of a cognitive problem regarding inflation measures. Here he is attempting to explain which one is appropriate:
It is no coincidence that of all the IT central banks in the world, not a single one targets the GDP deflator (is that what B&P suggested??). Its dependency on imputations (imputed rents, FISIM for financial services), the big share of GDP accounted for by government expenditures that have no market price and the importance of exports in the GDP deflator all make it a useless inflation indicator for central bank purposes… if one targets 5% nominal output, one could get 2% inflation (indifferently measured) and 3% growth, or 7% inflation (still indifferently measured) and -2% growth, which would be terrible.
The authors claim that countries with IT central banks have their economies blown off course when they are hit by external shocks, like a big hike in imported oil prices. Except they know very well that this isn’t true. The US Fed targets the personal consumption expenditure (PCE) deflator, but also monitors a core PCE deflator, based on personal consumption excluding food and energy. It would tend to ignore a big hike in the inflation rate that only came from an increase in imported oil prices, since this would not at least initially, affect the PCE deflator ex food and energy. The Bank of Canada’s operational guide, the core CPI, would similarly see through one-shot hikes in petroleum prices.
While B&P didn’t make the argument that the Fed should target the GDP deflator, he claims that it is a terrible measure because it excludes imports, when the point was made by B&P that is a better one to prevent confusion. He took the long and confusing way saying that having the central bank confuse oil price shocks with monetary inflation is a risk worth taking even if it means domestic growth suffers and job losses become elevated in such a situation as geopolitical instability. In other words, domestic demand must atrophy and many people get to lose their jobs if Nigerian rebels commandeer a series of oil platforms. Why don’t we just export the conduct of our monetary policy to the Nigerian rebels? And he certainly doesn’t seem to question why the central bank targets headline PCE if it really intends to target core PCE as he says it does. It sounds like just asking for a confusing situation to me.
The claim that IT central banks have their economies blown off course when they are hit by supply shocks can be and was true in 2008, not only of the Fed, but the of BoE, and the ECB to name just a few. The FOMC minutes from 2008 that discuss forecasts for 5%+ inflation in 2009 as a reason for not easing policy when the core measure was only slightly elevated above 2% are exhibit A. The countries in the example provided by B&P are countries whose central banks were not confused and did not suffer from an economic collapse. But Mr. Baldwin is steadfastly married to the idea that they wouldn’t become confused that he misses what happens when they do entirely. We get -8% GDP, -2% inflation, 10%+ unemployment and hit the ZLB purely from monetary malpractice, while the monetary authorities congratulate themselves on a job well done in protecting purchasing power as the world crumbles to the ground due to nominal rigidities. It sounds eerily familiar.
It’s not a situation I would like to see repeated even if Mr. Baldwin’s scenario of -2% RGDP and 7% inflation were to be the alternative. It would be merely a temporary condition because supply shocks are transitive and would temporarily hit the standard of living rather than nominal income, whereas the Great Recession resulting from the monetary screw up that caused income expectations to plunge and overall demand to atrophy is still with us and still smarting on the opportunity costs. And after writing down the nonsensical statement that the central banks would never mistake a negative supply shock for core inflation without the intellectual curiosity to question what would happen if they did, Mr. Baldwin applies his lack of curiosity to his potential readers:
If a central bank targets 2% inflation one at least gets a low inflation rate, and this is a positive even if the growth rate of the economy is not stellar.
Neglecting that inflation is a secondary effect (indicates something rather than causes something) and the different kinds of economic conditions that can result in low inflation, he doesn’t elaborate under which conditions a low inflation rate would be indicative of a positive. Perhaps if the economy is expanding, supply is increasing to meet increasing demand, and/or productivity is increasing, then the resulting low inflation would be a positive. But if we have low inflation with historically low employment and capacity utilization, which we know are the present case, then we are forgoing production and growth for the superficial plausibility that low inflation is a positive, which is a cost in real terms. Much of it is opportunity cost that can be approximately calculated by measuring the NGDP gap from trend and adjusting for inflation (currently north of $4T and getting larger), but there are also other costs that are realized considering indebtedness of governments with long term spending commitments (exploding deficits and tax increases) and the unexpected explosion in social spending in order to keep those not able to find employment from starving and becoming homeless. Certainly, if static anemic growth is the policy choice in order to get the coveted microscopic levels of inflation via monetary asphyxiation, then we have to consider the possibility that elevated social spending is required lest we intend to deny millions of people a means survival.
Perhaps if Mr. Baldwin didn’t take for granted the mantra that low inflation is always a good thing, the lower the better, and understood what it means to the people who can’t find a chair when the music stops, a group in which he could have easily have been included, he might just understand why NGDP level targeting is far superior to inflation targeting and that instead of debunking it, he actually made a much better case for it than he intended.