The moral case for NGDP targeting
The last few weeks have seen high-profile endorsements of having the Federal Reserve target a nominal GDP path. (See Paul Krugman, Brad DeLong, Jan Hatzius and colleagues at Goldman Sachs.) This is a huge victory for the “market monetarists”, a group that includes Scott Sumner, Nick Rowe, David Beckworth, Josh Hendrickson, Bill Woolsey, Marcus Nunes, Niklas Blanchard, David Glasner, Kantoos, and Lars Christensen. Sumner in particular deserves congratulations. He has been on a mission from God for several years now, and has worked tirelessly to persuade us all that central banks should target NGDP, and that they have to ability to do so even after interest rates fall to zero.
I have reservations about the market monetarists’ project. I’m not certain that the Fed has the tools to meet an NGDP target, or if it does have the tools, that the costs of deploying them to establish its credibility are supportable. Moreover, I don’t think that the market monetarists have sufficiently thought through the consequences of success, in accounting terms, if they restrict themselves to lending to the private sector (or, equivalently, purchasing debt instruments from the private sector). The market monetarists have grown in parallel with another fringe monetary theory, MMT. The two groups don’t consider themselves aligned, but I think they are two sides of the same coin. It would be great if they would combine their insights — the market monetarists with their NGDP-targeting central bank, the MMT-ers with their concern for balance sheet health and their understanding that transfers-to-be-taxed deleverage private sector balance sheets while advances-to-be-repaid do not.
But such quibbles are for another time. Here I want to join the market monetarists’ happy dance, and point out several moral benefits of NGDP targeting.
The most plain moral benefit of NGDP targeting is that it is activist. Relative to the status quo, it demands a serious effort to combat the miseries of depression. This is a big improvement over our current strategy, which is to shrug off and rationalize mass deprivation and idleness.
A second moral benefit is that under (successful) NGDP targeting, any depressions that occur will be inflationary depressions. Ideally, we’ll find that once we stabilize the path of NGDP, the business cycle is conquered and there will be no more depressions ever again. But that probably won’t happen. If depressions occur even while the NGDP path is stabilized, then they will reflect some failure of supply or technology. Our aggregate investment choices will have proved misguided, or we will have encountered insuperable obstacles to carrying wealth forward in time. It is creditors, not debtors, whom we must hold accountable for patterns of aggregate investment. There always have been and always will be foolish or predatory borrowers willing to accept loans that they will not repay. We rely upon discriminating creditors to ensure that funds and resources will be placed in hands that will use them well. Creditors allocate capital by selecting the worthy from innumerable unworthy petitioners. An economic downturn reflects a failure of selection by creditors as a group. It is essential, if we want the high-quality real investment in good times, that creditors bear losses when they allocate funds poorly. When creditors in aggregate have misjudged, we must have some means of imposing losses without the logistical hell of endless bankruptcies. Our least disruptive means of doing so is via inflation.
I do not relish inflation for its own sake, or advocate punishing creditors because they are rich and the tall poppies must be cut. But if, despite NGDP stabilization, real GDP cannot be sustained, someone has to bear real losses. There are only two choices: current producers can be taxed in order to make creditors whole in real terms, or past claims can be devalued so that losses are borne at least in part by creditors. In my view, the latter is the only moral choice, and the only choice that creates incentives for investors to maximize real-economic return rather than, say, hide behind guaranteed debt and press politicians to ensure the purchasing power of that debt is sustained regardless of the cost to aggregate wealth. (Sumner makes a similar point in his excellent National Affairs piece.)
Note that NGDP targeting doesn’t prevent the honorable Austrian remedy to credit misallocation: having creditors individually to bear losses via default and/or bankruptcy of borrowers. When it is possible to equitize or liquidate particular claims quickly and without creating terrible costs for the rest of the economy, we should do so. Every completed restructuring promotes real activity by reducing valuation uncertainty and debt overhang, and so reduces the degree to which an NGDP targeting central bank will need to tolerate inflation and spread losses to creditors generally. We should try internalize the costs of credit decisions via default and bankruptcy as much as possible, as doing so keeps investment incentives sharp. (On a stable NGDP path, we don’t have to worry so much that loans that should have been good turned bad because of a scarcity of aggregate income.) But whether it is particular bad lenders who suffer or creditors in aggregate, current producers should not be forced to bail out the bad or unlucky investment decisions of earlier claimants.
In fact, NGDP targeting, despite the stench of sugar-high money games that Austrians perceive in it, might actually increase our ability to impose losses on foolish creditors via default and bankruptcy. This would pay a huge moral dividend, in terms of our ability to avoid the unfairness of arbitrary bail-outs. Both Nick Rowe and Scott Sumner have suggested to me that if we had sufficiently aggressive monetary stabilization, we could avoid acquiescing to “emergency” rescues that flamboyantly reward bad actors, because allowing bad actors to collapse would no longer threaten the rest of us. Rajiv Sethi has made a similar point:
The main justification for these extraordinary measures in support of the financial sector was that perfectly solvent firms in the non-financial sector would have been crippled by the freezing of the commercial paper market. But as Dean Baker has consistently argued, had the Fed’s intervention in the commercial paper market been more timely and vigorous, it might been unnecessary to provide unconditional transfers to insolvent financial intermediaries. While I do not subscribe to Baker’s view that Ben Bernanke “deliberately misled” Congress in order to gain approval for TARP, his main point still stands: if the Fed can increase credit availability to non-financial businesses and households by direct purchases of commercial paper, than why is any financial institution too big to fail?
Perhaps we ought to think of “liquidationism” and stimulus as complementary rather than pin them to bitterly opposed camps. The palliative of stimulus might enable the medicine of consequences to work its pain without killing the rest of us. Obviously, fiscal and monetary interventions can be used to bail out failing incumbents, and as a matter of political economy, we might find ourselves unable to prevent this misuse. But precommitting to aggressive macro stabilization via tools that don’t discriminate in favor of particular firms or sectors might allow for more liquidation of bad claims than pretending we will be laissez-faire when the consequences of nonintervention would prove catastrophic.
In constrast to an inflation-targeting central bank, an NGDP-targeting central bank need not distort the division of income between capital and labor. Under current practice, the Fed tends to encourage asset price inflation but worries frenetically over any growth in unit labor costs, or, equivalently, labor’s share of income. Labor share of income has been collapsing since about 1970. I don’t mean to claim that the Fed has caused the collapse of labor share: globalization, automation, and deunionization would have put pressure on wages regardless of Fed action. But the credibility of the Fed’s consumer-inflation targeting regime is closely tied to moderation of wage growth. Managers, union leaders, and policymakers know that bargains whose effect would be to increase labor share might provoke contractionary monetary policy and even recession. This undoubtedly has had some effect. I don’t want to overattribute, but it seems more than coincidental that Rubinism and Clintonesque hypersensitivity to bond-market concerns arose after George H.W. Bush’s reelection was thought to have been crippled by cautious monetary policy and the jobless recovery it engendered. I think many labor-sympathetic observers view the Federal Reserve as an organization which tilts the scales against workers in subtle and unaccountable ways. I know that I do.
An NGDP-targeting central bank trying to contract would be indifferent between restraining wage and capital income. Wage income growth puts more pressure on consumer prices than capital income growth, but under NGDP targeting it’s all nominal income. In practice, devils live in details, and how the Fed actually works to achieve its target might or might not be neutral. But labor has a better shot of being treated equitably under an NGDP-targeting regime than under an inflation target that is inherently threatened by wage growth.
It’s a bit ironic that the “market monetarists” are gaining prominence at the same time as “End the Fed” is a rallying cry of social movements across the political spectrum. It is a mistake to associate “End the Fed” solely with Ron Paul’s unpersuasive sound-money fetish. (Unpersuasive, because the Fed over its history has preserved the purchasing power of a dollar held in any financial instrument other than a mattress.) Many Americans, including me, feel a strong antipathy towards the Fed, not because of it has debauched the currency, but because we believe that it has played favorites in the economy and in politics, usually in the shadows but brazenly over the course of the financial crisis. We think the Fed behaves immorally and unfairly. An NGDP-targeting Fed could be a better Fed, in a moral as well as technocratic sense. I wish the market monetarists luck in trying to make it so.
- 25-Oct-2011, 3:30 a.m. EDT: Changed “Clintonesque hypersensitivity to deficits and bond-market concerns” to “Clintonesque hypersensitivity to bond-market concerns” in order to make an awkward sentence slightly less awkward.
- 25-Oct-2011, 4:30 a.m. EDT: Changed “a loan” to “loans” to match plural subjects…
- 25-Oct-2011, 11:45 p.m. EDT: Corrected misattribution of Sumner article to “Nation Interest”. The piece appeared in “National Affairs”. Many thanks to commenter Matt for calling attention to the error!