Saturday, December 21, 2013

Ed Dolan — Latest Economic Growth Data Give Cheer to Market Monetarists, or, What is the NGDP Gap and Why do we Care?

The NGDP gap is equal to potential NGDP minus actual GDP. If the economy is operating below potential, the gap is negative. If it is temporarily operating in boom mode, above its sustaiable potential, the gap is positive.
Market monetarists watch the gap because they think the level of NGDP is even more important than its rate of growth. If the gap is negative, the Fed should apply more stimulus until the gap closes. As you can see, if the desired long-run growth rate of potential nominal GDP is 5 percent (composed, say, of 3 percent real GDP growth and 2 percent inflation), then the NGDP growth rate will have to be faster than 5 percent for a while to catch up. Similarly, the Fed would apply monetary restraint to temporarily slow NGDP growth below the long-run norm in order to cool off an overheated boom.
(Parenthetically, it is worth adding that some of the stimulus or restraint could, in principle, be applied through fiscal policy. Market monetarists think monetary policy has to do most of the heavy lifting, but some other economists, especially those who adhere to modern monetary theory, disagree. Exploring that debate would take us far beyond the bounds of this post. The only thing you need to know is that you are liable to cause great offense to your closest friends in the economics profession if you get market monetarism and modern monetary theory mixed up.)
Economonitor — Ed Dolan's Econ Blog
Latest Economic Growth Data Give Cheer to Market Monetarists, or, What is the NGDP Gap and Why do we Care?
Ed Dolan

According to MMT, the market monetarists have the story backward. Rising NGDP is a consequence rather a causal factor.

The Fed is unable to stimulate the economy through monetary policy, as QE shows as MMT predicted and explained, and the expectations fairy doesn't exist. The Fed saying that it is aiming at a specific increase in NGDP rather than an inflation target doesn't make it so. The Fed has no credible way to do this, and a negative interest rate won't do it either for reasons that MMT explains. 

In the first place, like QE negative interest acts as a tax. Secondly, banks are not constrained in leading to credit worthy customers demanding loans that are profitable to banks after risk weighting. Banks cannot be forced to lend through monetary adjustments as MM assumes. There is no "hot potato" effect associated with the monetary base.

MM is based on the discredited quantity theory along with a faulty understanding of money and banking, finance, and the operational reality of the current monetary regime with respect to economics.

According to MMT analysis, the way to stimulate the economy is to increase aggregate demand through government spending, which may also lead to some increase in measures of inflation, i.e., an increase in NGDP. However, the resulting stimulus is projected to also increase investment in response to increasing demand, there by also increasing real GDP.

MMT has explained the transmission through fiscal policy and lack of transmission with adjustments to monetary policy including forward guidance (expectations fairy). MM still hasn't given a convincing explanation of a transmission mechanism other than the expectations fairy and the so-called hot potato effect.

So MMT and MM agree that NDGP is the desired outcome and getting there is worth accepting some inflation above the Fed's current 2% target. They disagree over the causality, however, hence the policy means.



16 comments:

Dan Kervick said...

I think its a mistake to rely too much on aggregate demand management simpliciter as a solution to our economic ills, or to think that aggregate demand can be managed purely through monetary means, as though the challenges of economic life can be met through pure, abstract macroeconomic technique.

There is no reason to believe that full employment can be achieved simply through the injection of money into the economy, whether by tax cuts, fiscal helicopter drops and transfers, or central bank injections. Employment decisions and the organization of work are based on power relations. If the affluent sectors of society have structured the economy in a way which fails to employ all citizens, it is entirely possible that there is nothing that monetary operations of any kind can do to disrupt that system of social arrangements.

Also, it would be entirely possible for society to have full employment and no shortfall in aggregate demand, but for all of that employment and production to be going into producing a hell on earth. Our most important economic choices depend on what is produced, not just whether the production system is running at full capacity.

I would strongly recommend that people redirect attention away from the obsessive focus on monetary economics and

Increasingly, it strikes me that all of our prominent fields of economic discourse - whether freshwater, saltwater, monetarist, New Keynesian, Old Keynesian or post-Keynesian are decadent and aloof. They are all manifestations of money manager capitalism, with its obsessive, autistic focus on financial markets and monetary systems, and a persistent failure to engage with the hard challenges of what kind of world we want to build.

It is part of the disempowering, fatalistic, enslaving rhetoric of capitalism to teach people that decisions about what we should be producing are "out of bounds" as far as the political community goes, and are the preserve of private capital owners, and that there is a separate sphere of pure "economic" policy that is and should be neutral with respect to specific work, production and social organization decisions, as though there can be some abstract kind of economic health unrelated to what we are actually producing, exchanging and consuming. Modern macroeconomics has fully internalized this detached and slavish mentality, and is mostly juts an idle scholaticism. The discussions of the macroeconomists are mostly pointless, if not ludicrous. If Paul Krugman and John Cochrane disappeared from the face of the earth, nothing important would be lost.

Senexx said...

Attempting to paraphrase Dan. Outcomes first. Economics and Politics second.

Tom Hickey said...

Of course it all about power, and when one comes to grips with power and finds what those in power are willing to do to maintain control, there are only two alternatives, either resist guerilla-style or end-run. Many of us saw this clearly in the Sixties and Seventies and concluded that things were not going to change that much in our lifetimes and if we wanted to lead the lives we wanted to, then the optimal course was to end=run by dropping out of the system and creating alternatives, and pursuing social and political activism as sideline with no expectations. It worked pretty well for many of us, and now there is a vibrant alternative culture and alternative economy in the US and increasingly worldwide as young people today figure this out for themselves.

Dan Kervick said...

Senexx, I guess I would summarize it by saying that there is no dividing line between the economic choices a society needs to make and all of the other choices a society needs to make. It's all one sphere. The macroeconomists want to be neutrals in the war for the future. But we can't afford neutrality.

It makes no sense just to aim at "employment" or "demand" as a social goal independently of the form these activities take. We could have a world of full employment in which we continue sterilizing and poisoning the planet, and in which we "produce" torture implements that some of us use to torment others, and in which armies of peons are employed lick-cleaning the anuses of the rich. Macroeconomists seem incapable of addressing these issues. It's as though they are all suffering from a kind of brain damage.

Tom Hickey said...

Exactly. It's the confusion of economics with physics that has persisted since the advent of neoclassical economics and the preoccupation with mathematization.

Historically, it seems to have been a reaction to Marx. There is a discontinuity after Marx, with an ignoring of previous issues that were considered major, such as economic rent and economic power, which were seated in social and political arrangements.

Classical economics as economic liberalism was a reaction to the remnants of feudalism, which was based on hereditary privilege and land rents in economies that were still primarily agricultural, with land and labor the primary factors of production. Classical economic was about the transition to capital as a chief factor, and trade was a major focus. in an era dominated by mercantilism. This is what Adam Smith was writing about in Wealth of Nations, not the invisible hand as came to be imagined.

This was the era in which land rent that predominated during the feudal order was being superseded economically by capitalist rent as factories replaced land as the dominant mode of production and labor was shifted from land to machine. Smith surfaced a labor theory of value, which was developed by Ricardo. Marx took it over from there.

Marx investigated this in detail in terms of historical development based on socio-economic infrastructure, thereby giving Hegel's historical dialectic in the Phånomenologie des Geistes (Geist can be translated as mind or spirit) a material basis instead of an idealistic one. This was considered a move in the direction of empirical science, which was in trend with the time. Marx also framed some of his exposition formally, but realized that many important matters could not be formalized and needed verbal exposition. There is no huge break economically between Marx and the classical economists, in spite of the myth that Marx was a radical thinker that somehow appears out of left field (pun intended).

Marx was influenced by Comte, adopting a sociological approach based on progress, but rejected Comte's positivism. Marx also recognized that Darwin's natural selection did not include either an assumption or conclusion of progress. In this Marx was closer to Herbert Spencer and it's where his political theorizing and activism went off the rails in his dialectical conjecture, and why it is an artifact of the 19th century.

Of course, the use to which "Marxism" was eventually put resulted in Marx being outré in the capitalist world even though he is a major figure in the history of economics and insightfully integrated economics and political economy with history, sociology and anthropology with greater knowledge and skill than his predecessors.

All this shifted radically with Alfred Marshall, who was the forerunner of marginalism and mathematization. Verbal analysis was eschewed in favor of formalism, meaning that history and sociology were out of favor.

Moreover, the growing socialism of the 19th century and the success of communism in the early 20 century meant that in the capitalist world, certain matters were off the table for discussion, including economic rent and the relationship of power to economics. This meant any mention of Marx or any of the issues he dealt with were also excluded.

This has made conventional economics that replaced classical political economy sterile in that foundational material is excluded from consideration and a method adopted that is unsuitable for the range of the relevant subject matter.

The way the orthodox cast this is that it's either the conventional approach, or a return to Marx (ruled out) or a flaky methodology, which is the conventional definition of heterodoxy. So conventional economics dominates the universe of "relevant" discourse, and the state of the discipline is "dismal," as well as economic policy based on it.

Matt Franko said...

"Macroeconomists seem incapable of addressing these issues. It's as though they are all suffering from a kind of brain damage."

I dont know if it is theirs to address Dan, they seem to me to be focused on the empirical with all of these "models" and so forth, "money supply analysis", "injection of money" so-called, etc ... vice the philosophic/political issues you bring up...

To me, youre basically saying that our real problem(s) cannot be solved thru all of this empiricism we are witnessing within the macroeconomic academe (I agree btw)....

They are just trying to describe how our system functions/operates and failing miserably... to your point, not what we should be doing with our system... those are political/philosophical issues imo...

rsp,

Matt Franko said...

Tom,

"which may also lead to some increase in measures of inflation,"

Only if the govt or its agents agree to pay a higher price...

MMT says (often but not always): "Its about price not quantity..."

rsp,

Dan Kervick said...

Matt, I'm not sure that most of the models economists use are triumphs of empiricisms. Rather they seem to some from a large measure of a priori thinking and prejudice, and the economists keep using them despite the lack of solid empirical evidence.

Dan Kervick said...

"They are just trying to describe how our system functions/operates and failing miserably."

They also offer practical policy advice, all the time. But I think the idea that there can be a pure "macroeconomic" policy is an illusion.

Tom Hickey said...

"which may also lead to some increase in measures of inflation,"

Only if the govt or its agents agree to pay a higher price...

MMT says (often but not always): "Its about price not quantity..."


Yes, and MMT economists say that if an MMT JG is not adopted along with stimulus it could led to inflation as full employment is approached. But, like MM, they are OK with an inflation rate somewhat higher than the Fed is targeting if that is what it takes to achieve full employment without an MMT JG.

Tom Hickey said...

"which may also lead to some increase in measures of inflation,"

Only if the govt or its agents agree to pay a higher price...

MMT says (often but not always): "Its about price not quantity..."


Yes, and MMT economists say that if an MMT JG is not adopted along with stimulus it could led to inflation as full employment is approached. But, like MM, they are OK with an inflation rate somewhat higher than the Fed is targeting if that is what it takes to achieve full employment without an MMT JG.

Tom Hickey said...

They also offer practical policy advice, all the time.

And it is obvious that a lot of that policy advice is ideological and the models are constructed to deliver based on the choice of assumptions and selection of data.

Matt Franko said...

I see what your saying here Dan for instance Krugman, nominally an "economist" of sorts, has that column in the NYT 'conscience of a liberal' there where he opines on policy and politics, etc.. and his empirical view of economic systems influence his 'philosphy' or specific policy recommendations there no doubt...

Seems like there is 'cross pollinization' between the empirical and the philosophic of some sort in all this...

But I think there are specific cognitive skills that NOT everyone has related to "mathematics" that LIMIT peoples ability to understand the empirical case... and many leading macro economists just dont have the cognitive skill level required to understand our system viewed empirically...

Like their models (which btw many have learned thru 'rote' imo ) have failed miserably and they dont know why... because most if not all of them lack the skills to assess the empirical situation...

So they resort to more incorrect 'rote learning' or they fall victim to incorrect or outright false/misleading linguistic descriptions (false metaphors etc..) of how the system operates and cant see their way out of it and are trapped...

So they cant get out via the the empirical route, they lack adequate mathematical cognitive ability, so if we keep pounding the empirical like we are it is getting nowhere fast imo...

I think you and Tom as professional Philosophers have to step up here and start to direct this effort away from the empirical and towards the formal Philosophical (and I think you 2 basically are already.. I just want to call specific attention to what I see you 2 doing....).

The MMT people for the most part are empiricists imo and they do a great job there... and they have their political opinions too as we all do...

But I think there is a difference between being an empiricist with a political opinion vs. a true philosophical investigation...

It seems like we are failing with all of our empiricism... we only get thru to a small cohort that has the math skills and most of those people are not in positions of consequence...

So if we break this down, if what we really have is a philosophical problem, and we think we can solve it empirically, we are probably making a mistake... we have to solve this via philosophy looks like...

Keep going imo....

rsp,

Tom Hickey said...

The problem is that there is as yet no "correct" model as the dominant paradigm in econ as there is in classical physics, for example. Economists really haven't got a a good handle mathematically on modeling a huge complex adaptive system like a national economy let alone the global economy, so they'e developed a lot of more limited models that they trundle out to make points depending on their preferences and biases. They don't even have a useful model of the firm yet either, which is why businesses hire MBA's instead of economists.

Matt Franko said...

Well Tom I think their 'models' might actually work in a gold standard world... at least at some level I see some value in the current mainstream view of "inflation" or "quantity theory" if we are on a metallic standard... not perfect but at least better than trying to apply these concepts to what we have now......

The problem is that we went off gold and either nobody knows it or nobody at least understands the implications of this... so this is a problem with 'perception' or 'cognition' at core... which I posit may be better to solve NOT thru empiricism...

rsp,

Tom Hickey said...

Matt, might work in a bullion world of commodity exchange, which is a sophisticated version of barter, which is what they are modeling.

But even under a gold standard state money is still fiat. It's just the operational constraints are tighter.