Many of my objections stem from the focus on a single macroeconomic variable: NGDP.
Consider the recent period of high inflation. Almost all economists believe that inflation is caused by a combination of demand and supply side shocks. In contrast, I believe that all of the higher inflation has been on the demand side, with supply shocks playing no role at all, at least not for the entire 2019-24 period.
Consider some data from the past 4 1/4 years.
Under the 4% NGDP target, NGDP must increase by 18.1% between Q4 2019 and Q1 2024. The actual increase rate was 29.0%.
Under a 2% PCE inflation target, prices should rise 8.8% between January 2020 and April 2024. The actual increase rate was 17.8%.
If NGDP rises above 11%, it will exceed the inflation target by 9%. This means that supply shocks do not explain any of the following: total cumulative Excessive inflation. Yes, supply shocks certainly played a role in certain months of 2022. However, these negative shocks were offset by positive supply shocks in other months. The supply side of the economy was strong. Real GDP grew faster than expected, largely due to immigration. In fact, considering the NGDP growth rate, it is fortunate that inflation is not at all high. The positive supply shock (surge in immigration) has kept inflation slightly lower than predicted based on NGDP growth alone.
My contrarian views on the role of monetary policy in recent inflation reflect similarly heretical views on the Great Recession. I argued that the Great Recession of 2008 was caused by tight monetary policy. Very few economists agree with me. When I claim that the Great Recession was caused by a large drop in NGDP, people accuse me of being tautological. In their opinion, a big drop in NGDP It’s a recession.. They confuse nominal GDP with real GDP.
The last four and a quarter years clearly show that real GDP and nominal GDP are not the same. The large NGDP overshoot resulted from excessive inflation rather than very fast RGDP growth. That’s all about the “fishbowl” theory.
Another complaint is that falling NGDP was a problem in 2008, but there was nothing the Fed could do about it because we were stuck at the zero lower bound. However, in 2008 the lower bound was not zero. The Federal Reserve was implementing its usual conventional monetary policy. In fact, in October 2008, they introduced IOR to prevent interest rates from falling, i.e. from overheating the economy.
Why do my views differ so sharply from those of my colleagues? I think there are several factors.
1. If you didn’t expect a spike in inflation, it’s natural to look for some kind of unexpected factor to explain the results. Supply shocks are a convenient excuse, especially considering that they have contributed to higher than normal inflation over a short period of time. But this is motivated reasoning. Economists often overlook the fact that the economy continues to be hit by positive supply shocks, such as surges in immigration or supply chain repairs after the COVID-19 crisis subsides. They correctly saw negative supply shocks for certain months, but overlooked the fact that supply conditions overall have been excellent over the past 4 1/4 years.
2. Most economists are relatively supportive of the Federal Reserve’s monetary policy stance. They are therefore reluctant to blame monetary policy when NGDP deviates dramatically from its 4% growth path. That’s almost like blaming the economics profession for a policy disaster. It is much more satisfying to find an explanation involving mysterious “exogenous shocks.”
3. Monetary policy positions are often very different from what appears when looking at indicators such as interest rates. In 2008, interest rates fell despite money shortages. In 2022, interest rates rose dramatically (albeit slightly less than in 2021) despite monetary policy being significantly expansionary. If we misjudge our monetary policy stance, we are much more likely to misdiagnose the causes of a recession or high inflation. These mistakes are especially likely to occur when exogenous factors, such as a housing recession, cause large changes in the natural interest rate, making the Fed’s policy rate a very inaccurate indicator of its actual policy position.
The focus on nominal GDP explains why I am not impressed by unconditional forecasts. I find that many people are right about inflation in the early 2020s but wrong about the effectiveness of previous QE programs under Bernanke. (And vice versa.) I was much more impressed. conditional prediction. What do you think will happen if the Fed allows 29% NGDP growth for four and a half years after the fourth quarter of 2019? This is the question we need to think about.
NGDP is a useful indicator, but inflation and interest rates are not. If we say inflation is rising, we have no idea what that means for the economy without knowing whether the rise is due to a supply shock or a demand shock. Saying interest rates are going to go down doesn’t mean anything unless you know whether the decline is due to easier money or a weak economy.
Only NGDP provides a clear picture of the current state of the economy. It doesn’t tell us everything we need to know, especially in the long run. But no other variable is more important than how we understand the current macroeconomic situation in the short to medium term.
Economists are sometimes tempted to ignore the signals NGDP sends. Don’t do that! We returned on June 28, 2021. Jason Furman David Beckworth was being interviewed. Furman is:
So I somewhat agree with nominal GDP targeting. . . . If we were following along now, we would have already cut interest rates. And we are likely to exceed the nominal GDP target we have set by a very high level.
So under you [Beckworth’s] The framework requires that sustained periods of lower than trend nominal GDP growth be compensated for. I don’t mean to criticize you. This experience destroyed everyone’s plans that they had previously written down. These are really strange times. But to me it says: “I hope the Fed will consider that if unemployment is still at 5.5% a year from now, regardless of what is happening to nominal GDP or prices. “It’s an independent issue and issue for them to consider.” So I think everything should have a double duty, look at nominal GDP instead of inflation, etc.? maybe.
ouch! June 2021 marks a time when NGDP has just returned to its pre-COVID trend line. In retrospect, it was the perfect time to strengthen policies to prevent NGDP overshoot. Furman correctly guessed that tightening would be necessary to prevent NGDP overshoot, but he thought it was an unwise idea for other reasons. He thought the NGDP was sending the wrong signal that we should look at the unemployment rate (which in reality is an unreliable indicator).
In retrospect, it is clear that the NGDP signal was exactly right and Furman was wrong. It was time to tighten up.
Ignoring the NGDP is at your own risk.
