Nitpicking on nominal GDP targeting

Writing in the AFR, economics correspondent Jacob Greber begins his discussion of the Xenophon proposal with the assessment “What a stupid idea”. Given that he is dismissing proposals with wide support in the economics profession (including economists as different as me and Warwick McKibbin in the Australian context) one would expect that he had a knockdown argument to present. In fact, he offers a valid, but minor nitpick and a string of confusions and errors.

The nitpick relates to the distinction between nominal GDP growth, as reported by ABS, and the way the term is commonly used in the context of monetary policy discussion, to refer to the sum of the inflation rate and the real rate of GDP growth. Inflation is typically measured by the CPI. However, the statistical nominal GDP is associated with a different inflation measure, the GDP deflator, which is heavily influenced by export prices. So, a policy that targeted the statistical measure would imply trying to reduce growth when export prices boomed, and increase growth when they fell. In most times and places, the difference is too trivial to matter, but in the context of the recent minerals boom in Australia, it was substantial. So, I’d suggest we really want to use the phrase “nominal growth targeting” with nominal growth spelt out as the sum of CPI inflation and real GDP growth.

After that valid point, we have a mess of confusions and contradictions. First, Greber objects to Xenophon’s proposal on the basis that it would push up housing prices. If this is to be taken seriously, it means that the RBA should be targeting asset prices as well as CPI inflation. While there’s a good case to be made here (I discussed the issues in a paper with Stephen Bell quite a while back) it contradicts the central claim that everything is fine with inflation rate targeting.

Making the contradictions even worse, Greber notes that inflation has been well below the target range for some time. That is, under an inflation targeting system, the Reserve Bank should be cutting rates. But Greber appears to oppose this, while conceding that “To be fair, there is a legitimate debate to be had about how far and for how long inflation should range outside the current band”. In this context, the question of a shift to nominal growth targeting is a red herring. Real growth (about 2 per cent) is only marginally below the likely long term trend (2.5 per cent), so a monetary policy that targeted both growth and inflation would, if anything, be a little less expansionary than a strict inflation target

The obvious problem being ducked here is that, if the RBA sticks to inflation targeting, it may well have to cut interest rates all the way to zero, as most other central banks have already done. So, the temptation is to accept a long period when we are below the target rate. But that, in effect, is switching from a 2-3 per cent target to a 0-3 target, something for which no real justification has been given.

Like Bernard Keane and Glenn Dyer to whom I responded previously, Greber makes much of Australia’s special circumstances, treating nominal GDP targeting as (to quote Keane and Dyer) as “a foreign solution”. This piece of economic exceptionalism is surprising coming from a haven of orthodoxy like the AFR, and even more surprising in the context of monetary policy. Inflation targeting, central bank contracts and 25-basis point interest rate adjustments aren’t Australian inventions. We adopted this approach at the same time as the rest of the world and for the same reasons. We’ve had much better outcomes as Greber notes, but there’s nothing to suggest that inflation targeting is the main reason.

On the contrary, inflation targeting has evidently failed nearly everywhere in the developed world, in at least three ways
* it has not kept inflation within the target range
* interest rates have been driven to zero or below, so that “emergency measures” like reliance on open market operations now appear to be permanent fixtures
* it has not delivered on the promise that targeting inflation would also deliver stable GDP growth

The first of these problems is already evident in Australia, and the second appears imminent. We should think twice before saying that, since nothing has gone badly wrong so far, we should stick with our existing policy framework.

Greg Jericho in The Guardian has some similar thoughts.

49 thoughts on “Nitpicking on nominal GDP targeting

  1. @Ivor

    Unfortunately I don’t know the nuts and bolts of how interest rates got incorporated into owner equivalent rent (OER) in the 70s, so I’m not as informed as I need to be to answer your question properly. Someone (Dean Baker?) has written about it. But on my own I can see loads of problems:

    1) if you take the aggregate mortgage costs as changing with interest rates (debatable, see 2 below), then the NPV of future payments with which you might calculate OER is only known post-hoc: you can’t extrapolate NPV from the present rate, because the present rate will continue to change, and compounding can introduce almost an order of magnitude of error! So it depends how OER amortizes an incredibly indefinite NPV.

    2) In my own parent’s case, they were locked in at 6.75% all through the 70s, so they saw their OER go *down* in real terms.

    3) mortgage interest, in the US, is tax-deductible anyway, so that’d make the delta of OER deductible.

    4) housing’s an asset, so if rapid house price accumulation eats into current consumption, it’ll also radically increase future income (in something like a sophomore economics 2-period everybody-dies model). Essentially, OER is paying for an asset, it’s not consumption.

    5) if we incorporate price inflation of housing assets into CPI, why not incorporate price inflation of other assets, like stocks?

    Does that help at all?

  2. @vic twente

    Just thinking aloud here. Not sure I have any firm conclusions.

    I would think an owner-occupied house is a consumption good in at least one sense. It deteriorates with use and with time. Eventually it rots, rusts, crumbles or collapses especially without maintenance. It is not a standard capital good either. It is not deployed for future production of goods in the standard sense. Though we can see that a house can be deployed for the production and raising of humans (human reproduction). Rooms of an owner-occupied house can be let. Then it becomes an income producing asset to some extent. But it’s still a rented consumption good not producing goods in the standard sense.

    What we call consumption goods are goods we usually consume quite rapidly though there are exceptions. Clothing, food and jewelry are usually called consumption goods. Yet expensive jewelry does not decay over decades or maybe even hundreds of years.

    Food is also used to reproduce and grow new humans. In this sense food is like a house. They are both consumption goods with different shelf lives (destruction by time) and different consumption rates (short term versus long term).

    The thing we notice about both food and houses are that they are material. A stock or share is not material. Only the record of who owns what is stored in some material medium. A stock or share is an example of what Marx called fictitious capital. In more standard economics these are defined as “tradeable paper claims to wealth”. “Effectively, fictitious capital represents “accumulated claims, legal titles, to future production” and more specifically claims to the income generated by that production.” – Wikipedia.

    This last maybe gives an answer to your question 5. Because of the radical differences between real goods and real assets and these paper claims to real assets, the argument to include the value of paper claims to assets promising future production might be tenuous and might even be double-counting in a sense over time. I admit, I haven’t nailed this thought down properly.

    Overall, I think what our economic system calls a consumption good and what it calls an asset is in the end susceptible to some philosophical criticism in terms of category and mode of existence. However, tax law, finance convention and custom are used to rule these categories off into neat boxes. Given that, it is our moral or ethical value choices which decide some questions like the one of permitting negative gearing for investment houses but not for owner-occupied houses (Australia) or permitting owner-occupied mortgage payments to be deductible (USA). These are arbitrary decisions based on which social value goals we have chosen.

    In both the examples I mentioned above (negative gearing and tax deductible mortgage payments) we can notice that people with assets are given more money. That’s an interesting choice given there are really poor people in both countries.

  3. @vic twente

    These are different propositions than in the video you linked to.

    If

    it’s boneheaded to include mortgage interest into owner equivalent rent,

    then this should apply if interest rates are fixed as well.

    How is the “delta of OER” calculated?

    Housing is not a pure asset – except for landlords.

    For consumers – renters – it is a consumption item. Rents and owner occupier costs should be in CPI.

    Mortgage interest is a owner occupier cost. It is paid out of wages.

    How is price inflation of housing assets incorporated into CPI?

  4. @Apocalypse
    #1

    a) “The dismal economic performance of the developed world is due to the lingering effects of the financial crisis, which can’t be fixed by lowering interest rates to zero and beyond. ”

    Yes, subject to noting there are differences among juristictions, I agree.
    One of the reasons, possibly the most important one, for the said failure of lowering interest is that the money created (buying privately issued debt securities) to bring about lower rates went to the wrong people. It went to the banks, who had issued the debt securities. Banks didn’t spend the money on goods and services that require, among other inputs, people. Banks used the money ‘rebuild their balance sheet’. (Most obviously in the USA, the UK and some parts of the Euro-zone but by no means in every Euro-member country.)

    So, why did the monetary authorities in question give money to the wrong agents? IMO they had very little choice, in particular the USA, because the monetary authorities are also responsible for the payment system. It would not have taken much more than the Lehman event to have the entire US banking system to collapse – nothing coming out of ATMs, credit cards being cancelled by the simple means of some electronic network being switched off. Nothing moves, no trade, no shopping, no payments of wages – only barter. (I recall one finance industry person defining ‘security’ as the cans of food you own at the time of Lehman event.)

    Since the USA, the most relevant country in this context because this is where the GFC has its home, is linked with the rest of the world via the banking system and international trade, the monetary authority also has to keep an eye on the exchange rate. If the US banking system had collapsed, what would its major creditor, China have done? Would China have acted like the UK in relation to Iceland and, in an initial response, send military frigates?

    Setting all other economic policy objectives aside, Jan Tinbergen is still relevant even the narrow context of monetary policy as conceptualised in mainstream economics.

    b) “Changing the target for monetary policy from policy from inflation to inflation + real growth isn’t going to change this.

    Setting aside the Jan Tinbergen problem, I should think the conclusion depends on the relationship between the CPI measure of inflation and the GDP deflator and both in relation to a the full set of nominal prices and their timing and accuracy of measurement. This set of relationships is likely to vary both over time and across economies.

    JQ makes the point that in Australia export prices are important and their variability is captured by the GDP deflator and he recognises that physical (particularly real estate) asset and financial assets prices are potentially a problem.

    IMHO, the Tinbergen problem dominates even in the narrow monetary policy framework. If one wishes to look for an insight as to what the fundamental problem is, then Radner’s mid-1970s work on sequence economies with commodity and securities markets is a place to start off with. In contrast to commodity markets, there is no ‘lower bound’ on the issuance of financial securities by private agents.

  5. @Ernestine Gross

    I agree with your analysis here so far as I can understand it. I don’t fully understand the section that follows the first mention of Jan Tinbergen. That is a result of my very limited self-education in economics.

    Let me address the section I do understand and agree with. All that you say is true, in my opinion, bar a minor off-topic nitpick. If, as you say, the authorities were bound to act in the manner they did, and I fully agree with you, then this follows. The resources of the state were utilised (capacities, capabilities, institutions, real assets, monies, tax revenues etc.) to effect the rescues or bailouts. The people of a democratic state own the resources of the state in the sense that they are common resources to be used for common purposes. In this case, the common purpose furthered, for the USA in this case, was to save the financial system for everyone right down to having ATMs working and food on the shelves in supermarkets.

    In this case, the use of common resources ought to have mandated a (partial possibly) change in ownership of the institutions bailed out. They ought to have been either partly nationalised to the value of the bailout or treated in a second manner. The second manner would have been to relieve existing shareholders in said institutions of that proportion of ownership which had been underwritten by the state bailout. Let us say it is 25% of market capitalisation in a particular bank’s situation. In this case, that 25% should have been spread as shares on a per capita basis to every registered adult in the USA.

    To make this workable, the shares would have been held in escrow by the US government. Individuals could then elect, possibly at tax time or another time for social security recipients, to take the market value of the shares in money (sell them to the government or have the government sell them on the exchange on their behalf) or take full possession of these shares and add them to a private share portfolio. The government would conduct these operations to reasonably but not unduly protect said share prices over an appropriate period of time to meet all objectives.

    Minor Nitpick Below.

    China could not send frigates at the USA in the manner that the UK could send frigates at Iceland. I am sure you know this of course. This leads to the point that military power has economic effects even in its potential and of course it can have massive economic effects if open war is waged. At this stage, the US still over-trumps every other nation individually in military power. Nuclear capability deters open war between major powers as per MAD (mutually assured destruction) but of course this does not fully guarantee that large scale conventional or nuclear war will never happen. China has to play the long game to wait for the USA’s decay and its own growth to reverse the balance of power. Open conflict is not now in China’s interests. China’s long term strategy runs another way. This is not the thread for such a discussion though.

  6. @Ikonoclast

    I assume JQ won’t mind if we explore this topic a little more.

    The UK (partially?) nationalised banks which were ‘bailed out’. But only temporarily. Your suggestion regarding the US (partial nationalisation and spreading the shares among the people) makes sense to me. The outcome may still fall short of expectations – the former USSR privatised its previously state owned enterprises by spreading shares. It didn’t take long until share ownership concentration emerged and worse. But then the situation isn’t quite comparable, if at all.

    As to ‘frigetes’, to be sure I don’t even know whether frigetes were the type of war vessels that had been employed by the UK. Maybe I should have used 2 question marks.

  7. @Ernestine Gross

    “It didn’t take long until share ownership concentration emerged and worse.”

    Yes, I take it as a near certainty that this would happen again in our current economic system(s), albeit maybe at different rates in places like post Soviet Collapse Russia and contemporary USA.

    1. In the first instance, giving people, en masse, shares or money equivalent is at least a one off money or wealth transfer. It is a help that is better than nothing and a significant proportion is likely to liquidated and spent quite quickly likely boosting aggregate demand.

    2. The ability to hang onto and maybe even grow shares depends primarily on the initial wealth condition of the person at time t1. If he/she is living indigently (dirt poor, hand to mouth) then the shares must be liquidated straight away to eat and/or lodge better. Some people are just impecunious, disabled or foolish by misfortune or nature; this is true too. Better off, well organised people including those lucky by birth and circumstance can use money (or shares) to make more money.

    3. Your statement, which I quoted above, pertains to that precise point made about our current economic system and made by people from Marx to Piketty, though maybe in different forms and expressions. Our system functions a lot of the time to heavily concentrate wealth and the only way of “redress” or “rebalance” is redistributive taxing and spending (taxes and welfare or taxes and negative income tax (NIT)).

    4. This gets back to my endless bleating about changing the system at the front end. I mean at the level J.Q. terms “pre-distribution” and Marx terms “distribution” IIRC in each case. Terminology varies in different schools of economics so we need to be sure we are talking about basically the same thing.

    5. Changing the pre-distribution setup need not mean central planning in the usual centralised socialist economic sense. It could mean moving the balance between labour income and profits back towards labour. It could mean that share purchase from profits is subjected to a tax that share purchase from income from personal effort is not. It could mean moving ownership and management of enterprises from capitalists to workers. It could mean new laws essentially meaning companies and enterprises must take on junior partners in the first instance, as coopeerative owner/workers and not employees, unless the entrant freely prefers to be an employee and not a cooperative owner and worker. It also might indeed mean recreating institutions such that markets are more properly “completed” (correct term?) in the sense that you mean when discussing your work and that minumum wealth conditions are met again in the terms you mean. In turn, laws governing overall market operations, over-concentration of personal wealth, proliferation of financial instruments and inalienability of certain kinds of rights and wealth might all need to be theoretically designed, framed, implemented and then iteratively modified using real world results as the guide.

    6. This could be implemented in a variety of ways and one must needs get speculative. I have speculated in point 5 and add this. It would have aspects of market socialism and market capitalism about it which I won’t explore in detail here. Another overarching idea might be the Basic Income Guarantee (BIG) normatively conceptualised and implemented as an inalienable (unsellable, unforfeitable) share in the society one is born into or naturalised into and which yields a fortnightly income for all adults (18 years and over). Discussing child benefits introduces details which we can leave aside in a simple overview.

    7. Certainly my socialist ethics or “instincts” have not changed but the form in which I envisage implementation has been modified by debates on this blog and quite significantly by your views and expositions so far as I understand them.

    I could write more but it’s probably best to keep comments relatively short in any possible to and fro process.

  8. @Ikonoclast
    Your #32 above

    Keeping it short, if a tad belated, on the natter of “concentration”, my father used to say to me – back more than half a century ago – if we collected up our total wealth and then divided it equally amongst everybody, that within 6 months the rich would be rich again and the poor would be poor again. I still think he was probably right.

    Kinda like a short story I once read where a conman concentrated on bilking the poor because, compared to the rich, their hold on money was so much weaker.

    And whilst I sympathise to some extent with your “socialist instincts” it is surely clear long ere now that changing “systems” is just … well I won’t say “farting into the wind”, but that description is close. Whatever “system” we come up with, there will always be a sizable cohort of grifters and grafters, conmen and thieves – not to mention murderers and violators – who will immediately set to work to undermine and subvert order and propriety.

    And that cohort is clever and persistent and constantly renewed and expanded … and usually very successful, though individuals are not necessarily so.

    Although I admire idealism, it’s generally abut on a par with faithful belief in perpetual motion. But don’t let my cynicism stop you. 🙂

  9. @GrueBleen

    Quote : “… my father used to say to me – back more than half a century ago – if we collected up our total wealth and then divided it equally amongst everybody, that within 6 months the rich would be rich again and the poor would be poor again.”

    And my father used to say to me, “Money is like manure. Heap it up in big piles and it stinks. Spread it around and it helps everything grow.”

    We can refer to folk wisdom, or we can actually look at both human propensities and variabilities and system propensities and variabilities. Both are real factors. However, no matter what I blog I you won’t change your mind. It’s made up. I can see that. Feel free to skip my posts when I talk about socialism or inequality. 🙂

  10. @Ikonoclast
    Your #34

    Folk wisdom ? There’s no such thing, mate. As I may have said before, though knowledge can be transmitted from generation to generation, wisdom must be acquired afresh every time.

    But I still reckon my dad was a lot more right than your dad once the money is spread paper thin everywhere, what can people do with it ?

    Yes of course both human and system propensities and variabilities are real factors, when have I ever said, or implied, otherwise ? My thesis is simple: in the perpetual dance of life, the universe and everything, it’s the people propensities that are dominant.

    Can you, given your own propensities, see that my concern with injustice and inequality is what drives me to reject any possible faith in”systems” to correct those ills ? Or should I just opt for saying: “despite the obvious lessons of history about the considerable corruptibility of “systems”, the stuff I believe in will, this time, overcome all evil” ?

    I enjoy, and will continue to read, your declarations of transcendent faith, Ikono, but as you’ve stated, don’t expect me to believe in any of them.

  11. @GrueBleen

    I have a great respect for all of individual propensities, societal system propensities and natural system propensities. I endeavor to employ complex systems thinking where I don’t ignore the importance of each level and the influences and feedbacks between systems and sub-systems. Otherwise we can suffer from a form of intellectual tunnel vision where we over-estimate the determining influence of some sub-systems, as I consider you do with your implicit methodological individualism. Of course, methodological individualism is the soupe du jour for much modern thinking, especially in the fields of economics and liberal bourgeois politics. I take an unorthodox stance with respect to these but it is probably an orthodox stance with respect to recent complex systems philosophy and systems science.

    It’s not transcendent faith that drives me to these lengths, it’s existential despair. Believe me, if I was a happy, contented sort of person I wouldn’t be driven to this to level of ratiocination or rationalisation (pick a word).

  12. @Ikonoclast
    Your #36

    I know what you think you’re doing, Ikono, but i would commend to you the idea that most human thought is either woefully inadequate or just plain wrong.

    I would also comment to you the game Nomic (of which I vaguely remember there being a computer game version).

    Lastly, look carefully at that large heap of mammoth dung: that is where your next crop of pumpkins and maybe squashes or suchlike will come. And when they come, be sure to leave a just and equitable share for the mammoths, or they won’t be able to produce a pregnant heap next year. And don’t spread the dung too evenly and thinly, because then the cucurbita seeds won’t be able to successfully root and germinate.

    🙂

  13. @GrueBleen
    at #33

    Nice rationalization on giving up on changing the system for the better. Or, letting it getting worse and worse.

    I live in a country that went through such experiment, Croatia as it was part of Yugoslavia a communist country of some crucial difference from Soviet style system. So much dfferent that it was under the economic embargo from Stallin for not being the part of Warshaw pact nor NATO. Yugoslavia was initiator of Independent Block of countries.

    We had prety equal distribution for over 44 years and very low corruption. It was one of the safest countries to live in. For 44 years. Only chronic alcoholics were poor, nobody else.
    Inequality was comming only from inheritance, not from wages. That was the system. And also hgher inflation took care of any large savings (they had to be spent), only safe saving was into land and housing.

    Inequality is systemic probem, not the natural thing as you believe and rationalize so not to resist it. It depends on the system that is set up.

    It was so untill the war `91-`95. During the war it started a transition to cpitalism. The president himself described the vision he was seting up Croatia to transition into; There wil be 200 rich families that will compete against international corporations for the benefit of Croatians. That was the idealised story; the reality was that they did not care for Croatians but for themselves only and always demanded less rights for rest of the population so that they would be “able” to compete.
    They made them rich by giving them companies that used to be in workers ownership. they were paying for companies with credits that were put on company ledgers (basicaly they gave no money of their own since nobody had large savings)
    Another way was giving them Yugoslavian dinar that was pull out of circulation after separation. They took worthles (for Croatia) money and transported it in lorries into Bosnia and Serbia where it was exchanged for foreign currencies and ended up in private pockets.
    Onyl that way they could start the seed of extreme inequality now present in Croatia, it would not be natural procivity of a system to legaly grow inequality in short time, only by design.

  14. ‘Keeping it short, if a tad belated, on the natter of “concentration”, my father used to say to me – back more than half a century ago – if we collected up our total wealth and then divided it equally amongst everybody, that within 6 months the rich would be rich again and the poor would be poor again. I still think he was probably right.’

    ‘Sergeant Colon had had a broad education. He’d been to the School of My Dad Always Said, the College of It Stands to Reason, and was now a post-graduate student at the University of What Some Bloke In the Pub Told Me.’

  15. @J-D
    Your #39

    That’s really very good, J-D, where did you get that from ?

    And should we nominate you as the leading exemplar of Sergeant Colon Syndrome ?

  16. @Jordan from Croatia
    Your #38

    Well I’m just fascinated, Jordan, by your infallible capacity to misinterpret and/or misunderstand me. You are nearly as good at it as Ikonoclast.

    But thank you for your exposition of the near paradise that was Yugoslavia under Tito, and your description of how rapidly it disintegrated afterwards when none of its prior beneficiaries could be bothered defending it against the grifters and grafters, conmen and thieves, murderers and violators who took over.

    Much like in the once American near-paradise nobody can now be found to defend it against grifters and grafters etc etc.

    Not to mention how the once acknowledged “workers’ paradise” of Australia (once the land of the court mandated 8-8-8 and fair living wage) has fallen into the hands of the grifters and grafters etc etc.

    I think I’m beginning to see a pattern here – what do you think ?

  17. @GrueBleen
    Wooow, how many straw man did you pull out for this avoidance of the topic you pulled first: “It is the nature that man will have extreme inequality no matter what else.”

    1) near paradise
    2) nobody wanted to protect succh near paradise
    3) Those are drifters and drafters, conmen and thieves… not really the wealthy i am thinking of
    4) America was like Yugoslavia
    5)Australia was paradise
    6) Australia is controlled by grifters and grafters

    How about staying on topic that you started? Or you have no arguments for it, just beliefs?

  18. @Jordan from Croatia
    Your #42 of 30 August.

    Ha ha, Jordan, you are a very funny man – damn near as funny as J-D, but at least he can quote Terry Pratchett.

    When you learn to try to understand what you read instead of inventing your own ‘story’ to fool yourself with, then perhaps you will be able to join the human race in intelligent discussion. It will be a long, hard struggle, Jordan, but maybe you can last the course.

    Good luck !

  19. @GrueBleen
    Is that a new straw man or you just lost all your marbles and resorted to pure insults just as every ignorant person after loosing all arguments and out of sheer desperation think that insults will make you a winner?? more like !!!!! instead ?

  20. @Jordan from Croatia
    Your #45 and #46

    You see what I mean, Jordan ? No, I guess you don’t because you’re still making up little bedtime stories to beguile yourself with.

    Insults, Jordan ? No, the truth is never an insult, you’ll have to understand that as you grow out of childhood.

    But keep it up, don’t give up, you never know when your breakthrough will come and you’ll begin to apprehend reality. And you might eventually learn to be able to combine a couple of sentences into a single reply. Or did you just get so excited that you couldn’t contain yourself even for a moment ?

  21. I agree that inflation targeting could be improved upon, but I don’t think nominal GDP targeting is the way to do it, for reasons I explain here). I think price-level targeting would be a better alternative.

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