Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 24 July 2014

Synthesis!? David Beckworth's Insurance Policy

Could it be that New Keynesians and Market Monetarists can converge on a common policy proposal? I really like David Beckworth’s Insurance proposal against ‘incompetent’ monetary policy. Here it is.

1) Target the level of nominal GDP (NGDP)

2) “the Fed and Treasury sign an agreement that should a liquidity trap emerge anyhow [say due to central bank incompetence] and knock NGDP off its targeted path, they would then quickly work together to implement a helicopter drop. The Fed would provide the funding and the Treasury Department would provide the logistical support to deliver the funds to households. Once NGDP returned to its targeted path the helicopter drop would end and the Fed would implement policy using normal open market operations. If the public understood this plan, it would further stabilize NGDP expectations and make it unlikely a helicopter drop would ever be needed.”

In fact I like it so much that Jonathan Portes and I proposed something very like it in our recent paper. There we acknowledge that outside the Zero Lower Bound (ZLB), monetary policy does the stabilisation. But we also suggest that if the central bank thinks there is more than a 50% probability that they will hit the ZLB, they get together with the national fiscal council (in the US case, the CBO) to propose to the government a fiscal package that is designed to allow interest rates to rise above the ZLB.

There we did not specify what monetary policy should be, but speaking just for myself I have endorsed using the level of NGDP as an intermediate target for monetary policy, so there is no real disagreement there. A helicopter drop is a fiscal stimulus involving tax cuts plus Quantitative Easing (QE). Again we did not specify that the central bank had to undertake QE as part of its proposed package, but I think we both assumed that it would (outside the Eurozone, where for the moment we can just say it should). I think a central bank could suggest that an income tax cut might not be the most effective form of fiscal stimulus (compared to public investment, for example), but let’s not spoil the party by arguing over that.

Now this does not mean that Market Monetarists and New Keynesians suddenly agree about everything. A key difference is that for David this is an insurance against incompetence by the central bank, whereas Keynesians are as likely to view hitting the ZLB as unavoidable if the shock is big enough. However this difference is not critical, as New Keynesians are more than happy to try and improve how monetary policy works. The reason I wrote this post was not because of these differences in how we understand the world. It was because I thought New Keynesians and Market Monetarists could be much closer on policy than at least some let on. I now think this even more. 



21 comments:

  1. Or the central bank can just perform the heli drops by itself by providing deposits and payments system of electronic reserves to everybody. If the fed is tasked with providing a money supply the least it can do is provide an efficient pmt system for it.

    Also why resort to heli drops as a second line of defense? Couldnt the fed target the short term rate by expanding reserves to people and contracting through OMO's if necesary?

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    1. Re your first paragraph, the “payments system” already exists, as Simon implied. That is, money can be chanelled into the pockets of pensioners, the unemployed etc via the existing state pension system, unemployment benefits, etc. So there’s no need for a duplicate system is there?

      Re your 2nd paragraph, I’m in about 75% agreement. That is, in common with Positive Money and others, seems to me that stimulus should ALWAYS take the form of simply creating new base money and spending it, and/or cutting taxes. As to the “short term rate”, that strikes me as irrelevant. That is, there are host of reasons for thinking that interest rate adjustments are a poor way of influencing aggregate demand.

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  2. Market Fiscalist25 July 2014 at 07:30

    All this talk of "helicopter drops" and "logistical support to deliver the funds to households." seems overly dramatic to me. Market Monetarists believe that they can hit any NGDP-target by varying the quantity of base money. This quantity can be varied either by varying the government deficit (fiscal policy) , or by swapping other assets or money (monetary policy). Market Monetarists appear to favor monetary policy more for purists reasons than reasons based on solid economic reasoning, since both policies achieve the goal of adjusting the monetary base equally well if applied correctly

    I do not see the need for sudden "helicopter drops" in response to NGDP-emergencies.

    Why not a combined rules-driven approach that uses fiscal and ;policy in a coherent way ? For example: combine the use of interest rate policy with a sales tax that adjusts up or down in response to changes in expected NGDP. When interest rates are high then interest rates do the heavy lifting, as they lower and approach zero then the sales tax takes over (and could even become a sales subsidy in extreme cases).

    This has the advantages of preventing either policy from getting overly stretched and would avoid the precarious/risky nature of the kind of policies adopted when interest rates are brought close to zero.

    Just an idea.

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    1. Market Fiscalist, reading your comment I thought of this plot. The text below the plot explains it (in particular the red and blue arrows). At least according to the theory which produced that plot, economies can slowly evolve over time to a state where monetary policy is ineffective. If the theory is true, then it's not clear a one-size-fits-all approach to fiscal vs monetary policy will work. The theory produces a set of very low parameter-count models (1 to 3 parameters depending on the particular model or plot) that allows one to plot multiple economies on the same chart and compare them with theoretical curves (1 parameter in this case). Here's what a collection of economies over multiple decades look like in their price level and NGDP, compared with the theoretical curves. Each economy has a separate color (in the left-hand side plots). Those up near the knee where the curves flatten out are predicted to have less effective monetary policies. Since that post, the author has added Russia. It'll be interesting to see if different economies continue to fit his theory so well in future decades. But so far, I'm inclined to believe that monetary policy can be expected to produce different results in different countries, even if we restrict ourselves to considering only 1st world countries. Here's where Switzerland and Sweden fall on his plot, for example.

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    2. “..both policies achieve the goal of adjusting the monetary base equally well..” Hang on. If by “fiscal policy” you mean “government borrows £X, spends £X and gives £X of bonds to lenders”, then there is NO EFFECT on the amount of base money in private sector hands. But if by fiscal policy you mean the above plus QE, then the base does rise – and importantly – so does what advocates of Modern Monetary Theory call “private sector net financial assets”: that’s the sum of national debt and base money in private sector hands.

      However, “asset swapping” means NO CHANGE to PSNFA, while IT DOES raise the stock of base money.

      Thus your “equally well” point looks dodgy to me.

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    3. Ralph,

      Yes, for fiscal policy to increase the base it would need to be unfunded by bond sales.

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    4. Market Fiscalist25 July 2014 at 16:54

      I was thinking of fiscal policy as just the deficit. Any associated bond sales would count as part of monetary policy in my simple plan.

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    5. This comment has been removed by the author.

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    6. Market Fiscalist25 July 2014 at 17:15

      Tom,

      I've seen that "Information Transfer Economics' blog, but failed to grasp the idea. Is there a simple explanation any where ?

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    7. Market Fiscalist, here's a write up on the basic concept w/o much math. And here's a good math-free discussion of the general theory which gives some context and feel for the overall approach and its justification. And if you want more details, this paper describes the general model (math and all) which was the basis for Jason's adaptation to economics.

      Even if his hypotheses or models prove to be wrong ultimately, he's given a good example (IMO) of approaching economics scientifically: core hypotheses => auxiliary hypotheses => models => predictions => statement of what evidence would make it likely that his models are wrong. How often do you see that on econ blogs? Lol. (it probably helps that it's not his day job! :D)

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    8. ... and here's one step beyond the fundamental post I gave you above, this one also being specific to econ (I think in general you can start with his earliest posts from 1 year ago, though he did warn me I'd come across a few dead ends he went down doing that).

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  3. As I commented over at Beckworth’s blog.

    "Second, the Fed and Treasury sign an agreement that should a liquidity trap emerge anyhow [say due to central bank incompetence] and knock NGDP off its targeted path, they would then quickly work together to implement a helicopter drop."

    A central bank that did not do the right thing in 2008 due to inflation targeting is not going to agree to this. Might as well propose a plan to:
    ---
    Have the Fed sign an agreement that should a liquidity trap emerge anyhow [say due to central bank incompetence] and knock NGDP off its targeted path, they would then quickly drop their inflation target and do the right thing to bring NGDP back to level target.
    ---

    When it's not working it's silly to propose solutions that assume away the original flaw.

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  4. "A helicopter drop is a fiscal stimulus involving tax cuts plus Quantitative Easing (QE)."

    No, that is not a helicopter drop. A HC is fiscal stimulus plus a money transfer (in exchange for absolutely nothing) from the central bank to the treasury.

    A HC doesn't increase the gross national debt (it does increase the net debt, if you count the central bank as a government asset).

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    1. Oops, I typed "HC" when I meant "HD" (helicopter drop).

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  5. The Wren-Lewis / Portes proposal seems to involve JUST heli drops. I don’t like that because the intended effect is to boost JUST PRIVATE spending. Why not boost public spending as well?

    If the electorate votes to split GDP in the ratio X:Y as between private and public spending, then when stimulus is needed, the boost should apply to private and public sectors in the ratio X:Y.

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  6. Beckworth, Wren-Lewis and Portes want coordination between central bank and treasury at the zero bound. There’s a thoughtful article by Scott Fullwiler written a year ago claiming that such coordination is irrelevant. I think Scott’s article is flawed – for reasons I’ll probably put on my own blog in a day or two. But if anyone else has thoughts on Scott’s article, I’d be interested. See:

    http://neweconomicperspectives.org/2013/07/drop-it-you-can-call-for-helicopter-money-but-drop-the-call-for-coordination.html

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  7. Money-financed government investment would normally make more sense, since a lot more projects would presumably meet the NPV > 0 criterion at the ZLB. But helicopter money would be quicker to implement. I think the Australian government (though Oz never hit the ZLB) was a lot quicker to mail out cheques than the Canadian government (Canada did hit the ZLB) was to start building things.

    But I can't help but think: if the central bank does hit the ZLB, what this means is that the target trend NGDP growth rate was too low.

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  8. I can get behind the synthesis (while still preferring more government spending). In a way there already is a fiscal insurance program when the Fed fails: automatic stabilizers.

    http://krugman.blogs.nytimes.com/2009/07/15/deficits-saved-the-world/

    "Deficits saved the world

    JULY 15, 2009 8:54 AM

    Jan Hatzius of Goldman Sachs has a new note (no link) responding to claims that government support for the economy is postponing the necessary adjustment. He doesn’t think much of that argument; neither do I. But one passage in particular caught my eye:

    The private sector financial balance—defined as the difference between private saving and private investment, or equivalently between private income and private spending—has risen from -3.6% of GDP in the 2006Q3 to +5.6% in 2009Q1. This 8.2% of GDP adjustment is already by far the biggest in postwar history and is in fact bigger than the increase seen in the early 1930s.

    That’s an interesting way to think about what has happened — and it also suggests a startling conclusion: namely, government deficits, mainly the result of automatic stabilizers rather than discretionary policy, are the only thing that has saved us from a second Great Depression.
    ...."

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  9. "There we did not specify what monetary policy should be, but speaking just for myself I have endorsed using the level of NGDP as an intermediate target for monetary policy, so there is no real disagreement there."

    1) Define monetary policy.

    2) RGDP = 1%, price inflation = 4%, and productivity growth = 1.5%. Let's say employment falls. What do you want to do then?

    "A helicopter drop is a fiscal stimulus involving tax cuts plus Quantitative Easing (QE)."

    Let's say that leads to more gov't debt. Is the central bank going to buy existing debt or the new debt?

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  10. " I think the Australian government (though Oz never hit the ZLB) was a lot quicker to mail out cheques than the Canadian government (Canada did hit the ZLB) was to start building things."

    Did this increase gov't debt?

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  11. Like. +1. :-)

    Your problem, however, is not unifying the Market Monetarists and the Keynesians, but rather, getting political traction of any sort. Much stupider doctrines dominate Congress, and even the White House is ruled by strange doctrines such as "that number is too large to send to Congress".

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