QE Infinity

A lot of hot air has shot about the internet about nominal GDP targeting, the brainchild of Scott Sumner.

Some (including the usual suspect) have said that it’s Bernanke’s next big bazooka in the (ahem) “war on economic instability“.

What the growing recognition for nominal GDP targeting reflects is a wider awakening to something I have been talking about for a long time: Irving Fisher’s theory of debt deflation. When monetary circulation drops, prices tend to drop and nominal debts tend to become much harder to repay. Therefore, the nominal value of those debts rises: workers and businesses have to produce more to pay down debts. Inevitably, this leads to more defaults. This can lead to what I (and a few others) have termed a “default cascade” — one set of large defaults leads to deflation, leading more defaults, and eventually resulting in systemic failure.

Nominal GDP targeting gives the Federal Reserve the scope to buy assets until they hit a nominal GDP target, ensuring that no such debt deflation will occur. It is — in my opinion — the most powerful monetary tool yet-imagined for reinflating burst bubbles.

As Scott Sumner puts it:

Now why is Nominal GDP so important? That’s the total dollar value of income in the economy. And if you think about it, most debts are contracted in nominal terms. So in a sense, the economy’s dollar income is a good metric for measuring people’s ability to repay these previously contracted nominal debts.

QE was — in terms of reinflating bubbles — a blunt weapon. It shot off an arbitrary amount of newly-printed/digitally-created money, with the explicit target of lowering net interest rates (and the implicit bonus of combating debt deflation). Nominal GDP targeting flips this on its head.

The problem is that this focus on monetary means will not solve the larger systemic economic problems that America and the Western world face.

As I wrote yesterday:

The problem is that most of the problems inherent in America and the West are non-monetary. For a start, America is dependent on oil, much of which is imported — oil necessary for agriculture, industry, transport, etc, and America is therefore highly vulnerable to oil shocks and oil price fluctuations. Second, America destroys huge chunks of its productive capital policing the world, and engaging in war and “liberal interventionism”. Third, America ships even more capital overseas, into the dollar hoards of Arab oil-mongers, and Chinese manufacturers who supply America with a heck of a lot. Fourth, as Krugman and DeLong would readily admit, American infrastructure, education, and basic research has been weakened by decades of under-investment (in my view, the capital lost to military adventurism, etc, has had a lot to do with this).

In light of these real world problems, at best all that monetary policy can do is kick the can, in the hope of giving society and governments more time to address the underlying challenges of the 21st Century. When a central bank pumps, metrics (e.g. GDP and unemployment) can recover, under normal circumstances that is great. But with underlying challenges like the ones we face, a transitory money-printing-driven spike is often not enough to address the structural problems, and these problems soon cause more monetary and financial woe.

What I can say about nominal GDP targeting is that it is probably the best monetary tool for buying more time. But that is completely and totally useless if America fails to address the real problems in the mean time, and assumes that the energy, military and social problems (e.g. zombification) that are the real cause of long-term economic woe will just disappear.

A larger problem is that this “solution” will probably do more (by duplicating their dollar holdings) to annoy America’s creditors, including China and Russia, who have significant scope to cause America real economic problems through a trade war.

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11 thoughts on “QE Infinity

    • I think it’s simply that much of the establishment does not understand what fragility is. They see day-to-day and year-to-year volatility and mistake it for a curse to be eliminated through financial/social/international engineering and managerialism. Removing volatility (for example the abolition of deflation) seems to create widespread systemic fragility. This is operative in so many domains beyond economics — e.g. health, diet, environment.

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  2. Christine Romer also has come up with this same boondoogle POV of GDP targeting.

    Quote by Romer in her NY Times op-ed page the other day, “”It would work like this: The Fed would start from some normal year — like 2007 — and say that nominal G.D.P. should have grown at 4 1/2 percent annually since then, and should keep growing at that pace. Because of the recession and the unusually low inflation in 2009 and 2010, nominal G.D.P. today is about 10 percent below that path. Adopting nominal G.D.P. targeting commits the Fed to eliminating this gap.”

    Of course, she picks the near peak in the global debt bubble as a “normal” year. It would be funny if she wasn’t teaching our kids and hadn’t given advice (no longer) to the POTUS.

    Scarry stuff.

    On a side note, yahoo finance had an interview with Romer, and the commentors below just destroyed her. Perhaps there is hope after all?

  3. Pingback: Negative Real Interest Rates « azizonomics

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