NGDP Targeting And The Permanent Portfolio (long)

[JonathanH]

NGDP Targeting and the Permanent Portfolio

I thought it would be fun to think about how the permanent portfolio might behave in an economy where the central bank (CB) is targeting NGDP. I've heard it advertised as being "essentially the gold standard" depending on the NGDP level being targeted. I think the recent performance of the economy should be seen in this light. Gold has dropped and is staying at a lower level and we see stocks going up.

Rothbard vs Hayek and the Market Monetarists

As a fan of the Austrian school of economics I've read Rothbard for years. But only just recently have I read Hayek's work on monetary equilibrium. IMO this is a much better way to look at economic issues relating to the value of money. Rothbard has the same method of analyses but most of what I've seen from him focus on gold for ethical reasons and emphasizing it's supply stability.  Hayek has a more rigorous analyses and explains that in a free banking system the supply of money and the demand for money would stabilze (the MV in the equation of exchange MV = P (price) Y(GDP)) and we would experience stable NGDP. Hayek also illustrates how gold itself isn't perfect, because it has other non monetary uses that affect its value. In order for a banking regime to maintain a dollar peg to gold (like $35 / ounce), it has to buy and sell gold based upon gold's own supply and demand. He does emphasize that while inflation can cause bad market signals for people, so too does deflation. While a market correction needs to happen to clear away bad investments caused by inflation, a secondary deflation could be avoided through NGDP targeting. He does see NGDP targeting as a valid function for banks to perform even in a decentralized system.

This makes Hayek an early propoent of the idea, and perhaps a bridge between the Austrians and Market Monetarists.
Today's most prominent advocate of NGDP targeting is MM Scott Sumner. But there are many "Hayekian" Austrian's on board. They advocate different target levels, and the Austrians prefer a free banking system, but think NGDP targeting is the least destructive thing a CB can do.

Very cool stuff!

I was intrigued when I read Scott Sumner explain it as "effectively the gold standard" and "even Hayek supports it". How is it like the gold standard? Instead of pegging the dollar to a weight of gold, it's pegging the dollar to the entire output of the economy. An NGDP target of 0% would target the output, but population increases would force prices to adjust downward. An NGDP target of around 3% would accommodate a growing population. Hayek wanted 0%, some current Austrians want 3%, the MM want a target of 5% to provide and extra 2% of inflation. Scott Sumner's preferred mechanism for targeting NGDP is a future's market. Where market participants have control of the supply of money by speculating on the actual GDP of the economy. If it veers off target, the speculators profit. If it stays on target, then they make no money. This aspect is very confusing to me. In fact I probably didn't describe it right.

Another way to target NGDP is for the CB to just buy more government bonds (i.e. QE 3, QE 4, etc).
If there are no government bonds then they can buy corporate bonds, then stocks, etc. One can see where these activities could be seen as granting favor to cronies.

Scott explains that what Bernanke is doing is halfway to NGDP targeting. I think this is a much better way to look at what the economy has done. He's ramped up the supply of money to offset the fact that the velocity of money has slowed down. MV has sort of stabilized, and we can see how the economy has sort of stabilized. Although I've read recently that supply and velocity are dropping and if that continues we could see some negative repercussions.

Of course, the best way for MV to stabilize is not through the attempts of a CB to manufacture it, but for it to emerge spontaneously through the voluntary activity within a free banking system (according to Hayek).
But NGDP targeting is superior to inflation targeting; a sort of 2nd best alternative. Inflation targeting seeks price stability. Austrians have argued for 100 years that this is extremely dangerous. While the CB targets consumer inflation, other non targeted assets can boom then cause a bust.

NGDP targeting is supposed to have the effect of neutralizing capital distortions.

Some known issues:
If GDP falls below target, inflation will persist up to the NGDP target level. But if there is a period of high productivity, output will be allowed to grow and prices fall (like when we were on a gold standard). I read on a blog somewhere that Japan could be viewed as having a quasi NGDP target of 0% and some of the negative aspects of their economy are more related to ramping up government spending. I don't have the mental jujitsu to analyze that thought but it sounds curious.

Hopefully, an era of NGDP targeting will have more periods like the 1990s where output grows, inflation is low, and people prosper! I suppose that means stocks going up, gold staying low? Interestingly, there exists a motley crew of support from Austrians, Market Monetarists, and Keynesians.

Here is a link of some proponents and the work they've written in support:
http://www.ngdp.info/nominal-GDP-level- ... nents.aspx

And since we don't know what will happen in the future, we should hold all assets.

[kev_in_tw]

In the UK the new governor of the Bank Of England is apparently a believer in NGDP targeting. Or at least he mentioned it positively for a while and then back pedalled

http://www.businessinsider.com/mark-car ... ing-2013-2

I could see that an NGDP target of 0% would be like the gold standard. However a non zero NGDP target seems very different - you're essentially saying that either the GDP will grow by the target or the central bank will create money to create inflation of the target.

Now the problem with the gold standard or a zero NGDP target is that it arguably prolongs depressions. On the other hand it seems like non zero NGDP target risks getting stuck in a state with zero growth but inflation at the NGDP target. I.e. pretty much what we have at the moment.

It's not at all clear to me that creating inflation will magically cause growth to replace it. Theoretically low interest rates and inflation over target means savers in banks will see their savings erode and thus be forced to invest them.

Mind you you can definitely make a case that the central bank should allow a bit of slack in targeting inflation after a major crash. Which seems to be what the BoE is doing.

As far as I can see the BoE is doing "flexible inflation targetting". I.e. it will let inflation overshoot the target

https://www.bondvigilantes.com/blog/201 ... red-price/#

So that means we'll see low interest and high inflation to try to push people to invest. Will it work in practice? I'm not sure.