Thursday, October 27, 2011
Here's a chart that shows the quarterly annualized figures for nominal and real GDP growth. I've mentioned this before, but what strikes me again is how nominal GDP growth has been fairly steady since the recovery began, even as real growth has been quite volatile. Over the past year, nominal GDP growth was 5.0%, and that's actually a bit better than its 4.7% annualized growth over the past 20 years. There's a lot of talk these days (led by Scott Sumner) about how the Fed should target nominal GDP growth, and the recommendations typically call for a 5-6% nominal GDP growth target. Well, guess what, based on the last 8 quarters of GDP data, you could argue that the Fed has been doing almost exactly that.
Problem is, of course, that even 6% nominal GDP growth is not going to fix the mess that this economy is in. As the chart above shows, real GDP is still about 12% below its long-term trend. We would need quite a few years of exceptionally strong real growth (accompanied, no doubt, by at least 2-3% inflation) to get us back to a level of economic activity that would provide employment for the many millions who would like to work but can't find a job. So nominal GDP growth is going to have to be a whole lot more than 5-6% per year before the economy really recovers. So here's my question to the nominal GDP targeters: Do we need any special effort from the Fed to achieve the goal of full employment (e.g., QE3)?
This chart would say "no." The Fed has already accommodated a huge increase in money demand via QE1 and QE2. The surge in money demand has been the direct result of the waves of panic that have swept the global economy in the wake of the Lehman crisis in '08 and more recently the sovereign debt crisis. The current level of M2 could support a 20% increase in nominal GDP if money demand were to return to its pre-2008 levels. Thus, it's theoretically possible for the Fed to refrain from undertaking any further extraordinary easing measures, yet for the economy to regain full employment, provided one thing happens: the world regains its confidence in the future. That would reverse the huge increase in the demand for money that has built up in recent years, that would effectively finance a real and nominal GDP boom in the years to come. What we need is not more money, we need more confidence, and that can come from policies that reverse the errors of the past 5-10 years—policies that brought us the housing market collapse and the crisis of excessive, deficit-financed government spending.
Those in favor of nominal GDP targeting argue, I think, that the Fed contributed significantly to the mess we're in by not easing policy enough. I disagree, since I don't see how a huge money dump could have offset the tremendous damage to confidence and underlying growth fundamentals that stemmed from at least a decade of fiscal policy negligence.
Posted by Scott Grannis at 7:56 PM