Thursday, October 27, 2011

Thoughts on GDP

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.


brodero said...

One indicator I love is postponable purchases to GDP...
Postponable purchases is the durable goods component of GDP,
equipment and software spending of GDP, and residential investment.
Postponable purchases is now 17.36%
near the record low.No recession on
record (since 1947)has started unless first this
number gets above 20%.

Charles said...

The NGDP people can always say that we needed to make up the NGDP shortfall of the recession. But the bottom line is that there is no evidence that the fed can keep NGDP on a stable path through a recession and there is no evidence that attempting to do so would stabilize the economy.

The history of the last four quarters suggests that QE2 depressed real output and created inflation through a fall in the dollar and commodity speculation. Now that QE2 has ended, real GDP growth has resumed its prior trajectory.

qwe said...

Where there any times in the economy history when central banks were conducting nominal GDP targeting policy?

Ed R said...

" . . . . history of the last four quarters suggests that QE2 depressed real output . . ."

What is the evidence (or recognized theory) that QE2 (or any QE) depressed real output??

Public Library said...

The only way to restore confidence is to take the haircuts on debt and let the market swallow up the companies and countries that cannot survive as is.

Problem is CB's and the Electorate will not let it happen. Hence, the long slog ahead.

Public Library said...

Btw, America is back on track. Spending more than we earn and reducing the razor thin savings. We are a smart bunch.

Benjamin Cole said...

Actually, Scott Sumner would like the Fed to target a higher NGDP, but sometimes floats out a "tame" number so people are not scared of NGDP targeting.

Milton Friedman called for a similar action in Japan in 1997---the use of monetary policy to stimulate the economy is actually an old and conservative idea, and even Hayek advocated doing so. It sure offers an option to fiscal deficit spending.

Money is not "easy" in the USA or Japan---if money is easy in Japan, how do you explain that nation's deflation? Or the yen? Or real estate deflation in the USA? (The dollar lately has stabilized against other currencies, and in any event the dollar trading range may be influenced by its shrinking role as the international currency)

So, looking at interest rates tells you nothing, or even looking at M2.

Look at what counts---the economy. It is growing? How rapidly?

The Market Monetarists, led by Scott Sumner, have shown a very promising and conservative rules-based approach to monetary policy, one that could eliminate the push for fiscal activism.

I heartily encourage Scott Grannis to keep an open mind on this topic.

Benjamin Cole said...

BTW, most Market Monetarists (including myself) of course want the smallest government structural impediments and taxes possible.

This often becomes partisan, and unfortunately partisan politics always trumps reason.

For example, every GOP'er will rally against Obamacare as a new expensive structural impediment. Fair enough.

But where is the call for a more-open border, so we do not have a structural impediment against the importing of labor?

How about the doubling in real terms of defense spending, when we face no military foes? That is a 6 percent burden on our economy.

How about rural subsidies?

How about state licensing of lawyers? Insurance companies? What about local land regs, like the fact no one can build a condo skyrise on the beach in Newport beach?

It is difficult to determine which party has erected, or will erect, the most structural impediments.

Sheesh, it was Nixon who instituted wage and price controls.

elegantstroke said...

/* 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*/

Scott - if I understand correctly, I think the Market Monetarists are arguing that the Fed is not shaping expectations with certainty. It is causing more uncertainty within the markets, rather than alleviating the concerns. May be poor communication, less transparency etc.

Benjamin Cole said...


That right. Market Monetarists advocate transparent rules-based nominal GDP targeting. A simple computer could do it.

Right now, the Fed operates obliquely, and seems to press the brakes while hitting the accelerator.

Nothing about Market Monetarists suggests federal activism, or fiscal deficits. Unfortunately, the right-wing has come to conflate "tight money" and "no inflation" with anti-federalism.

Since the GOP can never really balance the federal budget, we end up with the Japan scenario: Big federal deficits and deflation through tight money.

Paul said...


"But where is the call for a more-open border, so we do not have a structural impediment against the importing of labor?"

Yes, we really need more of those high-skilled lettuce pickers and lawn mowers to propel our economy. That will fix everything.

You cannot simultaneously have free immigration and a welfare state.

~Milton Friedman

Charles said...

Ed R,

Look at the chart. QE2 began in Nov 2010 and ended in June 2011. The immediate consequence was faster inflation and slower growth in output. The mechanism is a rapid fall in the dollar combined with commodity speculation which led to inflation in globally traded goods and services and reduced consumer expenditures on goods and services that are domestically produced for domestic consumption. As soon as QE2 ended, the economy resumed its slow growth trajectory.

This is, as I said, a suggestion because proving anything in macroeconomics is next to impossible.

In particular, nobody has any proof that the fed can hit an NGDP target by buying financial assets and there is no proof that doing so would stabilize the economy.

NGDP is an endogenous variable that we observe. Over time it has a predictable relationship with real output. It does not follow at all that we can make NGDP a policy lever that will keep the real economy on a stable trajectory.

Rich said...

This is a little off the track of the discussion, but IMHO germane to the question. In fact it's a lot of the reason for why $GDP is lower; many things now are being given away for free rather than costing dollars.
For example, Craigslist replaces classified ads. Sales of classified ads declines, newspapers fail, newsprint sales go down to such an extent that there are multiple Ch.11's in the space. And what replaces all of this activity in measurable USD GDP? Practically nothing! Yet the job that classified ads did is now being done better.

Too many jobs are being done for zero dollars. If you aren't sure of this, I'd suggest looking at your paycheck for this blog!

Scott Grannis said...

Rich: that's an excellent observation. So I'm giving away a service for free that many institutional investors would normally be willing to pay $10-15K per year for. But presumably I'm contributing to making the markets and the economy more efficient. Even a very tiny increase in the market's efficiency translates into tons of dollars. More efficiency inevitably leads to a stronger and bigger economy.