Many of my opposing views stem from my focus on a single macroeconomic variable—NGDP.
Consider the recent period of high inflation. Almost all economists believe that inflation is caused by a mix of supply and demand side shocks. On the contrary, I believe that the higher inflation was part of demand, and supply shocks are not in play at all, at least in the 2019-24 period as a whole.
Consider some data from the past 4 1/4 years:
Under the 4% NGDP guidance, NGDP should have increased by 18.1% between 2019:Q4 and 2024:Q1. The actual increase was 29.0%.
Under PCE inflation guidance of 2%, prices should rise 8.8% between January 2020 and April 2024. The actual increase was 17.8%.
Note that the 11% excess NGDP increase led to 9% above target inflation. That means that supply shocks do not explain anything total accumulation excessive inflation. Yes, commodity shocks clearly played a role during some months back in 2022. But that negative shock was offset by positive supply shocks in other months. The supply side of the economy was strong—real GDP increased faster than expected, largely due to immigration. Indeed, given the rate of NGDP growth, we are lucky that inflation has not been high at all. A positive economic shock (increased immigration) has held inflation to a slightly lower level than one would have predicted based on NGDP growth alone.
My conflicting views on the role of monetary policy in the recent inflation mirror the same strange views of the Great Depression. I argued that the Great Recession was caused by tight monetary policy in 2008. Very few economists agree with me. When I argue that the Great Recession was caused by a massive fall in NGDP, people accuse me of engaging in a tautology. In their view, a significant decline in NGDP recession. They confuse nominal and real GDP.
The last 4 1/4 years clearly show that real and nominal GDP are not the same thing—higher NGDP has been seen as excessive inflation, not faster RGDP growth. So much for the “tautology” theory.
Another complaint is that when the fall in NGDP was a problem back in 2008, there was nothing the Fed could do about it because it was stuck at the lower bound of zero. But we weren’t at the bottom of zero in 2008—the Fed was doing normal monetary policy. Indeed in October 2008 they established the IOR to keep interest rates low, that is, to prevent the economy from overheating.
Why are my views so different from my partner’s? I see several features.
1. If you did not expect inflation, it is natural to look for some kind of unexpected factor to explain the result. Supply shocks are a valid excuse, especially given that in the short term they have contributed to higher-than-normal inflation. But this is an encouraging thought. Economists tend to ignore the fact that the economy is also affected by emergencies, such as the increase in immigration, or the repair of supply lines after the disruption of Covid. They correctly see supply shocks during certain months, but fail to see that over the last 4 1/4 years the overall supply situation has been very good.
2. Most economists are less supportive of the Fed’s monetary policy stance. So if NGDP deviates too much from the 4% growth path, they are reluctant to blame monetary policy. That is almost like blaming the economic sector for the policy crisis. It is more satisfying to look at explanations involving the mysterious “external shock”.
3. The stance of monetary policy is often very different from the way it appears when looking at indicators such as interest rates. Prices fell in 2008 even though the currency continued to strengthen. Rates rose sharply in 2022 as monetary policy remained more accommodative (though arguably a little less than in 2021.) If you misjudge the stance of monetary policy, you are more likely to misjudge the cause of recession or high inflation. This error is more likely to occur when an external factor (such as a housing downturn) causes a large change in the natural interest rate, making the Fed’s policy rate a very inaccurate indicator of the actual policy position.
My focus on nominal GDP also explains why I am not impressed with unconditional forecasts. I realize that many people who were right about inflation in the early 2020s were wrong about the results of previous QE programs under Bernanke. (And vice versa.) I’m very impressed conditional predictions. What do you think will happen if the Fed allows for 29% NGDP growth in the 4 1/4 years after 2019:Q4? That’s the kind of question we have to think about.
While NGDP is a useful indicator, inflation and interest rates are not. If you tell me that inflation is increasing, I don’t know what that means for the economy, I don’t know if this increase is caused by supply or demand shocks. If you tell me that interest rates will go down, it means nothing unless I know that the drop in rates is caused by easy money or a weak economy.
Only NGDP gives a clear indication of the current state of the economy. It doesn’t tell us everything we need to know, especially in the long run. But in the short to medium term, no other variable comes close as a way to understand current macroeconomic conditions.
There are times when economists are tempted to ignore the signals sent by NGDP. Don’t do that! Back on June 28, 2021, Jason Furman he was talking to David Beckworth. Here is Furman:
So I have some sympathy for nominal GDP guidance. . . . If we were to follow it now, we would have paid the interest. And we will exceed our GDP target.
So under you [Beckworth’s] framework, you will have to do so during a period of sustained lower growth than the GDP growth path. I don’t mean to kid you, this incident destroyed the plans of anyone who had previously written them down. It’s a strange time. But to me, that’s saying, “I’d like the Fed, if the unemployment rate a year from now is 5.5%, I’d like the Fed to consider that, regardless of what’s happening with GDP or rates as an independent problem and an issue that they need to look at.” So I think anything should have a dual mandate, but are you looking at nominal GDP and stuff like that, instead of inflation? It is possible.
Wow! June 2021 is when NGDP was just back to the pre-Covid line. In retrospect, it was an opportune time to tighten policy to prevent NGDP overshoot. To his credit, Furman correctly concluded that tightening would be necessary to prevent NGDP overshooting, but for other reasons he thought that was an unwise idea. He thought that NGDP was sending a misleading signal, that we should be looking at the unemployment rate (which is a really unreliable indicator.)
With the benefit of hindsight, we can clearly see that the NGDP signal was absolutely right and Furman was wrong. It was time to strengthen.
Ignore NGDP at your own peril.
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