Romania has to decide: with or without monetary policy

Romania has never embraced Inflation Targeting whole heartedly. It is not just the inflation outcome that says that it is also the design of the policy. The NBR has gone out of the way to create a list of reasons for why inflation target could not be achieved. Even more, the NBR research and that of few local economists has gone to great length to show that due to an unobservable but somehow measurable effect, the Ballassa-Samuelson, inflation could not fall below some certain level and the disinflation process would be long and arduous. I spoke about those here and here.
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Therefore I ask myself this very simple question: is Inflation Targeting the right monetary policy regime for Romania?

I am a strong supporter of this regime as I find it superior to the income targeting one but it is an inferior one to the price level targeting regime.  But in my view is not working for Romania. Especially for the structure of the economy as we have it today.

The Romanian economy is a euroized economy. It means that while people, corporate and government have their income – the asset side of their balance sheet –in RON their debts –the liabilities part- is in majority denominated in euro. The concept was developed for the Latin American and Asian economies which went through a similar process. One could say that this is an emerging markets’ “disease”.

Unfortunately, Inflation Targeting in this type of an economy is suboptimal or to put it bluntly useless. This has been recognized by the NBR which is now trying, but very timidly, to de-euroize the economy by making it more difficult for households to borrow in EURO.  I will tell you now that it will not work. As long as RON is perceived as the riskier currency agents will find ways to borrow/save in a much safer currency. Furthermore, as long as there is no real risk of depreciation this “campaign” to de-euroize the economy will be in vain.

To be fair the NBR recognized this problem and it has de facto abandoned inflation targeting in October 2008. It has just not communicated it yet to the markets thus creating lots of confusion and uncertainty.  As I showed before here the NBR uses M1 to keep the exchange rate stable. This is indeed one of the solutions recommended for a euroized economy. There is a whole body of research showing that once you allowed your economy to be dominated by another currency it is beneficial to keep the exchange rate from depreciating. Depreciation for an economy with almost all liabilities denominated in a foreign currency will have real costs for economic growth. But the problem with this solution is that it makes monetary policy useless to the rest of the economy via the interest rate channel. In fact it cancels monetary policy all together.

However, this is only a short term solution. In the long run policy makers have to decide:

  • they fully euroize the economy and peg the exchange rate  (similar to what we have today)
  • de facto  adopt the foreign currency (like Ecuador or Montenegro)
  • or be fully committed to de-euroizing the economy and stick to Inflation Targeting

The first two solutions require giving up your monetary policy while the third requires a fully flexible exchange rate while enforcing a monetary policy regime.   Furthermore, research and history has shown that a floating exchange rate regime is superior to a fixed one. But there is a catch: not for euroized/dollarized economies.

Considering all this, NBR has to make a choice and communicate it clearly to the market. So far it has claimed to follow an inflation targeting regime but it has acted almost like in a currency peg, going as far as communicating the comfortable level for exchange rate volatility.

What NBR should not do is to continue like this going forward. It cannot attempt to de-euroize the economy while keeping the exchange rate fixed. It will not work. It will further confuse the markets. And it will draw resources from the economy into this area as agents will try to overcome this hurdle in order to keep borrowing in a foreign currency

As I see it things are very simple. If the NBR wants monetary policy to work then it needs to allow the currency to float freely. Otherwise it should just peg the RON to the EUR or just adopt the EUR. It cannot have it both ways. The current situation creates uncertainty and unnecessary costs for the entire Romanian economy. Even more, in the current set up monetary policy cannot be used in the short term to help economic growth during recessions or stop irrational exuberance during booms.

49 thoughts on “Romania has to decide: with or without monetary policy

  1. “or be fully committed to de-euroizing the economy and stick to Inflation Targeting”

    Why do people talk as if the only the responsible way to conduct monetary policy is to target this mythical beast called “inflation” ?

    The latest idea to catch people’s fancy (to the extent to which monetary policy can do such a thing) is something called “NGDP targeting”.

    Goldman-Sachs endorsed it, the Fed openly discussed about it, Krugman had good things to say about it.

    Whereas “inflation targeting” has a proven history of dealing VERY BADLY with supply shocks …

    1. @Daniel
      Is not the only responsible way it is the current monetary regime in Romania. The basic idea is that as long as you have a central bank it is better to conduct monetary policy based on a rule than leave it discretionary.
      I would not go as far as calling inflation a “mythical beast”. WE might disagree on different measures of inflation but prices are volatile over time and there is a link between money/income and prices over time. One way to solve this is to have more indexes that measure inflation preferably done by independent private institutions.
      But if you think inflation is hard to measure you can apply a rule to monetary policy to control price level. Sweden has done successfully in the 1930s.

      The income targeting idea is not new. Woodford has been a supporter for a long time. I do do not think it is superior to inflation targeting. My big problem with income targeting is that when you are above target you have to push the economy into recession (for nominal level targeting) or target zero growth for GDP growth rate targeting. In other words for NGDP targeting you have to correct for deviations from target, so bygones are not bygones. The other problem is that GDP gets reported with a delay and thus monetary policy would be backward looking. There are some solutions offered, Scott Sumner, one being to create a forward market for GDP forecasts. No one is to eager to offer details about how it would work.
      I am not sure what you mean by “Whereas “inflation targeting” has a proven history of dealing VERY BADLY with supply shocks …” . Can you give me an example?

      1. “Can you give me an example?”

        The so-called “oil crisis” that tends to occur whenever the price of oil goes up.

        Since “inflation targeting” makes absolutely no difference between supply-side inflation and demand-side inflation (which is bad) … central banks freak out whenever the price of an important commodity (such as oil) rises, unnecessarily tighten monetary policy and inadvertently send the economy into a recession (and there have been academic papers on this).

        So yeah, I’d say that “inflation targeting” is flawed and does not ensure nominal stability.
        Not to mention that any measurement of this “inflation” is arbitrary.

        As for your arguments against NGDP targeting … I don’t get them.
        Yes, you’d have to correct for deviations from the trend … which shouldn’t occur anyway, if the central bank is credible in its intentions (the so-called “Chuck Norris effect”). What would be the problem with that ? One year you have 6-7% NGDP growth, the next year you’d have to aim for 3-4% (assuming the trend is 5% growth).
        And no, an NGDP futures market does not yet exist. Doesn’t mean it can’t.

      2. @Daniel,

        Thanks for the links. I do follow the debate quite closely including those authors. The main guy to follow is Scot Sumner from Money Illusion.
        Back to your oil shock example. What we see in reality is that central banks do not respond automatically to an inflationary shock. Especially in the cases you refer to, i.e supply shocks. In reality central banks target medium term inflation, this way they do not respond to supply shocks but only to the second round effects, i.e. if the supply shock has been incorporated in inflation expectations or prices via costs.

        The Chuck Norris effect, or credibility, is something that all central banks need, irrespective of the target. What I am saying is that it will be very difficult for a central bank to justify to the public why it would have to force the economy to grow by 3-4% instead of 6%. How would you know that the growth above target is not the result of a productivity shock and that the economy is actually on a different growth path/frontier? By responding to bring the economy to the Target NGDP you might actually push the economy off its new potential growth.

        There always going to be shocks but if you have to implement a policy I would use one deals with shocks that can be identified, oil price, not ones that need to be estimated, productivity.

        The NGDP debate is “hot” right now because the fiscal stimulus in US has not worked, so promoter of the NGDP targeting want the central bank to do even more. I do not agree but it is a debate. Also, it seems that Bernanke does not agree either as he decided to publish interest rates forecast, similar to RBNZ, which tells me that he sides more with Inflation targeting than with NGDP targeting.

  2. Well ok … but then how does one explain what happened in 2008 ? Why did we end up with deflation (central banks allowed NGDP to drop) ?

    Also, strict adherence to an arbitrarily defined inflation target means that economies that experienced a nominal shock (like the one in 2008) will have to suffer through quite a few years of internal devaluation until they return to full capacity …

    1. The very simple answer is that it depends on who you ask. A real business cycle person like Prescott would tell you that we suffered from a negative productivity shock A new keynesian would tell you that it was market failure and that why we need the government to intervene. then there are MMT-ers who will tell you that it was a negative monetary policy shock and how low interest rates do not mean loose monetary policy. Then there is the entire Chicago thinking.

      It all depends on how one thinks that the economy is working. I believe that we were brought to the 2008 situation by too much regulation and human nature. It was not the first time and it will not be the last time. What is important is how you set up the economy for the next growth phase. This is the most interesting part to me and in particular in the case of Romania (US has an army of economists looking after its interests).

      My fear is that under the pretext of saving the economy the Romanian government will become the Romanian economy. That will provide growth for a short while but in the end will only lead to higher interest rates, inflation and higher taxes. We have seen this movie before in many parts of the world.

  3. Only a nitpick, but by MMT do you mean “modern monetary theory” (the re-branded chartalism of old) or “market monetarism” ?

    But still, I do believe you are ignoring my point.
    Central banks, operating under an inflation targeting regime, completely dropped the ball and allowed NGDP to drop in 2008.
    If that isn’t an indictment of the inflation targeting concept … I don’t know what is.

    When it comes to Romania, I am in agreement with you (except for the inflation targeting part, but we are hammering it out 😀 )

    1. exactly, modern monetary theory.

      I am not ignoring nor defending the IT regime. In fact US did not have such a monetary policy regime and their objectives have always been inflation and full employment.

      In 2008 central banks responded immediately by lowering policy rates and then went the extra mile to lower the real rates in the economy. Central banks did everything that an IT-er should not do: intervened in the exchange rate markets, bought assets form bad banks, bought their own t-bills, indirectly finance deficits.
      I would say they acted like they targeted GDP not inflation. And of course, for me at least, without any result.
      You might be right if we look at Europe where ECB was slower to decrease rates and then last year increased them in the middle of a debt sovereign crisis. In my view Trichet acted looking backwards at inflation performance and not at future inflation expectations. If he would have done that then he would have not had a reason to increase rates.

      Now about Romania. Romania has never really adopted an inflation targeting regime. Since 2006 it cared more about the exchange rate than about inflation. That is why I am saying that going forward it has to decide on a regime, communicated clearly and stick to it.

      If it would come down to IT vs NGDP I would like to see some simulations for the Romanian economy. Theory is full of holes and caveats so I would like to see how the Romanian economy would respond to different shocks.Also, please remember that we have a euroized economy and we need to model monetary policy taking that into consideration.

      Finally, personally I like the IT versus NGDP because it is forward looking and it makes sense. In my view it is not the job of the central bank to create output, that is the job of the rest of the economy. The job of the central bank, if we decide that it beneficial for the economy to have one, is to guarantee the value of our currency. That is it. Leave the rest to us.

    2. @florincitu

      … and I wonder if BNR did not target NGDP between 1990 and 1996. It was a hyperinflationary… romance.
      As you said, Fed did it with no results. Unlike Romania of the ‘90s, in a debt-based monetary system you have to have a single neuron to expect a successful NGDP targeting during a debt bubble.

      1. Yeah man, that’s why NGDP was soaring at an insane rate in the early 90s. Because the central bank was aiming for a steady growth …

        “Fed did it with no results”

        Riiiiight, that’s why US NGDP is something like 13% below trend.
        Show me a bank that tried to inflate and failed – I dare you !

        “in a debt-based monetary system you have to have a single neuron to expect a successful NGDP targeting during a debt bubble”

        Wow. Just wow. First of all, that doesn’t even make any sort of sense.
        And second of all – are you some sort of God who can identify these mythical “bubbles” in real-time ?

        Yes, monetary policy was too loose prior to 2008. How exactly does that constitute an argument against NGDP targeting … is for you to prove (and not to assert) !

      2. First of all it is about the debt-based consumption economy model adopted in the ‘70s. This has lead to the development of global Ponzi schemes and the “final frontier” has been exceeded with the “real estate… business”.

        Then, the central banks have won the fight against… capitalism 😛 by developing government-debt Ponzi schemes, which are in fact wasted money on so called “investments”. (This is why politicians use to claim “we have $X to… spend”). 😀

        Though, the Fed is working hard to target a certain increase in NGDP, this task will not succeed only because of the side effects => impoverishment of the populations directly by Ponzi schemes and government austerity (due to indirect Ponzi schemes) => depression. 😛

        I can give you an example of very good “economists” who led us in the wonderland by … “assessing whether debt Ponzi schemes are feasible”.

        They’re not. 😛

        P.S. I am not God… but you might also use… your brain.

      3. First of all it is about the debt-based consumption economy model adopted in the ‘70s. This has led to the development of global Ponzi schemes and the “final frontier” has been exceeded with the “real estate… business”.

        Then, the central banks have won the fight against… capitalism 😛 by developing government-debt Ponzi schemes.

        Though, the Fed is working hard to target a certain increase of NGDP, this task will not succeed mainly because of the “side” effects => impoverishment of the population directly by Ponzi schemes => depression. 😛

        I can give you an example of very good “economists” who led us in the wonderland by … “assessing whether debt Ponzi schemes are feasible”.

        Wow. Just wow. First of all, that makes a lot of sense… 😛

      4. AC

        Like I told you before – all you’re doing is reading white noise.

        That, and making all sort of non-falsifiable claims … and turning things into a morality play.

        But hey … here are some links … because you are so sorely in need of education (and yes, I already know you WON’T read them … since you already think you know EVERYTHING and have nothing to learn from anyone who sees things differently)

        That Austrian stuff you love to gobble up … is pure nonsense.

      5. … nice words from a very smart gay who knows how to save the… Planet… Captain Planet. Although you have the solution, Bernanke ignores you… completely.

        All day long… NGDP targeting… up and down… and you do not understand what a Ponzi scheme is.

        Besides, Horea is very good with his TA, but it is just happening that we are both getting it right.

        However, it is not a coincidence that those who get it are not… economists or conventional (mainstream media) economists… Karl Deninnger, Mike Shedlock, Steve Keen or Nicole Foss. All you really need is a little bit of… common sense.

      6. @AC and Daniel
        Let’s keep this a professional debate about ideas and not about people. Our preference for one or the other does not have anything to do with our capabilities to understand a model. It has to do with how we view the world, price rigidities or not,endogenous inflation or not, money illusion or not, Ricardian equivalence or not, etc.

      7. Florin,

        Sorry man, but you can’t reason with the likes of Aristotel Costel.
        He thinks a guy like Karl Denninger is an authority on economics. Denninger doesn’t know the difference between nominal and real interest rates, between easy money (which, by the way, is something we don’t have right now) and easy credit, keeps railing against free trade (comparative advantage must be too complicated for the likes of him), thinks Chinese low wages are the source of US unemployment (and not rigidities in US labour markets and tight money), etc.

        No, I don’t want to engage this guy. He’s a joke (and a rude one, at that), he brings nothing to the conversation (except for ad hominems – since everyone who disagrees with him is a dishonest shill).

        Witness what he said above.
        NGDP targeting is worthless because Bernanke doesn’t want to adopt it (logical fallacy much ?).
        NGDP targeting is a Ponzi scheme (Ponzi schemes and bubbles – that’s all he ever sees) – because … well, because his gut tells him so.

      8. @Daniel,

        I agree with you that we do not have easy money in Romania and I have shown this on the blog before. That is the reason for this post. For me the only way permanently easy money in Romania you need to depreciate the currency but then you have the problem of euroization. Hence the title.

        Romania does not have a choice between NGDP targeting and IT. It has a choice between an independent monetary policy regime and a peg/euroization. For US the choice has been made so for now NGDP targeting cannot be tested in the real world. Hopefully, like in the case of IT, a small country like NZ will be brave enough to adopt NGDP targeting the Sumner way. Then we can talk more about merits and disadvantages.
        Maybe you have not realized it but I prefer my theory to be driven/developed by data and not the other way around.

  4. In the case of Romania, I don’t see the point of having our own currency. And with no currency, there is no point in having a central bank.

    But who would then take care of the commercial banks and of their fractional reserves? Banks should take care of themselves and keep all their reserves and consumers should be warned about the solvency of the banks. Consumers will have nothing guaranteed by the government. They will have to think hard before giving their money to the banks. I’m not saying to institute this process instantly, but it’s doable in a couple of years.

    BNR is spending like billions of euro each year just to keep the RON on track. That’s so much waste. With a few billions you could build hundreds of KMs of highways.

    At the moment(I’m not making any future predictions:P), USD, EURO, the Swiss Franc, Australian Dollar etc. are more stable than our currency.

    Yes, it will take a little bit of funds to get rid of the RON. But if you spread it over 5 years, the perceived costs will be much less. And after the transition phase is over, we can use the funds to build our gold and silver reserves. So if the main currencies go into hyperinflation, at least we would have a stable alternative prepared. We don’t need to buy gold and silver, we can simply dig for it in the ground.

    The funny thing about using other people’s currencies is that they can’t harm us without harming themselves. And by using their currencies, we will make them pay a little bit in the beginning. But the price is nothing for them if you consider the size of US or Europe. Bernanke already orders the printing of our monetary mass in dollars before breakfast. 🙂

    If you look at:
    Then you compare RON against major currencies over the past 5 years, you’ll see that most of them beat RON into submission. And during this time, BNR probably spent like 10 billion euros or more just to avoid the total collapse of the RON.

    My point: It’s nothing wrong with using other currencies and making them legal tender. So much thievery, problems and waste will be avoided simply by letting go of trying to control and target everything.

    1. @Adrian
      Exactly. The NBR has to decide: de facto euro adoption or fully flexible exchange rate. It cannot have it both ways as there are real costs for the rest of the economy.
      IF you look at 2011, I wrote something here also, corporate debt increase was almost exclusively in EUR. The only purpose for RON is to pay for taxes.

      1. “there are real costs for the rest of the economy.”
        90-95% of what I earn is US dollars. And I avoid withdrawing more money than I need. I prefer to keep them over the Internet.

        I know that every time I do it, they are exchanged to RON. And I have to pay a few percentages, 1 or 2%, just because of the exchange rate. You know: banks make money just because people exchange their money from one currency to another.

        Allowing multiple currencies will solve this problem too. Yes, banks will have to find other sources of revenue. But it will be good for the real economy and less good for speculators, banks and people who make money out of the manipulation of prices.

        “I wrote something here also, corporate debt increase was almost exclusively in EUR. ”
        And what do you think is the main problem with this? Is it just the fact that they corporations earn RON and then have to exchange it?

    2. @Adrian T. If people have to think hard where to put their money, they’ll probably put it into one or two huge banks, “cause everyone is doing it, so the money will be safer there” vs small banks. So you get a few too big to fails which are guaranteed to fail and guaranteed to lose everyone’s money when they do.

      1. @gheorghe
        Maybe so, but I’m not really sure it will happen in this way. That’s because once you educate people about the solvency rates of the banks, they will have one more indicator to base their decisions on.

        Plus, when they hear that a bank is near collapse, they will start considering the possibility. And they will also be warned that the government doesn’t guarantee their deposits regardless of the sum.

        No bank is too big too fail. And even if it fails, some of the money will still be returned, just not all of them and not immediately.

        The real problem would be if 4 million people in the private sector would die tomorrow. That would be a problem indeed especially for the drones inside the society. After a while, surely the Chinese will come and replace them. 🙂 But in the mean time, a lot of people will die of hunger being unable to adapt to the new order of things.

        My main points: 1. Individuals left alone will have no choice but to become more responsible and selfish. And this is a good thing. They will also make better decisions being given the right data and not fake date like they are being given right now.

        2. The economic system is based on what people produce and sell. Banks are built on top of the economic system of exchanging goods and services with the help of money as a faster means of exchange.
        I’m not going get into the history of banks, I’m saying that banks are not the real structure. They are an abstract structure based on the real economy.

        Banks or bankers can’t create sustainable wealth by themselves. Only people can do it.

        And money is not the real thing. Wealth is the real thing and money is not wealth.

  5. Personally I would stick to having my own currency. If the current crysis has shown us something, is that countries with their own currencies are viewed as being safer then those which no longer have the posibility to use monetary policy in order to adjust for shocks.
    Compare the UK with Italy, or France. Likewise Sweden and Denmark have lower CDS spreads then Finland (euro member) despite similar economic fundamentals.

      1. The painfull history with inflation has prompted both the private and the government to use defacto other currencies in order to evaluated assets (remember the Deutsche Mark, replaced by the euro after 2007) or liabilities. If we are to have several years of low inflation and some measures from the NBR I think deeuroization of the economy is possible. It is a matter of confidence in the RON and the NBR+Gov.

        Btw, I’m not sure the European Commissin would agree with a publicly announced pegged RON.

      2. @ddr
        There is some research showing that de-euroization is almost impossible but there is some hope if the central bank accepts full flexibility of the exchange rate. My preference is for a rules based monetary policy with flexible exchange rate. But if the NBR decides otherwise I am fine also. they just have to pick a side and stick to it. The current set up is just confusing and creates uncertainty.

  6. @ Adrian T.
    “I wrote something here also, corporate debt increase was almost exclusively in EUR. ”
    And what do you think is the main problem with this? Is it just the fact that they corporations earn RON and then have to exchange it?

    This should not be a problem, but it is. The corporations dont hedge against currency fluctuations. One reason is given by their unawareness, but also they are confident in RON’s strenght as NBR uses to intervene to stop any attempt of market to be free. 🙂

    1. @Sergiu
      I have my own opinion on the issue. And I think it’s bad for a couple of reasons. I was asking for the opinion of Florin Citu.

      1. @Adrian
        I do believe that corporate sector looks at the nominal interest rate cost. From my experience there too few who consider the interest rate risk or the exchange rate risk. They just compare the nominal interest rate for RON versus other currencies. In fact whenever you want to sell a hedging product to a corporate they point to the stable exchange rate. The NBR interventions induce more demand for EUR loans although theoretically NBR wants de-euroization.
        Also, banks push foreign currency loans more. Besides the lower interest rate they also offer longer maturities for EUR loans. Thus in the short term corporates have a smaller monthly payment which helps their cash flow.

        All in all, I think our corporate/households/government are just “myopic” and only care about short term. In their “model of the economy” borrowing in EUR just make sense, especially as nominal costs are lower and there is no perceived exchange rate risk .

  7. In case anyone is interested in reading about NGDP targeting (and I have to say that our host’s arguments against NGDP targeting and in favour of inflation targeting have failed to impress me), here’s someone making a case for it

    And a very serious paper arguing against inflation targeting

    Click to access 0512020.pdf

    I know, you might wonder why I’m so mono-maniacally focused on this subject.

    It’s because inflation targeting has failed. For one reason or another, central banks have dropped the ball and allowed NGDP to fall more than it ever did since the 1930s.

    1. @Daniel
      To be clear I am not a supporter of IT but a supporter of rules not discretion.
      It is fine to disagree with me. Inflation targeting has a minor disadvantage in the fact that it has already been applied. I do not mind if US fully adopts NGDP targeting, at least we will see if it works. I know it will not work and in fact it will backfire on us but unfortunately no central bank in the world has found it superior to rules that involve money or prices. Even the FED is moving further away from NGDP targeting towards IT.
      I read all the papers you refer to, there is even a better ones by George Selgin or HAll/Mankew or Bob Mccullum, and in fact I even congratulated Lars Christensen on his paper in this blog. I have already had a post comparing the two regimes and had comments from Marcus Nunes and Nick Rowe. If you read carefully enough the claim from that side of the fence is that recession was due to a tight monetary policy not loose one. Ironically that is the case in Romania and that is why I support more liquidity in the money market. But I digress.

      Regarding your serious paper, an interesting one but it is just a theoretical model. The assumptions can be relaxed or augmented and then you would get a very different result.
      As I see you like to read models here are few questions about NGDPT/NIT:
      -is this going to be rule or a discretionary policy? what I mean is the central bank going to have one instrument or it will use all means necessary to prop up nominal GDP? will it buy all kind of assets to increase aggregate demand?
      -how do you solve for inflation persistence? as the central bank does not care about prices or inflation presumably inflation expectations will rise.
      -supply shocks= a positive one increases quantity but lower the price while a negative one does the opposite. Taking the negative shock example you would have higher inflation while real and potential output would fall. IF the shock persists output remains low while prices increase. How does the NIT/NGDPT solve for this?

      I am sure we will discuss this further and if you really want I will send you few papers on IT or better yet on price level targeting.

  8. Also, for Aristotel Costel

    Because you’re averse to reading, here are two graphs which tell you EVERYTHING you need to know about the source of current economic woes (and please note that the US housing bubble burst in 2006, 2 years before NGDP fell – so much for your mono-mania with bubbles and Ponzi schemes)

    And while you’re at it, maybe you could show them to your friend Horea M, maybe he’ll be able be figure out why the world is experiencing a lack of aggregate demand.

    And if anyone cares to defend inflation targeting – he/she should explain why such a gap in NGDP occured … and how targeting inflation will help in filling it.

    1. @Daniel
      You keep talking about IT for US but the FED does not have such a policy regime.
      Just how would the NGDP targeting bring the level of NGDP up now in the US? what would the fed have to do besides what it has already done?

  9. The Fed does not have an explicit inflation target, that’s true. But they do have an unofficial one of around 2%.

    And are you seriously asking HOW could the Fed inflate ? Really ?
    Like I said before – show me a bank that was truly committed to creating inflation that failed to do so. I know of no such thing.

    And to turn things around – I should ask you – what makes YOU think central banks can’t bring about inflation ?

    1. @Daniel
      The question is not about inflation is about NGDP.I know they can inflate that is why they should have a rule to respond to deviations from a target. But what should the FED do to increase NGDP besides what it has already done?

    2. @Daniel
      And about the FED’s target that is something the markets have inferred from past behavior. It was not a rule. And you have to remember that the FED also has to keep the economy at full employment which means to keep it at potential GDP. This looks a lot like potential gdp targeting.

  10. Well the Fed certainly aren’t keeping the economy at full potential. Something IS keeping them from doing so. And that something, in my opinion, is their nebulous inflation target.

    “why they should have a rule to respond to deviations from a target”

    Ummm … because negative nominal shocks are not particularly pleasant ? (or did I misunderstand the question ? )

    “But what should the FED do to increase NGDP besides what it has already done?”

    Signal a CLEAR commitment to aggressively pursue quantitative easing until NGDP is back on track. If they are credible in their commitment, they shouldn’t even have to do that much – after all, who in their right mind would mess with Chuck Norris ? 🙂

    1. Didn’t the FED already do all that? interest rates low, bought assets, rescues the economy etc. what else should they do? are you saying that they did not relax monetary policy enough?
      The only thing left in my view is for the FED to intervene in the FX market to sell USD. it has tried pretty much anything else and the economy is barely moving along.
      Maybe there is something else happening. Whatever it is, is not making US companies invest or create jobs.

      Thus you do not believe that continuous money creation will lead to higher inflation expectation eventually and higher long term interest rates?

      On the deviation I was talking about inflation.

  11. Yes, monetary has not been relaxed enough. To quote Scott Sumner (since he is VERY GOOD), monetary policy can be “tight” or “loose” only relative to a target.

    And since NGDP is something like 13% below trend … then, yes, I would say that monetary policy is too tight in the US (and in the EU).

    Also, I think the choice of interest rates as sole “conventional” instrument for conducting monetary policy has been a very unfortunate historical accident – for the very simple reason that it can’t go below 0 (when sometimes it should).
    As proof – the fact that the whole economic profession is at a loss when it comes to solutions for further easing. In conventional wisdom, once interest rates hit zero … money is about as easy as it can be, monetary policy is not effective anymore, insanely expensive fiscal stimulus is required, blablabla …

    As you have said before, if the Fed truly wished to inflate, it could very easily do so. The fact that they aren’t doing so (see the graphs posted above) proves that they DO NOT WANT TO. The reason, in my opinion, is that they are still thinking in terms of “inflation targeting” – which is why is must be given up on.

    “you do not believe that continuous money creation will lead to higher inflation expectation eventually and higher long term interest rates”

    If the central bank manages expectation correctly (and that is a big part of what a central bank should do) and clearly states that it aims at steady NGDP growth and that it will not tolerate overshoots or undershoots … no, I don’t think we will end up with higher inflation in the long run.

    1. @Daniel,

      Just to push you further, I see a lot of “ifs” in your theory/model.Also, I asked you few specific questions about the model you propose.
      Regarding the trend GDP, who says that is the correct trend? what if the economy is on a new production frontier due to a negative permanent productivity shock?
      Finally, are you proposing NGDP targeting for Romania? (I will write more on monetary policy regime in romania on the blog soon)

      Yes Scott Sumner is very good. That does not make him right all the time.

  12. Ok, it’s my turn to be a bit more nuanced.

    In an ideal world, we’d have “free banking”. Since the free market is the best we have at allocating resources, why not let it work its magic and choose how much liquidity is needed ?

    Unfortunately, we don’t live in an ideal world. For political reasons, we ended up with central banks. And also for political reasons, we’re stuck with them.
    Which is very bad, because a central bank is a single point of failure. If they are asleep at the wheel (like they were in 2008), the whole economy goes belly up.

    As such, I do believe that getting the monetary framework right is of the utmost importance.

    In advanced economies like the US, where long-term productivity growth is of about 3%, I do believe that a nominal growth target of 5% is appropriate (3% real growth and 2% low inflation).
    Also, empirical evidence shows that two decades (the so-called “great moderation”) of 5% NGDP growth has been very beneficial.
    And if ain’t broke, why fix it ?

    As for Romania … ugh, this is iffy.
    Let’s face it, we are a third world country, whose citizens have ZERO confidence in their own currency (as proof of BNR’s incompetence).

    We could de-euro-ize the economy and only then move to NGDP targeting (but at a higher growth rate, since we have a whole lot of catching up to do) … but is that even possible ?
    Or we could accept that an independent monetary is the privilege of the well-off … and deal with it the best we can.

    In the short term, I am skeptical about the implementation of NGDP targeting. It would put central banks on an automatic pilot and would strip them of their discretionary powers … which is why I’m not holding my breath for it.

    1. @Daniel
      “In an ideal world, we’d have “free banking”. Since the free market is the best we have at allocating resources, why not let it work its magic and choose how much liquidity is needed ?

      In a free market, you have products and services traded freely among participants. The problem with inserting liquidity is that the liquidity you are talking about is not just a “liquid”. It’s something more because you can take the liquidity and swap it with another real asset.

      So you are basically printing a piece of paper and then you can buy a house with that piece of paper created from nothing. That’s magic.

      It’s nothing wrong if you increase the liquidity by x% for everyone. This move will not actually do much. When we switched from the old RON to the new RON and cut 4 zeros we were actually increasing the liquidity for everyone.

      Conclusion: You can’t actually print a piece of paper without doing anything for it, then buy a mountain. The net result is that you are getting a mountain in exchange for no work. You are simply getting the cash without giving back anything in exchange, no product or service. You are stealing from other people.

      The free market is an exchange of REAL products and services that come from the work of people. By inserting liquidity, you bring some of the work of the people to zero value and you will steal from them.

      “In advanced economies like the US”
      How come they have 15 trillion in public debt if they are so advanced? Didn’t they figure out already that it’s better to have no debt in the long term? I know, I know, that’s not a real problem, they can always devalue their currency and steal even more from themselves and the world at large who has dollars.

      “Let’s face it, we are a third world country, whose citizens have ZERO confidence in their own currency”
      If they have zero confidence then why they keep using it? When you have zero confidence in something, you don’t go and work 40 hour weeks for a paycheck in a currency you don’t trust.

      1. “When we switched from the old RON to the new RON and cut 4 zeros we were actually increasing the liquidity for everyone.”
        My bad here. It’s more like a decrease of liquidity if you consider the nominal values. It was a decrease by more than 99% when we turned 10.000 old RON into 1 new RON.

      2. Dude, you really need to start paying attention to what other people are ACTUALLY saying, not what you THINK they’re saying.

        FYI, “free banking” has actually been implemented (for example in 19th century Scotland and Sweden) – and with great success.

        So you might want to read up on the subject before passing off uninformed opinions.

        Regarding the likes of USA, the fact that they are “advanced” (that is, short of some great and unforeseen technological leap, there are no great productivity gains to be had) has got NOTHING to do with their over-indebtedness (which has a whole lot to do with how their tax system is set up – it explicitly favours debt and punishes saving).

        So you might stop setting up straw men.

        “If they have zero confidence then why they keep using it? ”

        Ummm, because the government mandates it ?

        Dude, seriously, you made zero sense. You addressed none of my points and instead chose to argue against things I didn’t say.

  13. Why not targeting macroeconomic stability?
    For me, the role of a central bank cannot be as simple as inflation or NGDP targeting.
    Take a look at the graphs from the link bellow:
    It seems to me that the debt is a real issue for economic growth starting from certain levels. Who should be dealing with these levels (and other macro levels like current account deficit etc)? If not a central bank, than what’s the point in having one?

    1. @ Sorin
      very good point. All these rules are also judged against output and macro stability. In my view in an economy where the central bank does not indirectly finance the deficit then there is a natural control of the debt from the market. In the crazy cases of GReece, Spain , Portugal, Italy, the market is signaling that there is a risk and has increased the price (risk premium). Without central bank interventions those countries would have to lower the public debt, not pay the debt or implement policies to help growth.

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