“Of course, the same problem occurs with high interest rates, which can be used to reduce high inflation but can also reflect high inflation expectations.”
So never reason from an interest rate (price of money) change? 😏
This quibble / joke aside, I really enjoyed this piece, and as a non-macro guy was able to follow it until near the end.
Australian experience is that expectations really matter, both expectations about the future path of the output-value of money and the future path of total spending, and things are much better if the latter is anchored, not just the former. I wish Bernie Fraser would get more credit as a successful central banker, since he came up with a policy approach that worked, and could be passed on to successors.
But there is a long pattern of “(North) Atlanticist” commentators having trouble noticing anything in the Southern Hemisphere. Australia is the best-governed nation in the Anglosphere. Does anyone notice?
“Australia is the best-governed nation in the Anglosphere”
You would know better than I, being far more informed on the former (and perhaps on all save the U.S.).
But how do you explain Australian government policies and positions on “climate change” and Israel/Palestinians cf. the U.S. in the context of this claim?
Or have I merely found the two major shortcomings, and your claim is based on superiority in most other areas?
Huge push from unstable countries. Huge pull from developed countries. Old people need a lot of personal care. Wealthy oldies can afford it. Crops need picking.
His Highness is like King Canute if he thinks his mass deportations will stop it. Working around ICE is just a hazard of the the job for most. Push and pull remains.
I wish I could live to 200 years old to see the consequences of the developed country demographic implosion.
Which will not be solved by immigration. We have three cases of mass immigration fracturing countries along existing fault lines: the US along its slavery fault line in 1860s*, Jordan in 1970-1, Lebanon along is ethno-religious fault lines in 1975-90. Mass immigration is fracturing the UK along its class and regional fault lines.
People are not interchangeable widgets, cultural differences matter and several studies show Middle Eastern migration to Europe is a net fiscal loss to their welfare states. As Borjas points out, since welfare states transfer income down the income scale, it is very unlikely that importing low-skill workers will do other than aggravate the fiscal problems of the welfare state. It clearly puts downward pressure on wages by suppressing the Baumol effect.
Australia did not have a pandemic-migration-pause surge in low end wages, unlike the US and UK, because our high-skill migration tends to raise the capital/labour ratio, not lower it.
*See Robert William Fogel, ‘Without Consent or Contract: The Rise and Fall of American Slavery,’ W.W.Norton, [1989], 1994.
I doubt that citing the US experience in the 19th century will convince many people, as mass immigration led to by far the most successful country in history.
And what does your comment have to do with monetary policy?
Also, you blog to try and get better policy and policy discourse. A lot of highly informed professionals and other folk in Britain in particular (but also elsewhere) have come to massively discount the claims of economists precisely because economists have so patently seriously underestimated the costs of immigration and so oversold its net benefits. If you are wondering why economists are finding it harder to sell free trade, that is a big part of the problem.
We live in an odd time where we are flooded in information yet so many live in such information bubbles and media siloes. Academics in particular have developed all sorts of mechanisms to discount inconvenient concerns.
It is clear that mainstream Economics has over-sold efficiency and under-considered the importance of resilience. Migration is just a particularly sharp example of this. (You push certain monetary policies in large part because they are more resilient.)
I am sure I have read as much migration economics as you have, and way more of the relevant non-economic scholarship. In my blogging, I use economic analysis all the time, I just try to avoid using Theory to select what counts as evidence.
Your career is built on your deep knowledge of monetary policy and history seeing how much of the conventional economic wisdom on such matters is not correct. What makes you think your colleagues somehow do just fine on migration? It strikes me as a case of the Gell-Mann Amnesia effect. https://en.wikipedia.org/wiki/Gell-Mann_amnesia_effect
Nothing, I was responding to a comment on immigration. My point is not that immigration is inherently bad—that would be silly, I am Australian. My point is that immigration can have very serious costs: ask the Lebanese.
Given that the fractures from mass immigration in the UK are so bad that serious commentators are discussing the possibility of civil war in the UK, it remains a live issue. After all, who would dismiss discussions of monetary policy just because it happened in the C19th?
The author has appeared on various podcasts discussing the issue with respect specifically to the UK.
That the costs of immigration are seriously uneven in their distribution is much of the problem. About half the population in Western countries are “Somewheres”: folk whose social connections are strongly local. Disrupting their locality-based social capital imposes costs on them that are apparently invisible to the “Anywheres” (whose networks are not locally-centred) who dominate institutions. A recent study found views of European politicians are systematically skewed on matters such as crime and immigration—which are strongly locality-skewed—but not on matters economic, which are more general.
But...civil war is highly unlikely. Not least because those same demographics that encourage the migrations means there's no one at home to fight it. Collapsing family size means so few/no spare young men. Globalization/division and specialisation of labour means the skills to make, maintain or even use weapons don't really exist in developed countries.
Identifying "the enemy" is difficult too given so much mixing of populations.
The worst "civil wars" are between people's who seem very alike to most outsiders (eg WW1 in NW Europe), Iran Vs Iraq, Iraq post Hussein, the English Civil War, the American Civil War, the Spanish Civil War, Rwanda, Sudan etc etc. AKA "the politics of small differences".
Not sure at all what "breaking point" means. Lots of angry keyboard warriors on social media, for sure (many times amplified by Russian or whoever bots). Far, far fewer real warriors. Demographics are brutal here again. NEETS on PIPs aren't fighters.
The UK justice system may be a bit under pressure but public disorder from illegal migrant protests to climate activists to Palestine Action are dealt with pretty speedily.
US maybe more likely than UK to have a civil war simply due to mass gun ownership. Also, the US is probably too big a country now for a working modern democracy. Secession is a risk if GOP (or DEMs next time) push too far.
It seems to me that expectations are doing a lot of heavy lifting in your arguments. If everyone believes and acts on the basis that the Fed can and will achieve the NGDP level target then there is no problem. The Fed barely needs to act.
But I don’t believe expectations are that powerful. Consumers are not paying that much attention. And when the housing market is in freefall with defaults rising and financial institutions becoming illiquid, if not insolvent, it seems heroic to believe that the Fed essentially saying “trust me, I’ve got this” could solve the problem.
To begin with, a Fed promise means nothing unless they intend to carry through with the policy. But when they do, Fed policy means a lot.
The general public's expectations are far less important than the expectations of the financial markets. If level targeting supports asset prices, the public form their expectations on that basis. When you target expected future NGDP growth, you are essentially targeting what the media calls "financial conditions".
My view on expectations is not at all out of the mainstream at least regarding level targeting. Aggregate demand at any point in time large depends on future expected aggregate demand. Thus when NGDP fell sharply in the second half of 2008, it did so largely because markets correctly understood that NGDP would remain highly depressed in 2009.
I understand that much of this seems very counterintuitive, as it goes against the general view presented in the media--which is that financial distress causes falling NGDP. In my three books, I provide lots of evidence that causality goes from falling NGDP to financial distress. There are lots of natural experiments that are highly suggestive on that point.
It sounds to me like NGDPLT works on recessions a bit like the Doomsday Device. Make your enemy (or consumers) so confident that any bad outcome will be immediately annihilated, so that no bad outcomes need to happen!
“But the whole point of [NGDPLT] is lost if you keep it a secret! Why didn’t you tell the world, eh?”
If FDR had truthfully told the public during mid-1932 that he planned to sharply devalue the dollar, then a dramatic economic recovery might have occurred at that time, making it less likely that he would have won the election.
Perfect except what is wrong with trying to maintain 2% inflation target? Granted that because real GDP trend growth changes slowly, the NGDP target the inflation target are very similar
More to the point, though, in your framework, how do you know when to do what and by how much.
Excellent. So you are on board with Trillionths and I suppose more intermediate tenor TIPS? And move the vector of instruments to keep Trillionths/TIPS on a 4%/2% target?
"...Basis on data in futures markets, stocks almost certainly would have risen if the cut had been 50 basis points..."
Not sure you can make this argument:
Equity Futures markets are priced off the spot under a no arbitrage condition. Apart from the expected dividend (minuscule in impact), expectations do not enter the future price, i.e. it does not contain more (expected) information than the spot price.
Further,
"..In fact, the quarter point cut led to a sharp fall in the asset markets, which pushed the economy into a mild recession in early 2008..."
The Fed cut rates on 11th of December 2007. If I take the day opening price on the day before the Fed (10.12) decision and the close of the following day (12.12), i.e. enough time to "digest" the Fed decision, I see a fall of 1.13%.
That is supposed to be a "sharp drop" in asset markets?
Here's what I wrote in The Money Illusion book, which I would encourage you to read:
"The Dow immediately plunged almost 1.5%, and ended the day almost 2.5% points below the pre-announcement levels. The Efficient Markets Hypothesis says that the immediate reaction is what counts, although there is often a delayed reaction as investors look past the headline interest rate announcement and digest the Fed’s full report, which can provide hints as to the future path of policy. So let’s say the announcement reduced the Dow by somewhere between 1.5% and 2.5%. The S&P 500 is a more accurate index, and it fell even more sharply than the Dow. Thus a 1.8% to 2.8% decline is a good ballpark estimate of the impact of the announcement on U.S. stock prices. Let’s pick 2% for the S&P500, a conservative figure.
In fact, this decline in stock prices grossly understates the impact of the December 2007 monetary shock, as prior to the announcement the fed funds futures market showed a 58% probability of a ¼% rate cut, and a 42% probability of a ½% rate cut. Thus the dramatic market reaction occurred despite the fact that the actual announcement was considered the more likely outcome. A ½% rate cut would have likely produced an even larger move in stock prices, but to the upside. If we assume that as of 2:15pm on December 11, the expected return on stocks over the next hour was near zero, then a ½% rate cut would have been expected to boost stock prices by (.58/.42) x 2% = 2.76%. That means stocks were valued nearly 5% lower with a 4.25% fed funds target that they would have been with a 4.0% fed funds target. That’s a huge difference for what most people (wrongly) consider a minor policy adjustment.
But even this understates the impact of the Fed announcements, as stocks usually respond almost as strongly in foreign markets (later we’ll look at the reasons why). If global stock market capitalization was about $50 trillion, then a 4% decline in global equity prices is about $2 trillion dollars.
Fed officials sat in a room on December 11, 2007, unsure of whether to cut rates by ¼% or ½%. It was a close call. In the end they opted for ¼%, and this decision immediately left global wealth $2 trillion lower than if they had opted for the 50 basis point cut."
I would add that the decision had such a strong bearish impact that interest rates actually fell on the news, whereas they normally rise when a rate decision is more contractionary than expected. But market participants were wise to mark down yields, as the decision led to such a quick deterioration in the economy that the Fed was forced into doing an additional 125 basis points in cuts over the next 6 weeks.
in combination with the bond market reaction the argument makes more sense.
I just want to point out that falling rates increase bond investor's "wealth", hence the impact on total global financial wealth was certainly much less (maybe even positive).
I have issues with how you calculate that 2 trillion figure: the shortfall relative to expectation matters, i.e. not the shortfall relative to imaginary gains in an unexpected easing scenario - otherwise everyone would be depressed all the time about the lottery he did not win
(technical note: probabilities derived from futures prices are risk neutral probabilities, they cannot be used to calculate an expected return the way you do)
I was planning to read Midas paradox this autumn since you said it is your favourite book. Shall I start with Money illusion instead?
Midas is my best book, but it's on the Great Depression and thus doesn't really explain my views on modern fiat money regimes. The Money Illusion covers the Great Recession. Either way, let me know what you think.
Bonds are both assets and liabilities, and represent zero net wealth.
I didn't say the decision reduced wealth by $2 trillion compared to current wealth, I said that was the difference in wealth between a 1/4% and 1/2% rate cut. That seems important!
I accept your technical note, but I believe even corrected probabilities would show a broadly similar estimate.
Great to see some focus on your work. But beats me how conventional macroeconomists still can't get their heads around NGDP, and still obsess about interest rates and RGDP. I suspect because conventional macro is still 100% bound up in the god-like status of central banks research departments and their iron law that central bankers are only responsive to and never casual of business cycles - despite what ignorant, prattling politicians may say.
And then, defensively, they all lump business cycles in the too boring/difficult bucket. Even Mazlish (who I'dnever heard of before) does this as an aside in an unrelated, but fascinating, recent post on AI/AGI.
Thanks for your thoughtful response. But I am 100% sure that my analysis is right. Bad regulation - Basel - caused the crisis and the resulting recession.
And I am 93.54% sure that you are putting too little weight on the monetary policy-->NGDP expectations-->asset prices-->financial instability channel. :)
I have not read Mr. Mazlish’s paper, but I cannot understand how he can argue that anyone would have been advocating zero interest rates in 4Q’07. In that quarter NGDP was still growing at a 7% rate and, as you point out, inflation was increasing. Is he simply misunderstanding your theory? (I’m not sure I totally understand your theory.)
In my opinion, lower interest rates would not have prevented the financial crisis. The only thing that would have prevented it would have been a Lehman bail out, and even that would still have left us with an extraordinarily fragile financial system. The cause of the crisis was the egregious systemic leverage of European banks and US shadow banks. This, in turn, was caused by the Basel Capital Standards. See my substack:
I wouldn't not over-interpret an offhand comment in a tweet. Recall that the recession began in December 2007, and elsewhere I argued that money was too tight in December 2008, despite zero rates at the time. It's an easy mistake to make.
I think you are vastly underestimating the impact of plunging NGDP in 2008 on the financial crisis. Tight money almost always leads to financial distress, and 2008 was no different. Lehman would have done far better in a world where NGDP was expected to keep growing at 5%.
Yes, but NGDP did not start plunging in 2008 until the 3rd quarter after Lehman failed. After that markets froze and no financial institution was going to lend to any counterparty at any price. The Fed had to support all US institutions and swapped dollars to European central banks who divvied them out to their institutions.
"Yes, but NGDP did not start plunging in 2008 until the 3rd quarter after Lehman failed."
I disagree. It looks that way if you focus on quarterly data, but if you look at monthly estimates of NGDP (from Macroeconomics Advisors), you can see that the big decline occurred between June and December 2008. Lehman failed roughly half way though that decline.
As far as the Fed, they were an arsonist masquerading as a firefighter. They adopted interest on reserves in early October 2008 precisely because they did not want to ease monetary policy. The Fed was directly to blame for the big fall in NGDP in the second half of 2008. Sure, they also did some lending to help out the banks, but the net effect of their actions was highly contractionary. The gains from their rescue programs were trivial compared to the damage they were doing with tight money.
They thought they needed to rescue the banking system, when the actual problem was falling NGDP. It was like trying to bail out a boat without first plugging the leak. It wasn't until March 2009 that they realized they had misdiagnosed the problem.
I strongly encourage you to take a look at my book entitled "The Money Illusion", which covers all of these issues in far more detail.
I'm a little confused by one of your criticisms you make. You say "In my view, the wrong way is to focus on an entire alternative path for the interest rate."
My understanding based on looking over the paper (and asking GPT 5 to fill in any gaps in understanding, it actually does a decent job) is that the charts that Zach posted aren't the path of policy per se, so much as they are the averages of multiple simulations that iterate through time. So that wouldn't be the path of what policy rates should be assuming you are in 2008 Q4 and just project into the future. So they get a path in 2008 Q4, throw out everything but the first period, move on to 2009 Q1, incorporate some shocks, get a new path, throw out except first period, etc.
So when you say he's suggesting an alternate move at one point in time, it's more like the paper is suggesting alternative move and then iterating through time. Like if in your example you started in 2007 Q4, thought up what policy should be, simulating a baseline for the variables but assuming some shocks that hit all the simulations and incorporating the effect of policy. Then you go to 2008 Q1 and do it again.
Of course there are differences in policy rules, but it goes without saying that your preferred rule would be different from what the mainstream of the profession would use. They are using one that selects the interest rates that minimize squared inflation, squared output gap, and squared changes in interest rates.
We come back to your argument that under the NGDP level rule, then you wouldn't have as bad an outcome. Level targeting looks like it's missing here (at least I believe their rule is only forward-looking). But don't sleep on them assuming some given shocks. You argue the poor performance during this time is related to bad monetary policy and if the policy is better, then we don't have the bad performance. If you take the shocks as given and assume monetary policy is orthogonal to them, then good policy can't fix them.
The sentence of mine that you quote was definitely not intended to be a criticism of that paper, or any other specific paper. I was simply clarifying that it would not be interesting to look at counterfactuals for interest rate paths, but might be reasonable to look at counterfactuals for interest rate changes at a moment in time.
"If you take the shocks as given and assume monetary policy is orthogonal to them, then good policy can't fix them."
Yes, that's what I meant by the Dr. Strangelove reference. Good monetary policy cannot fix supply shocks. At best, it can refrain from causing demand shocks. (Highly unstable NGDP.)
Please discuss the limits to NGDP level targeting. Doesn't NGDP level targeting give way to Cochrane's FTPL at some point in the debt-debasement trajectory? How far beyond sustainability in terms of ROW funding of our twin deficits can we go before we face a very hard reckoning, no matter what the Fed does?
It's possible, but we are still a long way away from fiscal dominance.
Ultimately, it will be a political decision. Would the public prefer higher taxes or higher inflation? Based on the Biden years, I suspect the answer will be higher taxes (or lower benefits). The 30-year T-bond market seems to feel the same way, as it is not predicting high inflation. But I cannot be certain.
I don't expect to live long enough to see how this all gets resolved.
30yr T-Bonds at 20 year highs (aka back to normal of pre-GFC) says something. Interestingly they correlate with surge in BLS data on working age population growth, back to pre-GFC levels.
So imprecise that His Highness fired the head of the BLS.
You are most likely right, of course, about the actual situation. Labor supply is very fluid at the moment. The UK had a massive increase recently, sort of unplanned, sort of necessary, sort of hugely problematic.
On your final PPPS, should the US be bailing out Argentina just because the Administration likes Millei and doesn't want to see him fail? There is a story on Bloomberg about just this happening with the support of Secretary Bessant.
“Of course, the same problem occurs with high interest rates, which can be used to reduce high inflation but can also reflect high inflation expectations.”
So never reason from an interest rate (price of money) change? 😏
This quibble / joke aside, I really enjoyed this piece, and as a non-macro guy was able to follow it until near the end.
Australian experience is that expectations really matter, both expectations about the future path of the output-value of money and the future path of total spending, and things are much better if the latter is anchored, not just the former. I wish Bernie Fraser would get more credit as a successful central banker, since he came up with a policy approach that worked, and could be passed on to successors.
But there is a long pattern of “(North) Atlanticist” commentators having trouble noticing anything in the Southern Hemisphere. Australia is the best-governed nation in the Anglosphere. Does anyone notice?
The UK tried to take Australia’s points-based immigration. Failed miserably for want of state capacity and too much human rights law.
“Australia is the best-governed nation in the Anglosphere”
You would know better than I, being far more informed on the former (and perhaps on all save the U.S.).
But how do you explain Australian government policies and positions on “climate change” and Israel/Palestinians cf. the U.S. in the context of this claim?
Or have I merely found the two major shortcomings, and your claim is based on superiority in most other areas?
It is a relative, not an absolute judgement. We are not immune to various contemporary stupidities, we just do better in general.
Yes. Fascinating.
Huge push from unstable countries. Huge pull from developed countries. Old people need a lot of personal care. Wealthy oldies can afford it. Crops need picking.
His Highness is like King Canute if he thinks his mass deportations will stop it. Working around ICE is just a hazard of the the job for most. Push and pull remains.
I wish I could live to 200 years old to see the consequences of the developed country demographic implosion.
Which will not be solved by immigration. We have three cases of mass immigration fracturing countries along existing fault lines: the US along its slavery fault line in 1860s*, Jordan in 1970-1, Lebanon along is ethno-religious fault lines in 1975-90. Mass immigration is fracturing the UK along its class and regional fault lines.
People are not interchangeable widgets, cultural differences matter and several studies show Middle Eastern migration to Europe is a net fiscal loss to their welfare states. As Borjas points out, since welfare states transfer income down the income scale, it is very unlikely that importing low-skill workers will do other than aggravate the fiscal problems of the welfare state. It clearly puts downward pressure on wages by suppressing the Baumol effect.
Australia did not have a pandemic-migration-pause surge in low end wages, unlike the US and UK, because our high-skill migration tends to raise the capital/labour ratio, not lower it.
*See Robert William Fogel, ‘Without Consent or Contract: The Rise and Fall of American Slavery,’ W.W.Norton, [1989], 1994.
I outline the mechanisms for 1860s US here:
https://www.lorenzofromoz.net/p/an-american-civil-war
I doubt that citing the US experience in the 19th century will convince many people, as mass immigration led to by far the most successful country in history.
And what does your comment have to do with monetary policy?
Also, you blog to try and get better policy and policy discourse. A lot of highly informed professionals and other folk in Britain in particular (but also elsewhere) have come to massively discount the claims of economists precisely because economists have so patently seriously underestimated the costs of immigration and so oversold its net benefits. If you are wondering why economists are finding it harder to sell free trade, that is a big part of the problem.
We live in an odd time where we are flooded in information yet so many live in such information bubbles and media siloes. Academics in particular have developed all sorts of mechanisms to discount inconvenient concerns.
It is clear that mainstream Economics has over-sold efficiency and under-considered the importance of resilience. Migration is just a particularly sharp example of this. (You push certain monetary policies in large part because they are more resilient.)
I am sure I have read as much migration economics as you have, and way more of the relevant non-economic scholarship. In my blogging, I use economic analysis all the time, I just try to avoid using Theory to select what counts as evidence.
Your career is built on your deep knowledge of monetary policy and history seeing how much of the conventional economic wisdom on such matters is not correct. What makes you think your colleagues somehow do just fine on migration? It strikes me as a case of the Gell-Mann Amnesia effect. https://en.wikipedia.org/wiki/Gell-Mann_amnesia_effect
Nothing, I was responding to a comment on immigration. My point is not that immigration is inherently bad—that would be silly, I am Australian. My point is that immigration can have very serious costs: ask the Lebanese.
Given that the fractures from mass immigration in the UK are so bad that serious commentators are discussing the possibility of civil war in the UK, it remains a live issue. After all, who would dismiss discussions of monetary policy just because it happened in the C19th?
https://www.militarystrategymagazine.com/article/civil-war-comes-to-the-west/
The author has appeared on various podcasts discussing the issue with respect specifically to the UK.
That the costs of immigration are seriously uneven in their distribution is much of the problem. About half the population in Western countries are “Somewheres”: folk whose social connections are strongly local. Disrupting their locality-based social capital imposes costs on them that are apparently invisible to the “Anywheres” (whose networks are not locally-centred) who dominate institutions. A recent study found views of European politicians are systematically skewed on matters such as crime and immigration—which are strongly locality-skewed—but not on matters economic, which are more general.
https://www.lorenzofromoz.net/p/when-politics-isnt-local
Lorenzo, many good points.
But...civil war is highly unlikely. Not least because those same demographics that encourage the migrations means there's no one at home to fight it. Collapsing family size means so few/no spare young men. Globalization/division and specialisation of labour means the skills to make, maintain or even use weapons don't really exist in developed countries.
Identifying "the enemy" is difficult too given so much mixing of populations.
The worst "civil wars" are between people's who seem very alike to most outsiders (eg WW1 in NW Europe), Iran Vs Iraq, Iraq post Hussein, the English Civil War, the American Civil War, the Spanish Civil War, Rwanda, Sudan etc etc. AKA "the politics of small differences".
I rate the risk lower in the US than in the UK. But there are a lot of angry downwardly mobile people in the US.
https://www.robkhenderson.com/p/rage-of-the-falling-elite
It is true that we simply do not know the breaking point of a modern developed democracy. It is foolish to presume that there isn’t such a point.
Not sure at all what "breaking point" means. Lots of angry keyboard warriors on social media, for sure (many times amplified by Russian or whoever bots). Far, far fewer real warriors. Demographics are brutal here again. NEETS on PIPs aren't fighters.
The UK justice system may be a bit under pressure but public disorder from illegal migrant protests to climate activists to Palestine Action are dealt with pretty speedily.
US maybe more likely than UK to have a civil war simply due to mass gun ownership. Also, the US is probably too big a country now for a working modern democracy. Secession is a risk if GOP (or DEMs next time) push too far.
This is part of a wider problem that bedevils so much commentary: the people unlike me problem.
https://www.notonyourteam.co.uk/p/people-unlike-me
It seems to me that expectations are doing a lot of heavy lifting in your arguments. If everyone believes and acts on the basis that the Fed can and will achieve the NGDP level target then there is no problem. The Fed barely needs to act.
But I don’t believe expectations are that powerful. Consumers are not paying that much attention. And when the housing market is in freefall with defaults rising and financial institutions becoming illiquid, if not insolvent, it seems heroic to believe that the Fed essentially saying “trust me, I’ve got this” could solve the problem.
To begin with, a Fed promise means nothing unless they intend to carry through with the policy. But when they do, Fed policy means a lot.
The general public's expectations are far less important than the expectations of the financial markets. If level targeting supports asset prices, the public form their expectations on that basis. When you target expected future NGDP growth, you are essentially targeting what the media calls "financial conditions".
My view on expectations is not at all out of the mainstream at least regarding level targeting. Aggregate demand at any point in time large depends on future expected aggregate demand. Thus when NGDP fell sharply in the second half of 2008, it did so largely because markets correctly understood that NGDP would remain highly depressed in 2009.
I understand that much of this seems very counterintuitive, as it goes against the general view presented in the media--which is that financial distress causes falling NGDP. In my three books, I provide lots of evidence that causality goes from falling NGDP to financial distress. There are lots of natural experiments that are highly suggestive on that point.
It sounds to me like NGDPLT works on recessions a bit like the Doomsday Device. Make your enemy (or consumers) so confident that any bad outcome will be immediately annihilated, so that no bad outcomes need to happen!
“But the whole point of [NGDPLT] is lost if you keep it a secret! Why didn’t you tell the world, eh?”
If FDR had truthfully told the public during mid-1932 that he planned to sharply devalue the dollar, then a dramatic economic recovery might have occurred at that time, making it less likely that he would have won the election.
I'll send you the bill for my brain.
The FED's current timing is perfect for N-gDp targeting.
The FED should have acted in 2006, by not raising rates.
Perfect except what is wrong with trying to maintain 2% inflation target? Granted that because real GDP trend growth changes slowly, the NGDP target the inflation target are very similar
More to the point, though, in your framework, how do you know when to do what and by how much.
Let the market guide you.
Excellent. So you are on board with Trillionths and I suppose more intermediate tenor TIPS? And move the vector of instruments to keep Trillionths/TIPS on a 4%/2% target?
What's not to like? :)
That's fine, but I prefer my "guardrails" approach.
Scott,
"...Basis on data in futures markets, stocks almost certainly would have risen if the cut had been 50 basis points..."
Not sure you can make this argument:
Equity Futures markets are priced off the spot under a no arbitrage condition. Apart from the expected dividend (minuscule in impact), expectations do not enter the future price, i.e. it does not contain more (expected) information than the spot price.
Further,
"..In fact, the quarter point cut led to a sharp fall in the asset markets, which pushed the economy into a mild recession in early 2008..."
The Fed cut rates on 11th of December 2007. If I take the day opening price on the day before the Fed (10.12) decision and the close of the following day (12.12), i.e. enough time to "digest" the Fed decision, I see a fall of 1.13%.
That is supposed to be a "sharp drop" in asset markets?
source:
https://www.investing.com/indices/us-spx-500-futures-historical-data
Here's what I wrote in The Money Illusion book, which I would encourage you to read:
"The Dow immediately plunged almost 1.5%, and ended the day almost 2.5% points below the pre-announcement levels. The Efficient Markets Hypothesis says that the immediate reaction is what counts, although there is often a delayed reaction as investors look past the headline interest rate announcement and digest the Fed’s full report, which can provide hints as to the future path of policy. So let’s say the announcement reduced the Dow by somewhere between 1.5% and 2.5%. The S&P 500 is a more accurate index, and it fell even more sharply than the Dow. Thus a 1.8% to 2.8% decline is a good ballpark estimate of the impact of the announcement on U.S. stock prices. Let’s pick 2% for the S&P500, a conservative figure.
In fact, this decline in stock prices grossly understates the impact of the December 2007 monetary shock, as prior to the announcement the fed funds futures market showed a 58% probability of a ¼% rate cut, and a 42% probability of a ½% rate cut. Thus the dramatic market reaction occurred despite the fact that the actual announcement was considered the more likely outcome. A ½% rate cut would have likely produced an even larger move in stock prices, but to the upside. If we assume that as of 2:15pm on December 11, the expected return on stocks over the next hour was near zero, then a ½% rate cut would have been expected to boost stock prices by (.58/.42) x 2% = 2.76%. That means stocks were valued nearly 5% lower with a 4.25% fed funds target that they would have been with a 4.0% fed funds target. That’s a huge difference for what most people (wrongly) consider a minor policy adjustment.
But even this understates the impact of the Fed announcements, as stocks usually respond almost as strongly in foreign markets (later we’ll look at the reasons why). If global stock market capitalization was about $50 trillion, then a 4% decline in global equity prices is about $2 trillion dollars.
Fed officials sat in a room on December 11, 2007, unsure of whether to cut rates by ¼% or ½%. It was a close call. In the end they opted for ¼%, and this decision immediately left global wealth $2 trillion lower than if they had opted for the 50 basis point cut."
I would add that the decision had such a strong bearish impact that interest rates actually fell on the news, whereas they normally rise when a rate decision is more contractionary than expected. But market participants were wise to mark down yields, as the decision led to such a quick deterioration in the economy that the Fed was forced into doing an additional 125 basis points in cuts over the next 6 weeks.
Scott,
in combination with the bond market reaction the argument makes more sense.
I just want to point out that falling rates increase bond investor's "wealth", hence the impact on total global financial wealth was certainly much less (maybe even positive).
I have issues with how you calculate that 2 trillion figure: the shortfall relative to expectation matters, i.e. not the shortfall relative to imaginary gains in an unexpected easing scenario - otherwise everyone would be depressed all the time about the lottery he did not win
(technical note: probabilities derived from futures prices are risk neutral probabilities, they cannot be used to calculate an expected return the way you do)
I was planning to read Midas paradox this autumn since you said it is your favourite book. Shall I start with Money illusion instead?
Midas is my best book, but it's on the Great Depression and thus doesn't really explain my views on modern fiat money regimes. The Money Illusion covers the Great Recession. Either way, let me know what you think.
Bonds are both assets and liabilities, and represent zero net wealth.
I didn't say the decision reduced wealth by $2 trillion compared to current wealth, I said that was the difference in wealth between a 1/4% and 1/2% rate cut. That seems important!
I accept your technical note, but I believe even corrected probabilities would show a broadly similar estimate.
Great to see some focus on your work. But beats me how conventional macroeconomists still can't get their heads around NGDP, and still obsess about interest rates and RGDP. I suspect because conventional macro is still 100% bound up in the god-like status of central banks research departments and their iron law that central bankers are only responsive to and never casual of business cycles - despite what ignorant, prattling politicians may say.
And then, defensively, they all lump business cycles in the too boring/difficult bucket. Even Mazlish (who I'dnever heard of before) does this as an aside in an unrelated, but fascinating, recent post on AI/AGI.
https://open.substack.com/pub/jzmazlish/p/ak-or-just-okay-ai-and-economic-growth?utm_source=share&utm_medium=android&r=gaql6
Thanks for your thoughtful response. But I am 100% sure that my analysis is right. Bad regulation - Basel - caused the crisis and the resulting recession.
"But I am 100% sure that my analysis is right. "
And I am 93.54% sure that you are putting too little weight on the monetary policy-->NGDP expectations-->asset prices-->financial instability channel. :)
(I do agree that banks were badly regulated.)
"undocumented worker" is not a legal term.
It's become a political term.
If you are working in the United States illegally, then you are one of three things.
1. Unauthorized alien
2. Alien unlawfully present
3. Noncitizen without lawful status
First offense = misdemeanor (8 U.S.C. § 1325) (followed by deportation).
Re-entry after deportation = felony (8 U.S.C. § 1326) (prison time, followed by deportation).
Furthermore, not all undocumented people work, and not all unauthorized workers are entirely undocumented.
Your facts are wrong.
Let's suppose that (as reported) Melania Trump and Elon Musk did work in violation of their visa. How would you categorize them?
I have not read Mr. Mazlish’s paper, but I cannot understand how he can argue that anyone would have been advocating zero interest rates in 4Q’07. In that quarter NGDP was still growing at a 7% rate and, as you point out, inflation was increasing. Is he simply misunderstanding your theory? (I’m not sure I totally understand your theory.)
In my opinion, lower interest rates would not have prevented the financial crisis. The only thing that would have prevented it would have been a Lehman bail out, and even that would still have left us with an extraordinarily fragile financial system. The cause of the crisis was the egregious systemic leverage of European banks and US shadow banks. This, in turn, was caused by the Basel Capital Standards. See my substack:
https://charles72f.substack.com/p/basel-faulty-the-financial-crisis
I think NGDP growth was under 5% at that time.
I wouldn't not over-interpret an offhand comment in a tweet. Recall that the recession began in December 2007, and elsewhere I argued that money was too tight in December 2008, despite zero rates at the time. It's an easy mistake to make.
I think you are vastly underestimating the impact of plunging NGDP in 2008 on the financial crisis. Tight money almost always leads to financial distress, and 2008 was no different. Lehman would have done far better in a world where NGDP was expected to keep growing at 5%.
Yes, but NGDP did not start plunging in 2008 until the 3rd quarter after Lehman failed. After that markets froze and no financial institution was going to lend to any counterparty at any price. The Fed had to support all US institutions and swapped dollars to European central banks who divvied them out to their institutions.
"Yes, but NGDP did not start plunging in 2008 until the 3rd quarter after Lehman failed."
I disagree. It looks that way if you focus on quarterly data, but if you look at monthly estimates of NGDP (from Macroeconomics Advisors), you can see that the big decline occurred between June and December 2008. Lehman failed roughly half way though that decline.
As far as the Fed, they were an arsonist masquerading as a firefighter. They adopted interest on reserves in early October 2008 precisely because they did not want to ease monetary policy. The Fed was directly to blame for the big fall in NGDP in the second half of 2008. Sure, they also did some lending to help out the banks, but the net effect of their actions was highly contractionary. The gains from their rescue programs were trivial compared to the damage they were doing with tight money.
They thought they needed to rescue the banking system, when the actual problem was falling NGDP. It was like trying to bail out a boat without first plugging the leak. It wasn't until March 2009 that they realized they had misdiagnosed the problem.
I strongly encourage you to take a look at my book entitled "The Money Illusion", which covers all of these issues in far more detail.
(BTW a version here: https://economics.mit.edu/sites/default/files/2025-05/mp_modelcnfctls.pdf)
I'm a little confused by one of your criticisms you make. You say "In my view, the wrong way is to focus on an entire alternative path for the interest rate."
My understanding based on looking over the paper (and asking GPT 5 to fill in any gaps in understanding, it actually does a decent job) is that the charts that Zach posted aren't the path of policy per se, so much as they are the averages of multiple simulations that iterate through time. So that wouldn't be the path of what policy rates should be assuming you are in 2008 Q4 and just project into the future. So they get a path in 2008 Q4, throw out everything but the first period, move on to 2009 Q1, incorporate some shocks, get a new path, throw out except first period, etc.
So when you say he's suggesting an alternate move at one point in time, it's more like the paper is suggesting alternative move and then iterating through time. Like if in your example you started in 2007 Q4, thought up what policy should be, simulating a baseline for the variables but assuming some shocks that hit all the simulations and incorporating the effect of policy. Then you go to 2008 Q1 and do it again.
Of course there are differences in policy rules, but it goes without saying that your preferred rule would be different from what the mainstream of the profession would use. They are using one that selects the interest rates that minimize squared inflation, squared output gap, and squared changes in interest rates.
We come back to your argument that under the NGDP level rule, then you wouldn't have as bad an outcome. Level targeting looks like it's missing here (at least I believe their rule is only forward-looking). But don't sleep on them assuming some given shocks. You argue the poor performance during this time is related to bad monetary policy and if the policy is better, then we don't have the bad performance. If you take the shocks as given and assume monetary policy is orthogonal to them, then good policy can't fix them.
The sentence of mine that you quote was definitely not intended to be a criticism of that paper, or any other specific paper. I was simply clarifying that it would not be interesting to look at counterfactuals for interest rate paths, but might be reasonable to look at counterfactuals for interest rate changes at a moment in time.
"If you take the shocks as given and assume monetary policy is orthogonal to them, then good policy can't fix them."
Yes, that's what I meant by the Dr. Strangelove reference. Good monetary policy cannot fix supply shocks. At best, it can refrain from causing demand shocks. (Highly unstable NGDP.)
Please discuss the limits to NGDP level targeting. Doesn't NGDP level targeting give way to Cochrane's FTPL at some point in the debt-debasement trajectory? How far beyond sustainability in terms of ROW funding of our twin deficits can we go before we face a very hard reckoning, no matter what the Fed does?
It's possible, but we are still a long way away from fiscal dominance.
Ultimately, it will be a political decision. Would the public prefer higher taxes or higher inflation? Based on the Biden years, I suspect the answer will be higher taxes (or lower benefits). The 30-year T-bond market seems to feel the same way, as it is not predicting high inflation. But I cannot be certain.
I don't expect to live long enough to see how this all gets resolved.
“(or lower benefits)”
Thank you for including this as one of the possibilities. Far too few experts / commentators do.
30yr T-Bonds at 20 year highs (aka back to normal of pre-GFC) says something. Interestingly they correlate with surge in BLS data on working age population growth, back to pre-GFC levels.
Yes, but population growth is now slowing sharply.
You may need to check the latest working age population data from the BLS, it may surprise you, it did me!
The estimates are very imprecise, and actual labor supply growth is very likely slowing sharply this year---mostly due to slowing immigration.
So imprecise that His Highness fired the head of the BLS.
You are most likely right, of course, about the actual situation. Labor supply is very fluid at the moment. The UK had a massive increase recently, sort of unplanned, sort of necessary, sort of hugely problematic.
On your final PPPS, should the US be bailing out Argentina just because the Administration likes Millei and doesn't want to see him fail? There is a story on Bloomberg about just this happening with the support of Secretary Bessant.
No.