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In a Sense, We are All Monetarists Now (Much to Bernanke’s Chagrin)

There has been much made of having the Fed target nominal GDP growth and employ monetary actions to achieve growth without regard to the component thereof derived from inflation. The concept was the subject of an op-ed recently by former Chairwoman of the President’s Council of Economic Advisors, Christine Romer,  in which Romer challenged the Fed to pursue a strategy of targeted nominal GDP. Paul Krugman later added his somewhat tepid support.

Not only do I think this to be bad policy (as I believe a majority of the FOMC would agree), but I would go so far as to suggest that to achieve nominal GDP growth through manufactured inflation in itself may be unachievable as much as it is undesirable.

Our repeated employment of Quantitative Easing has demonstrated that excess liquidity refuses to transmit through to wages amidst a global glut in the supply of labor, productive capacity and capital – relative to aggregate global demand. And attempts to devalue the dollar through extraordinary monetary expansion have been unsuccessful because of China’s ability to defend against such moves and, more generally, the status of the dollar as global reserve currency for which there is a safe-harbor bid amidst continuing global economic instability.

Instead, under present circumstances, excessive monetary easing transmits into a liquidity-induced bid for money substitutes: highly liquid commodities (oil, metals, food) and tradable equities. This has the effect of killing real growth and – in the aforementioned absence of wage growth – stifling expansionary consumer and business spending.

I believe that Milton Friedman, were he with us today, would see this conundrum quite clearly (apologies for co-opting his famous line about Keynesians in the title above). Having said this, the tendency of many of his disciples (among which I do not count myself, despite the respect I accord his mind) to ignore exogenous influences and to fall back on closed system analytical paradigms is disappointing.

It is vital to keep in mind that the great work of Keynesian, monetarist, and Austrian/classical/supply oriented economists, never contemplated the sudden emergence of billions of excess laborers into relatively direct competition with the Euro-American economies that formed the cauldron of all (non-socialist) economic thought. Ignoring this historic impact in formulating policy is to our greater peril.

2 Responses to “In a Sense, We are All Monetarists Now (Much to Bernanke’s Chagrin)”

EdDolanNovember 3rd, 2011 at 6:05 pm

"Attempts to devalue to dollar through extraordinary monetary expansion have been unsuccessful because of China’s ability to defend against such moves and, more generally, the status of the dollar as global reserve currency for which there is a safe-harbor bid amidst continuing global economic instability."

Uh . . . try looking at the data? I see a distinct downward trend in the dollar when I look at the BIS series on dollar REEI. Have you looked? Furthermore, as I have chronicled here most recently ( http://tiny.cc/9vsa2 ), the yuan is steadily appreciating against the dollar, much faster in real than nominal terms.

I am not so sure Friedman would have rejected NGDP targeting. His M1 growth rule was very close. Remember, back in the day, a key assumption of monetaryism was that velocity was fairly stable. If velocity is stable, targeting M1 is the same as NGDP targeting. Friedman's M1 rule would have allowed for higher than average inflation during periods when real output was growing more slowly than usual. I would say it was a precursor to NGDP targeting. NGDP targeting is monetarism for the new world of financial markets with unstable and unpredictable velocity.

smasson1November 17th, 2011 at 12:12 am

With the monetary base so high, do you see any reason this would not translate into a bid for risky assets… It is well supported historically, but will it come to play in todays environment or does the sluggish growth just make the base that much more powerful. How long can this last without growth to accomodate risk assets

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