So, a good row in comments at Nick Rowe’s blog, about nominal GDP targeting. I think I should probably develop the argument a little more. This particular “leftie” has doubts about NGDP targeting because, basically, I think it relies on assumptions about political economy that don’t hold.
Chris Dillow argues that the Bank of England is currently operating something very much like an NGDP target, in that it seems to have decided that inflation being over target isn’t a problem as GDP is in the toilet. I would add that the UK Treasury has a declared policy of austerity plus “monetary activism” – i.e. a ZIRP, quantitative easing, and at least benign neglect of the sterling exchange rate. (Although it devalued sharply early in the recession, it’s now picked up somewhat, so you can’t really say that they have a policy of competitive devaluation. But they certainly aren’t trying to push it up, and I suspect they’d welcome it if the rate went lower still.)
Now, this policy is certainly managing to add quite a bit of inflation to the flat or falling real GDP. Even the relatively low-reading CPI is over 5%. This is probably helping with the debts from the Great Bubble, but is it working for the real economy? The problem here is that prices are rising at an impressive clip but wages aren’t. The simple truths of household budgeting can only mean that consumption, the biggest chunk of aggregate demand, will be declining and that’s precisely what the statistics show. On the following chart, the red line shows the change in private consumption, the green line shows the change in wages, and the blue line shows the change in the consumer price index. Consumption obviously tracks wages, but it seems to be strongly influenced by the spread between wage and price inflation.
As a result, absent a massive export (what, with depression in the EU?) or investment boom (and a pony), the economy is going nowhere fast. If this situation persists, whatever is gained by inflating off the debts will be lost on GDP growth. The exact reckoning depends on how much the impact on wealth-effect of reduced debt helps demand vs. how much the squeeze on household budgets hurts it. But the key point is that the effects of the policy are working against each other, reducing its effectiveness
At this point, Nick Rowe accused me of being fallacious, being like Ron Paul (the guy whose newsletter advised readers to arm themselves in order to shoot at their black neighbours because “the animals are coming”, and worse, a big fan of let’em starve gold standard macroeconomics – stay classy, Nick), and being like Michal Kalecki. I guess that last one is an improvement.
His point is that, in theory, changes in the unit of account (like inflation) shouldn’t change anything in the real economy. Knock a zero off the currency, or tack one on, and relative prices – like pints of beer per hour of labour – should remain the same.
Well, that’s sensible enough in as far as it goes. However, it may not go very far. It’s trivially obvious that inflation (or deflation) does have different effects on different actors in the economy. People with lots of liquid savings lose out, people with debts benefit. People whose money is invested in bonds (if they aren’t indexlinked) lose out; people whose money is invested in shares tend to benefit. Entrepreneurs do well, rentiers don’t. In general, inflation (or deflation) changes the terms-of-trade between the present and the future. Inflation causes people to bring forward purchases, deflation to put them off.
To understand this, let’s work through the process. So there is inflation, and both prices and wages rise. But for some reason, prices inflate more than wages. Aggregate demand will, all other things being equal, be reduced. What happens if prices keep going up faster than wages? Eventually, they will price themselves out of the market and there will be a recession, which will eventually drag prices back in line. Mr. Keynes, however, will remind us that the long run can be very long indeed. If nominal prices were frictionless, of course, this wouldn’t be a problem, and I wouldn’t write this and you wouldn’t read this, and Nick Rowe would be out of a job as a macro-economist. We have to deal with the empirical realities.
Of course, I’ve left out an important actor here. What about workers? Sticking with the standard economic apparatus, you’d probably say that if prices inflate faster than wages, “wage bargainers” will integrate higher inflation expectations into their negotiating position and bid wages up. This is all very well if they can negotiate a raise. But we’re starting off in a recession, in the zero lower bound environment, with millions unemployed! Worse, we’re coming off 30 years of macro-economic policy designed to defeat the wage-price spiral – i.e. to damn well stop them bargaining wages upwards and to set expectations of wage inflation as low as possible.
This is where the political economy comes in. The idea of getting out of depression via NGDP targeting requires robust wage bargaining. In the absence of it, in a political context that has invested huge efforts in the destruction of expectations of wage growth, it is useless if not actively harmful.
There’s also another trap here. If prices have to overshoot and fall back in order for monetary neutrality to work, this requires deflation. Deflation is not generally considered – even by the most ferocious monetarist – to be a great recovery plan. And it is the exact opposite of an inflationary exit from a balance sheet recession.
Here’s a helpful chart of consumer price inflation and wage inflation in Canada from 1970 to the present day! As you can see, there is absolutely no spread between them. Or…is there?