I notice that the war cry for NGDP Targeting seems to be increasing with time. Michael Woodford, Christina Romer and many other economists have now endorsed it. The latest proponent is James Bullard of the St. Louis Fed. You can read his new paper here in case you’re looking for something to put you to sleep almost immediately.
I wanted to highlight one particular aspect of the paper (via the very astute Matthew Klein) which seems to reflect a consistent theme in macroeconomics – that of totally unrealistic modelling. Bullard writes:
To smooth consumption, the nonparticipant households use currency issued by the central bank. The price level in the economy will be determined by the currency demand of this cash-using group, subject to the aggregate labor productivity shock. The central bank supplies currency to the economy’s cash-using households and can effectively control the price level of the economy through this channel.
I’ve explained in the past where cash comes from. Cash is used by depositors who already have deposit accounts. That is, cash comes from being withdrawn by bank account users. So, inside money (deposits) naturally precedes cash which is outside money. The Fed cannot just send cash to households. There is no mechanism at present by which this is possible. So, the Central Bank cannot just supply currency to the economy’s cash using households. Yes, it can supply deposits via operations like QE, but that is supplied in exchange for some other financial asset like T-Bonds (much like swapping a savings accounts for a checking account as I’ve explained many times as to why QE doesn’t cause high inflation).
The point is, Bullard’s model is based on some alternative universe in which the Fed is capable of implementing a true helicopter drop of cash. So, I still fail to see the transmission mechanism by which NGDP Targeting works. And the models that have been released based on these purely theoretical worlds, do not give me great hope that its proponents understand the transmission mechanism either.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.