Sumnerian luck and monetary reform
By Scott Sumner
I can’t recall how many times I’ve visited some tropical paradise, only to be told, “that’s funny, it usually never rains at this time of year.” When I move to California, I can guarantee that their beautiful Mediterranean climate will suddenly become more like Morocco, due to global warming. Whenever I hear about a foolproof way to beat the market, it seems to immediately stop working the minute that I try it out.
So how can we use my bad luck to make monetary policy more effective?
Commenter Zathrus recently asked me the following:
Second, moving from Brexit to NGDP futures targeting, how could it be politically sustainable to set monetary policy with NGDP futures markets if there is a perception out there, even among market commentators like the one above on Bloomberg, that prices are being set by the elites? I would think that as soon as the market started doing something politically unpopular there would be overwhelming political pressure to detach monetary policy from the futures market and go back to what we have now (discretionary policy, bound by some rules). If market participants believed this was a possibility, a monetary regime attached to even a highly liquid NGDP futures market would never have the credibility to be successful in the first place. How could these political credibility issues possibly be overcome?
It turns out that both of these concerns can be easily addressed with a monetary reform that leverages my gloomy disposition.
Under the basic NGDP futures targeting proposal, the purchase and sale of NGDP futures contracts automatically adjusts the money supply (and hence interest rates), in a way that the market believes will lead to on-target future NGDP. This is the proposal that Zathrus thinks is too controversial, and he’s probably right. As a result I’ve recently moved over to a version of Bill Woolsey’s “index futures convertibility” approach, which is more analogous to the old gold standard, except that gold is replaced with NGDP futures. Under this plan, the Fed would have unlimited discretion to set the money supply and interest rates wherever they wished, as long as they made NGDP futures contracts convertible at a fixed price. This could be viewed as the central bank providing insurance to anyone concerned about NGDP volatility. In my plan, they would implicitly charge a price, and hence earn a profit. For instance, I’ve suggested a “guardrails” approach where the Fed takes a long position on 3% NGDP growth contracts, and a short position on 5% NGDP growth contracts. That means the Fed profits whenever the actual NGDP growth is within those guardrails. And yet, a three to five percent range is small enough to provide decent macroeconomic stability.
So far, you might wonder what any of this has to do with the little raincloud that always hovers over my head. It turns out that the existence of that raincloud is the key to making the entire system work. Back in late 2008, I would have been rubbing my hands together with glee. It was obvious that NGDP growth for the next 12 months was going to come in far below 3%. In that case, I would have had an easy way to get rich—just put my entire 401k plan into a short position in NGDP futures, and if you assume a reasonable margin requirement, I would probably have doubled my money. That would have pushed me from upper middle class to lower rich class.
Unfortunately, there’s the Lucas Critique. It’s very unlikely that someone like me will ever be presented with an easy path to riches. That means that if the Fed installs a monetary regime where obvious likely policy failure provides an easy path to riches, then as soon as the regime is implemented, there will no longer be obvious likely policy failures. In other words, opportunities like 2008 (or the 1965-81 period on the high side) will no longer occur. Darn it!
Of course for this plan to work, it’s essential that I stay alive, so that there is someone unlucky enough to make the entire system work. And I’m already 60. But surely among the 7.3 billion people in the world, there is at least one other person as unlucky as me.
So I’m confident that even after I am dead the plan would continue working.
And if the policy fails, we would all have at least one silver lining to look forward to—it would be extremely easy to get rich!
PS. This is obviously partly tongue in cheek, but on the actual policy proposal I’m dead serious. Don’t assume that you can find an obvious flaw of gimmick, just because it sounds silly.
PPS. I provided some responses to questions raised in David Henderson’s recent post.