Sumner and Tobin
By Arnold Kling
Scott Sumner cites James Tobin on the virtues of the Fed targeting nominal GDP.
I wish Tobin had lived long enough to have something to say about the role of money in the current financial crisis. As you know I am one of the few people who think tight money, defined as a policy of suddenly driving NGDP growth 8% below trend, was the most important factor in the financial crisis,
I strongly doubt that Tobin would say that Ben Bernanke carried out a policy of “suddenly driving nominal GDP growth 8 percent below trend.” I don’t think Sumner really wants to say that, either. At the risk of putting words in his mouth, I think that what Sumner wants to say is that there was a shock to velocity in 2008 that was going to drive expected nominal GDP growth 8 percent below trend, and the Fed, instead of doing something to offset that shock, mindlessly decided that with nominal interest rates already low there was nothing it could do.
What I would say is that if the Fed had printed more M, the result would have been even lower V. Whatever it was that was driving down PY (and, as you know, in my view it was recalculation), the Fed could not have done much about it. I doubt that Tobin would have embraced recalculation, but I doubt that he would have said that the Fed could have done something about nominal GDP in the very short run (two or three quarters).
I will conced that the Fed can affect nominal GDP growth beyond the very short run (or in even in the very short run with spectacular moves, such as doubling the money supply). However, my recalculation story implies that if the Fed had picked a higher path for nominal GDP growth, it would have gotten mostly more inflation, with little benefit to real output. Again, my guess is that Tobin would not have agreed with me about this, and he would have said that higher nominal GDP growth would have produced a lot higher real GDP growth, not just more inflation.
In his post, Sumner sketches out some microfoundations for the story of causality running from nominal GDP growth to real GDP growth.
It’s like musical chairs; when the music stopped there weren’t enough dollars of NGDP out there to pay the debts and salaries that had been contracted under much different expectations.
As to salaries, I just don’t think that the rise in real wages (less than 2 percent) is enough to explain 10 percent unemployment. When you say that debts were contracted under much different expectations, you make it sound like we had farmers taking out loans to plan crops when prices are 100, and then by the time the crops are harvested the prices are at 80, due to general deflation. That just does not seem like the story of the last year.
The borrowers who could not repay home loans or commercial construction loans or consumer credit were not hit by general deflation. They were hit by a sudden reversal of the trend in land prices. Some were hit by loss of employment.
I’m still wrestling with the issue of what caused such a deep recession. Another thought is that the domestic auto industry took another ratchet down in what has been a long-term trend. Manufacturing employment in general continued to ratchet down.
What was unusual was the lack of growth in any other sector to produce employment gains that might have offset the jmanufacturing ob losses. Throughout most of the past 40 years, as manufacturing workers lost jobs, new entrants to the labor force gained jobs in services. Over the most recent ten years, manual laborers were absorbed by the construction industry. In 2008 and 2009, the service sector did not come through, and construction was a loser rather than a winner.