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Posts Tagged ‘Quantitative Easing’

QE unwind? Yeah right

August 18, 2017 Leave a comment

Another very informative clip from the FT. Some of the salient points include:

  • Since the global financial crisis the Bank of England, US Fed, Bank of Japan and European Central Bank have bought assets and printed US$12 trillion.
  • Can interest rates return to what has been normal in the past – say 5% instead of close to 0%.
  • US Fed plans to shrink its balance sheet later this year – monthly reduction US$6bn in its assets. But this is a very small amount when you consider that the Fed holds US$4.5 trillion
  • But this is not happening elsewhere. Bank of Japan and European Central Bank are still printing money and buying assets. With Brexit the Bank of England faces huge uncertainties regarding their balance sheets.
  • Interest rates will remain low partly due to: ageing population, low productivity growth and a savings glut. This has reduced the attractiveness of capital spending.

RIP John Clarke

April 11, 2017 Leave a comment

Sad news yesterday of the passing of John Clarke. As well as his Fred Dagg character he was part of  ‘Clarke and Dawe’ which aired on ABC Australia in which prominent figures speak about matters of public importance. Below is the time they look into what Quantitative Easing actually is. Very amusing and his sense of humour will be missed.

How do we stimulate the global economy in tackling the next downturn?

March 24, 2016 Leave a comment

There is growing anxiety that policymakers in the develoPublic Debtped world will need to consider some radical approaches to tackling the next downturn. Quantitative easing (the buying of government bonds using the money of the central bank) is limited and with interest rates already a record lows a further drop is unlikely to stimulate much more aggregate demand. Fiscal policy could be employed – tax cuts and increases in government spending. However the issue here is how much fiscal stimulus can government’s afford with the debt they already have? See table

Government policy in recent years has done little to improve the economic climate. Although there has been many rounds of quantitative easing the productivity of those in work has been poor leading to lethargic growth levels. This ultimately limits real wage growth and tax revenue to reduce government debt levels.  Economies are now doomed to many years of weaker growth with lackluster demand which will mean more radical policies outside the square. Some policy options could be:

Fusing Monetary and Fiscal Policy

An option discussed in The Economist was to finance public spending and the tax cuts by printing more money. This could be more effective than Quantitive Easing (QE) as the money now bypasses the banking system and goes straight into the pockets of the consumers. This would hopefully encourage consumers to spend money straight away instead of going through the process of borrowing money from the bank as is the case with QE.

Incomes Policy – wage-price spiral

The aim of an incomes policy in the 1960’s and 70’s was to link the growth of incomes to the productivity so as to prevent the excessive rises in factor incomes which raise costs and hence prices. However the idea here is to generate higher incomes at all levels by using tax incentives and to encourage a wage-price spiral. This seems bizarre in the context of the 1970’s as this is what governments were trying to solve.

Infrastructure development

InfrastructureCapital spending on infrastructure is seen as a much more effective tool to stimulate growth than tax cuts. Unlike tax cuts, capital spending goes directly into the circular flow and it attracts complementary spending elsewhere in the economy more than any other intervention. It is estimated that a third of roads in the USA are in a poor state and over 10% of its bridges are not structurally sound. However although it might sound a good idea, infrastructure spending can be wasteful as even many years of capital spending in Japan hasn’t had the desired effect of boosting the economy.

Where to from here?

The problem, then, is not that the world has run out of policy options. Politicians have known all along that they can make a difference, but they are weak and too quarrelsome to act. America’s political establishment is riven; Japan’s politicians are too timid to confront lobbies; and the euro area seems institutionally incapable of uniting around new policies.

Source: The Economist – 20th February 2016

 

AS and A2 Macroeconomics: Internal and External Balances

October 15, 2015 Leave a comment

In explaining the differences between internal and external balances I came across an old textbook that I used at University – Economics by David Begg. It was described as ‘The Student’s Bible” by BBC Radio 4 and I certainly do refer back to it quite regularly. Part 4 on macroeconomics has an informative diagram that shows the impact of booms and recessions on the internal and external balances.

Internal Balance – when Aggregate Demand equals Aggregate Supply (potential output). And there is full employment in the labour market. With sluggish wage and price adjustment, lower AD causes a recession. Only when AD returns to potential output is internal balance restored.

External Balance – this refers to the Current Account balance. The country is neither underspending nor overspending its foreign income. For a floating exchange rate, the total balance of payments is always zero. Since the balance of payments is the sum of the current, capital, and financial accounts, saying the current account is in balance then also implies that the sum of the capital and financial accounts are in balance.

In the diagram right the point of internal and external balance is the intersection of the two axes, with neither boom nor slump, and with neither a current account surplus nor a deficit.

The top left-hand quadrant shows a combination of a domestic slump and a current account surplus. This can be caused by a rise in desired savings or by an adoption of a tight fiscal policy and monetary policy. These reduce AD which cause both a domestic slump and a reduction in imports.

The bottom left-hand corner shows a higher real exchange rate, which makes exports less competitive, reduces export demand and raises import demand. The fall in net exports induces both a current account deficit and lower AD, leading to a domestic slump.

In a downturn a more expansionary fiscal and monetary policy can hasten the return to full employment eg. Quantitative easing, tax cuts, lower interest rates. However one could say that today it doesn’t seem to be that effective.

To Taper or not to Taper – that is the question

February 7, 2014 Leave a comment

The US Federal Reserve announced on 18th December a tapering of its bond-buying program to $75bn a month beginning in January. This video from Paul Solman of PBS is a useful guide about the process and asks economists (including Robert Shiller) their opinion on the matter. Recently the Fed said that it would lower its monthly long-term Treasury bond purchases to $40 billion and mortgage-backed securities to $35 billion a month.

US Corporations doing well but little job creation

July 28, 2013 Leave a comment

Fed Chair Ben Bernanke recently testified before the House of Representatives Committee on Financial Services and acknowledged the troubling employment conditions. Unemployment rate at 7.6% remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high. Bernanke indicated that he would continue quantitative easing because of the unemployment figures but this method doesn’t seem to be working when you consider the lack of job growth – see graph. The U.S. Federal Reserve is currently purchasing US$85 billion of agency mortgage-backed securities and Treasury securities each month as part of its quantitative easing programme. This programme places downward pressure on long-term interest rates, and is intended to promote economic activity. However the S&P* earnings per share (eps) has grown above 70% since the bottom of the last cycle but job growth has been under 5%.

*The S&P 500® is widely regarded as the best single gauge of large cap U.S. equities.  There is over USD 5.58 trillion benchmarked to the index, with index assets comprising approximately USD 1.3 trillion of this total. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalisation.

S&PUSjobs

QE = Inflation?

July 9, 2013 Leave a comment

Money base v Money SupplyAs John Maynard Keynes stated:

“The long run is a misleading guide to current affairs. In the long run we are all dead.”

Should investors focus on the short run or long run? The majority are looking at short run gains rather than a long term focus as they are most likely driven by instant financial rewards after the GFC.

Investors are also looking to see if the significant monetary expansion over the last 5 years will lead to inflationary pressures. Niels Jensen of Credit Writedowns has been writing on this for awhile and has come up with a couple of reasons why we shouldn’t be worried about it. Firstly many investors don’t seem to have grasped the difference between the monetary base and the money supply.

The monetary base is the total amount of a currency that is either circulated in the hands of the public or in the commercial bank deposits held in the central bank’s reserves.

The money supply is the entire stock of currency and other liquid instruments in a country’s economy as of a particular time. The money supply can include cash, coins and balances held in checking and savings accounts.

See above for some figures from Neils Jensen

As he points out it is the money supply, not the monetary base, which influences inflation. The chart below shows that there is no growth in bank lending despite the QE measures of printing money.

Monetary base Bank lending

“As so aptly demonstrated in a recent IMF paper, the interaction between inflation and the economic cycle is very different today when compared to the 1975-1994 period. Whereas inflation back then was pro-cyclical, it is largely non-cyclical today with inflation well anchored around 2% regardless of the underlying economic conditions – see chart below. The obvious implication of this is that inflation should behave relatively well even as (if) economic fundamentals improve.” Source: Credit Writedowns

Inflation cy unemp

Rogoff and Reinhart error – but does it really matter?

May 1, 2013 Leave a comment

This Time DifferentLately there has been a lot of media coverage about an Excel error by academics Ken Rogoff and Carmen Reinhart – co-authors of ‘This Time is Different’ – 2009. A student from University of Massachusetts tried to replicate one their models regarding growth rates when a country has a public debt of greater than 90% of GDP. Rogoff and Carmen stated that with this level of public debt growth in a country falls to a mean of -0.1%. However using the same data the student found that a figure of 2.2% was applicable in this context.

However Rogoff and Reinhart have been cautious about saying that high debt causes slower growth rates but it does highlight the validity of analysis connecting debt and austerity to growth rates. Adam Posen in the FT stated that the claim of a clear tipping point for the ratio of Government Debt to GDP past which an economy starts to collapse doesn’t hold. Following the second world war the US, UK, Belgium, Italy and Japan had public debt greater than 90% of GDP but there was not much of an effect on their economies. In Italy and of late in Japan stagnation in economies led to slowly rising debt levels. In the UK and US in the 1950’s growth returned and debt levels declined. What this is suggesting is

Slow growth is at least as much the cause of high debt as high debt causes growth to slow.

But a certain amount public debt is necessary for future development of any economy especially when you think about the construction of infrastructure and government spending on education. Both of which contribute to future growth and in theoretical terms move the production possibility curve outwards. This in turn creates growth and subsequently income for a government.

USA – Mad Spending v EU – Nervous Austerity

With one side of the Atlantic – USA – involved in quantitive easing (printing money) and the other – EU – with severe austerity, maybe somewhere in between would be a logical way to go about things. But is moderation a choice for policy makers when they have already gone so far down the track of their respective plans?

Final thought
What can be concluded is that too much debt has costs for growth but the degree of those costs is dependent on the reasons for debt accumulated and what path the economy is actually taking.

10 Reasons not to use Quantitative Easing (QE)

March 9, 2013 Leave a comment

QE costsNouriel Roubini wrote a piece on the Project Syndicate site focusing on the costs of QE. After three rounds of QE one wonders about its effectiveness. Roubini came up with 10 potential costs.

1. QE policies just postpones the necessary private and public sector deleveraging and if this is left too long it can create a zombie economy – institutions, firms, governments etc lose their ability to function.  
2. Economic activity in the circular flow may become clogged with bond yields being so low and banks hoarding liquidity. Therefore the velocity of money circulation grinds to a halt.
3. With more money in the economy this implies a weakening of the currency but this is ineffective if other economies use QE at the same time. QE becomes a zero-sum game as not all currencies can fall simultaneously. QE = Currency Wars
4. QE leads to excessive capital to emerging markets. This can lead to a lot of extra liquidity and feed into domestic inflation creating asset bubbles. Furthermore an appreciation of the domestic currency in emerging markets makes their exports less competitive.
5. QE can lead to asset bubbles in an economy where it is implemented. It is especially prevalent when you’ve had an aggressive expansionary monetary policy (1% in USA after 9/11) already present in the economy for many years prior.
6. QE encourages Moral Hazard – governments put off major economic reforms and resort to a band aid policy. May delay fiscal austerity and ill discipline in the market.
7. Exiting QE is important – too slow an exit could mean higher inflation and assets and credit bubbles are created.
8. Long periods of negative real interest rates implies a redistribution of income and wealth – creditors and savers to debtors and borrowers. QE damages pensioners and pension funds.
9. With QE excessive inflation accompanied by slow credit growth, banks are faced with very low net interest-rate margins. Therefore, they might put money into riskier investments – remember the sub-prime crisis, oil prices up $147/barrel
10. QE might mean the end of conventional monetary policy. Some countries have discarded inflationary targets and there is no cornerstone for price expectations.

Japan’s three arrows of economic policy

February 5, 2013 Leave a comment

Japan’s Prime Minister Shinzo Abe recently addressed parliament stating that he plans to reverse the trend of issuing bonds to raise money but raise more in taxes. Japan cannot beat deflation and a strong currency (yen) if it adheres to the same policy of the past decade.

However his speech comes after the announcement of a $226.5bn stimulus package earlier in the year and this when Japan already has some serious debt issues – public debt that is almost three times the size of the Japanese economy.. He also wants the Bank of Japan to maintain an open-ended policy of quantitative easing (QE) and a doubling of the inflation target – 2%. Hopefully the fiscal stimulus package accompanied by more QE will drive down the price of the yen which will make Japanese exports more competitive. He stated his three arrows of economic policy:

1. Aggressive Monetary Easing
2. Flexible fiscal spending
3. A growth strategy that would induce private investment

Who knows if it will work but Shinzo Abe stated that it is worth the gamble.

Velocity not there for global recovery

January 7, 2013 Leave a comment

global savingsThe race for countries to devalue their currency (make their exports more competitive) has led to massive increase in monetary stimulus into the global financial system. We are all aware of the three rounds of Quantitative Easing from the US Fed and the indication that they would keep the Fed Funds Rate at virtually zero until 2015. To add fuel to the ‘dim embers’, in 2013 the US is going to inject US$1 trillion into the circular floe. However in China they have also embarked on some serious stimulus:

* More infrastructure development – US$60bn
* Additional credit – US$14 trillion in extra credit since 2009 (equal to entire US banking system)

Nevertheless even with all this artificial stimulus there might be some short-term growth but I can’t see it being sustainable when you consider the extent of global deleveraging. Also IMF figures show that the world saving rates are on the increase (* forecast):

With increased saving rates accompanied by significant austerity measures in many parts of Europe where is the consumer demand going to come from? Unemployment in Spain is 26% and predicted to hit 30% this year- more worrying is 50% of those under 25 are unemployed. Spanish protesters chanted “We don’t owe, we won’t pay” in a march against austerity. So in the US we have massive fiscal stimulus but across the water in Europe it’s all about “tightening the belt” and cutting government spending. Neither seems to be working and are we just putting off a significant downturn for a later date?

Paddy’s A to Z of the Economic Crisis

November 8, 2012 1 comment

Here is a very funny video from Paddy Cullivan who first performed this at Kilkenomics 2011. Worth a look.

AS & A2 – Global and New Zealand Update for November exams

October 16, 2012 Leave a comment

It is important that you are aware of current issues to do with the New Zealand and the World Economy. Examiners always like students to relate current issues to the economic theory as it gives a good impression of being well read in the subject. Only use these indicators if it is applicable to the question.

Indicators that you might want to mention are as follows:

The New Zealand Economy
The New Zealand economy expanded by 0.6 percent in the June 2012 quarter, while economic growth in the March quarter was revised down slightly to one percent. Favourable weather conditions leading to an increase in milk production was a significant driver of economic growth over the June quarter. The current account deficit rose to $10,087 million in the year ended June 2012, equivalent to 4.9 percent of GDP. Higher profits by foreign-owned New Zealand-operated banks and higher international fuel prices were factors behind the increase in the deficit during the year. Unemployment is currently at 6.8% but is expected to fall below 6% with the predicted increase in GDP. Annual inflation is approaching its trough. It is of the opinion that it will head towards the top end of the Reserve Bank’s target band (3%) by late next year.

The Global Economy
After the Global Financial Crisis (GFC) the debt-burdened economies are still struggling to reduce household debt to pre-crisis levels and monetary and fiscal policies have failed to overcome “liquidity traps”. Rising budget deficits and government debt levels have become more unsustainable. The US have employed the third round of quantitative easing and are buying US$40bn of mortgage backed securities each month as well as indicating that interest rates will remain at near zero levels until 2015. Meanwhile in the eurozone governments have implemented policies of austerity and are taking money out of the circular flow. However in the emerging economies there has been increasing inflation arising from capacity constraints as well as excess credit creation. Overall the deleveraging process can take years as the excesses of the previous credit booms are unwound. The price to be paid is a period of sub-trend economic growth which in Japan’s case ends up in lost decades of growth and diminished productive potential. The main economies are essentially pursuing their own policies especially as the election cycle demands a more domestic focus for government policy – voter concerns are low incomes and rising unemployment. Next month see the US elections and the changing of the guard in China. In early 2013 there is elections in Germany. The International Monetary Fund released their World Economic Outlook in which they downgraded their formal growth outlook. They also described the risk of a global recession as “alarmingly high”.

New Zealand Dollar in September

October 3, 2012 1 comment

Here is a great graphic from the BNZ showing how the NZ dollar performed in September. You could say that it strengthened on the back of notably QE3 from the US Fed and the improving global growth sentiment. Furthermore the NZ economy has performed well under trying circumstances.

June quarter GDP accounts revealed the NZ economy finished Q2 1.6% bigger than where it began the year. That is solid economic growth under ordinary circumstances. But given the ongoing challenging and uncertain global economic environment we should not under sell this achievement. It is the strongest six month expansion we have seen in the past five years. Source: BNZ

Bernanke turns on the taps once again – NZ$ on the rise

September 16, 2012 3 comments

It is the US Fed’s intention to buy volumes of mortgage backed securities and keep borrowing rates at near zero (0-0.25%) until the job market and broader economy pick up. Basically they are going to print money until there is some improvement in unemployment figures. Unemployment is at 8.1% and the Fed estimate that it will fall no lower than 7.6% in 2013 and 6.7 in 2014. Inflation is forecast to remain at or below 2% until 2015.

How does it work?
The Fed will buy $40 billion a month in mortgages and will keep doing this until unemployment starts to fall. This will have a couple of effects:

1. It might lower mortgages rates by another 0.25% (already quite low). The 30-year mortgage rate is 3.5% and could go down to 3.25%
2. When mortgage rates go down, the price of houses tends to go up which is beneficial even if you are not refinancing a mortgage
3. Investors tend to move out of low interest earning investments and put their money into stocks. The DJIA closed up more than 200 points and was 625 points off its all-time high.

Impact on NZ$
With the flood of US$ into the market this has put downward pressure on the US$ which will make its export market more competitive and imports more expensive. However risk currencies like the NZ$ and AUS$ have rallied. Looking at the NZ$, this has appreciated considerably against the US$ and will make NZ exports more expensive and NZ imports cheaper. This will not only hurt the export industry as the price of goods become more expensive but the domestic sector have now got to compete with cheaper imports. The NZ$ reached US$0.84 yesterday.

Khan Academy – some great presentations on Macro and Micro

March 12, 2012 2 comments

Below is one of many really good presentations on macro and micro economics from the Khan Academy. They are particularly useful for the more theoretical parts of the course and include just about every topic in the AS/A2 syllabus as well as other presentations on current economic issues like the one below. Here they are looking at the difference between quantitative easing in the US and in Japan. Well worth a look.

Should the Reserve Bank of New Zealand print money?

February 28, 2012 2 comments

Bernard Hickey wrote a very valid piece in the New Zealand Herald yesterday. The gist of his writing focuses on the RBNZ and the fact that it should be following other central banks in printing money – quantitative easing. In the 1930’s the RBNZ did inject money into the economy and this helped pull NZ out of the Great Depression.

Most people see the dangers of quantitive easing in the hyperinflation that may follow such an expansion of the money supply. However, if you look at Japan in the 1990’s (the lost decade) interest rates remained at near 0% and the printing of more money didn’t create inflation. Furthermore if you look at more recent examples you see the following:

US Federal Reserve, Bank of Japan, Bank of England, Peoples’ Bank of China, and the European Central Bank have printed a combined US10 trillion in the last 4 years and spent it on bonds, cash injections into banking systems. This normally happens when central banks run out of ammunition to stimulate growth – i.e. low interest rates and they enter a liquidity trap scenario. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

Bernard Hickey suggests that it would be much better if the government borrowed from the RBNZ rather than foreign banks and pension funds. Also to print money to fund the deficit which in turn will reduce the value of the NZ$ and therefore make exports more competitive. Click here to view the full article.

We need inflation to boost world economy

January 20, 2012 Leave a comment

It seems ironic that after a global focus to contol inflaton it transpires that what we really need is more. According to Time magazine there are 2 key points why we need inflation:

1. Inflation would shrink the value of the debts both the government and borrowers have to pay, improving our collective balance sheets. Higher salaries would also make it easier for borrowers to pay back their loans helping banks.

2. This might be the more important reason now, inflation pushes people and companies to spend money. If you know prices are going to drop or stay flat, then you will delay a purchase. That’s why most of us are late adopters when it comes to technology. But if you know prices are going to rise, then you will spend your money now. So increasing inflation could stimulate the economy, as well as lower our debts.

Also, according to Paul Krugman, in the long run, it’s very difficult to cut nominal wages. However when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis. Or to put it a bit differently, the long-run Phillips curve isn’t vertical at very low inflation rates.

The fortunate aspect of all this is that creating inflation is not a difficult task. The central banks just have to keep rointing money and buying up government debt. The issue is to do with the long-run and that inflation could get out of control like that in the 1970’s – 20% instead of being below 10%. However it is all to do with inflationary expectations – behavioural economics.

Switzerland – lowest inflation since 1900

December 21, 2011 Leave a comment

A recent article in the New Zealand Herald by Mark Lister (Craigs Investment Partners) suggested that the best way for an investor to beat inflation is to have an allocation of precious metals in a portfolio. Inflation affects the holders of monetary assets, e.g. bank deposits, savings, loans,government securities – as money loses value, so do these assets. Therefore, savings in real assets such as property are also advisable to beat the inflation monster. However what was interesting about the article was the history of global inflation and money over the last 100 years. Over that time period inflation has averaged 4.5% but it has been the last 10 years that has seen it accelerate significantly.

The table shows inflation rates of industrialised countries since 1900. Switzerland is the only country to have maintained an average inflation rate below 3% over the time period. One has to ask why other countries have found it so hard to keep inflation under the 3% level. Up until the mid 1970’s most major currencies were backed by precious metals. What it bascially meant was that a country could only print more money if it increased its stock of gold or other precious metals – the currency was backed by these precious metals. The rationale here was that the notes and coins could be exchanged for precious metals which meant that you couldn’t just print more money (quantitative easing) like they have been doing over the last couple of years. It was in 1971 when President Nixon suspended the convertibiity of US dollars into gold and by 1975 most other developed countries had followed suit. This led to a new era of just prinitng more money and currencies become known as fiat currencies – no inherent value. The term derives from the Latin fiat, meaning “let it be done” or “it shall be (money)”, as such money is established by government law. The key aspect about fiat money is the fact that its value relies entirely on the confidence the public have in it.

Up to 2000 Switzerland still kept linking its currency to gold and it was only after a referendum that authoriites loosened the requirement to hold a certain amount of gold as a back-up to paper money. Today, it’s as easy as a few extra numbers entered on a computer keypad. Printing money doesn’t achieve much other than inflation. There is still the same amount of goods and services to go around, but now there is more money chasing the same amount of goods, so the price simply goes up in reaction, which in turn makes your money worth less in terms of its purchasing power.

Bernanke needs to follow Volcker

October 31, 2011 Leave a comment

US Fed Chairman Ben Bernanke could really take a leaf out of former US Fed Chairman Paul Volcker’s book. In the 1970‘s the US economy was going through a period of stagflation – high unemployment and high inflation (both over 10%). Volcker believed that inflation was one of the worst of all economic evils and that it hinged on the growth of the money supply. He therefore began to target inflation which in turn would break people’s inflationary expectations. With this in mind he tightened the money supply and the prime interest rate reached 21.5% – the economy went into a nosedive. However the policy worked and inflation fell from 11% in 1979 to 3% in 1983 and subsequently with this lower inflation rate unemployment fell to 5.3% by 1989.

Today the US economy has 2.6% inflation and 9.6% unemployment and the current Fed policy, like that used in the pre-Volcker era, doesn’t seem to be working. According to Professor Christina Romer in the New York Times, Bernanke needs to be like Volcker and set a new policy framework which, this time, targets nominal gross domestic product which in turn would favour job creation. In the US normal output growth is around 2.5% and the inflation around the 2% so a target of 4.5% GDP would seem appropriate. How Professor Romer would see it operate would be like this:

The Fed would start from some normal year — like 2007 — and say that nominal G.D.P. should have grown at 4 1/2 percent annually since then, and should keep growing at that pace. Because of the recession and the unusually low inflation in 2009 and 2010, nominal G.D.P. today is about 10 percent below that path. Adopting nominal G.D.P. targeting commits the Fed to eliminating this gap.

How would this help to heal the economy? Like the Volcker money target, it would be a powerful communication tool. By pledging to do whatever it takes to return nominal G.D.P. to its pre-crisis trajectory, the Fed could improve confidence and expectations of future growth.

The expected increase in inflation would effect inflationary expectations but a small increase in inflation would be beneficial as it would lower borrowing costs and encourage spending a large budgetary items.

Even if we went through a time of slightly elevated inflation, the Fed shouldn’t lose credibility as a guardian of price stability. That’s because once the economy returned to the target path, Fed policy — a commitment to ensuring nominal G.D.P. growth of 4 1/2 percent — would restrain inflation. Assuming normal real growth, the implied inflation target would be 2 percent — just what it is today.

Other policies within the framework include:

Quantitative Easing – printing more money
Lower the US$ – makes exports more competitive

Would this work today to reduce unemployment? I suppose the US Fed are currently running out of policy options and like Volcker in the 1980’s there needs to be a quiet revolution in the Fed’s thinking. I don’t mean the shock therapy used in Latin American countries but a realigning of the objectives of ecoomic policy. It seems that the bold measures of Volcker in 1980’s and Roosevelt in the 1930’s actaully brought the US economy out of its depressed state but in both periods of time the process involved a lot hardship and protest. I just wonder if the US Fed is prepared to go through this pain again? As President Reagan said about the recession the US economy was about to go through in the 1980’s –

“If not now, when? If not us, who?”

However The Economist has a different point of view with regard to targeting nominal gross domestic product – NGDP.

Asking central banks to ditch inflation targeting and to pursue another goal could do more harm than good particularly if it left people less certain about the central bank’s ultimate commitment to prudence and stability. That is why a switch to NGDP targeting, whatever its virtues, should not be undertaken lightly.

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