Make nominal spending the new target? We hope not.

In the January 2 2013 edition of the Financial Times Mr. Scott Summer, economics professor at Bentley University, publishes an article titled Make nominal spending the new target, where he argues for the revolutionary, and increasingly MSM-pushed idea of making Nominal GDP Targeting (NGDPT) the official policy of central banks in most western countries. This policy was already hinted last December at a conference in Toronto by the present governor of the Bank of Canada (BoC), and future governor of the Bank of England (BoE), Mark Carney.

This in an article fraught with ideas that, if implemented, will permanently transform the nature of western economies and pave the way for structurally high inflation, potential hyperinflation, economic misallocation of resources, moral hazard (savers, wage earners and pensioners being punished), and general impoverishment of the population except for the few taking advantage of it thru their access to cheap financing: financial institutions and überwealthy individuals.

Mr. Scott Summer states: “Once a central bank sets an inflation target, they have essentially set a path for aggregate demand. In that case, what possible role can there be for fiscal stimulus? But as the past few years have shown, stimulus advocates and opponents are as vociferous as ever. And despite a widespread perception that most developed economies would benefit from more demand, central bankers seem unwilling or unable to deliver that growth.”

TYR states: This paragraph foreshadows the huge amounts of half-truths and outright lies that conform the article. It sets the stage for the assertion that a central bank’s main role is to foster “demand”, foster growth. This has never been the role assigned to monetary policy, whose main aim is, and should be, to preserve the purchasing value of the currency, that is , to keep inflation low. By positing that central banks should aim at fostering demand, the author conveniently ignores the fact that nominal GDP growth comes at the expense of inflation, that by debasing the currency in order to reach a theoretical NGDP target, no real growth is achieved, only the appearance of it, since that growth is basically inflation. This has been well-known since roman emperors clipped their silver coins. A not so obvious harm that such a policy would cause is a further misallocation of resources in the economy. By artificially fostering some sectors of the economy that depend on cheap financing (finance, housing) thru monetary policy, the same misallocation that was an important cause of the 2008 crisis is being perpetuated.

Mr. Scott Summer states: “Inflation targeting failed in two ways. First, it was a poor indicator of the adequacy of aggregate demand. Second, it is susceptible to “liquidity traps”, a period of near zero interest rates where central banks’ favourite tool – interest rate targeting – is rendered ineffective”.

TYR states: Inflation targeting was never intended to be an indicator of aggregate demand, but a (bad) tool to control inflation, the main aim of the guardians of the currency, central banks. Liquidity traps, a Keynesian and non-scientific term, is not caused by inflation targeting, but by debt overhangs, resulting in crisis, like the one in 2008, originated in  previous monetary laxity, precisely what the author recommends as future policy.

Mr. Scott Summer states: “This problem occurs because when the economy is very weak, even a 2 per cent inflation target might not be high enough to generate the sort of bullish expectations needed to stimulate demand. There’s already plenty of money in the system – we need higher spending growth expectations to push that money into circulation.”

TYR states: The author ignores the reasons behind the weakness in the economy, too much debt and misallocation of resources in the economy with some sectors overrepresented, housing and finance.

Mr. Scott Summer states: “Mark Carney’s speech on December 11 in Toronto demonstrated the growing interest in replacing inflation targeting with nominal gross domestic product level targeting, even among central bankers. The central bank would set a growth path for nominal GDP of perhaps 4 per cent or 5 per cent per year, and commit to return to that trend line when spending falls short or overshoots. Nominal GDP targeting would moderate the business cycle by being more contractionary than inflation targeting during a boom and more expansionary during a recession. And NGDP could do this while still delivering roughly the same long-run rate of inflation.”

TYR states: It is a huge mistake to assume that there is a “natural” nominal GDP growth rate, where is the scientific proof for this assumption? For centuries, GDP growth was very low, until the First Industrial Revolution speeded it up. What does that have to do with monetary policy? GDP growth depends basically on population growth and productivity, and productivity depends on availability of resources, capital and technological innovation, none of which are by any means affected by monetary policy.

Mr. Scott Summer states: “And there are many other advantages. If investors had known in 2008 that any declines in NGDP would be quickly made up, then asset prices would have fallen much less sharply, and demand would also have been more stable. The current prices of stocks, commodities and property are strongly influenced by their expected prices several years out. The severe asset price decline of late 2008 reflected the belief that central banks would fail to take decisive action to restore NGDP to the trend line.”

TYR states: Do we have to conclude that the inflated asset prices of 2008 should have been allowed to remain inflated for the sake of mantaining an arbitrarily determined nominal GDP level? In what way is this different from a centrally planned, fascist-soviet economy? What role does the cleansing mechanishm of failure have under such an economic system? This is certainly not capitalism.

Mr. Scott Summer states: “Some fear that inflation will become unanchored if we move to NGDP targeting. In fact, most of the problems that people associate with inflation are more closely linked to high and unstable NGDP growth. Wages tend to follow growth in national income. As long as NGDP growth is low and stable, wages and core inflation will remain well anchored.”

TYR states: Wages do not necessarily follow growth in national income. This has not been the fact in the last 40 years where wages have reduced their share as a percentage of GDP from 53% to 44%. It is corporate profits that have benefited the most from the covert inflation we’ve had since the USA dollar was unlinked from gold in 1971. But even if the author was right in this assumption, assume for example that we have a NGDP growth rate of 5%, an inflation rate of 5% and a wage growth of 5%…do we have any real GDP or income growth at all? No.

Mr. Scott Summer states: “A stable path for NGDP growth will also produce better policy decisions in other areas. Fiscal spending will have to be justified on a cost-benefit basis, once it is no longer expected to boost nominal demand. The cost of bailing out failed companies will be more transparent, as it will be obvious that more jobs in the rescued company are offset by fewer jobs elsewhere. Those claiming that Chinese exports cost jobs will have to provide a mechanism other than “less demand”, and won’t be able to do so. And, most importantly, countries will be able to address the public debt problem, as they should, without fear that austerity will cost jobs.”

TYR states: Here the author assumes that failed companies will be bailed out (moral hazard and misallocation of resources again) and that there will be fiscal prudence just because some mumbo-jumbo cost benefit analysis will conclude that any further spending does not contribute to nominal GDP growth. Central planning, covert economic fascism again. Finally, the author seems to assume that by central banks financing government deficits “countries will be able to address the public debt problem, as they should, without fear that austerity will cost jobs.”. Does anybody believe that by making deficits immune to their collateral negative effects, increase in interest rates and the associated recession, government deficits will be tackled?

Make nominal spending the new target? We hope not.