Pages

Showing posts sorted by relevance for query dereliction of duty. Sort by date Show all posts
Showing posts sorted by relevance for query dereliction of duty. Sort by date Show all posts

Tuesday, April 23, 2013

The Ongoing Dereliction of Duty

Last year I made the case that the Fed's failure to keep nominal income growth expectations stable was a dereliction of duty:
[We] have long made the case that a nominal GDP (NGDP) level target would firmly anchor the expected growth path of nominal income.  Doing so, in turn, would stabilize current nominal spending since households and firms are forward looking in their decision making.  For example, holding wealth constant, households generally will put off purchasing a new car or renovating their homes if they expect their nominal incomes to fall and vice versa.  This is why Scott Sumner likes to say monetary policy works with long and variable leads. This understanding implies, therefore, that the reason for nominal spending remaining below is its pre-crisis trend is that the Fed has failed to restore expected nominal income to its pre-crisis path. This failure amounts to a passive tightening of  monetary policy.
Since then, the Fed has improved its management of expectations by introducing the conditional asset purchasing program of QE3. While this program is progress, it is still far from adequate. This can be easily seen by looking at data from a question on the University of Michigan/Thompson Reuters Survey of Consumers where households are asked how much their dollar (i.e. nominal) family incomes are expected to change over the next 12 months. The figure below shows the average response for this question up through March, 2013:


The fall of household dollar income expectations and its failure to fully recover is stunning. It suggests that the now lower expected future income growth is depressing current household spending, a point forcefully made by Mariacristina De Nardi, Eric French, and David Benson of the Chicago Fed. Digging into the data, they find that expected nominal income growth deteriorates across all age groups, educational levels, and income levels over the past few years. This is not some sectoral-specific development, it is a systemic nominal problem. They also find that the collapse in expected dollar income growth explains much of the decline in aggregate consumption since the crisis erupted.

But there is more. The figure also indicates that real debt burdens are higher than many households expected prior to the crisis. Look at the dashed line. It shows the average expected dollar income growth rate over the 'Great Moderation' period was 5.3%. Now imagine it is early-to-mid 2000s and you are taking out a 30-year mortgage and determining how much debt you handle. An important factor in this calculation is your expected income growth over the next 30 years. If you were average, then according to this data you would be forecasting about 5% growth rate. But that did not happened. Household dollar incomes declined and are expected to remain low. Nominal debt, however, has not adjusted as quickly leaving higher than expected real debt burdens for households.

This is something that the Fed could correct. QE3 is a step in the right direction, but more needs to be done with this program to raise expected nominal income growth. One way to do this is to make the size of the asset purchases conditional. That is, instead of conducting fixed $85 billion purchases every month until the economic targets are hit, vary the size of the purchases depending on the progress of the recovery. For example, if inflation and unemployment are not moving fast enough to their target, then increase the dollar size of the of asset purchase and vice versa. For if $85 billion is not enough for the nominal economy to gain traction, then it must be the case that money demand is rising enough to offset the benefits of the $85 billion injection. If this conditionality were added and widely understood, QE3 would better manage expectations and pack a larger punch. No more dereliction of duty.

Update I: Per Nick Rowe's request I have added the following two figures.  The first one shows expected household dollar income growth plotted along side NGDP growth over the past year. The former does seem lead the latter.  


The second figure shows the mean and the median expected household dollar income growth. Interestingly, the gap between the two series is relatively stable until the crisis, after which it narrows.


Update II: The first two figures above use a three quarter center moving average to smooth the series. The last figure--the one directly above showing the mean and median--shows the raw, unsmoothed series.

Thursday, May 17, 2012

A Dereliction of Duty

Market Monetarists have long made the case that a nominal GDP (NGDP) level target would firmly anchor the expected growth path of nominal income.  Doing so, in turn, would stabilize current nominal spending since households and firms are forward looking in their decision making.  For example, holding wealth constant, households generally will put off purchasing a new car or renovating their homes if they expect their nominal incomes to fall and vice versa.  This is why Scott Sumner likes to say monetary policy works with long and variable leads. This understanding implies, therefore, that the reason for nominal spending remaining below is its pre-crisis trend is that the Fed has failed to restore expected nominal income to its pre-crisis path. This failure amounts to a passive tightening of  monetary policy. 

In the past I provided some supporting evidence for this view using data from the Survey of Professional Forecasters.  Thanks to Evan Soltas, we now know of an another measure of expected nominal income growth that provides further evidence for the Market Monetarist view. The data comes from a question on the Thompson Reuters/University of Michigan Surveys of Consumer where households are asked how mcuh their nominal family income is expected to change over the next 12 months.  The figure below shows this measure up through October, 2011.  

Source: Thompson Reuters/University of Michigan

This figure shows that for most of the Great Moderation the Fed kept consumer nominal income expectations anchored around 5%.  That is a remarkable accomplishment.  But the figure also screams massive Fed failure.  It shows a decline in expected nominal income growth that gradually begins in late 2005 and sharply accelerates in 2008. This fall is unprecedented in the series.  What is even more troubling, though, is that expected nominal income growth has remained flat. The Fed has failed to restore expected nominal income growth back to normal levels. It should be no surprise, then, that households are deleveraging and holding an inordinate amount of liquidity in their portfolios.  

Source: Thompson Reuters/University of Michigan, New York Federal Reserve Bank

A recent study that makes use of this data has findings that reinforce the importance of stabilizing nominal income expectations.  Mariacristina De Nardi, Eric French, and David Benson of the Chicago Fed in paper titled "Consumption and the Great Recession" examine the importance of changes in expected nominal income and wealth for aggregate consumption. Among other things, they find that expected nominal income growth deteriorates across all age groups, educational levels, and income levels over the past few years.  This is not some sectoral-specific (i.e. structural) development.  They also find that the collapse in expected nominal income growth was an important determinant of the fall in aggregate consumption during the Great Recession.

This new data, the Chicago Fed study, and my previous post all indicate how important it is for the Fed to properly manage nominal income expectations.  By this criteria there has been a dereliction of duty by the Fed. It is time for the Fed to recognize its failures and adopt an approach that better anchors nominal income expectations.  It is time for the Fed to adopt a NGDP level target.

P.S. Maybe the Chicago Fed study had some influence in converting Chicago Fed President Charles Evans to a fan of NGDP level targeting. 

Friday, September 9, 2011

How to Make Central Banks More Accountable For Passive Tightening

Yesterday we learned that despite the ongoing spate of bad economic news in both the Eurozone and the United States, monetary authorities in both places have decided to do nothing new for now.  In the Eurozone, ECB president Jean acknowledged the Eurozone economy faces "particularly high uncertainty and intensified downside risks" yet chose, along with the rest of the ECB authorities, not to further loosen monetary policy.  Across the Atlantic, Fed Chairman Ben Benarnke gave a speech where he too acknowledged the economy was surprisingly weak. He then noted that the "Federal Reserve has a range of tools that could be used to provide additional monetary stimulus" that he and other Fed offiicials "will continue to consider... at our meeting in September..."  In short, both central banks have decided to sit on the sidelines for now despite the ability and need to do more.

There is a term for this. It is called a passive tightening of monetary policy. It occurs whenever a central bank passively allows total current dollar or nominal spending to fall, either through an endogenous drop in the money supply or through an unchecked decrease in velocity.  This failure to act when aggregate demand is falling has the same impact on the stance on monetary policy as does an overt tightening of monetary policy.  Bernanke has made this point himself recently as a justification for maintaining the size of the Fed's balance sheet.  The passive tightening of monetary policy is like a school crossing guard who could have but failed to stop a student from running into traffic.  Though the guard didn't cause the student to cross into traffic, he still bears responsibility for failing to save the student.

Now the damage done by a passive tightening is no different than that of an overt tightening. The only difference is that the public is more aware of the overt form.  Consequently, the ECB and the Fed are not questioned for the harm they cause by allowing such passive tightening of monetary policy.  Thus, most people observing the economic problems in Europe and the United States never connect the dots between these central bank's inaction and what they are witnessing.  This allows the central banks to be conservative, play it safe, and not be held accountable for their passive tightening.

There is a way to change this.  Introduce a market for nominal GDP futures contracts.  It if were a deep and liquid market, it would provide real time analysis on market expectations of future nominal spending. And since the market's forecast of future nominal spending affects current dollar spending, it would provide real time analysis on how a central bank is actively and passively shaping the current stance of monetary policy.  For example, if a nominal GDP futures market existed currently for the U.S. economy it would probably indicate a sharp tightening of monetary policy.  The public would then interpret this as a dereliction of duty by the Fed.  

Such a market would instantly asses the nominal spending impact of any speech, news, action, or inaction taken by the central bank.  The Fed would not have the luxury to sit on the sidelines.   Having the Fed's performance judged in real time would make it far more accountable. This is why Scott Sumner has been arguing for it for so many years.  And this is why we need it so badly today.

Friday, May 10, 2013

Balance Sheet Recessions Are Really Nominal Income Recessions

I recently lamented the Fed's ongoing dereliction of duty as seen in the sustained declined of households' expected nominal income growth:


In that post, I noted this observed decline was problematic for two reasons: (1) current nominal spending decisions are influenced by expected nominal income growth and (2) past nominal debt contracts were based on certain expectations of nominal income growth that did not happen. Here is what I specifically said on the latter point:
The figure also indicates that real debt burdens are higher than many households expected prior to the crisis. Look at the dashed line. It shows the average expected dollar income growth rate over the 'Great Moderation' period was 5.3%. Now imagine it is early-to-mid 2000s and you are taking out a 30-year mortgage and determining how much debt you handle. An important factor in this calculation is your expected income growth over the next 30 years. If you were average, then according to this data you would be forecasting about 5% growth rate. But that did not happened. Household dollar incomes declined and are expected to remain low. Nominal debt, however, has not adjusted as quickly leaving higher than expected real debt burdens for households. 
An important implication of this development is that households' deleveraging over the past few years may not be so much about their weakened balance sheets as it is about the unexpected decline in their expected nominal income growth. Josh Hendrickson and I are working on a paper where we develop this point more fully and, among other things, report the figure below. It plots expected household nominal income growth against the percent change of nominal household debt:


This figure suggests that for households, expected dollar income growth matters a lot for deleveraging. It also implies "balance sheet recessions" are a byproduct of nominal income shortfalls. One policy implication, then, is that the Fed should have maintained aggregate nominal income growth at its expected path. It failed to do so in 2008 and has yet to fully make up for this shortfall.

I bring this up, because a new paper by Kevin D. Sheedy (hat tip Simon Wren-Lewis) shows that NGDP level targeting dominates inflation targeting for this very reason. It is much better at stabilizing the real debt burdens of households precisely because it is much better at stabilizing the growth path of nominal income. Here is his abstract:
Financial markets are incomplete, thus for many agents borrowing is possible only by accepting a financial contract that specifies a fixed repayment. However, the future income that will repay this debt is uncertain, so risk can be inefficiently distributed. This paper argues that a monetary policy of nominal GDP targeting can improve the functioning of incomplete financial markets when incomplete contracts are written in terms of money. By insulating agents' nominal incomes from aggregate real shocks, this policy effectively completes the market by stabilizing the ratio of debt to income. The paper argues that the objective of nominal GDP should receive substantial weight even in an environment with other frictions that have been used to justify a policy of strict inflation targeting.
Fed officials should take note. So should ECB officials since this finding is particularly poignant for the Eurozone. It is time to fully embrace NGDP level targeting.

Friday, March 27, 2015

Are Wages Primed for Take Off?

Just a quick note on whether the Fed should raise interest rates later this year. One concern that many observers have with the Fed tightening is that nominal wage growth has yet to show any signs of accelerating. They often point to the employment cost index which only shows modest nominal income growth.

An alternative way to think about this issue is to look at the University of Michigan/Thompson Reuters Survey of Consumers where households are asked how much their dollar (i.e. nominal) family incomes are expected to change over the next 12 months. I have used this series in the past to talk about the stance of monetary  policy. This measure had averaged near 5 percent prior to the crisis, but then crashed and flat lined near 1.5 percent thereafter. The Fed, I argued, should have restored expected household dollar income to its 5 percent trend growth and its failure to do so was a dereliction of duty

How times have changed. Here is the same series updated to the present. Since late 2013 it has accelerated and is now almost back to 5 percent.


This suggests the economy is heating up and getting closer to full employment. If we plot this series against the employment cost index we get the following figure. Note the expected nominal income growth tends to lead the actual income growth. This suggest that wages are primed to start accelerating.


So  the wage growth concerns over the Fed tightening this year may soon become a moot point. This may one reason some folks like James Bullard are calling for a rate hike later in the year.