Author: Vincent Geloso

On celebrating the new year with a thought experiment

Vincent Geloso Economics, Liberty , , , , , , ,

Each time I start teaching classes at the business school where I am a course lecturer, I am always amazed at the disconnect between the quantitative facts and the beliefs that individuals have. My favorite relates to poverty and inequality.

Everybody seems to think that poverty is increasing and that worldwide inequality is increasing. Each time, I have to show figures to shoot down those beliefs. I also do it in the french media of my home province of Quebec where – as a result of pointing out those facts – I am branded as a “neoliberal” for being optimistic for the fate of mankind.

However, let’s think about it in the context of the new year to see why there is room for optimism. Let’s make a thought experiment similar to John Rawls’ original position but somewhat differently. You have a hat with all the years since the neolithic age, each on a separate piece of paper. If you had to hope for one year in particular, which would prefer? I would pick 2016!

By picking 2016, I have one chance in ten of living under extreme poverty. At any earlier point in time, these odds would have been close to 90%. (The data comes from the Our World In Data project by the amazing Max Roser).

World-Poverty-Since-1820-full

Although this diminished poverty does not explain every improvement with regards to every other metrics of living standards (life expectancy, infant mortality, nutrition, heights, body mass, survival to diseases), it does explain an appreciable part of these improvements.

Sit down with some friends to celebrate the new year and ask them about this “thought experiment”. Ask them if they would pick 2016. Once it is presented as such, I am sure that in spite of all the headwinds facing mankind, they will be optimistic.

NGDP, NGO and total expenditures

Vincent Geloso Economics, Liberty , , , , , , , , , , , ,

I did not think that my post on NGO versus NGDP would gather attention, but it did (so, I am happy). Nick Rowe of Carleton University and the (always relevant) blog Worthwhile Canadian Initiative responded to my post with the following post (I was very happy to see a comment by Matt Rognlie in there).

Like Mr. Rowe, I prefer to speak about trade cycles as well. I do not know how the shift from “transactions” to “output” occurred, but I do know that as semantic as some may see it, it is crucial. While a transaction is about selling a unit of output, the way we measure output does not mean that we focus on all transactions.  I became aware of this when reading Leland Yeager (just after reading about the adventures on Lucas’ Islands). However, Nick (if I may use first names) expresses this a thousand times better than I did in my initial post. When there is a shift of the demand for money, this will affect all transactions, not only those on final goods. Thus, my first point: gross domestic product is not necessarily the best for monetary transaction.

In fact, as an economist who decided to spend his life doing economic history, I do not like gross domestic product for measuring living standards as well (I’ll do a post on this when I get my ideas on secular stagnation better organized). Its just the “least terrible tool”. However, is it the “least terrible” for monetary policy guidance?

My answer is “no” and thus my proposition to shift to gross output or a measure of “total spending”. Now, for the purposes of discussion, let’s see what the “ideal” statistic for “total spending” would be. To illustrate this, let’s take the case of a change in the supply of money (I would prefer using a case with the demand for money, but for blogging purposes, its easier to go with supply)

Now unless there is a helicopter drop*, changes in the money supply generate changes in relative prices and thus the pattern (and level) of production changes too. Where this occurs depends on the entry point of the increased stock of money. The entry point could be in sectors producing intermediary goods or it could closer to the final point of sale. The closer it is to the point of sale, the better NGDP becomes as a measure of total spending. The further it is, the more NGDP wavers in its efficiency at any given time. This is because, in the long-run, NGDP should follow the same trend at any measure of total spending but it would not do so in the very short-run. If monetary policy (or sometimes regulatory changes affecting bank behavior “cough Dodd-Frank cough”) causes an increase in the production of intermediary goods, the movements the perfect measure of total spending would be temporarily divorced from the movements of NGDP. As a result, we need something that captures all transaction. And in a way, we do have such a statistic: input-output tables. Developed by the vastly underrated (and still misunderstood in my opinion) Wassily Leontief, input-output tables are the basis of any measurement of national income you will see out there. Basically, they are matrixes of all “trades” (inputs and outputs) between industries. What this means is that input-output tables are tables of all transactions. That would be the ideal measure of total spending.  Sadly, these tables are not produced regularly (in Canada, I believe there are produced every five years). Their utility would be amazing: not only would we capture all spending (which is the goal of a NGDP target), but we could capture the transmission mechanism of monetary policy and see how certain monetary decisions could be affecting relative prices.** If input-output tables could be produced on a quarterly-basis, it would be the amazing (but mind-bogglingly complex for statistical agencies).

The closest thing, at present, to this ideal measure is gross output. It is the only quarterly statistic of gross output (one way to calculate total spending) that exists out there. The closest things are annual datasets. Yet, even gross output is incomplete as a measure of total spending. It does not include wholesale distributors (well, only a part of their activities through value-added). This post from the Cobden Centre in England details an example of this. Mark Skousen in the Journal of Private Enterprise published a piece detailing other statistics that could serve as proxies for “total spending”. One of those is Gross Domestic Expenditures and it is the closest thing to the ideal we would get. Basically, he adds wholesale and retail sales together.  He also looks at business receipts from the IRS to see if it conforms (the intuition being that all sales should imitate receipts claimed by businesses). His measure of domestic expenditure is somewhat incomplete for my eyes and further research would be needed. But there is something to be said for Skousen’s point: total nominal spending did drop massively during the recession (see the fall of wholesale, gross output and retail) while NGDP barely moved while, before the recession, total nominal spending did increase much faster than NGDP.

NGONGDP1

In all cases, I think that it is fair to divide my claim into three parts: a) business cycles are about the deviation from trends in total volume of trades/transactions, thus the core variable of interest is nominal expenditures b) NGDP is not a measure of total nominal spending whose targeting the market monetarist crowd aims to follow; c) since we care about total nominal spending, what we should have is an IO table … every month and d) the imperfect statistics for total spending show that the case made that central banks fueled spending above trend and then failed to compensate in 2008-2009 seems plausible.

Overall, I think that the case for A, B and C are strong, but D is weak…

* I dislike the helicopter drop analogy. Money is never introduced in an equal fashion leading to a uniform price increase. It is always introduced through a certain number of entry points which distort relative prices and then the pattern of trade (which is why there is a positive short-term relation between real output and money supply). The helicopter drop analogy is only useful for explaining the nominal/real dichotomy for introductory macro classes.
** Funny observation here: if I am correct, this means that Hayek’s comments about the structure of production would have been answered by using Leontief’s input-output table. Indeed, the Austrians and Neoclassicals of the RBC school after them have long held that monetary policy’s real effects are seen through changes in the structure of production (in the Austrian jargon) or by inciting more long-term projects to be undertaken creating the “time to build” problem (in the RBC jargon). Regardless of which one you end up believing (I confess to a mixed bag of RBC/Austrian views with a slight penchant to walk towards Rochester), both can be answered by using input-output tables. The irony is that Hayek actually debated “planning” in the 1970s and castigated Leontief for his planning views. Although I am partial (totally) to Hayek’s view on planning, it is funny that the best tool (in my opinion) in support of Hayek is produced by an intellectual adversary

Don’t target NGDP, target NGO!

Vincent Geloso Liberty

Before I start blogging at Notes on Liberty, I just want to say how happy I am to join this collaborative venture. I generally blog in French at the Journal de Montréal and my English writings are confined to my academic papers. Hence, I am very happy to communicate with English audiences.

Actually, this is an opportunity to write about NGDP targeting. In the anglosphere, this rule-based approach to monetary policy has been very popular. In the french world where I evolve, it is close to a fringe point of view (given a strong Old Keynesian/New Keynesian viewpoint). As a result, any effort to expand on the issue requires that the issue first be raised. Hence, I have avoided discussing monetary policy in my French writings. But there is a point that needs to be made about NGDP targeting as advanced by people like Scott Sumner, George Selgin, the late Bill Niskanen, Marcus Nunes, Benjamin Cole, David Beckworth, Lars Christensen and David Glasner : the idea of targeting nominal spending (me switching from the term NGDP to “nominal spending” is important) does not mean that we ought to target nominal gross domestic product.

The intuition behind NGDP target is that monetary policy should be aimed at reacting to changes in demand for money. Thinking of the equation of exchange (MV=PY), a change in V should be matched by an opposite change in M so that MV remains stable. Any increases in Y(output)should be met by reductions in P(rices) and no changes in MV. In practice, NGDP targeting is about avoiding deviations from long-term trends in NGDP. However, while the equation is often presented as MV=PY, the original papers by Irving Fisher and others present it as MV=PT where Y (output) is substituted by T (transactions).

But is PT the same as NGDP? At any point in time, total spending in the economy is much greater than the sum of final goods. There are intermediate goods which are being produced – intangible capital, capital inputs and producers goods.  NGDP avoids calculating these because it would lead to double-counting. Work by Austrian-friendly scholars like Mark Skousen proposes that the double-counting is actually a strength in certain cases. This is because the double-counting gives greater weight to production.  Skousen calls it “Gross Output”(GO) and he finds that GDP is generally a fraction of GO (at 53% in 1982).

Now, GDP is best for measuring welfare in the long-run. However, for short-run discussion, nominal GDP is not (at all) the sum of nominal spending. Imagine an easy monetary policy which incites firms to produce more, there might be a lag between the increased production and “arrival on shelves” for consumers to buy.  This occurs as firms acquire new producer goods and/or gear themselves to producing goods for other producers. This means that in the short-run, the ratio of NGO to NGDP (nominal Gross Output) could vary. Easy monetary policy could make NGO grow faster than NGDP.

In a way, I am saying that NGDP is Y while the equation of exchange should be about all transactions (T in the original Irving Fisher papers) and transactions is best represented by NGO. As a result, NGO is a better proxy for trends of nominal spending. Let’s make a first test of this (and I hope this gets the ball rolling) by looking at the data.

The NGDP crowd claims that prior to 2008, monetary policy was easy, allowing NGDP to grow above trend. Tight monetary policy during 2008-2009 led to a significant drop below trend which was the cause of the recession. With NGO (gross domestic output for all industries as presented by St-Louis Fed), we see the same story but much more clearly!

NGONGDP

From 2005 (when the data start for NGO) to 2008, NGO grows much more rapidly that NGDP (the ratio actually increases to 2008) and then it falls dramatically in 2008-2009 and barely recovers to remain stable thereafter. However, the drop from 2008-2009 is much more pronounced than that for NGDP. This suggests that “overall” nominal spending did fall more than NGDP suggests.

If monetary policy should shift to targeting nominal spending, NGDP is not the best indicator – NGO is.