Economist Magazine on Macroeconomic Alternatives

The Economist magazine has condescended to looking outside the economic mainstream box when it comes to economic policy, even to discussing Austrian economics. Unfortunately, this most realistic of all bodies of economic thought gets lumped together with some rather suspect theoretical frameworks. Much ink is given to so-called "modern monetary theory," the advocates of which advise the government merely print up as many dollars as it takes to cover our debt. That figure is now above $15 trillion (with a T)? That is, as they say, a recipe for rather bracing price inflation.

The writer devotes even more words to the new monetary fad on the block: nominal GDP (NGDP) targeting. NGDP targeting is being pushed by Bentley University professor Scott Sumner. His suggestion is for the Federal Reserve to adopt a new policy rule: instead of targeting a rate of growth in the money supply or prices or interest rates, the Fed should aim to maintain a certain level or rate of growth in NGDP.

As the Economist reports,

Central banks set targets to make their currencies credible and their policies predictable. The target for many is to keep consumer prices growing at 2% a year or thereabouts. For the past few decades that has largely succeeded in stabilising inflation; but in the current crisis it has singularly failed to stabilise the economy. In America NGDP plunged over 11% below its pre-crisis path and remains there; what people buy at the prices they pay for it is much less than most would want.

However, this begs the really important question. Why did NGDP plunge to begin with? Why does the Fed need to stabilize at all? If the secret to economic coordination is stable NGDP or a stable rate of growth in NGDP, why did things collapse in the first place

In order to properly consider such questions, it is imperative to have a good understanding of economic activity. All economic phenomena is the result of human beings applying scarce means to achieve theirs ends. The fundamental problem of scarcity cannot be eliminated by central bankers creating more monetary units. Those who advocate targeting some level of NGDP need to explain why society would be more prosperous if there are more monetary units.

In fact we know that increases in the money supply--even those thought necessary to achieve some target level of aggregate expenditure--do not provide a general social benefit. At best monetary inflation merely results in higher prices for the same amount of goods. Increasing the money supply via credit expansion, however, does redistribute wealth to those who receive the newly created money first and away from those we receive the new money later or not at all. Such artificial credit expansion also results in artificially low interest rates, leading unsustainable inflationary booms that necessarily must result in a recession. 

Additionally, what can the Economist be talking about when it says "what people buy at the prices they pay for it is much less than most would want?" This is only true from the perspective of the businessman. Consumers prefer to buy at lower prices. Ask those who shop at Wal-Mart. It also presupposes that markets do not equilibrate via price adjustments. This is an heroic assumption. Readers of this blog, for example, are well away that so-called "sticky wages" may not be that sticky after all.