I emailed Scott Sumner of Bentley University, the prime mover of the NGDP doctrine that has been embraced by Goldman Sachs. Scott was very cordial, and I enjoyed the brief exchange. But his ideas are pretty bold when you think about it. Before getting into his points emailed to me, here are some things that make the NGDP idea problematic for me:
1. The Fed would be an asset buyer if GDP slipped below the target. I remember watching the Beatles movie Yellow Submarine. Mr Nowhere Man had a large sucking tube on his face. He sucked everything up in the scene, then he sucked the scene itself into the tube, leaving himself and a blank screen. Then he sucked himself up leaving the blank screen. Bernanke would become Mr Nowhere man, if he isn’t already, and the sucking of assets into the black hole of the Fed could be massive. Scott would have the Fed buy paper, but I have heard of people wanting the Fed to buy residential real estate and who knows what.
2. The NGDP doctrine relies on targetting CPI futures contracts. The derivative bets would relate to the over under, like a football bet. If you are betting over, you believe that the Fed will overshoot the target, and if you bet under, you believe the Fed’s target for GDP will not be reached. Why you would want to bet on this ability of the Fed to meet it’s target is still unclear to me, but I thought we had enough derivatives. No?
With regard to Scott’s statements to me, which he did not indicate he wanted censored, I will try to share them with you. He is a bit cryptic, so there are brief answers and he ended up referring me to his blog. Anyway, here are some of the answers to my questions:
1. Scott believes there is no problem with $120 oil. I tried to pin him down on a magic number in which oil would tank the economy and he didn’t answer that. He expects that in a recovering economy, oil prices will go much higher. He says oil must go higher if the economy is to prosper.
2. Scott believes speculation makes prices more stable. He rejects traders who say a dollar 50 premium comes with churn of the oil markets.
3. Scott believes that the oil bubble of 2008 was not a bubble but was based upon increased demand. I have some trouble with that view. I don’t think he acknowledges momentum in trading.
4. Tight money caused the housing crash.I asked him for the cause of the tight money but he didn’t answer. I assume he thinks the Fed caused the housing crash.
5. He is opposed to out of control inflation. He was against the inflation of the 1970’s. While he says there was no inflation in the Roaring 20’s he didn’t seem to be concerned about the speculation taking place and betting by the banks, in the 1920’s.
6. When there is slack in the economy, NGDP rises faster than inflation.
Scott was very polite and a nice guy. I worry about the currency with his views, and I worry about Bernanke buying up everything under the sun to support markets. He no doubt does that now, but Scott Sumner would put that program on steroids.
The concept is complex, and I don’t pretend to understand all of it. But knowing that Scott is from the University of Chicago, where he obtained his Phd, we understand why he has huge faith in the Federal Reserve.
But I am convinced that the Fed caused the housing bubble and the crash. The crash was caused by higher interest rates and lax underwriting. Rates were raised to 6.5 per cent in 2006. I don’t fault the Fed for the crash. I fault the Fed for the bubble. But for Scott Sumner, the crash could have been avoided. I don’t know if he remembers massive defaults in 2006 as people were having trouble paying the teaser rates.
I think without a lot of further transparency from the Fed his views, if adopted, could be just result in more housing bubbles. People would have the expectation that nothing would ever crash, that no bubble would go unrewarded. At least, that is my take.