Sunday, October 7, 2012

Nominal GDP Targeting: An Introduction with Market Applications

A few weeks ago, I joined Michigan Interactive Investments, the premier finance club at the University of Michigan. Every week during our meetings, we have a market update during which we sound off our opinions on recent market events. And, as readers know, I take a great interest in monetary policy and have been very vocal about the positives behind the Federal Reserve's recent moves in terms of QE3 and conditional forward guidance.

However, I find that there's a disconnect between my understanding and perception of monetary policy and that of my fellow peers at MII. My suspicion is that it has something to deal with the differences between practitioners and academics, but I am still unsure of the specific difference. As a result, I prepared a presentation on this issue and wanted to share it with the rest of the blogosphere. I consider this different from Evan's excellent post on the layman's guide to NGDP targeting for two key reasons. First, this is targeted for those who are already financially literate -- ie they know what treasury bonds and other financial indicators are. Second, it's meant to be more visual to drive the point home in a presentation.

Considering I used quite a few graphs that have been inspired by debates I've encountered through blogging, I thought it would be apropos to present it here first. I hope it is useful for explaining nominal GDP targeting to a more technical financial crowd or undergraduate economics students. As always, comments are encouraged, and I'm happy to revise the presentation if I missed something.


  1. This is great, Yichuan. Thanks for the reference, and I thought this was a strong presentation just from the slides. I hope it was well-received, but of course, that depends on the audience...

  2. I'm presenting it this Thursday, so I'll be sure to let you know how it goes.

  3. Nice job Yichuan. I too look forward to hearing how your presentation goes.

  4. Hot potato can be tricky to explain to people who haven't heard of it before (most econ students, some professors). Better brush up on the relevant Nick Rowe posts. (Most people don't even think about "what's happening to the money in the economy" - they just think in a vague disconnected way about "demands" for things linking variables together, and voila! you have a transmission mechanism). Hard to convince the average macroeconomist that MV = PY is meaningful (even Scott doesn't like it...).

    I suggest: go back to circular flow of income - remind that money is a flow which goes opposite to goods (electricity analogy?) and that one flow can't exist without the other, basic yet ignored assumption. Monetary policy describes what controls that flow. Most people will be unfamiliar with this level of concreteness, build off of it.

    Also, as Scott discovered, no matter how intuitive the ideas it takes a while for a large audience to get a paradigm shift, especially one which works against existing biases. Don't expect any conversions from one presentation, just interest. Refer them to Scott's presentations on YouTube for more.

    Also, you might want to quote Mishkin, if you have that book, on how all asset prices transmit MP and therefore contain information about it.

    Your last line alarms me a little - I assume you're saying that further communications from Fed within recently announced paradigm will produce even bigger stock spikes than we just saw, but of course previous announcements all priced in now. We're assuming they do what Evan suggested and tighten their goal statement progressively from here on out.

    Looks like a good presentation though!

    1. Thanks Saturos. I quite like the electricity analogy considering I'll have some electrical engineers in the audience. I'll make sure to let y'all know how it goes!

    2. Specifically, I was thinking of a 2-way positive/negative current, with money being the negative flow, just as necessary to the current as the postive (goods) flow. But physicists are "Keynesian" and pretend it's all positive, when they measure amperes! That's like pretending that there isn't money in every market, the non-monetary Walrasian model we all switch to in economics right after teaching the circular flow!

      Also, you wrote the income identity wrong, it's C + I + G + NX. It'll look silly if you don't fix that.

    3. Any chance we could get video?

    4. Also, perhaps emphasize that QE3 is a long way from what you were actually recommending - vague, discretionary, real instead of nominal target, etc.

  5. Aaand Scott just linked to this. Success.

  6. I see that Saturos has done a lot of (useful) coaching!
    Good-luck with the presentation tomorrow and let us now how it went (if they hurled eggs at you, for example)

  7. The presentation went quite well today, but alas I could not get the video to work I recorded it, but I the recording software corrupted the file.

    I actually got quite a few compliments for the presentation -- no thrown tomatoes. So I'll keep on working to refine the presentation for future audiences.