Friday, June 14, 2013

One Is The Loneliest Number - Why a Single Rule Matters

First, this is not a normal "rule" in the usual sense of the word! Here's one way to think about a nominal targeting rule for central banks, as opposed to the kinds of inflation or interest rate targeting rules that simply try to put a cap on activities which may be running amok until that point. The nominal targeting rule says that you don't have to do X and Y or perhaps F and G for optimal monetary policy. It says instead that we have an anchor in which any activity between A and Z might readily happen, and then it simply shows how those things can happen in relation to one another that clarifies the equilibrium they use - or that they may elect not to use. Wait, what? Isn't a rule that lets anything happen between A and Z the same thing as running amok? Not quite. It depends on how much the mirror effect of consumption equilibriums gets utilized, to actually show the relationships between the various economic activities.

What, then, about the fact that a cap on output still exists? Isn't that "central bank control"? Not unless one thinks measuring our actual capacity to produce and consume is control, as some Austrians might suggest. This is why it is important to specify what anchor gets utilized, as the most stable economic element a nation has. If we designate a specific natural resource or balance sheet set as good anchors to follow, then the activities people take on may arbitrarily be restricted to whatever trajectories are suggested by them. Sometimes people may not have a lot of choice in that regard, especially if a nation's economic activity is not diverse to a point where it can readily move away from commodity or finance definitions (which is also when fiscal policies may have more "oomph" so to speak) and towards the path of diversified human capacity. Along the same lines, when a nation is not fully mature in a diversified sense, fiscal activity can be thought of as a way to bring a nation to economic maturity, until nominal monetary policy gains the opportunity to fully function for a nation's economic outlook.

Why, then, has it been so difficult to integrate this "human capacity as anchor" idea into the thought processes of others besides Market Monetarists? Cardiff Garcia has a good take on the dialogue between those economic factions which see aggregate demand as vital for moving ahead, in which he suggests, why can't these groups simply combine their ideas to better effect, instead of insisting on one or the other? Scott Sumner, in responding to Garcia's post, simply reiterated the position that it matters in terms of framing, for how people actually come to think of the economy in the years ahead. With such a basic understanding of economic capacity, people would know when central banks stray off course or become less than transparent. One is The Loneliest Number, because it provides the most suitable framework for how central banks respond to the potential of economic activity at the most basic level.

One reason such framing matters now is the fact that - by the improving overall numbers - it's becoming easier once again to be lulled into complacency, and arguments can readily be made on semantics. For instance, Paul Ormerod recently explained to students in a Tutor2U video that Paul Krugman is a "recovery denier" - an assertion that would likely make sense to some, but would only cause confusion for others. The problem for Krugman in this regard is that he is relying on how the lack of recovery "feels", when a rule of nominal targeting would actually give him a way to express what he feels to be true. What's more, the signals of interest rate targeting already imply a return to normalcy, especially as the housing market improves. As Marcus Nunes notes, regarding Ormerod's assertion: "Just because output is above the previous peak 'does not a recovery make'. You're still far below where you should be!"

In an immediate or statistical sense, perhaps the differences between nominal targeting and interest rate targeting aren't so obvious, especially in that they mostly diverge when too much future potential income has been diverted to present day contractual realities. However, the long run is also about the reclamation of our ability to stop excessive diversion from happening in the first place, either from the supply side or the demand side. It's easy to get distracted by what has happened to consumption potential, through the definitions of both business cycle and balance sheet theorists. However, both the business cycle and the balance sheet - in the effort to maintain control of supply and demand definitions, will still run with our consumption potential when they get the chance. The single rule of nominal targeting gives individuals the chance to reassert their own primary role in the process itself. That really matters for economic stability in the long run.

P.S. After putting this post together, I realized that I still didn't address the monetary and fiscal issues in the sense that Cardiff Garcia posed them, and I need some more time to mull that over! In a sense that aspect is more complicated, because fiscal and monetary activities just are not as separate from one another as they may seem.

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