The private sector can manufacture its own nominal gdp

by on September 26, 2012 at 7:37 am in Economics | Permalink

Loyal MR readers will know I’ve long had sympathy with ideas such as ngdp targeting, even though I think they require more rule-oriented behavior than our political system is able to supply.  It’s still worth pushing in that direction.

There is however one tendency in some of the writings on ngdp which I would frame differently, so I will lay this out in a little more detail. I”m not sure anyone has written anything which I consider literally wrong, but I get nervous at what seem — to me — to be the implications.

Here is one example from Bill Woolsey:

The typical Market Monetarist perspective is that nominal GDP has shifted to a 14 percent lower growth path.    For real output and employment to remain on its previous growth path, the price level and nominal wages need to also shift to 14 percent lower growth paths.   They haven’t.   Instead, they are only about 2 percent lower.

My worry is that some Market Monetarists speak of ngdp as if it is some block of stuff, handed down from on high (of course in the past our central banks have not been targeting ngdp).  It’s as if ngdp determines the size of the room, and a carpenter is then asked to build a house within that room.  If the room is too small, a large house cannot be built.  Or, if you are not given enough clay, you cannot build a very large sculpture.  Along these lines, if the growth path of ngdp is not robust enough, the economy cannot do well.

I get nervous at how ngdp lumps together real and nominal in one variable, and I get nervous at how the passive voice is applied to ngdp.

My framing is different.  My framing is that the private sector can manufacture its own ngdp.  It can do so by trade and it can do so by credit and of course velocity is endogenous to the available gains from trade.  Most of the major central banks are, today, not obsessed with snuffing out recovery and increases in real output.

To say “ngdp is low,” or “ngdp is on a low growth path,” or “ngdp is below trend,” and so on — be very careful!  Those claims do not necessarily have causal force.  Arguably they are simply repeating, in a new and somewhat different language, the point that the private sector has not seen fit to engage in more trade, credit creation, velocity acceleration, and so on.  Formally speaking, the claims are not wrong, but I don’t find them useful as an explanation for why economic growth or recovery, at some point in time, is slow.  It is one way of repeating or re-expressing the slowness of economic growth, albeit with some transforms applied to the vocabulary of variables.

This matters when we consider sticky nominal wages.  Sometimes it is suggested that the “inside workers” have frozen up or taken up so much ngdp with their sticky wage demands that the outsiders cannot find the ngdp to fuel their activities.  It’s as if there is not enough ngdp to go around, just as there was not enough clay to make a sufficiently large sculpture.  I would like to see this modeled (I will report back on any credible citation you offer me), but note in the meantime it is not how the most popular or most influential sticky wage models work.  Once you see the private sector as being able to manufacture its own ngdp, this argument does not seem to have enough force to prevent the outside laborers from exploiting available gains from trade.

The outside laborers are sometimes locked out, but that is when businesses simply do not wish to expand output.  Once businesses are wishing to expand output, the sticky wages of the insiders should not prove an insuperable obstacle to hiring the outsiders at lower wages.  The private sector can support this by manufacturing its own ngdp and if demand is low, well, the wages for the new workers will be lower too, as indeed is the case at Caterpillar and many other companies.

I also see that we have undergone some reflation — current ngdp is about ten percent above the pre-crash peak — so there ought to be enough clay, even if we accept that metaphor.  And the number of laborers in the work force is down.  Here are some related comments from Scott Sumner.

I do believe in the nominal stickiness of many wages, but only in the short run and only for some classes of workers.  Especially when the quality of jobs can and does change so readily, I don’t see the nominal stickiness of wages as lasting for more than a few years, at the most, at least not for the United States.  For legal and regulatory reasons, Western Europe is often a different story.

In any case, these are my worries about some of the current framings of ngdp.

1 Rahul September 26, 2012 at 8:22 am

That’s like worrying about an accurate depiction of unicorns in paintings…..

2 derek September 26, 2012 at 11:05 am

When unicorns is all you got, you want to get the depiction accurate.

3 Michael Heller September 26, 2012 at 8:35 am

“My framing is that the private sector can manufacture its own ngdp.”

Is it along the lines of privatising monetary stimulus? I like to think any additional rule-oriented behaviour on the part of the political system — which restores political as opposed to economic predictability, but at the same time frees labour markets — is a natural decentralising stimulus to privatized monetary stimulus by releasing the disaggregated but dammed-up pools of private money to flow into trade and credit. I can’t imagine how any political scientist or political economist could ever accept Scott Sumner’s faith in centrally synchronised flushing devices, even if in Sumner’s words, “NGDP is the hottest idea in macroeconomics”.

4 Doc Merlin September 26, 2012 at 8:38 am

“This matters when we consider sticky nominal wages.”

Its been 4 years and you are still talking about sticky wages? Shouldn’t that be evidence enough that this was a supply side effect?

5 Claudia September 26, 2012 at 4:22 pm

Doc, you do realize this is not an “either-or” case. Showing that wages/prices have largely adjusted does NOT prove that any shortfall is structural/supply side. Prices/wages are key drivers of demand but NOT the only ones.

6 allen September 26, 2012 at 8:39 am

Oh, has economics evolved to the point that the old joke about laying all the world’s economists end to end is no longer the literal truth?

7 Bill September 26, 2012 at 8:48 am

So, you support CEO compensation dropping 14 percent. If you look at total compensation the low hanging fruit is the top 1%.

8 Cliff September 26, 2012 at 10:09 am

I’m sure he wouldn’t have any objection to it, but that would have no impact on the labor market

9 Jared September 26, 2012 at 10:31 am

Exactly. The companies with expensive CEO’s are the ones sitting on cash with no idea how to spend it in the face of weak demand.

10 The Original D September 26, 2012 at 5:09 pm

Profitable companies and CEOs of banks. Always banks.

11 Bill September 26, 2012 at 12:43 pm

Cliff, Ask yourself this question: what is the implicit argument that lowering labor cost will do. Give up. The argument is that lower factor costs will lower product prices, thereby increasing demand. Management wages are factor costs, aren’t they, so if you believe this argument that during a period of low aggregate demand that factor inputs are too high, you should be arguing for smaller management payouts.

Of course if there is no demand for output….

12 Jared September 26, 2012 at 1:13 pm

Lowering supply costs is a demand side phenomenon?

13 Bill September 26, 2012 at 4:01 pm

Jared, Ask Tyler.

14 Brian Donohue September 26, 2012 at 1:00 pm

Relevant link:


“He starts off by questioning the idea that CEO pay always goes up. Granted, it shot up between 1993 and 2000. But since then it has fallen. Average estimated pay for the bosses of S&P 500 companies has declined by 46% since 2000. Median CEO pay has declined since 2001, though only slightly. In 2010 CEOs were paid about as much in real terms as they were in 1998.”

15 Alex Godofsky September 26, 2012 at 9:05 am

The private sector can’t manufacture its own NGDP if the Fed is going to choke off inflation over 2% and the requisite NGDP growth would require inflation temporarily larger than 2%.

16 msgkings September 26, 2012 at 11:25 am

Didn’t the Fed just say they aren’t going to do that, for the foreseeable future?

17 RPLong September 26, 2012 at 9:23 am

I get nervous at how ngdp lumps together real and nominal in one variable, and I get nervous at how the passive voice is applied to ngdp.

I don’t know how many times I’ve asked the question at TheMoneyIllusion and elsewhere: How much of what I spend is real and how much of it is nominal?

The problem with this NGDP obsession is that it is a closed, self-referential logical loop. It is circular reasoning applied to a topic so complex that either its proponents don’t understand that they’re engaged in circular reasoning or they know it full well and are deliberately employing that strategy as a way to win converts among the laymen.

18 Andrew' September 26, 2012 at 10:34 am

I’m a sucker for any story of why The Fed gets everything wrong, but I can’t tell if it’s a “Who’s on first?” routine.

“Due to a drop in NGDP, NGDP expectations dropped which made NGDP drop requiring us to raise NGDP by increasing NGDP expectations, and only then can we restore NGDP, otherwise expectations of NGDP will remain low until NGDP expectations rebound.”

19 Brian Donohue September 26, 2012 at 10:51 am

“The nickel today is not what it was fifteen years ago. Do you know what this country needs today?…A seven-cent nickel. Yessiree, we’ve been using the five-cent nickel in this country since 1492. Now that’s pretty near a hundred years’ daylight saving. Now, why not give the seven-cent nickel a chance? If that works out, next year we could have an eight-cent nickel. Think what that would mean. You could go to a newsstand, buy a three-cent newspaper and get the same nickel back again. One nickel carefully used would last a family a lifetime!”

20 DW September 26, 2012 at 9:44 am

So we’re taking off our market monetarist hats as the crisis draws to a close (and as the movement picks up steam!).

Look to Europe and Tyler’s previous post and his comments in this post carry much less force.

Horses for courses.

21 Pat September 26, 2012 at 10:19 am

This post is my favorite that you’ve ever written. I’ve razzed you a few times for requiring readers to read your mind but this post is so clear to me. Thank you.

22 Brian Donohue September 26, 2012 at 10:52 am

Very thoughtfully written. Tyler, you are a credit to your profession.

23 jadraki September 26, 2012 at 11:29 am


24 Jared September 26, 2012 at 10:59 am

“I do believe in the nominal stickiness of many wages, but only in the short run and only for some classes of workers. Especially when the quality of jobs can and does change so readily, I don’t see the nominal stickiness of wages as lasting for more than a few years, at the most, at least not for the United States. For legal and regulatory reasons, Western Europe is often a different story.”

The graph provided by Sumner in the post linked to would seem to directly contradict that.

“Formally speaking, the claims are not wrong, but I don’t find them useful as an explanation for why economic growth or recovery, at some point in time, is slow. It is one way of repeating or re-expressing the slowness of economic growth, albeit with some transforms applied to the vocabulary of variables.”

The use of NGDP boils down to making a target for the fed that corrects for supply side shocks. That inflation has run so much under target and had zero catch up is the market monetarist explanation for slow recovery

25 Brian Donohue September 26, 2012 at 11:11 am

Not convinced. Scott says:

“It is POSSIBLE that faster NGDP growth would merely lead to higher wages, and no gain in jobs, but how likely does that seem in this sort of labor market?”

To me, this is exactly what Scott’s graph is showing. Or perhaps “sticky wage” theory has broadened to “sticky wage growth” theory.

26 Claudia September 26, 2012 at 1:26 pm

“Formally speaking, the claims are not wrong, but I don’t find them useful as an explanation for why economic growth or recovery, at some point in time, is slow.”

That’s it. I want to know *why.* We live in a dynamic, complex economy, there’s a lot going on in NGDP … and the details can be important. To push the clay metaphor…if we see low pottery revenue what’s the problem? Is there a shortage of clay, did all the pottery wheels break, is the going wage too low for potters, is the price too high, or does no one want to buy a new set of dishes? Seems like useful information to know which is the main source of the shortfall. I am all for diagnostic tools, but a sufficient statistic of the economy seems like a tall order in the real world to me.

27 Philo September 26, 2012 at 2:02 pm

You seem to ignore expectations. Maybe, as you say, “’ngdp is low’, or ‘ngdp is on a low growth path’, or ‘ngdp is below trend’, and so on” have no causal force; but ‘*expected* ngdp is low’, and the like, *do* have causal force.

28 Martin September 26, 2012 at 3:02 pm


what do you mean by causal force? Isn’t in equilibrium everything co-determined?

In a money economy, it seems, nominal income is separate from production; in a barter economy when production is too low, income is too low, but in a money economy it can also go the other way, when income is too low, production is too low. How else could RGDP collapse when NGDP collapses? And if NGDP is persistently “too low” how are producers supposed to know that it could be higher?

As I see it, it’s as if you’re on an intersection where no one can see the street and all the lights are red. You can flip one of the lights to green so that at least some people can cross the street, flip too many lights to green or a wrong combination and you can get accidents. Whether or not you should flip the lights to green depends on the expected cost of the accidents and how valuable it is for people to cross the street.

29 Luis Pedro Coelho September 26, 2012 at 3:59 pm

It would be better for the private sector if it created more NGDP, but since the private sector is not an actor, but a multitude, it can not coordinate to create more NGDP. I think that the causality model is as follows:

[something bad] -> lower RGDP -> lower NGDP -> unemployment -> even lower RGDP

as opposed to

[something bad] -> lower RGDP -> more inflation

30 dirk September 26, 2012 at 5:52 pm

I can’t make any sense of this post. I thought much of NGDP was obviously manufactured by the private sector (and the rest by government spending), and that the role of the Fed was not to manufacture NGDP but to increase the velocity of money by making it less desirable to hold, leading to the private sector manufacturing more NGDP.

Sumner has frequently used the metaphor of the Fed “steering the ship”. The Fed can nudge the economy in one direction or the other by making it marginally more desirable to hold dollars or marginally more desirable to trade dollars for goods or services. This talk of the private sector manufacturing NGDP…. I don’t follow what it has to do with the discussion, since it seems so obvious as to be irrelevant.

31 Richard September 26, 2012 at 10:03 pm

Perhaps I’m missing the point here but isn’t NGDP targetting during times when RGDP is stagnant/falling the same thing as letting inflation rip to try to stimulate demand?

I’m not sure whether you know about the economies of the US and especially the UK in the 1970s & 80s but my memory is of inflation getting out of control due to some misguided belief that there was a trade-off between inflation and unemployment. The ‘stagflation’ caused in part by high inflation the UK in particular was destructive and painful to cure.

32 dirk September 27, 2012 at 12:49 pm

The trade-off between inflation and unemployment supposedly exists when there is a demand shock (like in 2008) not a supply shock (like in the 70’s).

Keep in mind that successfully targeting NGDP at 5% growth a year could only give you a maximum of around 5% inflation. If such a policy doesn’t result in average annual inflation of around 2-3%, then the policy will have failed to live up to its brochure.

33 Gastón September 27, 2012 at 1:15 am

“I get nervous at how ngdp lumps together real and nominal in one variable, and I get nervous at how the passive voice is applied to ngdp.”

Passive voice? The only sentence in your post that applies the passive voice to ngdp is the one quoted above …
Not only that, but you don’t explain why applying the passive voice to ngdp should make anyone nervous.

Just in case you have misunderstood what the passive voice is, here is an example:

Tyler Cowen was made nervous by Bill Woolsey’s remarks about NGDP.

34 Peter N September 27, 2012 at 4:43 am

One thing that makes this debate so confusing is collective and sometimes even individual equivocation on the word “money”. It can mean credit, securitized credit, one of the aggregates in the M1-M4 family (conventional or Divisia),currency + bank deposits, NGDP in costume or “I know it when I see it” (and let’s not forget velocity).

These different monies have very different properties, and confounding them guarantees the impossibility of reaching any conclusion. For instance:

There has been a huge drop in the ratings of around $5 trillion of collateral. This makes it impractical as low risk-low information collateral for repos and similar transactions. This should decrease the velocity of more powerful forms of money (money with greater liquidity and higher opportunity cost) by reducing the amount of exchanges of cash for collateral and forcing parties to use powerful money in places where they formerly would have used collateral (increasing the “demand for money”). So this type of money/credit is very tight and not easily controlled by actions of the Fed.

If you look at the various Divisia aggregates, it’s clear that they don’t follow the same path and that as you increase in broadness from M1-M4 the Fed’s control is some combination of weaker, more indirect and harder to discern.

If you believe NGDP growth determines tight money and other measures are inadequate, then money means “whatever it is that NGDP measures other than the ordinary NIPA meaning”. It seems to be a kind of dark matter that can’t be directly observed, but explains the behavior of the financial universe. Now if you said low NGDP growth indicates businesses are suffering this from a lack of available credit, then there should be ways of confirming this.

Then there is the role of high-powered money. Financial innovations like sweep accounts have undermined the 1950s era structure that introductory textbooks describe. If NGDP rates track tight money, and the Fed controls the supply of money by controlling the quantity of “high powered money”, then this should control the movement of NGDP, but it doesn’t. And at the zero rate bound the distinction breaks down, anyway.

It would help greatly if people writing about money would bother to explain what they meant by it.

35 Vuk September 27, 2012 at 6:12 am

“…current ngdp is about ten percent above the pre-crash peak…”

One problem of looking at NGDP targeting from an output gap perspective, particularly when the base year for comparison of actual and potential output is 2007, the year of the boom peak, is the distortion it offers. This creates a picture that the economy is way worse now than it really is, or in other words that the drop in nominal GDP was much worse than it really was.

However, whatever we take as the base year, there was a significant drop in nominal GDP, caused by the spilover effect of the housing bubble to the real economy. The mechanism was made primarily through the financial sector which reacted in tightening credit causing the real economy to run out of loans. Eventually this induced the real economy (businesses) to cut down current expenses like labor costs. A restructuring of the labor market that hasn’t been done before has been done now, in bad times. This was particularly the case in Europe.

I absolutley agree with your following statement:
“My framing is that the private sector can manufacture its own ngdp. It can do so by trade and it can do so by credit and of course velocity is endogenous to the available gains from trade. Most of the major central banks are, today, not obsessed with snuffing out recovery and increases in real output.”

I’m not saying the Fed should have been more responsive, but conducting a structural reform will always be extremely hard, no matter how supportive monetary policy is.

In fact, all the historical cases that succeeded in reforming its system and have managed to shift to a new paradigm of growth, have done it the hard way. Monetary policy wasn’t significant, free market reforms did the trick. The emphasis I had on the blog was on several examples like Sweden in 1992, Germany in 2003, or Latvia and Estonia during the current recession.

36 Brian Donohue September 27, 2012 at 12:36 pm


Like your link too.

One thing: you said: “The biggest problem I have with this approach is that it assumes that the crisis was just another aggregate demand shock which can be resolved by short-run stimuli. This perhaps was the case with the 2001 recession (which was initiated by a series of shocks like the 9/11 attacks, dot-com boom, and corporate scandals like Enron),”

9/11, and associated spending, was the springboard for extending a 40-year party for another 7 years. Prior to 9/11, it was looking like a rough recession, kinda like the recent recession and plodding recovery, without so big a slab of residential real estate mania layered on top.

37 Ron Ronson September 27, 2012 at 1:30 pm

– Falling AD means that firms face lower sales
– They can either reduce prices to increase sales again or reduce production
– Sticky wages mean that they choose lower output and layoff some workers, which further reduces AD
– In a healthy economy new businesses would see an opportunity to take market share by hiring these unemployed workers at lower wages and selling at lower prices. This would further affect established business ability to sell and cause either further layoffs or force them to address the sticky wages issue
– In an unhealthy economy however low current AD and uncertainty about future AD causes new business not to start-up but to wait and see.
– Your in a recession where the private sector is not able to manufacture its own NGDP or at least not until confidence about the future returns.

38 George Selgin September 27, 2012 at 1:32 pm

I hope Tyler will forgive me for re-posting here, with minor changes, my reaction to his post as reported at MoneyIllusion.


For the life of me…I cannot see any justification for Tyler’s assertion [that the private sector could manufacture more NGDP growth by acting in such a way as to boost velocity]. What grounds are there for imagining that, with constant M (however defined), the private sector will see to it that V increases at some steady rate? One might just as well assert that, if M is allowed to shrink, the private sector will automatically make up for that as well by seeing to it that the demand for M shrinks even more (that is, that V grows still faster). Of course, in the very long run, markets tend to address shortages of particular sorts of exchange media–thus the growth in use of checks in place of currency (and consequent increase in the velocity of currency) during the 19th century in response to an artificially constrained currency supply. But that long-run adaptation was of no help in preventing cyclical and seasonally increases in currency demand from leading to serious crises.

Under some circumstances it’s true that private market financial institutions can tend automatically to stabilize MV, even if the stock of base money is constant. I’ve devoted a lot of research to this very possibility, showing how it might arise under a free banking system, that is, if banks can issue currency and are free from any statutory reserve requirements. Even then there are a number of other special conditions that must hold to get the stable MV result.

Tyler, in contrast, asserts that this result–or better yet, a constant growth rate of NGDP, might be realized even in our present centralized and regulated monetary system were the base (or some other measure of M) constant. For once I’m tempted to ask him, “Where’s your model?” As a question insisting on a particular sort of formal model, I’ve always found the query obnoxious. But in this case I’d merely like to see any sort of logical argument–that is, something more than a naked assertion. Like Scott, I like to know how, exactly, an NGDP shortfall gives rise to profitable opportunities for agents to make do with lower real money balances.

39 fyoricet overnight October 23, 2012 at 10:56 am

I am totally agree with your thoughts. Keep doing these type of work.

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