Tyler Cowen on ECB policy By Scott Sumner

Here’s Tyler Cowen commenting on ECB policy options for addressing lowflation:

2. Nominal gdp targeting. In general I like this idea, but which ngdp gets targeted? Eurozone ngdp, presumably. But when you have multiple countries, individual countries can end up with insufficient nominal gdp even if the eurozone meets a well-specified target overall. (Given independent bank regulators, debt structures, fiscal authorities and the like, I view this as more serious than say the 50 U.S. states, which have a higher level of integration, most of all at the policy level.) How much of a guarantee is there that Portugal would reap expansionary benefits, given the private credit contraction in that country? The potential clustering of ngdp growth in some parts of the eurozone is another way of stating why the currency union wasn’t a good idea in the first place. This is still much better than doing nothing, but as a monetary policy rule ngdp seems better designed for the single-country case.

A few comments:

1. The “which NGDP gets targeted” question is easy–you definitely target the overall eurozone. As an analogy, no one would advocate having the Fed target the NGDP of a particular group of states.

2. Of course that leads to the optimal currency zone problem, and I agree with Tyler that the eurozone is not an optimal currency zone. But it’s also worth emphasizing that roughly 80% of the eurozone crisis is caused by insanely low NGDP growth overall (tight money) and 20% is caused by the one-size-fits-all problem.

3. Tyler’s last sentence is true but perhaps slightly misleading. Yes, NGDP works less well in a multiple country setting, but that’s probably equally true of inflation targeting. An NGDP target would have produced far superior policy during 2008-2014 than an inflation target. So the fact that the Europeans foolishly adopted a multiple country currency zone is actually an argument in favor of NGDP targeting.

3. A new and different inflation target. My current wish would be a new ECB mandate specifying a minimum core inflation rate of three percent for each of the largest countries in the eurozone, say France, Germany, Italy, and Spain. If any of these four countries seemed to be coming in under three percent inflation, the ECB would have to do more. And if need be, you could extend this rule through to more countries, with Malta and Cyprus probably at the end of that list. Sumnerians should note this also might be the best way to actually meet an operational ngdp target for a fair number of eurozone countries. Note that I accept many of Scott’s critiques of inflation rate targeting, at least on a theoretical level. The (only?) advantage of this policy is that citizens would know what it means. They would know they hate it, in the same way that say Americans hate higher gas prices. They would know this is a higher inflation policy and the ECB would know it could not spin it any other way. A fair amount of inflation and thus monetary stimulus would in fact result.

I strongly disagree with this. I can’t emphasize enough that the average voter doesn’t understand inflation targeting. They don’t even have a clue. They think it has something to do with central banks trying to help shoppers by holding down the rate of inflation. Voters don’t really understand monetary policy at all, indeed probably fewer than 5% even know what it is. (And no, “having something to do with controlling interest rates” is not an answer that shows they understand what it is.) Because they don’t know what monetary policy is, it’s best to think of public opinion in terms of outcomes. Europeans would prefer monetary policies that don’t create depressions and banking crises and high unemployment to policies that do create depressions and banking crises and high unemployment, even if the latter case led to a 4% inflation rate, such as what we experienced during the last 5 years of Paul Volcker. When voters don’t understand the issues, then it’s best to think of them as simply wanting good outcomes. That’s all. I refuse to believe that voters actually want outcomes that lead to a poor economy. Do European 60 year olds want policies where none of their 30 year old children can find jobs? Ask them that specific question; don’t ask them about “inflation,” with no distinction being made between supply-side inflation that lowers aggregate real incomes and demand-side inflation that raises overall aggregate real incomes. Even the Japanese elderly voted for Abe!

If you don’t believe me, describe the actual, true, honest-to-God, “public opinion” if polls showed the following:

1. 90% oppose having the Fed try to raise inflation.

2. 90% support Fed policies that will lead to higher levels of incomes for Americans.

Say both polls are accurate. Then what is the “true” stance of public opinion? More or less monetary stimulus? The polls are about as meaningful as asking Americans if they agree with the Copenhagen interpretation of QM or the Many Worlds interpretation.

BTW, when ascertaining public opinion on something like a gas tax, it is important to include the counterfactual. Is it an alternative tax such as a higher income tax? Is it a cut in Medicare or Social Security? No repair of potholes? Tax increases NEVER happen in a vacuum. If you replaced the current US government with a set of ordinary private citizens, and then showed them the budget and asked them what to do, they would enact all sorts of policies that public opinion polls supposedly show that ordinary people oppose. I recall when the older Bush was President, polls showed that two thirds opposed his Medicare “cuts,” but other polls showed that nearly 99% thought he was increasing Medicare spending too rapidly (when the polls discussed hypothetical options for percentage increases in Medicare spending.) So what did people actually believe?

There is no such thing as public opinion, just election outcomes.