Wednesday, September 7, 2011

A quick run down on concepts from today...

Hey Gang,

Great work today sifting through a lot of complicated information. Here's a quick guide to some of the concepts we discussed.

Gold standard: In a gold standard, the government maintains a constant price for gold, either by agreeing to always buy and sell gold at that price, or by intervening in the gold market such that the price does not go above or below that figure (it was $20.67/ounce in 1933 when the U.S. left the gold standard).

Fiat money regime: a monetary system in which the government maintains the value of currency only through its "full faith and credit," that is, by guaranteeing to restrain money growth such that only a tiny amount of inflation can occur. In other words, the government guarantees to maintain a modest but upward growth in the level of prices overall, rather than maintaining a specific price for gold or some other metal.

Nominal Gross Domestic Product (NGDP): the current-dollar value of all goods and services produced. Another way to say this is that NGDP is the total level of spending on all goods and services measured in dollars NOT adjusted for inflation. So NGDP = Real GDP + inflation. NGPD is currently far below the pre-2008 trend level of growth. A period of above pre-crisis average growth would be required to return NGDP to the trajectory it was on.

Real Gross Domestic Product (RGDP): The total value of all goods and services produced, adjusted for inflation (i.e., in constant, rather than current, dollars). To arrive at this number, economists apply a "deflator" to NGDP. When people speak of a "price deflator," they are talking about a measure of inflation, for this is the amount we have to deflate NGDP to arrive at RGDP.

Inflation targeting: the current method used by most central banks to conduct monetary policy. The central bank limits the growth in prices to a certain range. Currently, the Federal Reserve (the U.S. central bank) targets between 1 and 2 percent inflation (a lower rate than before the crisis, when the target was usually 2-3 percent). In practice, central banks often use short term interest rates as a way of gauging how stimulative their policies are. When commentators speak of the Fed "lowering" or "raising" interest rates, what this means is that the government is creating more money and uses certain interest rates to measure the impact this action is having. They never directly raise or lower interest rates. By the same token, although people often speak of the government "printing" money, they don't directly print it either, but rather transfer it electronically by purchasing government bonds. By law, the government must exchange the money they create for a safe financial asset, usually government bonds. This ensures that they cannot really "print money" in the sense of creating new currency to finance the government itself, but must buy assets which in turn can be sold in order to withdraw new money from circulation.

Level targeting: a system in which the central bank targets a specific growth rate of either inflation or NGDP, but makes up for past undershooting or overshooting of the target. For example, if a central bank is targeting a 2% level of inflation, and in a particular year inflation is 1 percent, in the following year the central bank will aim for slightly above 3% inflation to return to the previous trend. Before 2008, NGDP generally grew around 5% a year. If, as happened in 2008, NGDP fell about 8% below its average growth rate, it would take a little over 17 percent growth to return to trend.

Quasi-monetarism: a generally libertarian philosophy derived from the work of the right-wing Milton Friedman. Quasi-monetarists argue that Central Banks should stabilize the level of NGDP, targeting a specific rate of growth, and making up for overshooting or undershooting. 

New Keynesianism: similar to quasi-monetarism, but traces its roots back to the more left-wing John Maynard Keynes. New Keynesians favor interest rate targeting until short term rates hit zero, at which point they favor level targeting of inflation (i.e., targeting a specific rate of increase in prices, but making up for overshooting or undershooting).

Here is a good graph of NGDP over the past few years, from an article in which one blogger from our list discusses another blogger from our list talking about a third blogger (not from our list). The article discusses the difference between a level target (which makes up for overshoots and undershoots) and a rate-of-growth target (which doesn't).

Update: Libertarian-leaning David Beckworth (the blogger cited in the post above by Delong) here lays out a simple method by which monetary policy could have a major positive effect on the economy. 

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