While Bernanke must be having a Uri Geller moment if he thinks that he can “will” nominal GDP into expanding, Milton Friedman, from above, must be thinking that Ben has gone all “Reality TV”.
Why and when is nominal GDP targeting important?
In an economy with large amounts of personal, institutional and government debt, low growth and low inflation, it is more or less impossible to reduce debt without seriously impacting the GDP base.
The only practical way, given the cicumstances, to reduce debt as a % of GDP is to let nominal GDP growth reduce it. Unfortunately with low real rates of growth, the time frame for meaningful reduction increases your chances of being hit by an economic risk event. Time is of the essence.
The trouble is, where the growth fundamentals are weak, just pushing inflation up is not going to do much for the underlying real growth of the economy, and how inflation is going to be pushed up from the portfolio effect of QE3 is unclear. So it would be useful, amongst other questions, to know just what Bernanke Uri Geller considers to be a natural potential growth path, and of course, what is his portfolio theory. If he is wrong on either of these key assumptions, then he will likely be wrong on the nominal GDP/inflationary impact.
All we have done with QE is substitute fixed interest for cash and pushed the price of risky assets up because of extremely low yields on lower risk assets, although these low yields are not necessarily the result of QE. We also do not exactly have a dearth of supply of lower risk assets. So whatever Bernanke tries to do to increase cash allocations has over time largely been offset by new bond market issuance.
The following chart shows the 12 month average monthly fiscal deficit of the Federal government, a deficit which has ensured a steady supply of bonds for the Federal Reserve.
So, we have a constant tug of war between equities and new bond issuance and the underlying economy.
I fail to see how a rise in the price of risky assets will raise consumption and, over the short term, longer term expectations of asset class performance. We still need the trickle over to consumption and where we have a trickle over we need to increase our preferred cash allocations (by increasing our allocation to the transaction component of money supply holdings). Such will reduce the price of risky assets.
Additionally, who is to say that the low interest rates on cash and lower risk assets, whose supply has increased, will not reduce the ability of those with capital to consume. In fact, the necessary demand for what is an extraordinarily large supply of debt securities is itself a constraint on the impact of QE.
Between the start of Q1 2008 and the end of Q1 2012, outstanding US bond market debt has risen by $4,688bn, while GDP has risen by $1205bn.
With low levels of interest rates and high levels of indebtedness, we are left with those who have large asset bases and who depend on those asset bases for expenditure. At low interest rates, there will be a much greater dependence on equities for yield and security, meaning that you are less likely to see a transfer from higher risk equities to cash for consumption. Dividend yield increases take much more time to filter through to consumption.
I think it is fundamental that asset prices reflect the return generating potential of the asset, and QE risks initiating a mismatch between the two.
And, of course, with a structurally impaired economy, the last thing we need is more consumption financed by over valued assets, when what the US really needs is saving, reduced domestic consumption, and increased overseas demand for its output.
I do not know what is going through the Fed’s minds, I will need to think a bit more, but these are some thoughts on the fly. So much about QE is counterintuitive and desperate at this stage of the game. I do find it odd that we are looking to money to influence the real supply side of the economy as opposed to money being managed to facilitate the supply side. Economics has been turned on its head.
You can only have a nominal GDP target with valid real fundamentals if the economy itself is capable of generating adequate real growth. Perhaps some do not fully understand the structural imbalances that persist and which are the real reason for the slow economic recovery.