Christina Romer Advocates a Naked Emperor

Romer, who until a year ago was a failed architect of “President” Obummer’s failed economic policies, today wrote a hysterical piece in the New York Times which seeks to conflate image with reality.  In it she states the following:

Mr. Bernanke needs to steal a page from the Volcker playbook. To forcefully tackle the unemployment problem, he needs to set a new policy framework — in this case, to begin targeting the path of nominal gross domestic product.

Nominal G.D.P. is just a technical term for the dollar value of everything we produce. It is total output (real G.D.P.) times the current prices we pay. Adopting this target would mean that the Fed is making a commitment to keep nominal G.D.P. on a sensible path.

More specifically, normal output growth for our economy is about 2 1/2 percent a year, and the Fed believes that 2 percent inflation is appropriate. So a reasonable target for nominal G.D.P. growth is around 4 1/2 percent.

God, where to start.  How about a little thought experiment.   So let us suppose the Fed targets nominal GDP.  Further, suppose real growth is 2%.  To get to her 4.5% nominal target, the fed has to engineer 2.5% inflation by expanding the money supply presumably.  Well, that doesn’t sound so bad.  Now suppose real growth drops to 0%, say because the country is deleveraging after a credit binge caused in part because Fed left credit too loose for years and fiscal policy was an abomination, and after we allowed the controlled economy of China into the world trading system, and after the demographic bulge of baby boomers started winding down their economic activity among other things.  Now the Fed has to engineer 4.5% inflation.  With inflation on the rise and real output stagnating, you start getting a higher misery index.  So real growth goes to -2%.  Now the Fed has to engineer 6.5% inflation with yet more money printing.  Starting to get uncomfortable?  Wages are now declining, but the price of living is rising at a pretty heady clip.  Growth drops to -5%.  The Fed responds by throwing money out of helicopters (they do not call him helicopter ben for nothing) to achieve their 4.5% nominal target by getting 9.5% inflation.  Now there are riots.  So for a brief period output drops to -10%.  The Fed jacks inflation up to 15%.  Now we are on the path to Argentina.  It is called stagflation.  And if there is a widespread loss of confidence in the dollar, that can become hyperinflation.  Finally people have had enough and we get a real Volcker in to shock the system after Bernanke slips away to South America to avoid the mob.

Aside from the informational and timing issues, which are considerable, where does Romer go wrong?  She seems to mistake cause and effect for one thing.  Do rising prices cause output to grow?  Or does rising output cause prices to rise (again ignoring for the moment whether inflation, which can be measured by prices, is a monetary phenomenon exclusively or can be caused as output exceeds capacity constraints)?  Romer seems to be arguing the former, which seems to me obviously wrong.  She turns Volcker on his head.  Her prescription is not a page out of Volcker’s playbook as she asserts but out of the Anti-Volcker playbook.  Volcker, remember, hiked rates to combat stagflation.  He did not ease rates to create it.

Peggy Noonan wrote a piece in the Wall Street Journal not long ago in which she decried the Maobama Administration for telling stories rather than generating substantive ideas.  Romer apparently has drunk the Kool-Aid.  If you tell people something is true they will believe it to be true.  Except I do not think people are that stupid. You have to have some credibility to get people to believe something that does not appear true.  And this administration  and this Fed Chairman has precious little.  Without that credibility, they will not be able to pull off GDP targeting.  They should not try, or we really will need a Volcker to pick up the pieces.

One Response to “Christina Romer Advocates a Naked Emperor”

  1. Frank Dellaglio Says:

    Frank Dellaglio

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