I’ll use “(e)” to denote a (market) expected value.
NGDP(e) is the single most important variable in macro; it should be the centerpiece of modern macro.
How can we work with a central concept that is purely mental? Nominal GDP, or NGDP without the (e), is a measure derived from the market exchange of goods and services. Most concepts in macroeconomics, such as interest rates, or prices, are observable when goods or securities change hands.
NGDP(e) is not an observable result of goods or securities changing hands. It is something in people’s heads.
But it’s even more problematic than that. At least 99.9 percent of all people do not even have an NGDP(e) in their heads. Even most economists do not have one.
Even if you had a futures market in NGDP, NGDP(e) would still be a purely mental concept. In the wheat market, if you sell 1000 bushels of wheat forward, on the day that the contract expires you could deliver 1000 bushels of wheat to fulfill the contract. (Actual delivery does not take place in such markets, because buyers and sellers unwind their positions at expiration.) But nobody can deliver NGDP against an NGDP futures contract. It is a pure bet.
In any event, an NGDP futures market currently does not exist. So the most important variable in macroeconomics is something that exists in people’s minds, and yet in truth it exists in almost no one’s mind. I worry that this is like saying that in physics the most important variable is the ether, even though no one can observe it.
Low and stable NGDP growth minimizes the welfare costs of “inflation”, and also leads to approximately optimal hours worked.
NGDP is an observable variable, and Sumner argues that low and stable NGDP growth is associated with good performance of inflation and employment. So why bother with NGDP(e) at all?
At the risk of putting words in Sumner’s mouth, I think he would say that NGDP(e) is important because the Fed affects NGDP by manipulating NGDP(e). How did he get there?
Monetary theorists used to say that the Fed manipulates NGDP by manipulating the quantity of money. The problem with this is that it is impossible to find a definition of money that can satisfy two conditions at the same time: (1) that the Fed can control it; and (2) it closely correlates with NGDP. The former requires a narrow definition of money, and the latter requires a broad definition.
Old Keynesians said that the Fed manipulates NGDP by manipulating the short-term interest rate. When the short-term rate gets stuck at zero, it has to manipulate the long-term rate. Or it becomes impotent. But even when it is not stuck at zero, the Fed’s manipulations often seem ineffective. For one thing, long-term interest rates sometime do not respond, or they respond perversely.
Then there are the New Keynesian types who say that the Fed manipulates NGDP by manipulating expected inflation. But to me that is another ethereal concept. At the risk of putting words in their mouths, the New Keynesians are saying that the Fed can mysteriously change expected inflation through “quantitative easing” even if short-term interest rates and long-term interest rates are both impervious to Fed actions, or even if long-term rates react perversely.
From the New Keynesian view, it is a relatively small step to Sumner’s view. Just swap out the ethereal expected inflation for the ethereal NGDP(e).
Got it? In modern macro, we have everybody working in the GDP factory. And we have everybody forming expectations about the price of the output from this GDP factory, or about the total nominal value of that output. And booms and recessions are caused by changes in these expectations. And the Fed can manipulate these expectations through an immaculate process that cannot be measured using interest rates or the money supply.
I know that almost nobody who reads Specialization and Trade buys into my view that movements in aggregate price indices mostly reflect habits and inertia, rather than central bank operations. But when you see the contortions that monetary theorists have gone through over the years, I think I have a fair case.