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The Most Important Market No One Is Watching


You can't have stronger nominal growth and lower interest rates. When the market begins to discount may be anyone's guess, but it will most certainly show up in the bond market.


Coming out of last weekend's Jackson Hole symposium, perhaps no paper/speech delivered garnered more attention than the one titled Methods of Policy Accommodation at the Interest-Rate Lower Bound by Columbia's Michael Woodford. I didn't have the patience to read the whole thing but in scanning parts he discusses the policy of "forward guidance" and potential targeting of nominal GDP:
An alternative that I believe should be equally easy to explain to the general public, but that would preserve more of the advantages of the adjusted price-level target path, would be a criterion based on a nominal GDP target path, as proposed by Romer (2011) among others. Under this proposal, the FOMC would pledge to maintain the funds rate target at its lower bound as long as nominal GDP remains below a deterministic target path, representing the path that the FOMC would have kept it on (or near) if the interest-rate lower bound had not constrained policy since late 2008. Once nominal GDP again reaches the level of this path, it will be appropriate to raise nominal interest rates, to the level necessary to maintain a steady growth rate of nominal GDP thereafter.

Recall on July 30 in Bernanke's Astonishingly Good Idea that I thought you would start to hear more about nominal GDP targeting as a policy option and investors must be aware of the effects on inflation discounts in the dollar and bond market.
Something like the purchasing of private assets indeed could be Bernanke's nuclear option, and it's quite possible he bypasses the banking system to inject the liquidity.

I think we will start to hear more about a program along the lines of a nominal GDP (NGDP) target that is used to justify direct purchases of private assets.

The trick for a nominal GDP target is what the targeting output gap you are trying to achieve. Some have it as high as $17t vs. today's level of $15t.

Regardless you are still talking about creating a few trillion in nominal growth (i.e. inflation) out of thin air over the next couple of years. How do you do that when consumers won't borrow? It goes back to the "helicopter drop" Bernanke cites in his speech or purchasing private assets. It sounds crazy but what if they in effect just mail everyone $10,000 or offer to buy used computers, flatscreen TVs, upside down SUVs and condos in Florida at 2x the value. It's no crazier than a money financed tax cut.

In operating Fed policy since the crisis Bernanke has been using the playbook he outlined in his helicopter speech from 2002. Thus far policies have focused on easing credit conditions so that banks will lend. But can you successfully recapitalize an overleveraged economy with more leverage? A bankrupt company does not take on more debt to recapitalize, it converts debt into equity.
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