Cato Online Forum

Three Waves of the Magic Wand

By J. Bradford DeLong
November 2014

The problem I have with “magic wands” is that I am never sure just how powerful they are supposed to be. But let me propose three ideas, all of which require, as John Adams said, changes “in the hearts and minds of our countrymen” (and women):

Proposal 1: A Federal Reserve committed to nominal GDP level targeting, with a trend growth rate in nominal GDP of 7 percent a year

In my view the question of the origin of “general gluts” — demand-side business cycles characterized by (i) insufficient demand for pretty much every currently-produced good and service, and (ii) positively — rather than negatively-correlated fluctuations relative to trend of prices and employment — was decisively and correctly answered by John Stuart Mill back in 1829. A general glut arises when, if there is full employment, workers, savers, and managers wish to hold more in the way of liquid cash and readily-collateralizable safe savings vehicles than the economy is supplying. The private sector cannot produce cash and safe savings vehicles by any means short of deploying huge amounts of labor and capital to the Witwatersrand, and cannot produce large quantities of cash and safe savings vehicles quickly in any event. Only those organizations whose solvency is not just certain, but also generally known to be certain, can issue cash and safe savings vehicles. Others can only issue assets that are almost as good as cash until the tide goes out and you see how naked they are.

When, if there is full employment, workers, savers, and managers wish to hold more in the way of liquid cash and readily-collateralizable safe savings vehicles than the economy is supplying, everyone tries to build up their holdings by cutting their spending below their income. But since everyone’s income is other people’s spending, that does not work. Employment, production, and incomes drop until workers, savers, and managers feel so poor that they no longer wish to build up their stocks of cash and safe savings vehicles. And the economy undergoes a “general glut.”

A well-functioning free-market economy thus requires more than just property rights cut at the joints to minimize externalities, Pigovian taxes and bounties levied to compensate for remaining externalities, tort laws, contract laws, police, and judges. It also requires a “neutral” monetary policy — i.e., one that matches the economy’s supply of liquid cash and readily-collateralizable safe savings vehicles to the demand if there is full employment from workers, savers, and managers. The hope is that a central bank that has the power to target and does target a simple nominal GDP level-feedback rule — if nominal GDP is below the target, do more in the way of standard open-market operations, lending at the discount window on collateral that is good in normal times at a penalty rate, quantitative easing, and social-credit operations — will finally accomplish a properly “neutral” monetary policy.

A look back at previous ideas for what a “neutral” monetary policy—Newton’s fixed price of gold, Hayek’s fixed nominal GDP level, Fisher’s fixed price-level commodity basket, Friedman’s stable M2 growth rate, the NAIRU targeting of the 1970s, Bernanke’s inflation-targeting—leads immediately to the conclusion that anybody who claims to have uncovered the Philosopher’s Stone of a proper “neutral” monetary policy is a madman. But it is worth trying. Full employment is a very powerful boost to economic growth. And so is the elimination of future risks that businesses face as they try to calculate the chances that the profits to amortize investments will not be there because they will find themselves trying to sell into a “general glut”.

Proposal 2: State and local governments committed to raising salaries of K-12 public-school teachers relative to median salaries by 50 percent, in exchange for severe reductions in teacher tenure

As Eddie Lazear tirelessly points out, our state and local governments still substantially set public-school teachers’ salaries following a sociological pattern set generations ago, when the occupations open to women were (a) housekeepers, (b) laundresses, (c) waitresses, (d) telephone switchboard-operators, (e) secretaries, (f) nurses, and (g) teachers. Those days are long gone: women who would have become teachers and nurses in the 1950s are now becoming doctors, lawyers, managers, and bankers. School boards across the country have responded to the difficulties of hiring as the progress of feminism has allowed their captive female labor pool to escape by offering tenure in order to attract the risk-averse to teaching without having to require their taxpayer principals to face reality. But this is, at most, a second-best solution.

A nationwide network of good schools is both one of the very best ways to build productive capital — human capital — and a powerful step toward turning equality of opportunity in America from a sick and cynical joke to something not that far moved to reality.

How to actually wave this magic wand, however, is beyond me. My reading of the evidence is that charter schools have been disappointing in ways somewhat similar to those in which 401(k)s have been disappointing — too-high rewards to flash and marketing and too-little repetition for successful social learning about true quality to take place. Teachers will fight attempts to disrupt security of employment unless they have confidence that the grand bargain by which they trade security for higher salaries will be kept — which they do not have. Fiscal conservatives will fight teacher-salary increases unless they are confident that the Democratic Party-public sector union complex will then disarm itself of its weapons — which they are not.

Proposal 3: Increasing the number of legal immigrants from roughly one million per year to 2.5 million per year — 0.75 percent of the population per year

Everywhere else in the world, social conservatives are totally and completely terrified of our culture. Whether they admire American culture or despise it, all those who are attached to their own culture and do not want their young talking about going to Mt. St. Michel for le weekend or making hip-hop videos for YouTube are terrified of it. Yet we, somehow, fear that raising legal immigration above its current 0.3 percent of the population per year will in some way disrupt our culture? And we, somehow, fear that our politics is sufficiently broken that we cannot figure out a way to make increased immigration win-win for all current residents? Already for a 20 year old to crawl through a storm sewer from Tijuana to San Diego boosts the present value of future world GDP by $200,000. Give each one a green card too as he or she emerges and that number is boosted to about $400,000.

And let me note that I am not that big a fan of selling import licenses. It strikes me that the kind of people who would make it across the U.S. border from Nicaragua on foot are likely to be at least as large as political and economic assets as the princelings of the Chinese Communist Party, eager and able as the latter are to pay.


The opinions expressed here are solely those of the author and do not necessarily reflect the views of the Cato Institute. This essay was prepared as part of a special Cato online forum on reviving economic growth.

J Bradford DeLong is a professor of economics at the University of California – Berkeley.