I've recently started rereading passages of The Black Swan: The Impact of the Highly Improbable and I find it fascinating. The prose is fluid, and the arguments are powerful. Much of the book mocks economic theory, as models tend to minimize the role of large shocks that defy normal distributions. In the book, Taleb inserts the following chart that shows how much these "outliers" influence the stock market.
...fear of volatility, leading to interference with nature to impose "regularity" makes us more fragile across so many domains. Preventing small forest fires sets the grounds for more extreme ones; giving out antibiotics when it is not very necessary makes us more vulnerable to severe epidemics...
Which brings me to another organism: economic life. Our aversion to variability and desire for order and our acting on it has helped precipitate severe crises... Another thing we saw in the 2008 debacle: the U.S. government (or, rather, the Federal Reserve) had been trying for years to iron out the business cycle, making us exposed to a severe disintegration. This is the sort of reasoning I have against "stabilization" policies and manufacturing a nonvolatile environment ...
In a sense, the reduction of volatility in the Great Moderation was only an illusion of stability. We were, as Taleb would say, "sitting on a pile of dynamite," unaware of the risk that lay underneath.
Impact on NGDP Targeting Policy
This kind of critique seems rather damning against nominal GDP targeting. The typical analysis of NGDP targeting hinges on the assertion that low volatility implies high stability. But what if this isn't true? What if these times of low volatility are just times of high fragility? Some analysis of the arguments for NGDP targeting even suggest mechanisms by which this is the case. Debt problems are waved away because NGDP is stable, financial opacity becomes a non-issue because monetary policy compartmentalizes it, perceptions of "safe" assets change because expectations of nominal growth are maintained. Stable expectations permit these innovations because agents can plan ahead, allowing for higher growth.
However, this higher efficiency comes at the cost of redundancy. Taleb jokes in an interview with Russ Roberts that:
An economist would never design a human being with two lungs and two kidneys. It's wasteful. Deadweight loss.He follows up with:
So, the opposite of spare parts would be debt. And nature doesn't like debt. Nature likes redundancies. This mechanism of overreaction is redundancy.And this is what terrifies me about NGDP targeting. The incredibly stable regime creates an environment in which redundancy is eschewed in favor of fragility. Perhaps it would be better to have a more resilient economy that wouldn't be able to accumulate as much capital, but one that has lower levels of debt. The cost of a mistake in an NGDP targeting world would be incredible. Even if, theoretically, under a stable monetary regime, there are no demand-side recessions, would you be willing to bet the stability of the entire global financial system on it? Even if it were true, can you guarantee the Fed will be able to maintain a "stable monetary regime" for perpetuity?
I'm not trying to say the current monetary system is ideal; the dismal employment numbers firmly reject that view. But when we look onto NGDP targeting as the solution to the global economic malaise, we need to be careful that we don't put all of our eggs into one basket. NGDP targeting is an incredible tool for monetary policy; but it can't be a panacea for all of these troubles.
This critique of NGDP targeting brings up another key issue for the design of policy. Optimal policy has to do more than maximize welfare, it must also be robust to errors. While in the game playing, platonic world of models NGDP targeting should create incredible reductions in volatility and instability, what are the possible effects on global fragility? Policy engineering needs to take into account Murphy's Law: "If anything can go wrong, it will." The only question is how we prepare.