Should the state care about savers? May 23, 2013 at 9:05 am

I have been perhaps too focussed in this past on the potential influence on monetary policy of savers: issuing linkers rather than fixed rate bonds, for instance, to facilitate better ALM for pension funds. Suitable government debt can, after all, substitute for some of the equity component of a traditional pension fund.

Reading the ever-excellent Simon Wren-Lewis, it occurred to me that NGDP targeting has a place in this discussion. First he points out:

A good deal of the borrowing that goes on in the economy is to smooth consumption over the life cycle. We borrow when young and incomes are low, and pay back that borrowing in middle age when incomes are high. To do this, we almost certainly have to borrow using a contract that specifies a fixed nominal repayment. The problem with this is that our future nominal incomes are uncertain – partly for individual reasons, but also because we have little idea how the economy as a whole is going to perform in the future. If the real economy grows strongly, and our real incomes grow with it, repaying the debt will be much easier than if the economy grows slowly.

As most individuals are risk averse, this is a problem. In an ‘ideal’ world this could be overcome by issuing what economists call state contingent contracts, which would be a bit like a personal version of equities issued by firms. If economic growth is weak, I have a contract that allows me to reduce the payments on my debt. However most people cannot take out debt contracts of that kind, or insure against the aggregate risk involved in nominal debt contracts.

Linkers help both borrowers and savers here of course. However, they are not quite what we want – that would be a risk-free security that pays out based on the path of nominal GDP* – but they are close.

Wren-Lewis then goes on the discuss a paper by Sheedy which suggests – in a stylised model – that NGDP-targeting produces lower over-the-cycle costs for savers than inflation targeting. (Or rather that the optimal mix between the two is heavily biased to NGDP targeting.) He suggests that

It may make sense for inflation to be high when real growth is low, and vice versa, because this reduces the risks faced by borrowers.

The obvious corollary of this argument is that governments should issue those NGDP-linked bonds to provide a curve against which private borrowers can issue. Such instruments would be even more attractive to many classes of savers than linkers, and would produce a better match to borrowers needs too. Moreover, combined with monetary policy which targeted NGDP, such instruments should be rather low volatility, stable stores of wealth.

*By analogy with linkers, I have in mind a security that pays a constant spread on and returns an NGDP-linked notional.

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