Ngdp Futures Convertibility -- Unworkable?

Scott Sumner has been championing "nominal gross domestic product futures" ("NGDP futures") every bit a agency of creating "market-based monetary policy." This has provoked all kinds of debate, such every bit whether the Efficient Markets Hypothesis holds. In my view, this is a distraction from the master copy bespeak -- the marketplace would non function. Sumner has proposed a few models; this article discusses what he said is his electrical flow preference -- futures convertibility.

Michael Sankowski has written a long article virtually the difficulties amongst gross domestic product futures implementation. I stimulate got non spent much fourth dimension looking at nominal gross domestic product futures, but I stimulate got looked at CPI futures. Those futures failed for reasons real similar to what Sankowski describes. Please annotation that I meet a neat many issues amongst Sumner's idea; this article is only touching on 1 issue. I am to a greater extent than interested inward his comments on the linkage to the monetary base, which is a bailiwick that fits inward amongst my upcoming mass -- Abolish Money (From Economics)!

In the newspaper  "A Market-Driven Nominal gross domestic product Targeting Regime" Sumner writes:

William Woolsey proposed about other method of using marketplace expectations to take away monetary policy, which uses a regulation similar to the classical gilded standard. The basic thought is to brand coin (currency in addition to banking concern reserves) convertible into NGDP futures contracts at a fixed toll (such every bit $1.0365) [emphasis mine - BR], inward much the same way that currency notes were in 1 lawsuit convertible into gilded bullion at a fixed price. However, dissimilar the NGDP futures targeting innovation discussed earlier, at that spot is no automatic connective betwixt the purchase in addition to sale of NGDP futures in addition to open-market operations past times the primal bank.

The employment amongst this thought is that it makes no feel if "NGDP futures" resemble other traded futures.

When you lot come inward into a futures contract, the commons convention is that you lot pay no coin -- whether you lot are long or short. (You do stimulate got to post service collateral, which is based upon the toll volatility of the contract.)

Let's assume a NGDP time to come has a notional of $1,000,000, in addition to the toll (based on annualised GDP) is $1.06 (corresponding to 6% annualised gross domestic product growth). For numeric simplicity, I assume that the primal banking concern is offering convertibility at $1.05 (5% growth).

If you lot recollect gross domestic product increase is going to hold out 7%, you lot desire to come inward into a long position. You stimulate got 2 options:

1. Put downwardly $0, in addition to come inward into a long seat at $1.06 (which has a notional value of $1.05 million).
2. Pay the Fed $1.05 1000000 for the privilege for entering into a long futures seat (the Fed would stimulate got to hold out brusque to residue the opened upwardly interest) at a toll of $1.05. This agency that you lot paid $1.05 1000000 for the privilege of getting a mark-to-market gain of $10,000 on a futures contract. 

The primal bank's conversion choice is only of value if annualised increase is greater than 105% (or less than -95%). Since it would never hold out exercised exterior of a hyperinflation, it is alone irrelevant, in addition to the thought is reduced to having a futures on nominal gross domestic product (which would neglect inward the same way that CPI futures did).

The only way that this tin sort-of piece of work is that what Sumner/Woolsey are actually talking virtually is nominal gross domestic product "bonds", where you lot stimulate got to position 100% downwardly to purchase them. In this case, the convertibility choice is only a one-way toll peg (or a two-way toll peg, if you lot tin convert the bond to cash) at the primal bank's conversion toll (he uses $1.0365 for about reason).

The employment amongst an musical instrument that you lot position 100% downwardly is that it is indeed a bond, in addition to thence wearisome bond analysts commencement bespeak awkward questions. Who is the borrower? What is the coin used for? How volition they pay me back? The inability to answer those questions cleanly is 1 real of import argue why futures operate on the "no coin down" principle.

(Update: added this discussion.) For those readers who are unfamiliar amongst the justifiable paranoia of fixed income analysts, allow us imagine that unsmooth fossil oil futures operated amongst 100% coin down. Assume that nosotros bought $100 1000000 inward unsmooth fossil oil futures. There are 2 sensible places where the $100 1000000 would larn -- either the seller(s) of the unsmooth fossil oil futures, or the futures exchange.

1. If it goes to the seller, what is to destination fly-by-night operators from pocketing the $100 million, in addition to jetting off to a province without an extradition treaty amongst my country? Since nosotros cannot inquiry our counterparties inward a futures trading environment, this is completely unacceptable. (Investors are obligated to investigate the creditworthiness of each of their over-the-counter (OTC) derivatives counterparties; in addition to smart investors mostly do non construction trades to advance large amounts of coin through derivatives structures.)
2. If it goes to the futures exchange, what is it going to do amongst the money? If the futures commutation is sitting on hundreds of billions inward liquid securities, what is to stop it from jetting off amongst a field of the stash? (Yes, investors post service collateral, but it is a fraction of the notional amounts.) 

Even if nosotros imagined that NGDP futures operated amongst 100% collateral requirements, it nonetheless costs us $0 to purchase the contract; nosotros only demand to honor collateral. That collateral, every bit the refer implies, is nonetheless our property. It nonetheless makes no feel to "convert" coin into the futures contract.

(c) Brian Romanchuk 2016