Futures contracts on NGDP are designed to be “entered into,” not simply bought and sold like typical assets. Upon maturity, funds are exchanged based on whether the actual NGDP surpasses or falls below a pre-defined threshold within the contract. To mitigate risk for the Federal Reserve, particularly given the potential for discontinuous market movements reminiscent of events like the 1987 crash or flash crashes, the implementation of daily limits warrants serious consideration. These limits would serve as a clear signal to the Fed regarding market anxieties, for instance, fears of NGDP growth dipping below 3%, while simultaneously capping the Fed’s potential payout obligations, preventing them from escalating into trillions of dollars. Furthermore, these daily limits are not set in stone; they can be adjusted upwards should market conditions necessitate it over consecutive days.
Another crucial design element concerns the direction of contract payouts. Structuring contracts so that the Fed is exclusively responsible for payouts when NGDP growth lags behind the 3% target, and conversely, non-Fed participants are the sole contributors when NGDP growth exceeds 5%, introduces a self-correcting mechanism. This structure ensures that contract payments themselves contribute to steering NGDP back towards the desired target range. The logic here is to avoid a “perverse” scenario where non-Fed entities pay the Fed during NGDP shortfalls, and the Fed pays out during economic booms, which would be counterproductive to the intended stabilization goals. Therefore, Why Not Both implement daily limits to manage risk and structure payouts to be counter-cyclical, creating a more robust and effective NGDP futures market?
Regarding the operational timeline, specific timeframes are necessary for both initiating futures contracts and executing related payouts. For instance, for a fourth-quarter 2017 NGDP contract, clear deadlines are needed to define the last date market participants can enter into such a contract, as well as the exact settlement date when contracts are finalized and payments are made. Clarity on these dates is essential for market participants to effectively utilize these instruments for hedging and investment strategies.
Expanding the toolkit beyond futures contracts, offering NGDP insurance or options for NGDP shortfalls below a certain threshold, perhaps starting conservatively at 3% or even lower at 2% or 2.5% to refine the process, presents another avenue worth exploring. A surge in demand for such insurance should indeed serve as a “panic signal” for the Fed, indicating heightened market concerns about economic underperformance. The key differentiator between these options/insurance and futures lies in the pricing mechanism. With options or insurance, the Fed would establish a premium, paid upfront by market players for coverage against NGDP shortfalls. This upfront premium model shields buyers from unlimited risk exposure in scenarios where NGDP significantly overshoots the threshold, a risk inherent in futures contracts. Considering these benefits, why not both offer NGDP futures to capture market expectations and NGDP insurance/options to provide downside protection, creating a comprehensive suite of tools for managing NGDP-related risks?
