A rather weak attack on NGDP targeting

I find much value in the idea of the Federal Reserve adopting a nominal GDP target. It provides a rule-based system to guide monetary policy and an anchor to economic expectations. It might even allow monetary policy to be purely market-guided. By avoiding major monetary policy errors, it is far less likely the U.S. economy would suffer the sort of major contractions that lead to financial crises whose aftermaths are often ones of expanded government through bailouts and new regulation and fiscal stimulus.

But Forbes contributor Louis Woodhill disagrees. I look forward to responses by Scott Sumner and David Beckworth. But I can get the ball rolling. Woodhill:

Engineers test system designs against what are called “boundary conditions”.  So, let’s run a simple test on NGDP targeting.  What if the Fed took Scott Sumner’s advice and (somehow) produced NGDP growth of 5% from now on? And, what if (somehow) Congress enacted a solution to the “fiscal cliff” that eliminated the corporate income tax, thus causing real GDP growth to surge to 7%?  Answer: Sumner’s system would break, and it would have to be abandoned.  In the process, whatever credibility that the Fed had gained by adopting a rules-based system would be lost.

Wait, is Woodhill talking about a spurt of high growth like the U.S. had coming out of the 1981-82 recession? Or he is talking about high-growth New Normal where the U.S. grows at China-like rates for a sustained period? If it is the latter, then the point is ridiculous. The U.S. economy is not going grow at 7% in real terms this side of the Singularity. And a quarter or two of high, bounce-back growth after a deep recession really poses no problems for NGDP targeting since the point is to get the the growth rate back to a yearly trend. Lars Christensen explains:

It is also key that the Market Monetarists are in favour of targeting the level path of NGDP rather than the growth of NGDP. Typically, Market Monetarists prefer a moving target in the sense that the central bank targets a path for the level of NGDP with a fixed growth rate of, for example, 5%. An advantage of targeting the level rather than the yearly growth of NGDP is the rule hashistory, so if the central bank overshoots (undershoots) its target one year then it will have to make up for this in the following period. This is contrary to money supply growth rules or an inflation target, both of which are forgiving rules. Hence, if the inflation target is overshot one year, the central bank will not pay back the following year. Level targeting therefore anchors long-­‐term expectations to NGDP better than a growth-­‐based rule. It should also be noted that NGDP targeting will reduce short term fluctuations as the public expects faster going forward whenever growth falls below target in the near term.

UPDATE: My guy Joe Lawler over at RealClearPolicy reminds me that Scott Sumner addressing the point of above-average growth in his National Affairs, while also explaining how a market-based NGDP targeting system would work:

Another approach — which would be more radical, but perhaps also more effective — would limit the Fed’s role to setting the NGDP target, and would leave the markets to determine the money supply and interest rates. This would mitigate the “central planning” aspect of the Federal Reserve’s current role, which has rightly come under criticism from many conservatives. To give a simplified overview, the Fed would create NGDP futures contracts and peg them at a price that would rise at 5% per year. If investors expected NGDP growth above 5%, they would buy these contracts from the Fed. This would be an “open market sale,” which would automatically tighten the money supply and raise interest rates. The Fed’s role would be passive, merely offering to buy or sell the contracts at the specified target price, and settling the contracts a year later. Market participants would buy and sell these contracts until they no longer saw profit opportunities, i.e., until the money supply and interest rates adjusted to the point where NGDP was expected by the market to grow at the target rate. …

Nominal GDP targeting would produce lower than average inflation during a productivity boom. Indeed, one criticism of inflation targeting is that, because central banks focus on consumer prices, they allow asset bubbles to form, which eventually destabilizes the economy. Nominal GDP targeting cannot completely eliminate this problem, but it can impose more monetary restraint during periods of high-output growth than can inflation targeting.




5 thoughts on “A rather weak attack on NGDP targeting

  1. “And, what if (somehow) Congress enacted a solution to the “fiscal cliff” that eliminated the corporate income tax, thus causing real GDP growth to surge to 7%?”

    Not only would this further bankrupt the country, all you would do is spur the sales of Prada dresses and Hermes ties.

    GDP wouldn’t grow by a turd’s worth. Growth drives profits. Profits don’t by themselves drive growth, and that evidence is sitting in front of you RIGHT NOW. As Father Kung would say “This Day, This Hour, This Minute.”

    This is the drivel that is produceds when people are paid what to write as opposed to being paid to write what they think.

    One morning Mr.Pethokoukis will have his own epiphany about this- and it’s going to cause him considerable pain.

    Is this output of fecal slurry worth your soul, Mr. Pethokoukis?

      • Mr. Pethokoukis wasn’t always like this. He gets paid to write what he does, and I will pay him the compliment that I sincerely doubt he believes one tenth of what he produces.

        I’ve been around the block a few times, pal. I know what goes on. You would do well to listen.

  2. I find much value in the idea of the Federal Reserve adopting a nominal GDP target. It provides a rule-based system to guide monetary policy and an anchor to economic expectations….

    Why not just let the free market deal with the demand for money and credit? Since when is the AEI admitting to favouring central planning?

  3. Absolutely, market driven algorithms worked so well for program traders in the 80s and long term capital mgmt in the 90s, why not put the Fed on autopilot?

    The Fed has the authority to print money, which is what NGDP targeting is all about. What’s more it has used it to the point of alarming some FOMC members. Here is Dallas Fed chief Fisher speaking in QE1 — the Fed is now on QE3 — to make the point that more liquidity won’t help until someone actually uses it: “The Fed, as I see it, has taken a leap of faith that our political leaders will forge a sensible budgetary and regulatory path that incentivizes businesses to put to work the money the Fed is printing to invest in creating jobs for American workers.”

    Can you say Keynesian? Can you understand now why AEI would embrace a path that clearly scares the crap out of Fisher?

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