I was listening to Russ Robert’s Econtalk chat with economist Scott Sumner while driving yesterday. In it, Sumner makes a key analogy between targeting the level of nominal GDP and the gold standard:
My view is that there really should not be a serious debate about whether monetary policy can drive nominal variables. It’s just a question of how determined the central bank is. They can print almost unlimited amounts of money.
I think the real debate, in my mind, is: What is the proper path of nominal spending or inflation or whatever nominal variable you wish to target–could be the money supply, as Milton Friedman proposed. There’s going to be some nominal variable that’s going to be the anchor for the monetary system.
Another example is the gold standard, where it was anchored to a fixed nominal price of gold for many years.
So, you have a monetary policy that in some sense determines nominal aggregates–and I happen to think nominal income is the best one to stabilize.
And then the second question is: If you do that, what sort of real outcomes in the economy do you get? And that’s where I distinguish between the business cycle and long-run growth. I think monetary policy can help smooth out the business cycle by having a stable path of nominal income growth, but it can’t speed up the real growth in the economy. That’s due to structural factors, government policies, incentives, all sorts of productivity, etc.
No one is counting on the Fed to raise the potential real growth rate of the US economy. That is a taxation/regulation/education/immigration/innovation/population issue. That is a supply-side issue. But is there a way to conduct monetary policy that avoids monetary mistakes and prevents really nasty recessions — and keeps inflation expectations anchored? I think there is.