I don’t have much time now, but a quick reply to Kevin Drum:
The thing is, it’s not clear to me how much real difference there is between targeting NGDP, targeting inflation, targeting real interest rates, dropping money from helicopters, or engaging in quantitative easing. This is what I’d like NGDP advocates to make clear. Instead of telling us what they’re targeting, or what their preferred policy is called, tell me three things:
â– What do you want the Fed to say publicly?
â– What open market operations do you want the Fed to engage in?
â– Beyond that, is there anything else the Fed should be doing?
To see the advantages of NGDP targeting over inflation targeting, just look at the UK, where CPI inflation is running about 4.5% and NGDP growth is somewhat lower. Under inflation targeting the BOE would have to tighten right now; with NGDP targeting they should ease. I’m pretty sure Kevin Drum would agree that at least in that case, NGDP targeting gives the “right” answer.
As far as the question of what should the Fed actually say; I’ll give two answers. In general, the Fed should promise to maintain NGDP growth along a 5% growth trajectory, and commit to make up for any near term overshoots or shortfalls. That’s called level targeting.
The tougher question is what to do right now, when they’ve clearly undershoot the implicit Fed target for demand growth. At first I wanted them to return to the pre-2008 trend line, but I think that’s now clearly (politically) impossible, and perhaps unwise. Recently I’ve been throwing out numbers like 6% or 7% NGDP growth for 2 years, and 5% thereafter.
But what matters isn’t what I think, but what the Fed thinks. They need to decide on a NGDP target that they are willing to commit to, and make a very public commitment based on a majority vote. It must be public, to make them very reluctant to renege on their promise. Fortunately, the Fed doesn’t currently have strict inflation target, they have a dual mandate, so my proposal would not require them to abandon a previous target.
It’s clear that the Fed would like at least somewhat faster NGDP growth, as the newspapers are full of stories that they are strongly considering another initiative, and they’ve recently done two experiments (Operation Twist and the 2 year promise of low rates.) The Fed needs to decide how much NGDP growth they’d like to see over a period of several years, and promise to keep buying (or selling) assets until they expect to hit that target.
As to the question of how do they “actually” implement the policy, the promise does most of the heavy lifting (see this Nick Rowe post for an explanation.) I’ve often argued that with a robust NGDP growth target (say 7% for 2 years) the Fed might well have to reduce the monetary base, not increase it. The base is already almost three times its normal level. There are two explanations for that unusually high base demand; interest on reserves and very low expected NGDP growth. If you eliminate IOR, and dramatically raise expected NGDP growth, I don’t see where people and banks would want to hold all that much base money. But of course it’s a free country, and if idiots want to lend $10 trillion to the Federal Government at an interest rate of 0%, I see no reason not to accommodate their demand. I don’t know the precise laws governing Fed purchases, but given all the wild and crazy things the Fed has done since 2008, I doubt there would be any law preventing them from buying up close to $15 trillion in US, Japanese, Canadian, and German government debt. Of course this is reductio ad absurdum, in practice NGDP growth expectations would quickly soar much higher if they actually started down this road, and I’d guess that before long the monetary base would drop from its current bloated level back to about $1 trillion, its normal level.
BTW, I don’t even think the elimination of IOR is at all essential; if they are worried about the MMMF industry then a level targeting commitment plus a vow to buy trillions if necessary would be enough. It would cause such an upward explosion in asset prices that no purchases would be necessary.
However if the Fed actually does NGDP targeting, they are more likely to let-bygones-be-bygones, and go for 5% NGDP growth. In that case OMPs might be necessary. The less they aim for, the more heavy lifting with market distorting OMPs will be required. And that policy might well result in 4% NGDP growth over the next 12 months, and be perceived as a failure.
PS. All this talk of “helicopter drops” is a waste of time. A central bank radical enough to contemplate such a policy would never be at the zero bound in the first place. There are far less costly and radical ways to reflate.
PPS. I just returned from 4 days in Washington. My visit to the Senate fell through, but I did have a presentation at the Treasury that seemed to go well. I was brought back to Earth by my presentation at the Atlantic Economic Society meetings this morning. No one showed up, even 3 of the 5 presenters failed to appear. I guess I’m not as popular as I was beginning to assume.
I’d love to post more on NGDP targeting but won’t have time for a while, as I’m far behind in my school work. Ditto for answering comments. It’s frustrating, as I’d like to “strike while the iron is hot,” but numerous factors beyond my control will prevent that from happening. If you send me emails, don’t expect a quick response.