People often ask me what would have happened if the US had done 5% NGDP targeting, level targeting, in 2008. I suggested we would have had stagflation. A very mild and short recession, with above normal inflation. Maybe 6% or 6.5% unemployment. Evan Soltas has a new post where he argues that the Bank of Israel has been doing NGDPLT in recent years, with a 6.5% trend rate of NGDP growth:
You might wonder whether this was just good luck; is there any smoking gun? Evan makes two good arguments that it’s not coincidence:
What gives the Bank of Israel’s NGDP level target away, to me, is the temporary increase in inflation in 2008 and 2009, which cancels out the slowdown in real growth such that NGDP growth is constant through the recession, and the tendency of monetary policy to correct for past errors to maintain a 6.5 percent year-over-year growth path; see the swing between 2006 and 2007. As real growth has slowed since the first quarter of 2011, inflation has been allowed to rise.
Think about it. How often have you heard people say; “Of course inflation slowed during the recession, that’s natural.” No, it’s unnatural. For any given MV, a lower Y implies a higher P. Lower inflation during recessions is a sign of procyclical monetary policy, i.e. policy failure. You’d like lower inflation during booms and vice versa. Indeed it’s the Fed’s mandate to produce countercyclical inflation, although for some strange reason they don’t seem to understand their mandate.
Evan’s second piece of evidence is that the Bank of Israel is headed by Stanley Fischer. Here’s Fischer on NGDP targeting:
“In the short run, monetary policy affects both output and inflation, and monetary policy is conducted in the short run–albeit with long-run targets and consequences in mind. Nominal- income-targeting provides an automatic answer to the question of how to combine real income and inflation targets, namely, they should be traded off one-for-one…Because a supply shock leads to higher prices and lower output, monetary policy would tend to tighten less in response to an adverse supply shock under nominal-income-targeting than it would under inflation-targeting. Thus nominal-income-targeting tends to implya better automatic response of monetary policy to supply shocks…I judge that inflation-targeting is preferable to nominal-income-targeting, provided the target is adjusted for supply shocks.” (“Central Bank Independence Revisited,” AER, 1995)
To say Evan Soltas is on a role roll is an understatement. I bet Matt Yglesias gobbles this up.
HT: David Levey