Back in late 2008 I was horrified to see NGDP growth expectations plunging sharply. This is exactly what a modern central bank is supposed to prevent from happening. And yet almost no one (with a few exceptions like David Beckworth) was discussing this issue. That got me going on this crusade, even before I started blogging.
Commenter 123 just sent me a FT article that quotes 90 experts on British monetary policy (I didn’t even know there were so many experts.) Much of the discussion is on the merits of NGDP targeting; whether it will happen and whether it is a good idea. Respondents are split on both questions. Before getting into specifics, let me point out that market monetarists have already won one battle. Never again will global NGDP plunge at the sharpest rate since 1938 with almost no one paying attention, almost no one noting that monetary policy is way too tight. That doesn’t mean that we will have explicit NGDP targeting—but at a minimum it will be part of the discussion, part of the policy mix. NGDP now has nowhere to hide.
Here’s one interesting critique of NGDPL:
David Blanchflower, Dartmouth College and former MPC member:
The Treasury should – and I suspect will – abandon inflation targeting which failed to deliver stability. It should broaden the remit to include growth although I am unconvinced of the merits of a numerical NGDP target not least because of the problem of data revisions. About 2/3rds of real GDP revisions down to revisions to NGDP. It makes little sense that the MPC might have to call an emergency meeting to react to data revisions. I would favour an explicit targeting of the unemployment rate as the Fed has done. The evidence is that a 1% increase in unemployment hurts four times more than a 1% increase in inflation. Unclear though that we need a committee of eight clones when Carney could do it all perfectly well on his own …! So maybe time to think about scrapping the MPC entirely.
I’m genuinely open to ideas here, but let me suggest a pragmatic solution. Rather than take an either/or attitude toward data revisions, let’s think about the policy regime that would lead to the greatest macroeconomic stability. I’d like to distinguish between two types of data revisions (at least for the US, I know less about the UK):
1. Revisions that reflect new data on stuff like international trade, which comes in with a one or two month lag. These lagging data series largely explain why the main two NGDP revisions occur within the first two months. Most importantly, these revisions tend to change our understanding of where the economy is right now.
2. Revisions that occur infrequently, and reflect a different way of thinking about data that was measured in real time much earlier. For instance, a few decades ago the Italian government added an estimate of the size of the underground economy to its GDP. If the estimated GDP suddenly rose by 15%, that obviously would not indicate that the economy was dramatically overheating, and in need of ultra-tight money. It doesn’t change our understanding of where we think inflation and/or the output gap are right now.
I will concede that not all revisions fall neatly into one category or the other. I recall some big revisions a couple years ago, which changed our understanding of the 2008-09 slump. But I also believe that a panel of experts could come up with a reasonable estimate of the right GDP series to use in order to maximize macro stability. For instance, instead of targeting NGDP 12 months out, you could target 14 months forward NGDP, where you use the second revision. That picks up much of the data lag problem. With that series, you don’t allow any base drift in NGDPLT. On the other hand revisions of the sort that Italy undertook to include the underground economy obviously don’t change our current view of where we are in the business cycle, and should be accommodated with “base drift,” which means letting bygones be bygones.
Does that seem like a pragmatic solution? Other options include targeting Nominal Gross Domestic Income, which in theory is identical to NGDP, but is less subject to revisions. Or you could develop a model to predict revisions, and target the outcome of that model. Any other suggestions?
PS. I’ve always preferred targeting NGDP per capita, or per working age population, but rarely mention that fact. It has the side benefit of keeping inflation slightly more stable in the long run, for those unenlightened folks who still believe that price inflation causes problems above and beyond the damage caused by excessive and unstable NGDP growth.
PPS. Totally off topic, but I’ve been asked about David Henderson’s recent critique of my claim that liberal Massachusetts and Washington (state) reject progressive income taxes, whereas many southern states ruled by ultra-conservative Republicans have surprisingly progressive income taxes. He pointed to the fact the Massachusetts constitution doesn’t allow a progressive income tax. Yes, but in 1994 this question was put to the Massachusetts voters in a referendum, and the progressive income tax was rejected. You can’t get much more democratic than a referendum. Others claimed I cherry picked some states. True, but the claim is often made (by people like Matt Yglesias) that low MTRs for the rich is the defining issue of the modern Republican Party. It’s the only issue they really care about strongly. So I still think these exceptions are interesting to think about. That’s not to say there aren’t good explanations. Some pointed to the fact that the GOP has only recently gained power in the South. And (in comments) David noted that my referendum argument applied to voters, not Democratic politicians in Massachusetts. Let’s watch to see if the South gradually moves to lower and flatter income taxes.