Here’s Charles Goodhart in the Financial Times:
But observations of policy-making over the years raise doubts that an ad hoc entry into a new policy regime will be followed by a nimble exit when the appropriate time comes. The fear is that, once the sell-by date of these initiatives passes, central bankers will be acting contrary to everything learnt, painfully, in the 1970s. They will be relating monetary management to real variables on a longer-term basis. In the end, any short-term benefit will be dwarfed by the long-run pain as they push inflation higher in the vain pursuit of a real economic objective.
NGDP does not target real variables; it targets a 100% nominal variable. And it is not an expedient—the goal is to permanently replace the discredited inflation targeting regime, which forces central banks to lie about what they are really trying to do.
While there may now be a case for some further temporary monetary expansion, this can be done within the context of the present flexible inflation target.
Central bankers would be better employed by improving unconventional instruments of monetary policy. The UK’s funding-for-lending scheme is a good start, as it offers a route to stimulating aggregate demand that bypasses the clogged arteries of conventional stimulus. The BoJ already has a significant portfolio of loans on its books, and the Fed would be wise to follow if the pace of the US expansion remains tepid.
It’s a big mistake for central banks to get in the business of influencing the amount of credit in the economy. Much better to focus on producing a stable growth path for nominal income and let the markets decided how much of that income gets allocated into borrowing and lending. Instead of ad hoc “unconventional instruments” that are unlikely to work in an emergency, why not use a policy target that reflects the central bank’s actual goals. Then you won’t ever need to use unconventional instruments to make up for the failure of inflation targeting.
Adopting a nominal income (NGDP) target is viewed as innovative only by those unfamiliar with the debate on the design of monetary policy of the past few decades. No one has yet designed a way to make it workable given the lags in the transmission of monetary policy and the publication of national income and product.
I had thought that “targeting the forecast” was one of the cutting edge ideas in monetary economics. If so, then data lags are not a problem. It’s a shame that people like Michael Woodford have not kept up with research in monetary economics over the “past few decades.”
Rather, a NGDP target would be perceived as a thinly disguised way of aiming for higher inflation. As such, it would unloose the anchor to inflation expectations, which could raise, not lower, interest rates by elevating uncertainty about the central bank’s reaction function.
NGDP targeting is not intended to raise the rate of inflation. For any long run inflation target, there is a NGDP target path that produces the same expected rate of inflation. Ex post inflation might be higher, but it’s equally likely that it would be lower. And the inflation uncertainty would not raise interest rates, as the debt markets care much more about NGDP than inflation. In the long run nominal interest rates are more closely correlated with the long run trend rate of NGDP growth than inflation.
We do not know, and cannot predict, what will be the sustainable rate of real growth in our economies. Let’s hope it is well above the relative stagnation observed in recent years in the UK, US, and Japan. But it would be over-optimistic to believe our economies can permanently revert to prior faster growth. In the short run, excess monetary expansion might temporarily lead to a burst of growth. But the likely implications of a dash for growth and the abandonment of an inflation target would at some point unhinge the government debt market.
Again, Goodhart is assuming debt markets care about inflation. They don’t. They care about NGDP growth. As long as NGDP growth is around 4%, long term nominal rates will remain relatively low. That’s the case regardless of whether the 4% NGDP growth is associated with o% RGDP growth and 4% inflation, 2% RGDP growth and 2% inflation, or 4% RGDP growth and 0% inflation.
Furthermore, Goodhart seem to believe that we need to estimate the long term RGDP growth rate in order to choose a NGDP target path. But one of the strongest arguments for NGDP targeting is that it avoids the need to estimate trend real GDP growth, or output gaps, or the natural rate of unemployment.
HT: Nicolas Goetzmann