[Update: I initially read the Steil/Walker post as opposing NGDP targeting. But the actual target of their post was the bad weather fans of NGDP targeting, who would abandon it when they didn’t think it was needed. Obviously I don’t disagree with their view that the policy should not be an expedient. Here’s a longer version of their argument.]
I’ve been meaning to comment on a recent post by Benn Steil and Dinah Walker, but Jeff Frankel has just made the argument that I was going to make:
I have in mind, especially, the views of Benn Steil and Dinah Walker of the Council on Foreign Relations, as expressed in “Why Nominal GDP Targeting is a Fad“:
“NGDP targeting having once been the intellectual stomping ground of economists on the right (notably Scott Sumner), its newest supporters come overwhelmingly from the left (such as Christy Romer)…. We think the rage will be short-lived. The reason is that NGDP targeting’s newest supporters are bad-weather fans. That is, they like it now, when NGDP is well below its 2007 “trend” line, meaning that the policy implies extended and more aggressive monetary loosening. But what happens when NGDP goes above its target, as it eventually will? NGDP targeting then requires tightening….”
Let’s consider the analytics first, and hold off awhile on the less edifying political labels. The nominal GDP proposal was originally studied and supported by many prominent economists in the 1980s. The problem at the time was a need for monetary discipline, anchoring expectations, and reducing inflation. Nominal income targeting was not designed as a way of getting easier monetary policy, but rather the opposite. It is equally good for either purpose: the target can be set high or low, depending on the times.
Originally, the leading competitor for the role of monetary anchor was money supply targeting (monetarism). This was the regime that was adopted in the early 1980s by the central banks of the largest economies. But they were forced to abandon it subsequently. Later on, the leading competitor became Inflation Targeting; but it too ran into difficulties in the 2000s. The general argument for nominal GDP throughout has been that it is robust to a variety of shocks, positive and negative. It dominates money targeting in that it is robust with respect to velocity shocks. It dominates inflation targeting in that it is robust to supply shocks.
In other words, Nominal GDP Targeting is not a short-term expedient but is fit precisely for the long run.
. . .
Steil and Walker support their argument that the proposal is not fit for the long run with an attractive graph. It shows that in many of the years since 1981 when the rate of growth of nominal GDP was above 4 ½ %, which they claim would imply monetary tightening under the proposed regime, unemployment was above 5 ½ %, prompting the Fed to loosen (wisely, in the authors’ view, if I understand them right).
The problem with this argument is that of those eight years when the Fed is shown loosening in response to unemployment above 5 ½ % (by my count), seven of the years came during the first part of the sample: 1983, 1985, 1986, 1987, 1990, 1992, 1993. (The only year from the more recent half of the sample is 2003.) Why is this a problem for the argument? In the 1980s and even the 1990s, it seems to me that nobody would have set a target so aggressive as to require monetary tightening when nominal GDP reached 4 ½ %. Back then we were coming down from high levels of inertial inflation and this process was understood to be gradual. Furthermore, the rate of growth of potential output was higher than today as well. Thus the numbers chosen for the nominal GDP target would have been higher than today. They would not have forced the Fed to tighten when unemployment was 7%.
During the Great Moderation liberal economists were quite willing to go along with higher interest rates, when needed to keep inflation on-target. After 2008 many liberals began questioning the 2% inflation target, but so did lots of moderates and conservatives who saw a need for more aggregate demand (and who opposed fiscal stimulus.) This is how things should work. Inflation targeting was an improvement on previous regimes such as the gold standard and the unanchored discretion of the 1965-81 period. And NGDP would be an improvement on IT. Despite my half-joking comments about NGDPLT being “the end of (macro) history” I do understand that at some point a consensus might develop that an alternative regime is even better than NGDPLT. Indeed I’ve mentioned that an index of NGDP excluding indirect business taxes might be superior.
But the key point is that when this occurs, the new consensus should not reflect the fact that some policy would be superior at the moment, but rather that it would be superior in the long run. I think that’s how NGDP proponents feel. We don’t just think it would have been better since 2008, but rather that NGDPLT over the past 100 years would have outperformed IT.
PS. One slight quibble with the Frankel post. He mentions how it might be wise to adjust the NGDP target occasionally, presumably to reflect changes in trend RGDP growth. Elsewhere I’ve argued that that’s not really necessary (except for population growth), although I’ve also argued it would be a price worth paying to get an NGDP targeting regime in place. Over time I believe people would start viewing NGDP (per capita) as the relevant nominal aggregate (appropriate for questions relating to the “welfare costs of inflation”) rather than the price level.