Mark Thoma recently asked the following question:
So, for those of you who are advocates of nominal GDP targeting and have studied nominal GDP targeting in depth, (a) what important results concerning nominal GDP targeting have I left out or gotten wrong? (b) Why should I prefer one rule over the other? In particular, for proponents of nominal GDP targeting, what are the main arguments for this approach? Why is targeting nominal GDP better than a Taylor rule?
The entire post is rather long, and Thoma raises issues that I don’t feel qualified to discuss, such as learnability. My intuition says that’s not a big problem, but no one should take my intuition seriously. What people should take seriously is Bennett McCallum’s intuition (in my view the best in the business), and he also thinks it’s an overrated problem. I think the main advantage of NGDP targeting over the Taylor rule is simplicity, which makes it more politically appealing. I’m not sure Congress would go along with a complicated formula for monetary policy that looks like it was dreamed up by academics (i.e. the Taylor Rule.) In practice, the two targets would be close, as Thoma suggested elsewhere in the post.
Instead I’d like to focus on a passage that Thoma links to, which was written by Bernanke and Mishkin in 1997:
Nominal GDP targeting is a reasonable alternative to inflation targeting, and one that is generally consistent with the overall strategy for monetary policy discussed in this article. However, we have three reasons for mildly preferring inflation targets to nominal GDP targets. First, information on prices is more timely and frequently received than data on nominal GDP (and could be made even more so), a practical consideration which offsets some of the theoretical appeal of the nominal GDP target. Although 20 collection of data on nominal GDP could also be improved, measurement of nominal GDP involves data on current quantities as well as current prices and thus is probably intrinsically more difficult to accomplish in a timely fashion. Second, given the various escape clauses and provisions for short-run flexibility built into the inflation-targeting approach, we doubt that there is much practical difference in the degree to which inflation targeting and nominal GDP targeting would allow accommodation of short-run stabilization objectives. Finally, and perhaps most important, it seems likely that the concept of inflation is better understood by the public than the concept of nominal GDP, which could easily be confused with real GDP. If this is so, the objectives of communication and transparency would be better served by the use of an inflation target. As a matter of revealed preference, all central banks which have thus far adopted this general framework have chosen to target inflation rather than nominal GDP.
1. I believe the federal government could estimate monthly nominal GDP numbers that are accurate enough to be useful for policy purposes. However, even if they could not I’d still favor NGDP targeting, because like Lars Svensson I believe the Fed should be targeting the forecast, that is, setting policy in such a way that the Fed’s forecast of future NGDP is equal to their policy target. I also favor level targeting (recently recommended by Woodford), and I think this would reduce the overshooting problem associated with futures targeting.
2. It seem to me their second point (which isn’t really a criticism at all) was actually disproved during the recent crisis. Between mid-2008 and mid-2009 NGDP fell over 8% below trend (or about 3% in absolute terms.) On the other hand core CPI inflation fell only slightly below trend. Because the Fed is an (implicit) inflation targeter, the slight slowdown in CPI inflation did not present an unambiguous signal (in their view, not mine) for aggressive stimulus. Hence they waited until November 2010 to undertake QE2. If they had been targeting NGDP along a 5% growth trajectory, it would have been immediately obvious that NGDP was coming in well below target, and would remain below target for many years. In my view the QE2 program would then have been adopted much sooner and in larger amounts, and I think it retrospect it is clear that additional stimulus would have been welcome in late 2008 and 2009.
3. The third point is where I most strongly disagree with Bernanke and Mishkin. In the current crisis we’ve seen just how difficult it is to communicate the need for higher inflation. The public interprets that as the Fed trying to raise their cost of living. I’m not surprised the plan is unpopular. I’d guess that in 1997 Bernanke and Mishkin were thinking about the central bank communicating the need for lower inflation, not higher inflation. In contrast, NGDP is essentially nominal income. The Fed can tell the public they are trying to raise nominal growth to 5%, because a healthy economy requires the incomes of Americans to grow by about 5% per year. That’s much less negative sounding that trying to raise the cost of living. Of course the opposite could be argued on the upside, but the Fed has shown a much greater ability to hold inflation down that increase it, as the zero rate bound has left them spinning their wheels when inflation has fallen below target. I think it would be easy to explain to the public that an excessively rapid growth in nominal incomes could be inflationary, and raise rates when needed. Especially given that they were widely criticized for not raising rates enough during the housing bubble.
4. Regarding revealed preference, NGDP targeting is more desirable the larger and more diversified the economy. If an economy is dependent on just a few industries, then a major price shock in one export industry might force a dramatic contraction in other industries under NGDP targeting. Price level targeting might provide for a better macroeconomic outcome in that case. Thus I wouldn’t expect small countries to be the first to adopt NGDP targeting. And would I be out of line in noting that the BOJ and ECB haven’t become famous for creativity and boldness?
Update: I just noticed that Bill Woolsey has a long and very informative reply to my discussion of NGDP futures, and also a response to some of the points made by Brad DeLong. Bill knows my plan better than I do, so I usually defer to his judgment. He’s correct that I cut some corners in selling the idea to the National Review’s readers, and that the actual plan is more complicated than I suggested. Indeed, I believe he was the first to use the phrase “index futures convertibility.”