Beckworth and Ireland on NGDPLT
David Beckworth’s recent interview of Peter Ireland is one of his very best podcasts—highly recommended. In this excerpt, Ireland is discussing how a policy of NGDPLT would have done better in 2021:
Ireland: You just draw a target path for the level of nominal GDP, and you base the target path in the fourth quarter of 2019. What you see is that throughout 2020, and even on into early 2021, the economy was still in a big hole.
Ireland: So you could say, wow, compared to a Taylor rule, which is focused on growth rates, even though we’re having inflation that’s above 2%, that’s just putting us back to where everybody thought they would be when implicit or explicit nominal contracts were signed, when decisions were made before the pandemic. But with that kind of target, the nominal GDP goes back to the target path in the fourth quarter of 2021. In that case, what the strategy tells you is you should be all the way back to neutral. The thing is that… I’m willing to forgive some of this, but at a minimum, a consistent strategy like that would’ve dictated an earlier start to normalization. By not making reference to the target path all along, they got caught in a very difficult situation, too, because it became clear then later on in the year that inflation was going to be a problem. But the way the Fed operates, you have to prepare markets, and you have to prepare the political system. Actually, I was worried, late last year, that what they were going to do out of fear of the political system is just hope they could get away with not even talking about anything. They had that thing, we’re not even talking about talking about this. They were-
Beckworth: Right.
Ireland: … going to try and do that until the middle of this year. That would’ve been a total disaster. But the point is that they weren’t set up to make the transition they needed to from extraordinary ease to the beginning of normalization fast enough. They would’ve been able to do it… David, you could have maintained a consistent viewpoint, and I think you did by saying like, look, I’m looking at this target path. My strategy is nominal GDP level targeting, and then you could have said as the year wore on, “well, look, my forecasts were wrong, but my strategy remains in place, and now the strategy dictates an earlier start to lift off. But that’s simply because the economy is doing so much better than I expected, coupled with the fact that the price increases seem more persistent and broad-based than I expected.”
Beckworth: Yeah, I agree with that completely. In fact, mentioning Jason Furman, he actually took my rule that I developed in a paper I did on nominal GDP targeting, and he told me in an interview last year about midway through said, “Well, David, your rule would imply the Fed needs to raise rates right now.” I was a little reluctant to embrace that implication, but he was right. I think part of it also is… for me at least, is I was doing too much looking in the rear view mirror analysis, like, well, nominal GDP still a little bit below, it’s getting close. I think what I suffered from was more… I needed to be more forward looking. What’s the forecast of nominal GDP?
This is what so many pundits miss. Having the correct regime in place makes monetary policy more effective. In 2021, a regime of NGDPLT would have helped in two distinct ways:
1. As Peter Ireland suggests, it would have made it easier to quickly raise rates without spooking the markets with an unexpected change in policy. The Fed could have stated that a stable NGDP is the policy, and rates need to adjust as appropriate to keep NGDP stable.
2. More importantly, even if the Fed were a bit late in raising rates, financial markets would have pushed longer-term rates higher in anticipation of the future Fed rate increases required to stabilize NGDP along a 4% growth path.
In 2021, I naively assumed that the Fed was serious about FAIT, and that it was sort of similar to NGDPLT. Late in the year, the financial markets gradually realized that the Fed was not serious, and hence did not push rates high enough to slow NGDP growth as we approached the trend line.
