# Ed Dolan on why monetarists should favor NGDP targeting

Here’s Ed Dolan:

I see NGDP targeting as the natural heir to monetarist policy prescriptions of the 1960s and 70s.

If we look at the textbook version of monetarism, the point is almost trivial. Textbook monetarism begins from the equation of exchange, MV=PQ, where M is money (M1, back in the day), V is velocity, P is the price level, Q is real GDP, and PQ is NGDP. Next it adds the simplifying assumption that velocity is constant. It follows that targeting a steady rate of money growth is identical to targeting a steady rate of NGDP growth.

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13 Responses to “Ed Dolan on why monetarists should favor NGDP targeting”

1. Indy
5. November 2011 at 09:59

It’s a very concise way to put it, well done to Ed Dolan.

The Classic Monetarist says dM should be set to A, and V is assumed to be a constant B, so d(MV) = A*B, or some constant K.

So Market Monetarists say, “Why assume anything about V, just set d(MV)=K.” and since d(MV)=d(NGDP), and people will predict the Fed to do whatever it takes to achieve that constant, you get level targeting of the NGDP forecast.

2. ssumner
5. November 2011 at 10:25

Yes, I always wondered why Friedman didn’t favor NGDP targeting. If monetarists want V to be constant, they implicitly want a stable NGDP growth rate.

3. Patrick R. Sullivan
5. November 2011 at 11:09

Someone should forward the piece to Amity Schlaes.

4. flow5
5. November 2011 at 11:31

Textbook monetarism? That equation has never worked. The variables are bogus.

5. Lars Christensen
5. November 2011 at 12:22

Scott, Friedman acknowledged that velocity was not stable anymore most clearly in his 2003 paper on Fed’s Thermostat.

Here is Friedman:

“To keep prices stable, the Fed must see to it that the quantity of money changes in such a way as to offset movements in velocity and output. Velocity is ordinarily very stable, fluctuating only mildly and rather randomly around a mild long-term trend from year to year. So long as that is the case, changes in prices (inflation or deflation) are dominated by what happens to the quantity of money per unit of output…since the mid ’80s, it (the Fed) has managed to control the money supply in such a way as to offset changes not only in output but also in velocity…The improvement in performance is all the more remarkable because velocity behaved atypically, rising sharply from 1990 to 1997 and then declining sharply — a veritable bubble in velocity. Velocity peaked in 1997 at nearly 20% above its trend value and then fell sharply, returning to its trend value in the second quarter of 2003….The relatively low and stable inflation for this period …means that the Fed successfully offset both the decline in the demand for money (the rise in V) before 1973 and the subsequent increase in the demand for money. During the rise in velocity from 1988 to 1997, the Fed kept monetary growth down to 3.2% a year; during the subsequent decline in velocity, it boosted monetary growth to 7.5% a year.”

Hence, Friedman clearly acknowledges that when velocity is unstable the central bank should “offset” the changes in velocity. This is exactly the Market Monetarist view – as so clearly stated by Ed Dolan above.

6. Lars Christensen
5. November 2011 at 12:22

Scott, Friedman acknowledged that velocity was not stable anymore most clearly in his 2003 paper on Fed’s Thermostat.

Here is Friedman:

“To keep prices stable, the Fed must see to it that the quantity of money changes in such a way as to offset movements in velocity and output. Velocity is ordinarily very stable, fluctuating only mildly and rather randomly around a mild long-term trend from year to year. So long as that is the case, changes in prices (inflation or deflation) are dominated by what happens to the quantity of money per unit of output…since the mid ’80s, it (the Fed) has managed to control the money supply in such a way as to offset changes not only in output but also in velocity…The improvement in performance is all the more remarkable because velocity behaved atypically, rising sharply from 1990 to 1997 and then declining sharply — a veritable bubble in velocity. Velocity peaked in 1997 at nearly 20% above its trend value and then fell sharply, returning to its trend value in the second quarter of 2003….The relatively low and stable inflation for this period …means that the Fed successfully offset both the decline in the demand for money (the rise in V) before 1973 and the subsequent increase in the demand for money. During the rise in velocity from 1988 to 1997, the Fed kept monetary growth down to 3.2% a year; during the subsequent decline in velocity, it boosted monetary growth to 7.5% a year.”

Hence, Friedman clearly acknowledges that when velocity is unstable the central bank should “offset” the changes in velocity. This is exactly the Market Monetarist view – as so clearly stated by Ed Dolan above.

7. Friedmanâ€™s thermostat and why he obviously would support a NGDP target « The Market Monetarist
5. November 2011 at 12:22

[…] Ed Dolan as the same view as I have (I have stolen this from Scott Sumner): […]

8. Lars Christensen
5. November 2011 at 12:26

Scott, Friedman acknowledged that velocity was not stable anymore most clearly in his 2003 paper on Fed’s Thermostat.

Here is Friedman:

“To keep prices stable, the Fed must see to it that the quantity of money changes in such a way as to offset movements in velocity and output. Velocity is ordinarily very stable, fluctuating only mildly and rather randomly around a mild long-term trend from year to year. So long as that is the case, changes in prices (inflation or deflation) are dominated by what happens to the quantity of money per unit of output…since the mid ’80s, it (the Fed) has managed to control the money supply in such a way as to offset changes not only in output but also in velocity…The improvement in performance is all the more remarkable because velocity behaved atypically, rising sharply from 1990 to 1997 and then declining sharply — a veritable bubble in velocity. Velocity peaked in 1997 at nearly 20% above its trend value and then fell sharply, returning to its trend value in the second quarter of 2003….The relatively low and stable inflation for this period …means that the Fed successfully offset both the decline in the demand for money (the rise in V) before 1973 and the subsequent increase in the demand for money. During the rise in velocity from 1988 to 1997, the Fed kept monetary growth down to 3.2% a year; during the subsequent decline in velocity, it boosted monetary growth to 7.5% a year.”

Hence, Friedman clearly acknowledges that when velocity is unstable the central bank should “offset” the changes in velocity. This is exactly the Market Monetarist view – as so clearly stated by Ed Dolan above.

So why did Friedman man not come out and support NGDP targeting? To my knowledge he never spoke out against NGDP targeting. To be frank I think he never thought of the righthand side of the equation of exchange – he was focus on the the instruments rather than on outcome in policy formulation. I am sure had he been asked today he would clearly had supported NGDP targeting.

9. Lars Christensen
5. November 2011 at 12:28

Sorry, no clue why my comment was published three times…

10. flow5
5. November 2011 at 13:40

Friedman advocated using income velocity. It’s the transactions velocity of money that actually represents money exchanging hands (turning over). The transactions velocity isn’t stable y-y or otherwise. It’s speed was largely driven by financial innovations. The extraordinarily simple equation of exchange (MVt=PT) is vastly superior to the conventional model(MV=PQ).

11. ssumner
5. November 2011 at 14:04

Lars, The problem is that he favored offsetting V and Y, in order to stabilize P. He favored stable inflation, not stable NGDP.

Flow5, MV=PY isn’t a model, it’s a definition.

12. flow5
6. November 2011 at 06:42

All analysis is a model.” – Ken Arrow: That doesn’t erase the model’s obvious shortcomings. You can’t use MV=PY to forecast, whereas you can use MV=PT to forecast. That’s a fact.

13. John
8. November 2011 at 07:40

MV=PT is most certainly a definition. Whatever story you tell about it, or however you use it to forecast is you applying an outside theory into a clumsy, ill-defined equation.