George Selgin on John Taylor and the dual mandate

I did a post a while back that responded to John Taylor’s criticism of NGDP targeting.  In the comment section Statsguy pointed out that Taylor’s argument was even more flawed than I assumed.  And now George Selgin shows that it was even more flawed than Statsguy assumed:

Thus Professor Taylor complains that, “if an inflation shock takes the price level and thus NGDP above the target NGDP path, then the Fed will have to take sharp tightening action which would cause real GDP to fall much more than with inflation targetting.” Now, first of all, while it is apparently sound “Economics One” to begin a chain of reasoning by imagining an “inflation shock,” it is crappy Economics 101 (or pick your own preferred intro class number), because a (positive) P or inflation “shock” must itself be the consequence of an underlying “shock” to either the demand for or the supply of goods. The implications of the “inflation shock” will differ, moreover, according to its underlying cause. If an adverse supply shock is to blame, then the positive “inflation shock” has as its counterpart a negative output shock. If, on the other hand, the “inflation shock” is caused by an increase in aggregate demand, then it will tend to involve an increase in real output. Try it by sketching AS and AD schedules on a cocktail napkin, and you will see what I mean.

Good. Now ask yourself, in light of the possibilities displayed on the napkin, what sense can we make of Taylor’s complaint? The answer is, no sense at all, for if the “inflation shock” is really an adverse supply shock, then there’s no reason to assume that it involves any change in NGDP. On the contrary: if you are inclined, as I am (and as Scott Sumner seems to be also) to draw your AD curve as a rectangular hyperbola, representing a particular level of Py (call it, if you are a stickler, a “Hicks-compensated” AD schedule), it follows logically that an exogenous AS shift by itself entails no change at all in Py, and hence no departure of Py from its targeted level. In this case, although real GDP must in fact decline, it will not decline “much more than with inflation targetting,” for the latter policy must involve a reduction in aggregate spending sufficient to keep prices from rising despite the collapse of aggregate supply. A smaller decline in real output could, on the other hand, be achieved only by expanding spending enough to lure the economy upwards along a sloping short-run AS schedule, that is, by forcing real GDP temporarily above its long-run or natural rate–something, I strongly suspect, Professor Taylor would not wish to do.

If, on the other hand, “inflation shock” is intended to refer to the consequence of a positive shock to aggregate demand, then the “shock” can only happen because the central bank has departed from its NGDP target. Obviously this possibility can’t be regarded as an argument against having such a target in the first place! (Alternatively, if it could be so regarded, one could with equal justice complain that similar “inflation shocks” would serve equally to undermine inflation targeting itself.)

Another good reason to “never reason from a price change.”  However it wasn’t all good news for me, as George also took me to task for sloppy reasoning about the dual mandate:

But lurking below the surface of Professor Taylor’s nonsensical critique is, I sense, a more fundamental problem, consisting of his implicit treatment of stabilization of aggregate demand or spending, not as a desirable end in itself, but as a rough-and-ready (if not seriously flawed) means by which the Fed might attempt to fulfill its so-called dual mandate–a mandate calling for it to concern itself with both the control of inflation and the stability of employment and real output. And this deeper misunderstanding is, I fear, one of which even some proponents of NGDP targeting occasionally appear guilty. Thus Scott Sumner himself, in responding to Taylor, observes that “the dual mandate embedded in NGDP targeting is not that different from the dual mandate embedded in the Taylor Rule,” while Ben McCallum, in his own recent defense of NGDP targeting, treats it merely as “one way of taking into account both inflation and real output considerations.”

To which the sorely needed response is: no; No; and NO.

We should not wish to see spending stabilized as a rough-and-ready means for “getting at” stability of P or stability of y or stability of some weighted average of P and y: we should wish to see it stabilized because such stability is itself the very desideratum of responsible monetary policy. The belief, on the other hand, that stability of either P or y is a desirable objective in itself is perhaps the most mischievous of all the false beliefs that infect modern macroeconomics. Some y fluctuations are “natural,” in the sense meaning that even the most perfect of perfect-information economies would be wise to tolerate them rather than attempt to employ monetary policy to smooth them over. Nature may not leap; but it most certainly bounces. Likewise, some movements in P, where “P” is in practice heavily weighted in favor, if not comprised fully, of prices of final goods, themselves constitute the most efficient of conceivable ways to convey information concerning changes in general economic productivity, that is, in the relative values of inputs and outputs. A central bank that stabilizes the CPI in the face of aggregate productivity innovations is one that destabilizes an index of factor prices.

We shall have no real progress in monetary policy until monetary economists realize that, although it is true that unsound monetary policy tends to contribute to undesirable and unnecessary fluctuations in prices and output, it does not follow that the soundest conceivable policy is one that eliminates such fluctuations altogether. The goal of monetary policy ought, rather, to be that of avoiding unnatural fluctuations in output–that is, departures of output from its full-information level–while refraining from interfering with fluctuations that are “natural.” That means having a single mandate only, where that mandate calls for the central bank to keep spending stable, and then tolerate as optimal, if it does not actually welcome, those changes in P and y that occur despite that stability.

I mostly agree with this, but I also think there is some ambiguity as to the meaning of “mandate.”  Some view it as similar to “target,” but I don’t.  Consider this from Congress’s perspective.  They don’t understand the fine points of money/macro, but notice that it sure looks like there are suboptimal employment fluctuations and that at times inflation is excessively high and/or erratic.  Now of course George might very reasonably argue I am being far too kind.  They simply want MORE JOBS, and know nothing about “suboptimal employment fluctuations.”  Nevertheless, inflation and unemployment can be viewed as two distinct problems.  A monetary policy that produces optimal employment fluctuations with an average inflation rate of minus 1%, could probably have done the same with an average inflation rate of plus 1%.  I.e., money is approximately super-neutral, and hence decisions about the average inflation rate (or preferably average NGDP growth rate) are logically distinct from how we vary the inflation (or NGDP growth) rate to avoid suboptimal employment fluctuations.

Of course we shouldn’t target inflation at all, but Congress doesn’t understand that.  Nonetheless their intuition about “inflation” being bad is roughly correct; an average NGDP growth rate of 10% is also bad, even if employment is always at its Walrasian equilibrium level.

So let’s suppose that Congress tells the monetary authority to address those two vague goals.  Is that reasonable?  I think it is.  But that doesn’t mean the Fed should actually target inflation and unemployment, or inflation and output gaps.  They should address the dual mandate with something like an NGDP target (or productivity norm, or nominal wage target.)  They should address the dual mandate with a single target.

The super-neutrality of money allows us to maintain optimal employment with either a high or low average inflation rate.  Since inflation is costly, we might as well pick a low rate, and hence a fairly low NGDP target.  But money may not be precisely super-neutral at very low inflation rates, as there is a sharp discontinuity in nominal wage gains at just below zero percent (which implies money illusion.)

To summarize, George Selgin is right that the goal should not be zero employment fluctuations; it should be to reproduce the employment levels of an economy with wage/price flexibility (or perfect-information, to use George’s characterization.)  But that still doesn’t pin down the average inflation rate, or the average NGDP growth rate.  So I do think that the concept of “dual mandate” makes some sense, at least as a sort of political aspiration.  What we need to avoid is dual monetary policy targets.

PS.  Elsewhere I’ve argued that the welfare costs assumed to flow from inflation are actually caused by high and unstable NGDP growth.  I’ve used inflation in this post to avoid needlessly complicating the issues discussed by George Selgin.



27 Responses to “George Selgin on John Taylor and the dual mandate”

  1. Gravatar of StatsGuy StatsGuy
    1. December 2011 at 17:53

    Selgin has a way with words… quite like reading Kant. This is a nifty quote:

    “A central bank that stabilizes the CPI in the face of aggregate productivity innovations is one that destabilizes an index of factor prices.”

    Conversely, I would add, a central bank that stabilizes CPI in the face of raw input supply shortages is one that destabilizes an index of complementary factor prices… AND ASSET PRICES – and, indeed, it is one that stabilizes the consumption power of owners of currency-denominated assets by focusing the ENTIRE burden of reduced consumption onto the non-dollar denominated asset and production factor owners.

    Am I exaggerating? No…

    “The typical U.S. household headed by a person age 65 or older has a net worth 47 times greater than a household headed by someone under 35, according to an analysis of census data released Monday.

    While people typically accumulate assets as they age, this gap is now more than double what it was in 2005 and nearly five times the 10-to-1 disparity a quarter-century ago, after adjusting for inflation.”

    Yes, that’s right, the fact that bond prices have spiked at double digits annually for the last 3 years has helped dollar-asset owners and hurt those 65 have seen household wealth increase since 2005. And this ONLY counts direct assets, leaving out the fixed income / inflation adjusted obligations of pension programs, not to mention medicare.

    Scott, here’s an idea for you – how about we just index the value of the dollar to a certain % of per capitized NGDP, with an annual decay of 2%… Then, isn’t that exactly what NGDP targeting does? Money becomes a claim on the share of output, rather than a distortion-inducing claim on a prior-year stock of output.

  2. Gravatar of ssumner ssumner
    1. December 2011 at 18:43

    Statsguy, That’s what NGDP futures targeting does, except the decay rate is 4% in my proposal (assuming 1% pop. growth.)

  3. Gravatar of Morgan Warstler Morgan Warstler
    1. December 2011 at 19:26

    Old people die, the easy solution is to tax healthcare consumption like everything else.

    MORE TO THE POINT, if you care about the young, the ONLY NDGP play is my approach, you target level 4%, and bask in the glory of a constrained Fiscal policy, that firs public employees, and reduces the American debt.

    Anyone talking about youth, without both reducing overall spending then and reducing it even MORE on old people…. isn’t serious about helping youth.

    I’m frankly confused by Taylor’s complaint… it seems like he got it from Friedman.

    The answer is simply, if inflation runs ahead of the target, you raise rates… just like Volker did.

    What conservatives like Taylor need to have explained is the HUGE CLEAR DEMAND for less government spending that will arise from 4% (or less).

    Even if you don’t want it to be 4%, you should be HELPING THEM UNDERSTAND, instead of just leaving it to little old me.

    You want devotees even if they demand $% or less.

  4. Gravatar of Benjamin Cole Benjamin Cole
    1. December 2011 at 19:53

    Selgin makes terrific arguments. Still I wouldn’t worry too much about fine-tuning and minor disagreements among Market Monetarists.

    Even the most devout monetarists should concede that the steering wheel has a lot of play in it—the real world has huge institutional and information imperfections, and wage stickiness and money illusion.

    It is better to be roughly right than exactly wrong.

    In the current circumstance, not only is Taylor wrong, but his sentiments—that inflation is the big bugaboo, and not sustained unemployment and under-trend GDP—are off base.

    Give to me five years of five percent real GDP growth, and I will eat five percent inflation for breakfast. So would the whole USA.

    In short we need huge and sustained monetary stimulus now, and so does Europe.

    Bernanke needs to pull the lever on the money-printing press to “high” and then snap it off.

  5. Gravatar of Dustin Dustin
    1. December 2011 at 20:19

    Bernanke needs to pull the lever on the money-printing press to “high” and then snap it off.

    If he does that, then how can he stop the machine when NGDP is at the proper level? We’ll end up with Zimbabwe style NGDP!

  6. Gravatar of Bob Murphy Bob Murphy
    1. December 2011 at 20:21

    I don’t remember if you did the same thing, Scott, but for what it’s worth I think Selgin didn’t really answer Taylor’s argument about an inflation shock. Suppose for whatever reason the demand to hold money starts falling off rapidly, so that we get CPI inflation of 10% in a year.

    Taylor is saying that under inflation targeting, the Fed would tighten, but only enough to bring *next year’s* inflation back under 2%.

    But (Taylor claims), with level NGDP targeting, the Fed has to really really tighten, and will end up causing CPI to fall (say) 6%.

    In response, Selgin said that if NGDP really did grow too fast in a given year, then we’re by definition not following NGDP targeting. I hope Scott you agree that that is too glib.

    If not, then I propose the Murphy Rule of targeting prosperity. If we ever end up in a bad depression, I can with full validity claim that my advice was disregarded.

  7. Gravatar of Paul Andrews Paul Andrews
    1. December 2011 at 20:48


    In this article you assume super-neutrality of money.

    Does the model on which you base your belief in the efficacy of NGDP targeting assume super-neutrality of money?

  8. Gravatar of Selgin’s Monetary Credo – Please Dr. Taylor read it! « The Market Monetarist Selgin’s Monetary Credo – Please Dr. Taylor read it! « The Market Monetarist
    1. December 2011 at 21:46

    […] Marcus Nunes also has a comment on Selgin as do Scott Sumner. Share this:TwitterFacebookLike this:LikeBe the first to like this post. 1 Comment by Lars […]

  9. Gravatar of Morgan Warstler Morgan Warstler
    1. December 2011 at 23:09


    If we get an inflation shock of 10%, and the Fed has to raise rates dramatically….

    What matters is do the guys caught without a chair when the music stops get gutted? Are they DESTROYED? Do their wives leave them?

    If so, the market will price that risk in, won’t it?

    Once again, you are freaking about about a inflation shock, without focusing on the kick ass bit, with this much transparency, the public will never stand for debt spending again.

    Once they face immediate higher borrowing rates anytime the government wants to deficit spend, they will riot. EVERYONE who want a loan will judge gvt deficit spending as a horrible evil.

    We can make everyone who wants a loan become a Republican.

  10. Gravatar of Peter Peter
    2. December 2011 at 01:28

    “the goal should not be zero employment fluctuations; it should be to reproduce the employment levels of an economy with wage/price flexibility”

    This is a great statement. Thanks for this one Scott!

  11. Gravatar of Peter Peter
    2. December 2011 at 01:35

    Although, what exactly do we mean with wage flexibility? Unemployment benefits increase wage rigidity. Do we want the unemployment levels that we would have with no unemployment benefits and no minimum wage laws and no money illusion and only day to day wage contracts?

  12. Gravatar of Bob Murphy Bob Murphy
    2. December 2011 at 04:40

    Morgan wrote:

    We can make everyone who wants a loan become a Republican.

    And that’s a virtue of the policy?

  13. Gravatar of Morgan Warstler Morgan Warstler
    2. December 2011 at 05:51

    Yes, Bob that is.

    All good libertarians vote Republican.

    Tax theft is the crucial and prime most violated liberty.

    My god man, having every person who seeks a loan become ANGRY when the government deficit spends is a supremely Austrian / Libertarian position.

    You at minimum have to admit it is better than what we have now.

  14. Gravatar of Morgan Warstler Morgan Warstler
    2. December 2011 at 06:25

    “Do we want the unemployment levels that we would have with no unemployment benefits and no minimum wage laws and no money illusion and only day to day wage contracts?”


    I’m sure that’s what Scott wants too.

  15. Gravatar of Mike Sax Mike Sax
    2. December 2011 at 06:54

    Good old George Selgin. Tell you what Scott, I’m a fan. Whether or not you have the time to visit

    he does and already has done. So that’s Nick Rowe, Brad Delong, Jared Berstein, and now your mentor himself. Scott I would hate for you to lose relevance by not hanging out where all the cool economists are nowadays!

  16. Gravatar of Mike Sax Mike Sax
    2. December 2011 at 07:45

    Scott so you can catch up on the latest see my latest on me, George Selgin and other cool economists.

  17. Gravatar of George Selgin George Selgin
    2. December 2011 at 07:47

    Bob Murphy has a point–and I’ve amended my post accordingly.

  18. Gravatar of John Thacker John Thacker
    2. December 2011 at 08:05

    Meanwhile, Greg Mankiw moves ever closer to market monetarism in his latest post. Not that the Harvard man ever has to pay attention to or cite someone at poor old Bentley University.

  19. Gravatar of Benjamin Cole Benjamin Cole
    2. December 2011 at 08:36


    I was engaging in a little hyperbole.

    However, within reasonable limits, it would be hard to over-stimulte this economy. Remember, we import good, capital, services and (until recently) labor at will.

    Big increases in demand are met with global supply chains. Hard to get inflation in that scenario. And, as opposed to the 1970s, we have almost no unionized workers.

    Bernanke could pour it on. But, like central bankers everywhere, he lives in abject terror of inflation. He does not live in abject terror that growth is below trend.

  20. Gravatar of Cthorm Cthorm
    2. December 2011 at 09:37


    That’s a drastic oversimplification. The GOP has been, at least in it’s rhetoric, more friendly toward libertarian ideas than the Democratic party on fiscal issues but that hardly means they are the best fit. The sad fact for libertarians is that neither party has enacted many policies that are ‘libertarian.’ Even the Reagan administration, which is much lauded for it’s fiscal conservatism, failed to follow up it’s tax cuts with reduced spending. The Obama administration has obviously done an about face versus the Obama campaign’s positions on the Drug War.

    Frankly as a libertarian I think the Drug War is the most important issue of our day; the drug war and it’s justification (the expanding commerce clause and nanniysm) have led to unprecedented damage to civil liberties, government spending, state’s rights, police powers (and police union power), prison population, and the integrity of poor families.

  21. Gravatar of Bob Murphy Bob Murphy
    2. December 2011 at 11:34

    Morgan wrote:

    All good libertarians vote Republican.

    Tax theft is the crucial and prime most violated liberty.

    My god man, having every person who seeks a loan become ANGRY when the government deficit spends is a supremely Austrian / Libertarian position.

    Morgan, I’m only saying this because several years ago I thought just like this. (I.e. I’m not mocking him, I’m sincerely trying to show you what I think is a blind spot in your viewpoint.)

    The Republicans talk a good game about cutting the deficit, but look at them in practice. During the 1980s with Reagan, the excuse was always those darned Democrats in Congress. Well, the Republicans had a clean sweep under George W. Bush, and look what they did.

    It was a Republican in the White House who took us off gold (though maybe you applaud that, not sure) and gave us wage and price controls, and it was a different R in office who literally nationalized the banks. Talk about your commie conspiracy!

    Let’s take something more recent. Remember the debt ceiling brou ha ha? The Republicans just had to not raise it, and they automatically had a balanced budget rule. But of course they didn’t actually want to balance the budget, they instead wanted to position themselves to gain more seats in the next election because of “Obama’s reckless spending.”

  22. Gravatar of Bob Murphy Bob Murphy
    2. December 2011 at 11:38

    Thanks for the update, George (Selgin). I would want to think about it more to be sure, but off the cuff I think you’re right that Taylor wasn’t really criticizing NGDP vs. inflation targeting, but rather rate versus level.

  23. Gravatar of Bob Murphy Bob Murphy
    2. December 2011 at 11:38

    …oops other way around (level vs. rate).

  24. Gravatar of Integral Integral
    2. December 2011 at 17:16

    I think I raised the point that an inflation shock is, properly speaking, nonsense. Inflation is an endogenous variable; it can only be “shocked” by some combination of AS and AD (PC and IS) shocks, there is no such thing as a “pure inflation shock” unless your model has some very special structural features, most prominently a very particular lag structure.

    In the absence of such a lag structure, of course it matters which kind of shock drove up inflation, because different shocks have different implications for Y and hence NGDP.

  25. Gravatar of ssumner ssumner
    2. December 2011 at 17:43

    Ben, Yes, the disagreements are minor.

    Bob, Yes you’re right, in that passage Taylor’s actually criticizing level targeting, not NGDP targeting. But I don’t buy that argument either. If NGDP and RGDP are too high, it’s good that they fall.

    (Oops, I’m almost starting to sound like an Austrian, hopefully Bob won’t use that against me in January.)

    Paul, I don’t think it does, but I’d have to give it some thought. Superneutrality comes in when deciding where to set the NGDP growth rate. Money’s not perfectly superneutral, which is why the NGDP growth rate does make some difference. But the basic idea behind NGDP targeting doesn’t seem to involve superneutrality.

    Peter, That’s a complicated question, In general, you take unemployment insurance as a given, something that affects labor supply. On the other hand one could argue that stimulus would cause Congress to reform the UI program, reduce the maximum benefits. If so, then it does need to be taken into account.

    Mike, I have read your blog; you have a very Saxy blog.

    George, Yes, he had a point.

    John Thacker, We are much more working class than Harvard, we should be called Kia, or Hyundai University, not Bentley.

    Integral, That’s right. I had assumed he meant supply shock, as when people say “price shock” in macro, they usually mean supply shock. But I agree, that’s horribly confusing.

  26. Gravatar of Rajat Rajat
    3. December 2011 at 04:30

    One thing I’m thinking about is whether explicit NGDP targeting in an increasingly re-regulated labour market economy like Australia could encourage trade unions to become more aggressive with wage demands. At least with an inflation target, unions are kept in check by the credible threat that the RBA will crunch the economy if they push for 5-6% annual wage increases. But under 6% NGDP targeting, they could gun for 6% and it would be accommodated to a greater extent.

  27. Gravatar of ssumner ssumner
    3. December 2011 at 07:05

    Rajat, I don’t agree, for any inflation target there is a NGDP target that produces identical inflation rates over time.

    Indeed, as Nick Rowe recently pointed out with NGDP targeting it makes it more obvious that big wage gains are stealing income from others in the economy.

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