John Taylor on NGDP targeting

Here’s John Taylor criticizing NGDPLT:

One change is that, in comparison with earlier proposals, the recent proposals tend to focus more on the level of NGDP rather than its growth rate. This removes some of the instability of NGDP growth rate targeting caused by the fact that NGDP growth should be higher than its long run target during the catch up period following a recession. But it introduces another problem: 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 targeting and most likely result in abandoning the NGDP target.

I am puzzled my his comment:

1.  I don’t understand why Taylor assumes a price shock would raise NGDP.  It will clearly raise the price level, and reduce RGDP, but it’s not obvious to me that it would raise NGDP.

2.  We had a test of Taylor’s hypothesis during the period from mid-2007 to mid-2008, when a huge price shock drove energy prices much higher (as well as some other commodities.)  NGDP growth did not increase at all, indeed the growth rate decreased.  NGDP growth also slowed in 1974, another huge price shock. Even worse for Taylor’s argument, adoption of NGDPLT in mid-2008 would have been far superior to the Fed’s actual inflation targeting regime—even many of NGDPLT’s critic would concede that point.  NGDPLT would have called for a far easier monetary policy from mid-2008 to 2010, which would have made the recession milder.  In contrast, the Fed cited fear of inflation as their reason for not cutting rates (from 2.0%) in their meeting two days after Lehman failed in mid-September 2008.  In retrospect the Fed should have cut rate sharply.

If NGDP did rise above trend during a price shock, it would be appropriate to have a tight money policy that resulted in lower NGDP growth (and lower RGDP growth) in the short run.

So I don’t see any theoretical or empirical support for Taylor’s claim.

HT:  Michael Darda

Update:  I must be getting senile.  I didn’t notice that this was an old post.  I already responded.  Nevermind.



12 Responses to “John Taylor on NGDP targeting”

  1. Gravatar of Arthur Arthur
    14. January 2013 at 09:17

    Taylor about NGDP target: “The rule also has the virtue of simplicity. Explaining how it works to policymakers seems easy.”

    Didn’t read it all, but it seems his rebuttal paper is all about the “long and variable lags”.

  2. Gravatar of Ron Ronson Ron Ronson
    14. January 2013 at 09:17

    ” I don’t understand why Taylor assumes a price shock would raise NGDP. It will clearly raise the price level, and reduce RGDP, but it’s not obvious to me that it would raise NGDP.”

    If import prices suddenly increased and caused price inflation to rise ahead of wage inflation wouldn’t some people use their savings to maintain their standard of living and wouldn’t this cause NGDP to rise ?

    Is 2007 a fair test as at that time much more was going on that would cause NGDP to decline beyond the price shock that affected energy prices?

    I agree though that even if people are reducing their money holdings (diminished demand to hold money) in this scenario then some monetary tightening to keep NGDP on target would be appropriate.

  3. Gravatar of marcus nunes marcus nunes
    14. January 2013 at 09:38

    Things keep coming back…
    Both you and I had ‘responded’ to Taylor´s critique at the time he wrote:

  4. Gravatar of marcus nunes marcus nunes
    14. January 2013 at 09:38

    You responded here:

  5. Gravatar of Saturos Saturos
    14. January 2013 at 09:58

    Scott, doesn’t he mean excess AD, i.e. too loose monetary policy (shifting NE curve to the right)? Of course that is supposed to be less likely in the first place with NGDPLT. But if there is overshooting, why should correction hit RGDP more than inflation targeting? Makes no sense to me.

  6. Gravatar of Bill Woolsey Bill Woolsey
    14. January 2013 at 10:05

    Supply shocks are realizations of the random variable at the end of the quasi-phillips curve.

    Inflation t = Expected inflation t + (real GDPt – potential GDPt) + random variable a.

    That last term is supply shock. You are assuming that potential GDP = potential GDP trend + random variable b.

    If random variable a and random variable b are independent, then “supply shocks” as in positive values of random variable a just cause higher inflation that must be offset by generating a negative output gap.

  7. Gravatar of Saturos Saturos
    14. January 2013 at 10:30

    John Cochrane has this interesting new post on liquidity traps:

  8. Gravatar of ssumner ssumner
    14. January 2013 at 11:10

    Everyone–Didn’t realize it was an old post–I added an update.

    Saturos, A price shock usually refers to a supply shock. If he meant demand shock, then obviously you’d have to tighten under inflation targeting.

  9. Gravatar of Saturos Saturos
    14. January 2013 at 11:38

    In case you haven’t seen it already – Noah Smith has a piece in the Atlantic about robots replacing us all: (I hate the easy unexamined conflation of capital biased change and rising inequality between humans.)

    And “price shock” is a terrible way of putting it. Must be an old-Keynesian relic.

  10. Gravatar of Bill Woolsey Bill Woolsey
    14. January 2013 at 11:42


    He means an increase in the price level that has no impact on potential output.

    Real output remains equal to potential and both growing, say at 3%. The “supply shock” involves the price level rising more than traget, say 3%. Nominal GDP grows 6%. To get nominal GDP back to target, we must raise interest rates so that prices grow 2% and real GDP grows 2%. Real GDP grows below potential next period.

    The Market Monetarist approach would be that the supply shock is a simultaneous reduction in potential real output growth to 2% and an increase in inflation to 3%. Real GDP is presumed to grow with potential at 2%, so nominal GDP grows 5%. It remains on target. Inflation is 3% rather than the 2% trend, and real GDP remains equal to potential. There is no output gap.

    If, somehow, real GDP grew 3%, 1% above potential, and inflation was 3% as before, then it is true that nominal GDP would grow 6%. If we tighten money and inflation is 2% and real GDP only grows 1%, then real GDP has returns to potential. What is the problem?

    Market monetarists typically assume that shocks to potential output and the price level are not independent, but rather have a covariance of minus one.

  11. Gravatar of Benjamin Cole Benjamin Cole
    14. January 2013 at 21:17

    As a non-economist, I must say I am disappointed at economists.

    I can only conclude that preserving one’s theories or political agendas is more important than figuring out what is what.

    First, it is obvious that money printing causes AD to rise, and growth and inflation, not deficit spending. See Japan. See the USA for the last 30 years.

    If anything, the larger federal deficits the USA has run the lower inflation goes.(What is John Cochrane talking about?)

    Secondly, at this point John Taylor (a nice guy, btw) seems to be arguing for the sake of arguing. He likes NGDP targeting, but not the level, or something like that.

    Rules-based NGDP targeting is just a better and smarter Taylor Rule. I don;t see how anyone could think the Taylor was a step forward and not think the rules-based NGDP targeting is even better. Besides, what does the Taylor Rule call for when inflation is dead? Negative interest rates?

    But the worst shortcoming of economists, is that you are still blabbering about inflation, when the real risk is that the USA goes into a type of perma-zero-bound recession or slow growth funk, that could last for decades. See Japan.

    Cochrane is talking about inflation, when we might have to engage in QE hot and heavy, to the tune of trillions in the next 10 years.

    The real question is whether the Fed has the institutional flexibility to chart such a course.

    I think not. We are four years behind schedule as is (finally the Fed goes to open-ended QE).

    It may be the Fed has no credibility—as a force to get us out of perma-recession zero bound.

    Now that is what we should be talking about .

  12. Gravatar of ssumner ssumner
    15. January 2013 at 07:56

    Saturos, Yes, bad terminology.

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