Why liberals should support NGDP targeting

A commenter named Richard A. asked me why there don’t appear to be any liberal economists who support NGDP targeting.  For a moment I was stunned.  I am so used to NGDP targeting be attacked from the right that I forget that it has no supporters on the left.  Recall that conservatives usually support inflation or price level targeting, and think that NGDP targeting is soft on inflation.  So why no liberal support?

Not knowing any liberal macroeconomists, I can only guess:

1.  Maybe they somehow associate the idea with the infamous MV=PY equation.

2.  Maybe they think price stickiness is a much bigger problem than wage stickiness.

3.  Maybe they think it too crude, as it seems to put equal weight on P and Y fluctuations, and pays no attention to the output gap.

I suppose some right-wingers might have arrived at NGDP targeting via the equation of exchange.  Once people started criticizing Milton Friedman’s “4% rule” by pointing out that velocity fluctuates, then it is natural to think about monetary rules that offset changes in velocity.

But of course this is no reason for a Keynesian to oppose NGDP targeting.  After all, it is equally true that price level targeting can be explained in terms of this tautology:

P = M/m

Where P is the price level, M is the supply of base money, and m is the real demand for base money.  And yet I doubt whether any economist has ever rejected inflation targeting because they found that tautology offensive.

Regarding price stickiness, I think the Keynesians are wrong about it being more important than wage stickiness.  As I recall this view is partly based on post-war studies that showed real wages to be procylical.  But (in a 1989 JPE article) Steve Silver and I showed these studies are flawed and that real wage cyclicality is consistent with sticky-wage business cycle theories.

I think the third objection is the most important (and is also mentioned by Bill Woolsey in a recent comment to this post.)  How likely is it that the optimal coefficients on price level and output fluctuations are exactly the same?  And why not take into account the output gap, rather than merely the change in real GDP?

I would give several answers.  First, we aren’t even close to developing a macro model capable of showing which coefficients would be best, and which is also generally accepted by policymakers and economists.  Indeed I’d go further and argue that even new Keynesian policymakers and economists don’t agree on these issues.

Second, we don’t know how to measure the output gap.  All we know is that when output falls sharply, there is usually an output gap.  This means we don’t know enough to make a Taylor Rule produce dependably better results than a NGDP target.

Furthermore (as Woodford recently pointed out), we really need level targeting, not growth rate targeting.  Level targeting is obviously really easy to do with an NGDP target.  There are ways to do it with a Taylor Rule, but you have to rework the model, and there is already great disagreement about which Taylor Rule is best.

Most importantly, you can’t fight something simple and appealing with something complicated and unappealing.   Americans are conservative people.  What sounds more appealing:

1.  Stable prices


2.   Maximize some complicated social welfare function involving inflation and output gaps.

NGDP targeting is a sort of focal point that liberals and (some) conservatives could rally around.  It also appeals to pragmatic moderates like Bennett McCallum.

Until liberals realize this they will continue to lose out to the Plosser’s of the world, who have a simple and appealing message.  We need a similarly simple message, such as “The Fed must provide enough money to keep America’s nominal income rising at 4% per year.”

I just picked 4% at random, but in principle it isn’t random, it’s the sum of the current forecast of long run RGDP growth (say 2.5%) and the current policy goal for inflation (say 1.5%.)  So it’s not an entirely new goal, but rather a better way of achieving goals we already have, whether we admit it or not.

Here’s my fallback position.  Let’s suppose liberal macroeconomists don’t think NGDP targeting is good enough, because of issues like the output gap.  OK, then call it “flexible NGDP targeting.”  After all, many liberal macroeconomists say they support flexible inflation targeting, where the term ‘flexible’ indicates that they don’t look solely at inflation.  The problem with this is that inflation still lies at the center of their policy; it is still the variable everyone sees.  But inflation didn’t provide anywhere near as unambiguous a signal in 2008-09 as did NGDP.  If we had been talking about NGDP, it would have been obvious to everyone that money was far too tight.  But when you looked at variables like core inflation (horribly distorted by its failure to detect the fall in housing prices) you got much more ambiguous signals.  It gave the inflation hawks a leg to stand on, something they wouldn’t have had if everyone viewed policy in NGDP terms (even flexible NGDP terms.)  Again, flexible NGDP targeting is hardly my first choice (too much chance for mischief) but it is still light years ahead of the vague flexible inflation targeting regime we are currently operating under.

Don’t let the perfect be the enemy of the good enough.  Forget about the policy goals embedded in Taylor Rules.  It’s going to be NGDP targeting, level targeting, or we will continue to have monetary screw-ups because we have hopelessly vague inflation targets that allow policymakers to oppose monetary stimulus after a deep fall in NGDP.  (And for you Austrians, recall that inflation targeting allows the Fed to have easy money when NGDP is rising too fast.  They just point to core inflation.)