Tuesday, October 18, 2011

Greg Mankiw Answers My Questions

Back in May, 2011 I wrote the following on my blog:
Greg Mankiw recently referred to a paper where he assess which inflation rate should be targeted by the central bank.  Here is his conclusion:
[A]central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages. 
There are several good reasons laid out in the paper for targeting nominal wages.  Here I like to point out that stabilizing nominal wages is similar to stabilizing nominal income per capita.  It is not too much of a stretch to go from this to a nominal income or nominal GDP target.  In fact, Greg Mankiw and Robert Hall have a 1994 paper that sings the praises of a nominal GDP target, especially one that that targets the consensus forecast of the nominal GDP level. 
So where does Greg Mankiw stand today on nominal GDP level targeting?  If he still supports it, does he see the need to return nominal GDP back to its pre-crisis trend or at least higher than its current level?
Though I have never got a direct answer from Greg Mankiw, there is now enough circumstantial evidence to know his answers to my questions. First, he and coauthor Matthew Weinzierl have a recent Brookings Paper on the optimal stabilization policy.  They go through a menu of policy options, but reach this conclusion if monetary policy is not constrained:
The second level of the hierarchy applies when the short-term interest rate hits against the zero lower bound. In this case, unconventional monetary policy becomes the next policy instrument to be used to restore full employment. A reduction in long-term interest rates may be sufficient when a cut in the short-term interest rate is not. And an increase in the long-term nominal anchor is, in this model, always sufficient to put the economy back on track. This policy might be interpreted, for example, as the central bank targeting a higher level of nominal GDP growth.
In other words, monetary policy targeting a nominal GDP level is sufficient to bring the economy back to full employment.  That sounds like a rather favorable view of nominal GDP level targeting to me.   If that were not enough, Greg Mankiw today implicitly endorses nominal GDP level targeting by linking on his blog to the Goldman Sachs paper on nominal GDP level targeting.  I'd say Mankiw has answered my questions clearly.

Now Mankiw is not just a big-time academic economist at Harvard.  He is also an economic adviser to  Mitt Romney, the likely GOP candidate for president.  That means NGDP level targeting might eventually find its way into the White House.  There are good reasons for Republicans to endorse such an approach to monetary policy.  I hope Mitt Romney is hearing them.

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