Via the FT's Alphaville we learn that Goldman Sachs is discussing some "radical" options the Fed could use if economic conditions deteriorate further. One of the options discussed is a nominal GDP level target. It would be a radical change from way the Fed currently operates, but such a shock is exactly what the public now needs. For the past few years the economic outlook of households and firms has been dismal and consequently they have had been accumulating a large stock of money assets. If the Fed were to announce a nominal GDP level target it would provide a big expectation shock that would reverse much of this buildup.
One of the ways this shock would play out is through the many more observers who would be wailing about the reckless course of monetary policy, the horrors of debasing the dollar, the end of Western Civilization, and other hard money concerns. Similar concerns were raised when FDR effectively did the same thing in 1933 with his own QE and price level target program. These concerns about FDR's program provided a much needed shock to nominal spending and inflation expectations. As a result, there was robust recovery from 1933 to 1936. A nominal GDP level target would provide the same kind of shock today if it were properly signaled and followed through by the Fed.
It would require the Fed to buy up assets until the nominal GDP level target was reached. In other words, the Fed would be committing if needed to a permanent increase in the monetary base, something it has yet to do as recently noted by Michael Woodford. The effectiveness of such a shock would not be contingent on increased financial intermediation (though it ultimately would be affected too). Rather, this shock would work two ways. First, by raising inflation expectations, it would increase the cost of holding money assets for the non-bank public. This would create a hot-potato effect for non-bank holders of money assets and that, in turn, would lead to a mother-of-all portfolio rebalancings. Ultimately, this rebalancing would end with higher nominal spending. Second, it would simultaneously cause nominal spending forecasts to rise and this too would lead to more current nominal spending. Given the large slack in the economy, the increase in nominal spending would mean a rise in real economic activity.
But enough from me. Here is what Goldman Sachs has to say about nominal GDP targeting:
[W]e have again received some questions about the possibility that the FOMC might move to a nominal GDP target ... It’s important to note that depending on the interpretation, the Fed’s dual mandate (in which policy responds to both employment/real GDP and inflation) already has some similarities with a nominal GDP target (in which policy responds to the product of real GDP and the price level). The key differences are that (1) an announced nominal GDP target is much simpler and therefore more powerful than the hazier dual mandate, which is interpreted differently by different people; and more importantly, (2) the dual mandate is defined in terms of rate of change of prices, while a nominal GDP target depends on the level of prices. ...The implication is that a nominal GDP target, Fed officials attempt to “make up” for past undershooting of inflation via future overshooting. In other words, a move to a nominal GDP target is tantamount to a temporary increase in the inflation target.
I am glad to see Goldman Sachs telling its clients about nominal GDP targeting. The fact that nominal GDP targeting is now being discussed by Goldman Sachs, The Economist, The Financial Times, The Wall Street Journal, The Telegraph, The National Review, and other media outlets means this idea is gaining traction. The public needs a sharp expectation shock and a nominal GDP level target is radical enough to do it.