Friday, February 24, 2012

NGDP Targeting News Roundup

Just when you thought interest in nominal GDP (NGDP) might be waning there is more, including some discussions of it from central bank officials.  

First, Mark Carney, Governor of the Bank of Canada delivered a speech where he discussed what would be a monetary policy for all seasons. He had some nice things to say about NGDP targeting, but ultimately comes out in favor of flexible inflation targeting as the top choice.  The thing is, flexible inflation targeting is effectively like a NGDP target if conducted properly.  Sweden is a good illustration of it.  There are other examples, but the point is this: why not just be explicit about it?  Doing so would not just formalize what is being done implicitly, but it would better anchor nominal expectations--especially if it were an level target--and thus reduce the chances of  large collapses in aggregate nominal spending.  Why not add more clarity?  And why focus on a symptom (i.e. inflation) when one can focus on the cause directly (i.e. changes in aggregate demand)? 

Now the above assume the flexible inflation target is executed flawlessly and ends up stabilizing aggregate demand. In practice, the discretion afforded a central bank under flexible inflation targeting makes it vulnerable to poor leadership and bad decisions.  And it is likely bad decisions will arise under flexible inflation targeting because of supply shocks.  In principle, such shocks should not be a problem for flexible inflation targeting, but in practice with political pressure and with real time data limitations they do create problems.  Imagine, for example, there is a great productivity boom.  All else equal, the natural interest rate would rise and disinflationary pressures would emerge.  The central bank should ignore the disinflationary pressures and let the policy rate rise to the level of the natural interest rate to keep the economy at full employment.  However, it might be tempting to leave the policy rate below the natural interest rate since the economy is humming from the productivity gains and inflation is low.  It certainly would not be a popular move to raise interest rates.  With a NGDP target such problems are ignored altogether. Simply focus on stabilizing the path of aggregate demand.  Keep it simple.  

Second, Renee Holtom of the Richmond Fed has a nice article examining the implications of the Fed tolerating higher inflation as a way to kick start a robust recovery.  She discusses all the reasons for doing so, including a NGDP target..  The one thing missing is that she fails to mentions that the proper response to folks like Raghuram Rajan, who argues the Fed would do more harm to savers if it allowed higher inflation, is that the point of the temporarily higher inflation is to spark a recovery that would ultimately lead to higher real returns for savers.  Interest rates are low because the economy is weak. Spark a robust recovery and watch real interest rates take off.  This is a point that is missed by many, especially Bill Gross.  (Also see Scott Sumner's response to Holton.)

Third, in what appears to be the latest convert to Market Monetarism, Jason Rave does a good review of NGDP targeting.  

2 comments:

  1. What a fantastic speech from Carney. Top notch.

    Very interesting how the BoC make explicit the period over which they aim to bring inflation back to target, I hadn't realised any CB did that. I'd noticed that the Bank of England are flexible about which forecast period they seem to pay attention to, and had presumed this was just arbitrary/sloppy.

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