Wednesday, November 2, 2011

Greg Ip Takes on Nominal GDP Targeting

Greg Ip has a long post criticizing nominal GDP targeting.  This is not the first time he has expressed skepticism about nominal GDP targeting so his response is not entirely surprising.  What is surprising is some of the arguments he makes.  Ip does not seem to understand the theory or evidence for nominal GDP targeting.  Fortunately, Ryan Avent, Nick Rowe, Scott Sumner, and Bill Woosley provide replies to many of Ip's criticisms.  I hope Ip reads them.  

Now let me add a few more points to the discussion.  One thing Greg Ip asks for is "evidence linking NGDP targeting to the behavior of private actors."  Now there have not been any explicit nominal GDP targeters from which to draw lessons, but we do have evidence on the importance of nominal GDP expectations and actual nominal GDP performance.  Based on this evidence it seems likely that Fed would pack quite a punch if it adopted a nominal GDP level target.

Greg Ip also claims that since "2007 the Fed has worked overtime to push employment higher and keep inflation from falling."  If the Fed has been working overtime then why did total current dollar  spending take its biggest postwar fall in late 2008, early 2009? The data clearly show that the Fed failed to fully respond to the fall in velocity starting in 2008. And it has failed to restored robust nominal spending ever since.  What Ip fails to appreciate here is the notion of a passive tightening of monetary policy.  Fed chairman Ben Bernanke takes it seriously.  Ip should too.

Finally, Greg Ip cites one study by Laurence Ball (1999) that theoretically finds problems with NGDP targeting. What he failed to mention is that the results of this study have been shown to be fragile.  Here is what I wrote before about this paper: 
Laurence Ball (1999) demonstrated theoretically in a widely-cited paper that nominal GDP targeting can lead to increased volatility of output and inflation.  Lars Svenson (1999) later reconfirmed Ball's findings. This made some observers questions whether nominal GDP had any future.  Bennett McCallum (1999), however, said not so fast.  He showed that their conclusions were based on special backward-looking IS and Phillip curve relations that are "theoretically unattractive" (because they are backward looking)  and whose results fail to hold up with more general specifications.  Richard Dennis (2001) later confirmed that Ball and Svenson's results were fragile.  Finally, Kaushik Mitra (2003) showed that even with adaptive learning, nominal GDP targeting remains a desirable objective for monetary policy.  Thus, there have been no robust studies that show nominal GDP targeting increases volatility.   
I hope Greg Ip wrestles with these points and those made by the other commentators replying to him.  If he does, I think he will better appreciate why more and more folks are becoming enamored with nominal GDP targeting.  Who knows, maybe he too will catch the nominal GDP targeting bug!

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