Friday, August 31, 2012

Michael Woodford Endorses Nominal GDP Level Targeting

Michael Woodford, arguably the top monetary economist in the world, endorsed nominal GDP level targeting today at the Jackson Hole Economic Symposium.  He did so as part of a broader critique of the Fed's monetary policy over the past four years.  Among other things, he makes the following points in his critique:

(1)  Quantitative Easing has not been very effective because the increase in monetary base it created is not expected to be permanent.  If it were expected to be permanent, then the future price level and nominal income level would also be expected to permanently increase.  Households and firms would respond to this development by increasing nominal spending today. The key point is to communicate some part of the monetary base increase will be permanent. See Bill Woolsey for more on this issue. 

(2)  The forward guidance provided by the Fed on the expected path of the target federal funds rate is doing little-to-nothing to restore robust economic growth.  When the Fed lowers the expected path of the policy interest rate in its forecast is it because the Fed is truly adding monetary stimulus or is it because the Fed now expects a weaker economy?  In the latter case, the Fed would be seen as simply maintaining the status quo of weak, anemic growth.  See here for more on this point.

(3)  Large scale asset purchases have not been effective in driving down long-term interest rates.  If anything, it is the weak economy that explains most of the decline in yields.  Exactly.  While there are long-term structural changes (e.g.. aging, saving preferences in Asia, lower expected productivity growth) that may explain some of the decline, the fact that over the span of the crisis the 10-year treasury yield has gone from above 5.1% to 1.6% suggests a cyclical story.  Simply, the ongoing expectation of weak economic growth in advanced economies is pushing down yields.  The irony here is that the Fed, through its influence on global monetary conditions, could change economic expectations for advanced economies and raise long-term yields.  In a sense, then, the Fed is responsible for the low interest rates just not in the way most observers think.  

Woodford sees a nominal GDP level target that returns nominal GDP to a pre-crisis trend path as the best way forward for the Fed.  It implemented properly, this approach would not be susceptible to the above critiques.  Here is Woodford:
An alternative that I believe should be equally easy to explain to the general public, but that would preserve more of the advantages of the adjusted price-level target path, would be a criterion based on a nominal GDP target path, as proposed by Romer (2011) among others. Under this proposal, the FOMC would pledge to maintain the funds rate target at its lower bound as long as nominal GDP remains below a deterministic target path, representing the path that the FOMC would have kept it on (or near) if the interest-rate lower bound had not constrained policy since late 2008. Once nominal GDP again reaches the level of this path, it will be appropriate to raise nominal interest rates, to the level necessary to maintain a steady growth rate of nominal GDP thereafter.
He even invokes the now-popular NGDP-below-trend figure to show that NGDP is 10-15% below where it should be. By implication, then, Woodford is accusing the Fed of effectively keeping monetary policy too tight since late 2008.  There is far more to the article, but how refreshing it is to see someone of Michael Woodford's stature to endorse what Market Monetarists have been saying for the past four years.  Moreover, it adds to the growing momentum for monetary regime change at the Fed.

P.S. No mention of Market Monetarism and the influence it has had in promoting NGDP level targeting, but that is okay (though footnote 33 was a pleasant surprise).  What matters more is to minimize that vast amount of human suffering being caused by tight monetary policy.  Woodford's article pushes us one step closer to that goal.


  1. Congrats David! You have done fantastic work to promote NGDP targeting! Thanks.

  2. All of us have, especially Scott Sumner. I am sure Woodford is a big fan of Sumner.

  3. Bernanke must be thinking: "What the hell did I do to my legacy"!

  4. Marcus, I would love to be fly on the wall in his hotel room after hearing this paper.

  5. The only reason NgDp targeting is talked about is that no economist understands that Friedman's income velocity is a contrived figure.

  6. I have nothing to add, except a smile.


  7. I still wonder if the secular downtrend in global sovereign interest rates means that we will all be Japan someday and not too far off, either.

    In that scenario,. central banks will have to use QE by default, and obtain huge balance sheets.

    How to handle these balance sheets is an interesting question, and includes questions about transparency and government in democracies.

    Congrats to Beckworth and others on this momentum!


  9. He said focus on NGDP. He then wrote that typical monetary policies are incapable of 'stimulating spending immediately'. Everything he suggested was essentially a FISCAL actions, whether by the monetary or fiscal authority or in coordination.

    (p 86) "...stimulate spending immediately without relying too much on expectational channels. Neither a program of expanding the supply of bank reserves nor a program of expanding the central bank’s holdings of longer-term Treasury securities is a good example of the latter kind of policy."