Monday, December 17, 2012

Is the 20-Year Inflation Targeting Detour About to End?

Harvard's Jeffrey Frankel says nominal GDP targeting's time has finally come:
It is time for the world’s major central banks to reconsider how they conduct monetary policy... Monetary policymakers in some countries should contemplate a shift toward targeting nominal GDP – a switch that could be phased in gradually in such a way as to preserve credibility with respect to inflation. Indeed, for many advanced economies, in particular, a nominal-GDP target is clearly superior to the status quo.
Central banks announce rules or targets in terms of some economic variable in order to communicate their intentions to the public, ensure accountability, and anchor expectations. They have fixed the price of gold (under the gold standard); targeted the money supply (during monetarism’s early-1980’s heyday); and targeted the exchange rate (which helped emerging markets to overcome very high inflation in the 1980’s, and was used by European Union members in the 1990’s, during the move toward monetary union). Each of these plans eventually foundered, whether on a shortage of gold, shifts in demand for money, or a decade of speculative attacks that dislodged currencies.
The conventional wisdom for the past decade has been that inflation targeting – that is, announcing a growth target for consumer prices – provides the best framework for monetary policy. But the global financial crisis that began in 2008 revealed some drawbacks to inflation targeting...A nominal-GDP target’s advantage relative to an inflation target is its robustness, particularly with respect to supply shocks and terms-of-trade shocks.
Frankel reminds us that NGDP was first widely discussed in the 1980s, but then fell out of vogue with the advent of inflation targeting in the early 1990s.  Recent developments indicate that this almost 20-year detour into inflation targeting may now be ending as noted  by Matt O'Brien over at the Atlantic:
It's okay if you have that Animal Farm feeling. There's been a revolution, but nothing has changed. The Fed still thinks it's first rate hike will come in 2015-ish, and it's still buying $85 billion of bonds a month. This is a true fact. But it undersells the intellectual shift at the Fed. It's gone from mostly thinking about inflation to creating a framework to guide its thinking about inflation and unemployment. And it's done that in just a year. This framework, the Evans rule, is really just a quasi-NGDP target. It's not exactly the catchiest of phrases, but NGDP, or nominal GDP, targeting would be a real revolution in central banking. In plain English, it's the idea that central banks should target the size of the economy, unadjusted for inflation, and make up for any past over-or-undershooting. In theory, a flexible enough inflation target should mimic an NGDP target, which is why the Evans rule is so historic. It's an incremental step on the way to regime change at the Fed.

That doesn't mean we should expect the Fed to move towards NGDP targeting anytime soon. A risk-averse institution like the Fed will want to see another country try it first -- and it might get that chance soon. Incoming Bank of England chief Mark Carney, who currently heads the Bank of Canada, endorsed the idea in a recent speech, and British Treasury officials indicated they might be open to it too -- which is significant because the British Treasury can unilaterally change its central bank's mandate. It might not be long till NGDP targeting comes to Britain, and from there, the world. If it does, you can be sure that Charles Evans will be figuring out how to make it work here.
Big changes are afoot in the central banking world.  My guess is that by 2020 most large, advanced economies will be doing some kind of NGDP targeting. 


  1. "It might not be long till NGDP targeting comes to Britain, and from there, the world". It's too optimistic. UK economy will remain one of the most underperformers because of her austerity policy. Professor Frankel does not believe NGDP is enough to avoid fiscal cliff.

  2. Fascinating blog post.

    I hope the suggestion in title is correct---otherwise we are talking Japan, all the time everywhere in the world (except China, where they target 4 percent inflation).

    Check out charts on sovereign debt yields. All trending towards zero.

    And that scary. No one is really sure how to get out of zero-bound recession Japan-style. Once Economy Grandma slips on the zero-bound ice....

    I think Market Monetarism and aggressive QE will work, but that is just a theory at this point.

    Independent central banks may be a bad idea. They pursue hallowed, and even worshipped organizational ideals at enormous costs to real output.

    Because they are independent.

    Can we go back to robust growth and moderate inflation?

  3. What about if potential gdp surges and we artificially constrain inflation to meet a lower ngdp target?

    NGDP targetting is a good policy, but only if there is some flexibility to account for potential GDP fluctuation.

    I'm not sure how that would affect CB credibility, but the current state of macro accepting high unemployment in the name of unreasonably low inflation rates is certainly not sustainable and NGDP targetting would definitely be an improvement especially in the short-run.

  4. A surge in potential output due to improved productivity would entail lower unit costs for many firms, which would motivate them to expand production and lower the prices for which they sell output. This would generate disinflation. There is no need to "tighten" policy to cause disinflation.

    In order to prevent this disinflation, it is necessary to create an expansionary monetary policy that will either offset disinflation, or more realisticially, will largely cause increases in the prices of goods which had little or no exceptional gain in productivity.

    If potential output grows because of a greater supply of labor, either due to population growth (say immigration) or a higher labor participation rate, then the analsys is different and less attractive. There is a silver lining in that by its very nature, this sort of surge impacts starting pay which is likely for flexible than the pay of existing workers.

  5. Isn't targeting NGDP the same as believing the economy can continue compound growth indefinitely? rather than growth being a means to an end. We need a post-modern economics that takes into account the message of the environmental movement. Even "modern" economists like Smith and Keynes accepted that growth would eventually have to fizzle out, they just never focused on it because that time seemed far in the future.

    So what is the role of a central bank, if any, in an economy that is changing in quality but not quantity? I think there would be a need for more explicit bank portfolio regulation. We would need to make hard decisions to distinguish between what is real investment and what is clear speculation. No new money for speculation. Afterall, when the economy fails spectacularly, isn't leveraged speculation the culprit every time? Doesn't the Feds very existence acknowledge that free banking is a failure, that bankers are no better at assessing the creditworthiness of an investment than anybody else?

  6. The Fed's Bullard:

    Liesman: "Easy for you to say, you have a lot of dollars to spend; you get to print them!"

    Bullard: "Haha, aaahh, indeed we do."