Wednesday, June 13, 2018

Optimal Monetary Policy For the Masses: the James Bullard and Larry Summers View

James Bullard and Ricardo DiCecio have a new paper where they model wealth, income, and consumption inequality.  They also incorporate fixed-price nominal debt contracts.  They then derive the optimal monetary policy for the masses in such a model. Here is what they find:

This paper builds upon the risk-sharing view of NGDP targeting. The basic idea is that in a world of fixed-price nominal debt contracts (i.e. the real world), a NGDP level target provides better risk sharing among creditors and debtors against economic shocks than does a price stability target.  

This is because a NGDP level target makes inflation countercyclical. During recessions, inflation rises and causes creditors to bear some of the unexpected pain by lowering the real debt payments they receive from debtors. During booms, inflation falls and allows creditors to share in some of the unexpected gain by increasing the real debt payments they receive from debtors. Debtors, in other words, bear less risk during recessions but also share unexpected gains during expansions. 

NGDP level targeting, in other words, causes a fixed-price nominal debt world to look and feel a lot like an equity-world. In a similar spirit, some observers have called for a risk-sharing mortgages as a way to avoid another Great Recession. The point of this paper is that the same benefit that such risk-sharing mortgages would bring can be had by having a central bank target the growth path of NGDP.

Larry Summers is also worried about the masses and is therefore rethinking the Fed's 2 percent inflation target
My conclusion, therefore, is that in our current framework the economy is singularly brittle. We do not have a basis for assuming that monetary policy will be able, as rapidly as necessary, to lift us out of the next recession. This has a substantial cost likely in the range of at least $1 trillion over the next decade. This suggests the suboptimality of our current monetary policy framework... 
If I had to choose one framework today, I would choose a nominal GDP target of 5 to 6 percent. And I would make that choice for two reasons. First, it would attenuate the issues around explicitly announcing a higher inflation target, which I think are a little bit problematic on political economy grounds. Second, a nominal GDP target has an additional advantage in its implicit response to changing conditions. Arithmetically a nominal GDP target has the property that the expected rate of inflation rises as the expected real growth in GDP declines. This is desirable. If growth in underlying real GDP declines, neutral real interest rates are likely to decline as well. In this case allowing higher inflation to make possible even more negative real rates reduces the risk of policy impotence.
Sounds good to me, but are there any real world examples of NGDP level targeting? Probably the best example of a country following something like a NGDP level target has been Israel over the past decade. The Bank of Israel officially targets an inflation range of 1-3 percent, but in practice has made inflation so countercyclical that effectively it has been doing a NGDP level target. The figure below shows this countercyclical nature using the GDP deflator:

Note that both inflation overshooting and undershooting have been tolerated. The GDP deflator has been as hight as 6 percent and almost as low as 1 percent. Overall, its inflation rate has averaged about 2 percent, right in the center of the 1-3 percent target range. So this approach provides both a nominal anchor and short-run inflation flexibility for Israel.  

As consequence of making Israeli inflation countercyclical, the growth path of NGDP has been kept stable: 

This is what monetary policy for the masses looks like!


  1. Dear Prefessor David Beckworth,


    Let me learn more about how Israel has been performing very well under the NGDP targetting.
    Many thanks,

    An ex-World Bank Economist

    1. Tomo, as I mentioned in the post, Israel is not explicitly doing NGDP targeting. Rather, its actions are consistent with NGDP targeting.

  2. Larry Summers says target NGDPLT at 6% annual growth.

    I have been saying that since 2008!

    Kudos to me!

  3. David,

    Many thanks for your quick response.


    Incidentally, how do you assess the recent FOMC action, particularly in light of NGDP targeting policy?

    It seems to me FRB is far behind the curve, since US real GDP appears to be growing at close to 5% during Q2 2018 according to GDP Nowcast. The US nominal GDP is presumably ruuning at around 6-7% in 2018, while the US policy interest rate has been just raised to no more than 2%.

    US NGDP level targeting policy appears to me to suggest the similar story above.

    In fact, just now, I am disapponted to have observed that the BOJ did not change its monetary policy at all in its statement issued this morning.

    In my view, all central banks including FRB are failing to recognize the need to monitar developments of nominal gdp of each economy, or significance of NGDP (level) targeting policy.

    Sincerly yours,


  4. Beckworth has interviewed both Scott Sumner and Roger Farmer about combining NGDP targeting with an NGDP futures market and the commitment of the Fed to buy or sell debt instruments (Sumner) and/or equities (Farmer) if the futures market is below or above the target. Larry Summers' view of NGDP targeting slowly evolved over the past few years, going from mild statements of approval to his written endorsement. To his credit, Beckworth has given Sumner and Farmer a platform to both educate others and promote the concepts.

  5. Very good but the model is too simple to accommodate the need for an optimal amount of inflation (the amount needed to mitigate price stickiness). And if the amount of stickiness changes over the business cycle, one still needs a "dual mandate."

    And unless the monetary regime actually eliminates changes in real interest rates and fluctuations in the difference between aggregated resource demand and resource supply (unemployment of some resources) a government following an invariant NPV rule for expenditures will still carry out what looks like countercyclical fiscal policy.

    Conclusion: we still need active monetary and fiscal policy, even if we agree that a monetary of targeting NGDP at the pre-recession rate would have been vastly better than the ineffective fiscal policy and the inactive mal-active monetary policy that we in fact got.

  6. How to reach NGDP of 6% in face of the "savings glut"? More QE just means more asset inflation. Real helicopter $ (not just a channel through the banks) appears unavoidable.

    1. A helicopter drop-linked NGDP target!


    Good day everyone,I can’t hide this great testimony that took place in my life I will love everyone to know it and be a partaker of this, that is why I want to share it to the whole world by placing this advert on classifieds, I am Mrs Karen Brown by name, I live in Chattanooga, Tennessee United State, I want to thank ROBBINSON MOORE for his kindness upon my family life, I never knew that there is still a sincere and trustworthy lender like this on the internet and on earth. Just some days I was in search for a loan of $ 100,000.00, As I was running out of money for feeding, School fees, My business was really going out of capital and my rent. I was scammed about $15,000.00 dollars and I decided not to involve my self in such business again. But a Friend of mine introduced me to a loan firm due to my appearance and doings and also my complains to her. And I told her that I am not interested in any loan deal anymore but she told me that there is still a sincere lender who she will recommend me to, And she gave me the details of this man who is called MOORE ROBBINSON. And I really put a trial and I am most greatful and lucky today, I was given a loan amount of $95,000,00 Dollars by this great firm MOORE LOAN COMPANY. If you arew in need of a genuine, Sincere, durable and a truth worthy loan lender or financial assistance and also you know you can be reliable and trusted, capable of paying back at the due / duration time of the funds I will advice you to send your contact to them via email @[] OR Text +1(414) 454-9493 . And you will be free from scams on the internet. Please I am begging everyone on earth to help me thank Mr ROBBINSON MOORE. And I ill always being sharing this great surprise and testimony that happened in my life everyday to all that need loans. Contact them now if you are in need of a loan: AS THEY ARE EFFICIENT,DYNAMIC AND RELAIBLE.....Again there contact email [ OR Text +1(414) 454-9493..

  8. David, what is missing here is the counterfactual: What would RGDP have looked like absent NGDP targeting? We can't just presume that because NGDP evolves in a stable manner that the path (or volatility) of RGDP is optimal (or better, in some sense, relative to what it otherwise may have been).

  9. I am not a conspiracy theorist, but I can't look at the stability of Israel's NGDP in that chart and believe it is real unless 1) luck, 2) omniscient and omnipotent central bank, or 3) some quirk in how they measure things. Does one really think that a central bank can manage a 4+% decline in RGDP (~2012) to be almost perfectly offset by a ~5% increase in inflation? Shouldn't we be expecting some lags here? I say call an Israeli economist before betting the farm on it.

    1. This data seems to match the RGDP and GDP Deflator data, but the NGDP growth reported in the same site looks much more volatile. It is hard to guess growth rates in the NGDP level graph.