Scott Sumner  

Nominal GDP targeting in developing countries

Greenhouse Gases... Never reason from a bond price...

Commenters Patrick Sullivan and gofx directed me to a post on NGDP targeting in developing countries, by Pranjul Bhandari and Jeffrey Frankel:

Targeting Nominal GDP has been proposed in the context of major industrialised countries. (Frankel, 2012, gives other references to the literature.) But a good case can be made that the idea is in fact more applicable to countries further down the income ladder. The reason is that emerging market and developing countries tend to experience bigger terms of trade shocks and supply shocks than industrialised countries do. NGDP targets are robust with respect to precisely these kinds of shocks.

I've argued that NGDP targeting is less likely to be optimal for developing countries than developed countries. Does that mean I disagree with Bhandari and Frankel? Not entirely. I think they are right that developing countries are more prone to supply shocks, and that NGDP targeting is superior to inflation targeting when there are supply shocks. In that case the gain from switching from inflation targeting to NGDP targeting might well be larger for developing countries.

However I've also argued that NGDP targeting is not optimal when countries depend heavily on the production of commodities with very volatile prices. Suppose 50% of Kuwait's NGDP were oil production. If global oil prices doubled, and Kuwaiti oil output remained unchanged in physical terms, then the central bank of Kuwait would have to reduce non-oil production to zero in order to keep NGDP stable. Obviously that would not be optimal.

My hunch is that the optimal monetary policy target is something slightly different from NGDP, perhaps total labor compensation. If nominal hourly wages are sticky, then targeting total nominal labor compensation will tend to minimize employment volatility, while still keeping inflation low on average.

For a big diversified economy like the US, Japan, or the eurozone, there isn't much difference between targeting NGDP and targeting nominal aggregate labor compensation. Indeed that may also be true of large developing countries like China (and increasingly true of India, as agriculture declines as a share of GDP.) But for a country like Kuwait the two series might diverge sharply. In that case, target total labor compensation. One implication of this claim is that Australia might want to let NGDP growth slow slightly if the mining boom peters out.

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COMMENTS (8 to date)
ThomasH writes:

Seems like inflation targeting excluding the volatile tradable good would work as well. Plus, the monetary authority would have to have the credibility that it actually WOULD prevent inflation from falling below target which might imply buying things other than just short term government debt.

Scott Sumner writes:

Thomas, Removing volatile commodity prices might improve IT, but it would still be inferior to NGDP targeting. Inflation measures are distorted by lots of other factors, such as the cost of housing (measured by rental equivalent.)

Whether or not the central bank needs to go beyond short term debt and buy long term government debt, or other assets, depends on the size of the debt, whether the central bank does level or growth rate targeting, and also the trend rate of NGDP growth that is chosen.

Kenneth Duda writes:

Scott, it strikes me that targeting total nominal labor compensation might be a very good way to help pitch MM. NGDPLT might cause more inflation than the Taylor rule (particularly at the ZLB). This is problematic because many consumers dislike inflation (as they focus on retail prices instead of on their own incomes and the reduction of the real value of debt). Positioning MM as a way to guarantee regular increases in their (nominal) incomes might be an easier sell. So, perhaps we should push targeting total labor income instead of pushing NGDPLT.

You've argued in the past that it's not consumers we need to convince to give MM a chance in the real world, but rather, we need a consensus of professional economists behind MM, as the Fed generally follows the professional consensus. But it doesn't seem to me that a professional consensus exists, and with the number of nuts posing as professional economists, I'm not optimistic of a professional endorsement for MM any time soon, so I continue to wonder about other channels for action here.


Kenneth Duda
Menlo Park, CA

Garrett writes:

I suppose it'd make sense to account for changes in the labor force too, so level targeting of the average nominal wage in the labor force would be theoretically optimal. Would this be the best way to implement Market Monetarist macro policy in countries with a shrinking labor force?

Scott Sumner writes:

Ken, You may be right about the politics of targeting national income. However I'm not too worried about the "nuts"--the Fed pays no attention to them.

Garrett, Yes, per capita NGDP, or per capita total labor compensation, is probably better.

Edogg writes:

Garrett and Scott,

Would it be theoretically better to account for the type of workers entering and exiting the labor force? Because more people in the labor force making low wages would lower the average. (I know that's not the most revolutionary of insights.) Am I understanding you correctly that you want monetary policy to not respond to that effect?

I don't know what would be better. Target the total or average nominal labor compensation of those who were in the labor force and stayed in the labor force? But then you can't level target...

Scott Sumner writes:

Edogg, Yes, members just entering earn less, but those already in see their relative wages rise, that is they increase faster than the aggregate wage level.

Arthur writes:
"Suppose 50% of Kuwait's NGDP were oil production. If global oil prices doubled, and Kuwaiti oil output remained unchanged in physical terms, then the central bank of Kuwait would have to reduce non-oil production to zero in order to keep NGDP stable. Obviously that would not be optimal."

This is simply wrong. You're forgeting about exchange rates.

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