Scott Sumner  

NGDP targeting is not "easy money"

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One of the many frustrations that I face in advocating NGDP targeting is the misconception that this policy regime is more "expansionary" than inflation targeting. In fact, the two are identical in the long run, and in the short run each of the two will be more expansionary about 50% of the time and more contractionary about 50% of the time. The misconception probably came about from the fact that market monetarism first became known around 2008-09, when NGDP targeting was the more expansionary option.

Tracy Wilkinson sent me a very nice article by Christina Leung and Kirdan Lees, discussing the advantages of NGDP targeting for New Zealand:

Right now the gap between inflation and nominal income growth is pretty big and growing, yielding materially different interest rates settings depending on the underlying framework.

Our current inflation targeting framework says lower interest rates are required to hit a two percent target while a nominal GDP target would suggest interest rates are about right.

If the current low inflation environment persists for much longer it is difficult to justify the extended period of inflation away from target as temporary factors. Either rates need to be lower or the inflation target is undermined.

In contrast, nominal GDP targeting seems like an increasingly sensible framework for setting monetary policy delivering a better mix of inflation and GDP growth.

At the very least, there are appealing options should inflation targeting run out of steam.

Thus at this particular moment in time, NGDP targeting calls for a tighter monetary policy stance than inflation targeting. (Perhaps due to the recent plunge in commodity prices, especially oil.)

As far as I recall, back in the 1980s most advocates of NGDP targeting were right of center (although not all.) In recent years it's been the opposite (at least among elite macroeconomists, not including market monetarists.) This is unfortunate. It should not be viewed as a hawk vs. dove issue; this is a technical problem---which government (fiat) monetary policy minimizes distortions in a market economy? Which monetary policy is least likely to lead to an unstable economy, giving the public the (false) idea that there is something wrong with free market capitalism? Both liberals and conservatives should be opposed to destabilizing monetary policy.

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COMMENTS (6 to date)
James writes:

Doesn't this all depend on the targets?

If the central bank targets a NGDP growth rate of 5% and the RGDP grows at an average rate of 3%, then NGDP targeting is no more expansionary or contrationary than a 2% inflation target. If RGDP grows at an average rate of 6%, and the central bank targets NGDP growth of 5%, then monetary policy will be contractionary.

ThomasH writes:

If (and it is a big "if") the Fed really targeted NGDP level, that is likely to be more expansionary ("inflationary") that "inflation targeting" where the inflation target is subject to a ceiling. It is a mistake to term what the Fed has done since 2008 "inflation targeting." You are not really targeting inflation if you miss only in one direction.

Indeed, the main advantage I see to NGDP targeting is that it is easier during a recession for the Fed to explain that it is trying to raise NGDP than to explain that it is trying to raise inflation, even though the instruments it would use (massive purchases of longer term government securities, or non-government securities, or foreign exchange, or negative rates on reserves) would be the same.

Michael Reddell writes:

Here was my response to Lees/Leung, making the point that an NGDP target for NZ would not at present actually argue for relatively tighter policy than inflation targeting would (as well as some other critiques). I agree that this should be seen as a technical issue, rather than a ideological one, but on that point I had been under the impression you did not regard NGDP targeting as appropriate for a commodity-exporting economy.

bill writes:

Great post.

Brian Donohue writes:

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Scott Sumner writes:

James, Yes, it entirely depends on the target, moving to NGDP targeting in and of itself has no implications for the stance of policy, in either the expansionary or contractionary direction.

Thomas, You said:

"If (and it is a big "if") the Fed really targeted NGDP level, that is likely to be more expansionary ("inflationary") that "inflation targeting" where the inflation target is subject to a ceiling."

No, that's not true. It depends on where you set the NGDP target. No one should ever support NGDP targeting on the grounds that it would be more expansionary than IT in the long run.

"It is a mistake to term what the Fed has done since 2008 "inflation targeting." You are not really targeting inflation if you miss only in one direction."

You need to distinguish between missing the target and having a different target. I see no sign that the Fed has changed its target. Maybe they have, but the current low rate doesn't prove that. There were similar misses in the 1990s and 2000s.

Michael, Yes, I've argued that NGDP targeting may be inferior to total labor comp. targeting for a commodity intensive exporter. I don't know enough about NZ to know how NGDPLT would work out. I suspect it would be OK, but not optimal.

Thanks Bill and Brian.

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