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Monetary policy

Momentum building for NGDP targeting

Oct 17th 2011, 19:33 by R.A. | WASHINGTON

AS AN avowed enthusiast for the idea of changing central banks' goals to nominal GDP targeting, I would be remiss in not calling attention to a new Goldman Sachs research note produced by Jan Hatzius and Sven Jari Stehn. I'm unable to link, unfortunately, but the authors argue that NGDP targeting is consistent with the Fed's dual mandate and if implemented credibly would improve economic performance.

The note includes an analysis of the policy, the outcome of which you can see at right (H/T Matt Yglesias). The authors make an argument I've voiced here at Free exchange: that the announcement of an explicit target is likely to substantially increase the potency of asset purchases (similarly, asset purchases increase the credibility of the target announcement). In their simulation, unemployment falls rapidly when asset purchases are combined with an NGDP target, while inflation remains well under control.

Unfortunately, the Fed is unlikely to move quickly to adopt the policy, for a couple of reasons, both related to the central bank's conservatism. The Federal Open Market Committee will be reluctant to change policy goals, and when and if it decides that an NGDP target is the better policy it will be reluctant to make a quick change. It seems more likely to me that over the next couple of years, Fed policy is likely to ever more closely approximate an NGDP target.

While that's fine for long-run policymaking, it will make for disappointing results in the short to medium-term. Even under Goldman's sunny esimate of the impact of NGDP targeting, unemployment remains above 6% for the next 2.5 years or so. So it goes; the lessons learned in major crises are primarily of benefit to the people who live through the ones that come later.

Readers' comments

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Eduardo Weisz

I HAVE READ YOURS AND YGLESIAS ARTICULES AND DID NOT UNDERSTAND: ARE YOU TALKING ABOUT A SHORT RUN SOLUTION OR ABOUT ESTABLISHING A NEW TARGET IN MONETARY POLICY?

I MEAN IF THE IDEA IS TO BUST ACTIVITY THROUGH MORE INFLATION, THE YESTERDAY'S INFLATION WILL BE THE THE FLOOR FOR TODAY'S INFLATION. IF THIS IS CORRECT, INFLATION WILL NECESSARILY SPIRALIZE. IS IT CORRECT TO SAY THAT THIS WILL NECESSARILY MEANS THAT AFTER A WHILE WE WILL BE IN A HYPERINFLATION ECONOMIC ENVIRONMENT? IS IT CORRECT TO SAY THAT WE WILL NEED AN ANCHOR TO INFLATION? ISN'T ANY ANCHOR TO INFLATION A WAY OF MANIPULATING ALL THE OTHER ECONOMIC VARIABLES IN ORDER TO REACH A PRE-DETERMINED LEVEL OF INFLATION? ISN'T IT CALLED INFLATION TARGETING?

WOULD YOU MIND IF I ASK YOU A FAVOUR? WHAT GOING A LITTLE DEEPER IN THE SUBJECT? I BELIEVE THAT THERE ARE OTHER READERS THAT DID NO UNDERSTOOD WHAT ARE YOU ACTUALY TALKING ABOUT.

THANKS

Gordon L

Does a central bank really have that much influence over growth? Surely government policy elsewhere can strengthen or strangle growth regardless of central bank action.

What would be the response to the stagflation -high inflation and zero growth- that took place during the late Seventies?

Doug Pascover

I like the last sentence but agree with Bampbs. Plus as soon NGDP targeting results in 8% unemployment, we'll be reading about how the timid FED refuses to get out of it's NGDP targeting box and do something courageous.

hedgefundguy

Alwats good to hear GS telling others how to spend their money - this time it's what to buy after printing it.
(The Republicans would love this as a weapon.)

QE1 starts - the market goes up.
QE1 ends - the market goes down, more calls for QE.

QE2 starts - the market goes up.
QE2 ends - the market goes down, more calls for QE.

Do we see a pattern here?

We have cellular crack - cell phones
Cardboard crack - instant bingo
Cable crack - cable TV
Monetary crack?

Regards

rollswrangler

How do we unwind problems that began with over-deregulation in the early 1970s with a simple Fed "tweak"? This suggests that the Fed can finesse the situation. Isn't the Fed completely tapped out?

fTqCtuzB2B

According to the second graph, we're going to see 1% inflation for a substantial amount of time. If that's not a economic disaster, I don't know what is.

bampbs

"So it goes; the lessons learned in major crises are primarily of benefit to the people who live through the ones that come later."

But not too much later. By the time a generation or two has passed, the damned fools in charge will have forgotten everything, or will believe that none of it applies to them, anyway.

Cthorm

@ShaunP

Nominal GDP targeting, as described by Scott Sumner, would work through a futures market. The Fed would target some level of NGDP growth (say a constant 4%), effectively setting a target price for that future contract. If prices continue to be depressed below a level consistent with 4% NGDP growth, the Fed can respond by increasing inflation by the shortfall. Conversely, if prices continue to reflect NGDP growth above 4% (say, 6%) then the Fed would bring about 2% deflation.

ShaunP

I apologize, but could someone please explain the mechanics of targeting Nominal GDP. If it is done via asset purchases then how is that any different than QE? Would they just change the types of assets they buy?

I am completely lost on how they would go about targeting NGDP.

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