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The Atlanta Fed's macroblog provides commentary on economic topics including monetary policy, macroeconomic developments, financial issues and Southeast regional trends.

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January 18, 2013


Still a Skeptic: Addressing a Few Questions about Nominal GDP Targeting

In a comment to last week's post on inflation versus price-level targeting, David Beckworth asks the following (referring back to an even earlier post on nominal gross domestic product [NGDP] targeting):

You refer back to your previous post on NGDP level targeting, but fail to take note of the comments that respond to your concerns about it. Specifically, see the ones by Andy Harless and Gregor Bush. Would love to see your response to those ones. Do you have a response for them? I am listening if you have one.

Here is an excerpt from the Harless comment...

Most people who advocate NGDP targeting today advocate level path targeting, not growth rate targeting. I don't believe that your "historical justification" applies in this case. Indeed, I think it makes the case for level targeting (of either the price level or NGDP, but there are reasons to prefer the latter) relative to the current system which centers on a growth rate target for the price level (in other words, an inflation target).

...and here is the Bush comment:

Just to add to Andy's point, advocates of NGDP level targeting argue that it's precisely because of uncertainty around estimates [of] potential output [that] NGDP targeting should be adopted. They argue that [as] long as the central bank keeps nominal spending on, say, a 5% trend line, there will be neither demand side recessions (mass unemployment) nor high inflation. In other words, AD will be stable and this will produce a stable macroeconomic environment. Whether inflation is 2% and real output [grows] at 3% or inflation is 3% and real output grows at 2% is of no concern.

In the post on NGDP targeting I was in fact thinking about level targeting, and Gregor Bush's last sentence gets to—in fact is—the heart of our disagreement. I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy:

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate...

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision.

This excerpt does not imply, of course, that the Fed need slavishly pursue a numerical inflation target in the shorter run and, as I have pointed out before, in his last press conference Chairman Bernanke explicitly indicated that the FOMC does not intend to do so:

The Committee... intends to look through purely transitory fluctuations in inflation, such as those induced by short-term variations in the prices of internationally traded commodities, and to focus instead on the underlying inflation trend.

My price-level targeting post, co-authored with Mike Bryan, was exactly making the point that, over the past couple of decades, the FOMC has essentially delivered on a 2 percent longer-term price-level growth objective, while accepting plenty of shorter-term variability.

In the end, it is an open question whether credibility in delivering price stability, hard won in the '80s and early '90s, could be sustained if the FOMC says it does not care so much about the exact level of the average rate of inflation, even in the long run. To be truthful, I can't give you an answer to that question. But neither can the proponents of NGDP targeting. I just don't feel that this is an opportune time for an experiment.

Update: Scott Sumner responds.

Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

 

January 18, 2013 in Federal Reserve and Monetary Policy, GDP, Monetary Policy | Permalink

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Comments

"I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy:..."

Presumably the damning part of the FOMC statement is the following portion:

"...The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision..."

This might be relevant if nominal GDP (NGDP) level targeting were indeed "specifying a fixed goal for employment." But NGDP level targeting is not specifying a fixed goal for employment. Rather it is specifying a fixed goal for NGDP.

The only thing that the Fed can reliably target are nominal variables, such as inflation and NGDP.

But one very significant problem with targeting inflation is that it is a totally artificial construct requiring that we come up with an estimate of the extraordinary abstraction known as the "aggregate price level." To see how preposterous this is imagine equating the aggregate price level between what it is now and what it was in say 14th century England. The goods and services are so different it requires the complete suspension of one's disbelief.

Inflation is the difference between NGDP and real GDP (RGDP), meaning inflation is nothing more than the estimated residual between a nominal variable, which is relatively straight forward to measure, and a real variable, which is fundamentally an exercise in crude approximation.

In short, this is precisely backwards.

Posted by: Mark A. Sadowski | January 19, 2013 at 12:42 PM

Thanks David,
I appreciate your response. I have to disagree with this statement though:

“I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy.”

I don’t think that’s correct. It’s true that monetary policy can’t target real variables in the long run. But it can certainly target any nominal variable that it wants to. The Hong Kong Monetary authority has targeted an exchange rate of 7.75 HKD per USD for almost 30 years and it has been completely successful in doing so. Inflation over that period of time has fluctuated substantially, reaching a high of +12% in 1991 to a low of -6% in 1999. Over that 30 year period, Hong Kong inflation has averaged about 1.3 percentage points above US inflation. Does all of this mean that the HKMA has no credibility? Of course not. It has been and continues to be completely credible with respect to the chosen target. Now, we could argue whether Hong Kong might be better severed if it targeted 2% CPI inflation rather than the nominal USD exchange rate (I think it would be). But that’s an argument over which comes closer to the socially optimal target, not over which target would give the central bank more credibility.

We could make a similar argue with the Bank of England successfully targeting the nominal price of gold in the 1871 to the 1914 period. So I see no reason why the Fed couldn’t target nominal GDP and be completely credible with respect to its NGDP target. If Congress instructed the Fed to switch to an NGDP level target would you bet against the FOMC hitting it?

“I just don't feel that this is an opportune time for an experiment.”

Here again, I disagree. I think it’s an excellent time. The only better time would have been January of 2009. The performance of the economy over the past 5 years has been an unmitigated disaster. And the “hard won battles” of the early 1980s and 1990s weren’t enough to prevent it. It turns out that anchoring inflation expectations at 2% is not enough to prevent a massive and sustained shortfall in aggregate demand. In 2007, I thought that a 2% inflation target ruled out the possibility of a recession of this magnitude. But I was wrong.

Posted by: Gregor Bush | January 21, 2013 at 04:56 PM

Thanks David for taking the time to reply. I have been meaning to respond, but as you note Scott already has. I would also encourage you to take a look at Scott's piece in the FT Alphaville where he engages in a similar discussion:

http://ftalphaville.ft.com/2013/01/24/1353932/guest-post-scott-sumner-responds-on-ngdp-level-targeting/

Also, see Bill Woolsey's response to Charles Goodhart's NGDPLT critique:

http://monetaryfreedom-billwoolsey.blogspot.com/2013/01/goodhart-on-ngdplt.html

Posted by: David Beckworth | January 24, 2013 at 10:22 AM

I am fully convinced that the Fed policy and tac is incorrect. 0% interest rates and continuous monetization of the debt through QE is not getting us anywhere.

There are opportunity costs as well.

I realize the fiscal policy which the Fed doesn't control isn't optimum either. But, the Fed ought to let the charade stop.

Posted by: Jeff Carter | January 30, 2013 at 10:13 PM

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