A Simple Question about NGDP Targeting
by Mike Kimel
A Simple Question about NGDP Targeting
It seems that a big part of the econosphere these days talks about NGDP targeting. Translating this into English, a number of economists believe the Fed should be adjusting monetary policy to achieve a desired level of nominal GDP in any given year. To be very precise, both the economese and the English should be adjusted slightly to explain what is really meant: the Fed should be adjusting monetary policy to achieve a given desired rate of nominal GDP in any given year
To me there are two very obvious problems with this. The first should be evident to anyone who ever spent time in South America in the 1970s or 1980s, or has so much as heard of, say, Zimbabwe or the Weimar Republic: why should the Fed or anyone else care about nominal growth rates? Nominal figures are useful for Sowellizing, which apparently can be very profitable, but in the end, only inflation adjusted figures tells us whether we’re better off or not.
But there is a second problem, and the easiest way to state it is by analogy. Think of the Fed as the quarterback on an American football team. I don’t much like American football, but it is evident that the goal of a quarterback is not to throw a specific number of completed passes, or even to get certain score the board. The goal is to do what it takes to win the game. Getting 28 points doesn’t help you if the other team walks away with 35. On the other hand, 28 to 21 achieves the quarterback’s goal nicely. (And of course, whether 28 points looks impressive or not depends on a number things, including the condition of your teammates and the other team’s defense.) For a good quarterback, winning the game sometimes means mostly staying out of the way, while at other times it means taking charge. But specific measurable numbers mean nothing in the end.
Now, the Fed has a dual mandate (imposed by law): set policy to maximize employment and keep prices stable. Of course, the two goals conflict to some extent. Stable prices means keeping inflation rates at about zero, which nobody advocates as it would generate slow economic growth (and thus low levels of employment). Maximizing employment could be accomplishing economic growth rates, but the Fed often tries to slow down growth rates in order to prevent the onset of inflation.
The Fed is left with something that loosely translates as this: “try to get the economy to grow as quickly as possible without setting off too much inflation.” It accomplishes that goal to a greater or lesser extent at different times.
But given the number of moving parts out there, that seems to be a much easier, and much more logical approach than saying: let’s shoot for a 3% increase in nominal GDP this year.
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Lest this post be seen as a defense of the way the Fed does its job, I should note: I personally think the Fed has been doing a very poor job for quite a while, and some of my earliest posts are criticisms of the Fed. I’m especially horrified by the Fed’s approach to the economic mess we’re in – as I’ve been noting since 2008, ensuring that institutions with insane and harmful business models survive to engage in more spectacularly bad behavior is no way to help the economy, and that is true whether one has NGDP targets or not.
The fed in the US and the ECB are part of the Big Lies.
The fed has proven good at encouraging usury [with arbitrage], and keeping insolvent zombies alive with cheap liquidity (QE non job producing flirting with inflation…………………………..
Those objects do not relate to keeping price levels stable nor “full employment”.
ilsm,
I agree with your sentiment but with respect, I am uncomfortable with the term “Big Lie.” The Fed has a certain mandate, plus it deals mostly with the member banks. That virtually guarantees it becomes an object of the banks. But there is no concerted effort to lie or bamboozle. The economy is made up of a bunch of individual players. People who work for banks want to do what is in the best interest of their employer. Nobody is out there saying to themselves, “I’m a villain and my goal is to screw eveeryone else” which I think is an implication of a term like “Big Lie.”
Leaving aside that, I mostly agree with yoou. I think the Fed does allow arbitrage (and not just in the current times – the way it flat out tells the primary dealers what it plans to the Primary Dealers seems to me to be one heck of a subsidy at the expense of the public), and as you note, keeping the zombie banks alive isn’t helping. They do not keep prices stable or help with employment. I would argue they actually hinder employment.
I don’t know, but sometimes I wonder if people feel nominal more immediately, whereas inflation is a little slower to be noticed.
The nominal economy expanded nicely after WWII, wheras inflation adjusted not so much. But did people “feel” they were falling behind or mobving ahead?
1. Real GDP matters much more than nominal GDP (inflation per se does matter a bit). But real GDP is a target the Fed can’t hit. Given (approximate) long run neutrality, the only target the Fed can actually hit (on average, over time) is a target measured in $.
2. You lost me a bit here. But if someone asks what does “try to get the economy to grow as quickly as possible without setting off too much inflation.” really mean in practice, so we know what to expect?, then “target 5% NGDP” might be a good answer.
Mcwop,
I can’t speak for the post WW2 experience, but I get the feeling that people notice the “real” world more than economic constructs such as nominal GDP. For instance, technically we’re not in a recession, but most Americans feel we are in something very similar regardless of the definition. (I’m sensitive to this one – I wrote about the start of it in March of 08, and in Dcember I wrote about it ending in the first half of 2009 – all techncially correct, but in retrospect, so what? Not much really changed.)
In Brazil in, say, 1983 (and this I can speak about) nobody was saying – well, I got a double digit raise this month, woo-hoo, I’m rich. They might not know the precise inflation rate, but they know its there. And most Americans have a pretty good idea of what interest rates are too. People getting a 3% raise now are much happier than people getting a 3% raise in 1998.
As an example – you may recall that in Dec 2008 I mentioned the recession would end in the first half of 2009. I was right… but its not something I can make
imagine you know that scott sumner and david beckworth have advocated NGDP targeting for at least a few years, but it didnt become the latest blog fad till a goldman economic note recommended it in mid-october…
if anyone wants more background, links to that goldman note & about 2 dozen other posts on it are near the beginning of this oct 22 blogpost, right after the links to that weeks Fed news…
Nick,
As I said, I wouldn’t have picked an actual GDP level, whether real or nominal. Picking a growth rate (real) makes more sense, but I still don’t see the benefit of a target per se. Give me faster real growth – as fast as we can get without letting inflation get too high. (Want to target something – target inflation. Give me all the growth you can get for whatever level of inflation we can tolerate.)
Targeting a 5% growth in NGDP doesn’t tell us whether you’re going to set off inflation or not.
Nick,
As I said, I wouldn’t have picked an actual GDP level, whether real or nominal. Picking a growth rate (real) makes more sense, but I still don’t see the benefit of a target per se. Give me faster real growth – as fast as we can get without letting inflation get too high. (Want to target something – target inflation. Give me all the growth you can get for whatever level of inflation we can tolerate.)
Targeting a 5% growth in NGDP doesn’t tell us whether you’re going to set off inflation or not. Between now and next year (or next quarter) prices can start to move. You can get to your NGDP level for precisely the wrong reason (prices changed, real output didn’t) and declare victory (and that’s assuming you have some idea what GDP will look like).
Thanks rjs.
mike
i’m not so sure they don’t know they are villains. they have to have some idea of the effect of their policies, and if they choose to maximize their own (employer’s) interests to the harm of everyone else, that is villany.
personally i like to reserve Big Lie for the Peterson campaign against Social Security, because I can identify specific lies and show very deliberate deceptions. But now that Peterson has succeeded and the Democrats are doing his work for him, it won’t be necessary for him to keep spending all that money to fool us. So maybe I can let ilsm use the term to describe his own understanding of how the powers deceive the people to their hurt.
as you note, the Fed has a dual mandate. that implies a need for some sort of judgement… balancing inflation against growth.
that is a hugely different concept than picking a number at shooting at it in the dark.
I admit that I’m not an expert on NGDP as the idea is fairly new to me but what seems claer is the current paradign “try to get the economy to grow as quickly as possible without setting off too much inflation.” isn’t working too well as the inlfaton mandate is driving the bus. In the 90s it was believed that unemployment under 6 percent was unacceptable-that was the believed Nairu rate of the time.
As there is a dual mandate-and in this say what you will about the Fed it is better than in Euro[e where price stablity is the sole mandate-NGDP might be a better way to target both objhectives that at least can conlfict at the same time.
As I understand Sumner he’ claims that what is desired is less “price stability” than “nonminal stability” If the Fed simply targeted real GDP there would no way to deal with the inflation side of the mandate.
Pleaee see my piece on Cuomo’s tax hikes on the rich and the WSJ’s apocalyptic response.
Cheers
oops http://diaryofarepublicanhater.blogspot.com/2011/12/wall-street-journals-economic-fiction.html
coberly,
I think the post makes clear I don’t see the point of a target. But that said, I imagine if the Fed decided to target NGDP at some point, they would not be picking the number blindly. Somewhere along the way they’d decide… well, we can as high as X without having inflation of Y.
And no, I don’t think people think of themselves as villains. Even a guy like, say, Thomas Sowell (follow the link in the post) doesn’t think what he’s doing is “lying” or dishonest. They merely justify in their heads what they want to do. Different people can justify more… and being able to justify more is lucrative.
rjs,
That’s an extensive set of links!
I don’t really know David Beckworth. I’ve had some online correspondence with Sumner, and I think he and I see the world in a very, very different way… as in I see black exactly where he sees white, and vice versa. There isn’t enough common ground between our viewpoints for the two of us to be both sane and honest. That said, I can follow his thought process most of the time (even if it causes me scratch my head an awful lot), and I trust he’s honest (which is more faith than I put in, say, Hubbard, Mankiw or Barro to name three).
I know Sumner has been pushing this for a long time. The main selling point (it comes right at the top here: http://www.adamsmith.org/sites/default/files/resources/ASI_NGDP_WEB.pdf) seems to be that if you target ngdp, you are targeting both inflation and jobs. But here’s a prime example of him seeing black and me seeing white – I don’t see it. I don’t see that you’re targeting either one well. To me its like saying that if you pick output, you are also selecting demand and price.
Mike Sax,
“isn’t working too well as the inlfaton mandate is driving the bus. “
Absolutely correct. I should have mentioned this in the post. There is a difference between what people believe they should do, and what they feel is vitally important to put in first place right now. Fear of inflation is definitely driving.
On this question of why not GDP mike Sumner gives his reason here-my idea here agrees with what he said that if you target GDP by itself then you have no ability to also target inflation.
http://pragcap.com/scott-sumner-on-ngdp-targeting
and yet in your answer below to rjs you don’t seem so sure about the honesty of some…
i have dealt with pathological liars and i know they convince themselves that what they say is the “real” truth…
but i have also dealt with cynical liars… remember Enron’s folk lauging about aunt millies electric bill..
at the end of the day it isn’t worth trying to tell them apart.
whether they cogitate before they set a target… inflation or GDP.. it doesn’t matter. it’s the same mistake people make with SS… used to make… you can’t set a target like a guided missile, you actually have to drive down the road and turn when the road turns and avoid the ditch on the right and the oncoming traffic on the left
and you need something better than a number…”most Americans feel… most Americans have a pretty good idea…” as someone once said. We can tell when it’s not right, whatever the numbers say.
There are plenty of people who are dishonest, but they don’t think of themselves as villains.
like i said, trying to tell whether you are dealing with psychopathic evil or cynical evil becomes at some point not worth the effort.
Hmmm. The fact is I don’t even think the Fed *can* control NGDP. I mean, we’ve had global QE1, QE2, operation twist and a host of other liquidity measures and NGDP is still low. Sumner’s argument seems to rest on the idea of expectations – if the Fed announce they are targeting NGDP, then people will expect it to be high and it will be. This seems akin to the confidence fairy to me – I mean the average person doesn’t even know what a Central Bank does or what nominal GDP is, and even if they did would they adjust their spending based on its policy targets? I think we’;re entering cuckoo land.