Understanding NGDP targeting

NOMINAL GDP targeting is not a new idea. It has an intellectual pedigree that goes back well before the crisis, but even if we just focus on the recent debate over changing Fed policy to targeting growth in the level of nominal output, we're talking about nearly 3 years' worth of public discussion. Scott Sumner started his blog in early 2009, was linked by Tyler Cowen just a few weeks later, and had the economics blogsphere debating intensely by the end of that year. It has taken a while for non-economist elites to notice, but the debate has been bubbling for a while. Neither has the American debate proceeded in isolation. Central banks pay varying amounts of attention to the path of nominal output, and some—among them the Bank of England—put quite a lot of weight on NGDP. But Kevin Drum writes that it's important to get the NGDP debate out in the open. I suppose that's right; I just figured that's what we'd all been doing for the past 30 months.The trigger for Mr Drum's post was a recent Wall Street Journal op-ed which purported to call into question claims made on an NGDP target's behalf. What it mainly demonstrated was that quite a lot of journalists haven't paid attention to the debate over NGDP targeting. I supose that's to be expected. Those who have simply must do a better job explaining the contours of that debate to others. Now is as good a time as any for me to do a little of that explaining. Mr Drum writes:Matt [Yglesias] is right that one of the theoretical virtues of NGDP targeting is that it combines both employment and inflation into a single metric, which would make this question moot for policymakers, but it unquestionably does imply that during recessions the Fed would tolerate higher inflation. I think that's a good thing (as does Matt); [WSJ writer Evans doesn't]. But it's certainly a key issue that deserves plenty of public discussion.Let's slow down here. Does an NGDP target imply greater inflation in recessions? Were the Fed to adopt an NGDP level target right now, most supporters of the policy would recommend that the Fed allow for a period of "catch-up", during which the economy would expand at an above-trend rate in order to make up some of the ground lost during the recession. This isn't a feature unique to NGDP targeting; advocates of price-level targeting would call for something similar. During a period of catch-up, inflation would probably run above the desired rate, as would real output growth. This actually isn't even inconsistent with an inflation-rate target. A central bank actually targeting an inflation rate should react to deviations above and below target similarly, suggesting that the Fed should be no more aggressive in fighting above-normal inflation than it was in fighting below-normal inflation; 2% on average is good enough. A period of catch-up NGDP growth and inflation is really only inconsistent with a policy of steady opportunistic disinflation or, to the extent that the two are different, of central bank incompetence. One way of understanding the push for an NGDP target, I think, is as a means to get the central bank to take its mandate more seriously.read more