Nominal GDP (NGDP) Targeting19 October, 2011, 4:22. Posted by Zarathustra
Ben Bernanke was speaking. He did not seem to speak anything explosive. With conventional monetary policy tools running out, the Fed now has limited options.
Thus Ben Bernanke has emphasised that the Fed might be relying more on communication on future policy
An evolving consensus holds that central banks can dedicate separate toolkits to achieving their financial stability and macroeconomic objectives, but this consensus must be viewed as provisional. Certainly, those toolkits appear to be much better stocked today than before the crisis: monetary policy tools that can be brought to bear if necessary include the management of the central bank’s balance sheet and, to a greater extent than in the past, communication about future policies. Financial stability policy encompasses, as the first line of defense at least, a range of microprudential and macroprudential tools, both structural and varying over the cycle, supported by enhanced monitoring and analysis of potential risks to systemic stability. Clearly, understanding and applying the lessons of the crisis will take some time yet; both theorists and practitioners of central banking have their work cut out for them.
Scott Sumner does make some very good points here I think. In particular, he points out that monetary policy in the second half of 2008, and particularly after Lehman Brothers collapsed was actually tight. The reason why it is tight is that as asset markets collapsed and people deleveraging, we know that there would have been a shortage of US dollar as people needed to sell assets and obtain US dollar to paid off their debts with nothing but US dollar as their debts are denominated in that currency. As a result of that, monetary condition was actually very tight, and the demand for the dollar drove US dollar exchange rate way up. And for that matter, I have pointed out that the same might be happening with the Euro, and that’s why the Euro has actually been holding up stronger than many people would have expected. Thus despite interest rates cut, the true monetary condition was not really under the control by the Federal Reserve. Should the Fed recognised this, he argued, the monetary easing could have been even more aggressive and probably ealier.
In his paper on NGDP targeting, he wrote:
Nominal GDP targeting provides a way to address both inflation and output stability, without placing the central bank in the confusing situation of having to aim at two separate targets. Consider a country where the trend rate of output growth is roughly 2.5%. A 4% NGDP target would insure a long run rate of inflation of roughly 1.5%, with modest short term variation in response to real economic shocks, such as a sharp increase in energy prices. For instance, suppose oil prices rose sharply. Under strict inflation targeting, non-oil prices would have to fall to offset the increase in oil prices. If nominal wages are sticky, the fall in non-energy prices might lead to much higher unemployment. In contrast, NGDP targeting would allow a temporary period of above 1.5% inflation, along with somewhat lower output, in order to cushion the blow on the non-oil sectors of the economy.
The preceding example might make NGDP targeting seem less “hawkish” than inflation targeting, a backdoor method of allowing excessive inflation. Yet the argument is completely symmetrical. George Selgin pointed out that NGDP targeting would produce lower than normal inflation during a productivity boom. One of the criticisms of inflation targeting is that because central banks focus on consumer prices, they allow asset bubbles to form, which eventually destabilize the economy. Nominal GDP targeting cannot completely eliminate this problem, but it would impose more monetary restraint (as compared to inflation targeting) during periods where output growth was above normal. Indeed Friedrich Hayek advocated nominal income targeting for exactly that reason, to prevent “malinvestment” during productivity booms.
This sounds nice. There are just a few problems that I have with it. First of all, he proposed an NGDP futures market, so that by assuming efficient market hypothesis, he thinks policymakers can get real-time data on what the market is thinking about where the economy is going, and react accordingly. Now even though everyone in the market routinely make inferences about the economy through various asset prices, I think we actually know that these prices information could be wrong because the market is really not efficient (and since we haven’t yet got any NGDP futures market, I think policymakers can consider targeting Bloomberg Consensus estimate of NGDP instead?).
Second, I hesitate to think that the best thing to do right now is to throw even more monetary stimulus. The US is in such a situation where fiscal stimulus is almost impossible in such a political climate, while Republican presidential candidates are quite keen to kick Ben Bernanke out. Unless Ben Bernanke isn’t worried about his job, it is probably hard to fire-up even more massive stimulus. Even if it can, I wonder if monetary policy alone can really raise NGDP growth, and if it can’t (as I suspected), that would just be trying to create an illusion that the Fed is stimulating the economy, while it isn’t (that’s the key reason I joked about Operation Twist as Operation Illusion). Of course, the Economist has also pointed out that it is probably not possible even in the near-term because of possible opposition within the Fed.
On the whole, this could be an interesting idea that seems to be worth considering, although it is not quite so clear to me (at this moment in time by the way) that it can really work, and that we can see that happening soon.
Update a day later: With more thoughts, I now don’t think it really works. NGDP targeting is just a policy target, but ultimately central banks can only put in money to stimulate the economy in hope to reach the target. At the current environment, money created by the Federal Reserve only sits on banks as excess reserve but not lending. That is useless in stimulating the economy as the money are not going into people’s hand as saving, and without credit, you are not really creating money via the banking system. You can announce whatever NGDP growth target you like, but I struggle to think of more monetary policy tools that can really get the money creation in the system going. If so, you can communicate whatever target you like and still not getting it no matter how hard to are pumping money it.
Yes, I was being a little bit too kind to the idea at my first glance. I think this will surely go down as an Operation Illusion.