NGDP targeting has been catching on across the blogosphere, and, to a more limited extent, in the mainstream. So far, it appears to be the best response to the crisis that mainstream economists can come up with. However, I remain unconvinced – the whole thing, to me, appears to beg a lot of questions.
The rationale for NGDP targeting is roughly as follows: macroeconomic policy can only reliably influence the nominal; the distribution between real income and inflation is determined partly by long run supply-side factors and is partially out of our control. Hence, if we keep nominal spending constant then we will know there is never an AD deficiency – any problems lie elsewhere.
Firstly, I have to agree with Rogue Economist:
Wow. Imagine, business planners and executives will have no more compunctions about claiming to their investors that they will attain at least 5% nominal revenue growth year in year out. If they don’t achieve it via additional sales volume, the Fed is going to make sure they achieve their targets via inflation. Recessions will be a thing of the past. Woohoo!
To believe that we can magically promise stable income growth, no matter the state of anything else in the economy, is to hand wave away the problem of macroeconomics in its entirety. How can it be so easy? Why hasn’t this been adopted before – after all, it’s not a new idea?
The fact is that no rigorous theoretical case has been made that supports NGDP targeting. As evidence, advocates of NGDP targeting offer no more than a graph showing that NGDP declined during the recession, with the implicit assertion that nominal income is what drives the macroeconomy. But is this true? Left Outside’s endorsement of NGDP targeting included this graph, showing that low NGDP is correlated with low RGDP:
This is a clear example of confusing correlation and causation. When looking at two correlated variables, a good question to ask is which one moves first – here, the drop in RGDP clearly precedes the drop in NGDP. This suggests that the decline in RGDP is not a result of the decline in NGDP; rather, its the opposite.
So what happened in 2008? Obviously, the conventional story is true: a large drop in asset prices made many households and firms realise they were less wealthy than they thought; this caused firms to lay off workers; real production decreased; nominal income followed; expectations dropped; this created a spiral. The NGDP-driven story doesn’t withstand scrutiny, else we’d expect the NGDP drop to come first.
Another example of the lack of concrete justification for NGDP targeting is its proponents completely refusal to discuss transmission mechanisms at the zero bound. As we know, government bond yields across the world are about as low as they’re going to get, so ‘traditional’ monetary policy measures are exhausted. What to do?
The CB could begin buying other assets, but that leads us to the question of what happens when these reach the zero bound, or worse, when there are no more assets left to buy. This is at least theoretically possible. Furthermore, there is the obvious observation that merely purchasing assets will not do anything for the real economy. What if NGDP is 5% and RGDP is -5%?
Expectations are often touted as highly important to NGDP targeting, but if expectations are relied on as a transmission mechanism when all other transmission mechanisms become impotent, this undermines itself. For if the CB wishes to make a ‘credible commitment’ to a certain outcome, and this ‘credible commitment’ is vital to the outcome materialising, then that suggests the CB does not have any other way to create the outcome, and hence undermines the credibility of the commitment. To put it another way: the CB can only change things by making people think it will, if it is able to change those things without relying on people thinking it will. Expectations are a product of very real phenomenon, rather than something that can be magically manipulated to produce any desired outcome. Furthermore, even if they could be, evidence suggests that they don’t have that much of an impact.
So the foundation of NGDP targeting – that the CB controls NGDP so they should control NGDP – is completely circular; evidence suggests that nominal spending does not drive the real economy; it is not at all clear exactly how the CB would go about controlling NGDP, and it’s also not clear that targeting NGDP is a particularly desirable policy. Bearing all of this in mind, I’m inclined to agree with Winterspeak – NGDP is just the latest in a long line of mainstream stupidities.