Nominal GDP Targeting
By Arnold Kling
Because of a cold, i will be missing an invitation-only event featuring Scott Sumner. In the spirit of sharing my ideas without my germs, let me offer some thoughts on nominal GDP targeting.
1. For the Fed, a target represents a justification for taking action. Some people may be upset with what your action does to the exchange rate or the interest rate. Having a target allows you to justify your action.*
2. I would like to see the Fed use a target to justify its actions.
3. If the Fed were to use a target, then future nominal GDP would be an excellent choice.
4. In the current environment, a target for future nominal GDP could be used to justify expansionary actions.
5. There are plenty of expansionary actions available. The Fed could charge a penalty for holding excess reserves. The Fed could be buy foreign bonds (this might require a change in current law). There still are plenty of long-term Treasuries out there for the Fed to buy.
6. In the best case, the Fed would hit a target for future nominal GDP, unemployment would fall fairly quickly, and we would live happily ever after.
7. In the worst case, we would begin to shift to a regime of high and variable inflation. The Fed would have to undertake strong contractionary measures in order to keep nominal GDP on target, while unemployment remains high.
8. A lot depends on the relative importance of two factors in causing unemployment. One factor is high real wages, due to sticky nominal wages and low prices. The other factor is what I call recalculation or co-ordination failure. If the wage stickiness factor is most important, then nominal GDP targeting will give us the best case. If recalculation is most important, then we are more likely to get the worst case. I put the probabilities at .3 for wage stickiness as most important, .6 for recalculation as most important, and .1 for something else that I have not considered.
9. In spite of these probabilities, I would gamble on nominal GDP targeting. Given how bad the unemployment situation is now, anything that has a shot at helping is worth a shot.
*Why, then, is the Fed so averse to stating a target? I can only come up with cynical possibilities:
(a) They do not want to be embarrassed if they are unable to hit a target
(b) This is what Tyler Cowen would call a Straussian situation, in which the insiders must never reveal their true agenda, or horrible demons will be let loose, leading to social breakdown and bloodshed.
(c) They fear that announcing a target would create “lock-in” and cost flexibility.
(d) A target would make many of the departmental functions and rituals (such as FOMC meetings) long cherished at the Fed seem pointless.
(e) The Fed is institutionally more concerned with the stability and profitability of the banking system than with macroeconomic variables.
These are not mutually exclusive, I tend to put the most weight on (e), but the fact that the Fed does not state this explicitly means that I also have to put a positive weight on (b), even though I think that Cowen’s Straussianism owes a great deal to Tyrone.