Scott Sumner on NGDP Targeting
He makes his case in National Review.*
In 2009, the U.S. saw the biggest fall in nominal GDP (NGDP) since 1938. It is thus no surprise that we had a debt crisis: Borrowers almost always have trouble repaying debts when nominal income comes in much lower than was expected when the debts were contracted.
Just to be obnoxious, let me note that the debt crisis began late in 2006 when house prices started to level off, and the worst period was 2008. Why did the crisis get rolling in 2007 and reach a crescendo in 2008, if the biggest fall in NGDP was in 2009? Rational expectations?
Some economists use interest rates as an indicator of monetary policy. If the result is bad economic performance, they blame changes in the relationship between interest rates and the economy. Worst case, they blame the so-called “zero bound.”
Other economists want to use a measure of the money supply as an indicator. If the result is bad economic performance, they might blame changes in velocity.
Sumner argues for what I call “no-excuses” monetary policy. You undertake whatever technical operations you would use to manipulate the money supply or interest rates, but you focus on hitting a target for NGDP.
The 1960’s version of Milton Friedman would not have gone along with this. Back then, he would have said that the “long and variable lags” in monetary policy would make NGDP targeting a destabilizing practice. When you think NGDP is too low, you pump in lots of money, causing NGDP to overshoot, so you slam on the brakes and cause a recession, etc.
But Sumner’s solution of focusing on expected future NGDP is an attempt to avoid such destabilization. I cannot speak for the late Milton Friedman, but I personally feel comfortable that Sumner’s approach would not be destabilizing. If I could, I would appoint Sumner to run the Fed. As it stands now, the Fed appears to me to be conflicted over what to target, and I hate to say it, but the default has been to target bank profits. If banks are profitable, you can count on the Fed to stay the course. It only does something drastic when banks get in trouble. (Speaking of this, see Tyler Cowen’s review of the new Perry Mehrling book, which is sitting beside me waiting for me to read next.)
Having said that, I think NGDP targeting poses a risk, particularly if my Recalculation Story is correct. If it takes a while for the entrepreneurs to arrive at new patterns of comparative advantage, you would hit the NGDP target primarily by causing inflation. Right now, one has to be aware of the possibility that expansionary monetary policy will feed a commodity boom, as opposed to magically putting people back to work.
(*Just as an aside, NR’s web site is one that I detest, because of all the adware on it that makes it take forever to load, and every time you get careless with your cursor it zaps you with an annoying pop-up. Die, user-hostile web designers, die!)