Larry Summers on NGDP targeting
By Scott Sumner
Over at TheMoneyIllusion a commenter named Julius Probst told me that he asked Larry Summers about NGDP targeting, and Summers seemed supportive. After I mentioned this in my blog, Politico decided to ask him directly. Here’s what they found:
Did Summers, who is likely to have the ear of the next White House if a Democrat wins in 2016, call for a change in how the Fed does business?
We emailed him to check, and he quickly wrote back: “I didn’t quite endorse NGDP targeting. I said that I would prefer a shift to NGDP targeting to a shift up in inflation targets.”
What does Summers mean by “a shift up in inflation targets?” Over the past few months, a debate has emerged in economics over whether the Fed’s 2 percent inflation target should be raised in light of the persistent low levels of inflation in recent years. A higher inflation target would enable the Fed to lower real interest rates further–to -3 percent, for instance, instead of -2 percent–to spur demand in the event of another recession.
Summers argues that an NGDP target is preferable to a higher inflation target for two reasons. “The lower real growth [is], the lower real rates may need to go and [NGDP] unlike pure inflation targeting guarantees this,” he wrote. Summers also expressed concern about measuring inflation. He added, “a target that doesn’t depend on inflation adjustments” makes more sense.
While Summers isn’t endorsing NGDP targeting, he’s tiptoeing awfully close to the line. By parsing Summers’s words–in particular, the word “quite”–you can tell he’s not far off. Adopting NGDP targeting would be a revolutionary change for the Fed, and Summers’s almost-backing is indicative of the speed at which it’s gaining supporters.
The NGDP debate stems from the emerging concern that the powerful Fed hasn’t quite been powerful enough to sustain a strong recovery. The Fed cut short-term rates to zero, for instance, but that wasn’t enough to snap the economy out of its prolonged slump. The Fed also used unconventional policies such as “quantitative easing” — the purchase of hundreds of billions of dollars of Treasury bills and mortgage-backed securities to lower long-term interest rates. Those all helped, but the recovery has still been slow.
How would NGDP targeting have changed this? It generally doesn’t change the tools at the Fed’s disposal, like setting short-term interest rates, but it would let the central bank use them more aggressively. Nominal GDP growth has been around 4 percent for the past five years. Under a 5 percent NGDP target, the Fed would have had to loosen policy even further, perhaps by increasing its asset purchases. If inflation suddenly increased, nominal GDP growth, by definition, would rise as well, requiring the Fed to tighten policy to fulfill its mandate. In both cases, proponents say, the Fed would be creating a more stable macroeconomic environment.
Summers isn’t in office, true, but few economists have his academic pedigree and his influence in Washington. In January, he co-authored a report for the Center for American Progress that is widely considered to be a preview of Democratic presidential candidate Hillary Clinton’s economic platform. Summers himself nearly became Fed Chair last year but Obama ultimately nominated Janet Yellen after Senator Elizabeth Warren (D-Mass.) and other liberal senators opposed Summers’s nomination.
If anyone could move this idea from the classroom to reality, it would be Summers. That might not be too far away.