NGDP or NGO?
By Scott Sumner
Vincent Geloso has a new post, where he suggests using nominal gross output (NGO) as an alternative to NGDP targeting:
The intuition behind NGDP target is that monetary policy should be aimed at reacting to changes in demand for money. Thinking of the equation of exchange (MV=PY), a change in V should be matched by an opposite change in M so that MV remains stable. Any increases in Y(output)should be met by reductions in P(rices) and no changes in MV. In practice, NGDP targeting is about avoiding deviations from long-term trends in NGDP. However, while the equation is often presented as MV=PY, the original papers by Irving Fisher and others present it as MV=PT where Y (output) is substituted by T (transactions).
But is PT the same as NGDP? At any point in time, total spending in the economy is much greater than the sum of final goods. There are intermediate goods which are being produced – intangible capital, capital inputs and producers goods. NGDP avoids calculating these because it would lead to double-counting. Work by Austrian-friendly scholars like Mark Skousen proposes that the double-counting is actually a strength in certain cases. This is because the double-counting gives greater weight to production. Skousen calls it “Gross Output”(GO) and he finds that GDP is generally a fraction of GO (at 53% in 1982).
I do believe that we should be open to alternatives to NGDP targeting, indeed I’ve suggested targeting nominal labor compensation per capita. But I’m not convinced by Geloso’s argument. Let’s start with the first sentence I quoted:
The intuition behind NGDP target is that monetary policy should be aimed at reacting to changes in demand for money.
I don’t agree with this claim, as it would apply equally well to inflation targeting. Instead, I would argue that the intuition behind NGDP targeting is that it helps to stabilize labor markets and credit markets, at least relative to most alternatives, including inflation targeting.
Geloso is right that PT is not the same as PY, but by far the biggest difference is the exclusion of financial transactions, not intermediate goods. Transactions in the foreign exchange market alone are roughly 100 times larger than GDP. So any “transactions” based approach to monetary targeting will inevitably focus almost exclusively on financial markets, and basically ignore the real economy.
That doesn’t mean that targeting NGO is a bad idea, but I don’t see any persuasive arguments in the Geloso post. Certainly not enough to justify the exclamation point in its title:
Don’t target NGDP, target NGO!
As a practical matter, I think a NGO target would do about as well as a NGDP target. But where they diverge I’d prefer NGDP for two reasons:
1. NGDP is probably more closely linked to labor markets, and the idea is to avoid unnecessary fluctuations in employment caused by instability in the flow of nominal income.
2. NGDP is probably more closely linked to credit markets. The goal here is to avoid financial crises causes by a sharp reduction in the flow of nominal income, relative to the income flows expected when debts were contracted.
In both of those two cases, I see no good argument for replacing NGDP with NGO.
PS. I don’t quite understand this comment:
Imagine an easy monetary policy which incites firms to produce more, there might be a lag between the increased production and “arrival on shelves” for consumers to buy. This occurs as firms acquire new producer goods and/or gear themselves to producing goods for other producers. This means that in the short-run, the ratio of NGO to NGDP (nominal Gross Output) could vary. Easy monetary policy could make NGO grow faster than NGDP.
Unless I’m mistaken, NGDP measures all output, including inventories of intermediate goods that have not yet been sold.