Nominal GDP as a policy guide
The Fed repeatedly makes policy mistakes by ignoring erratic swings in nominal GDP. Today, two important media outlets published persuasive arguments in favor of NGDP targeting. Here’s Clive Crook in the Washington Post:
The Fed delayed raising interest rates until now because it wasn’t sure why inflation had spiked and whether the pandemic-driven contraction of the labor force would reverse. An excess of demand over supply is driving prices up — but how much of this excess is due to high demand and how much to temporary interruptions in supply?
A central bank that watched NGDP can be agnostic about this. It would compare actual NGDP to its target, and aim to keep it growing on track. Changing supply conditions would then determine what happens to inflation and output. . . .
The chart compares actual NGDP with a benchmark Beckworth calls “neutral NGDP” — a steadily rising level of demand consistent with medium-term growth and low average inflation, which is neither expansionary nor contractionary. Following the pandemic-induced shock in 2020, demand had recovered to this benchmark level by the second quarter of 2021. Had the Fed been watching, it would have seen a strong signal to start tightening no later than last summer — and would have been equipped with a simple explanation for lift-off.
And here is a similar suggestion, from Bryan Cutsinger and Alexander Salter in the National Review:
Monetary policy affects total spending, and hence aggregate demand. To fight recessions, it’s appropriate for the Fed to push back when demand collapses, stabilizing both labor markets and the dollar’s value. You can’t have one without the other. How much employment is full employment depends on supply, over which the Fed has no power. All the central bank can do is pick the level of demand, and hence the purchasing power of money.
This doesn’t mean the Fed is unimportant. On the contrary: Stable demand is a boon for the economy. Instead, it means the employment component of the mandate is superfluous at best and dangerous at worst. By keeping nominal income on a steady path, the Fed creates a solid foundation for labor markets to flourish. No micromanaging needed.