Over time, the labor force (employed plus unemployed) usually tends to grow at a pretty stable rate. In addition, hourly wage rates are sticky, or slow to adjust to shocks. As a result, a healthy economy requires a relatively slow but steady growth in nominal labor compensation. One way to do that is to have the central bank target NGDP growth at 4% or 5%/year.
In a recent post, I suggested that the Covid recession was one case where NGDP targeting might not have worked very well. That’s because the labor force plunged much lower in March and April 2020. Given the slow adjustment in nominal wages, it was appropriate to have some slowdown in NGDP growth. For the same reason, it’s probably appropriate that French NGDP dips a bit each year in August. Thus central banks probably shouldn’t try to target current NGDP, rather they should set policy at a position expected to produce on target future NGDP. How far in the future? I’m not sure, but a year or two seems reasonable.
Here’s an example. Suppose the Fed is targeting NGDP growth at 4%/year. Also suppose that in the 4th quarter of 2024, the previous 12-month growth rate has been only 3%. In that case they might aim for a total growth of 9% by the 4th quarter of 2026. This would represent growth of 4%/year for 2 years, plus 1% more of catch up growth. I believe that sort of policy regime would have worked fine during the Covid recession, although I can imagine situations where even that approach might not be appropriate. (Say an epidemic kills 50% of the labor force.)
I’d also emphasize that the Covid recession was highly unusual. Even the Spanish flu of 1918-19 did not cause a big recession or a major fall in the labor force. (The big recession in 1920-21 was unrelated to the Spanish flu—it was caused by tight money.) So the Covid recession was very unusual, and monetary policy going forward would do better to focus on preventing ordinary recessions.
PS. Stable NGDP growth also helps with financial stability. That slightly modifies the analysis provided here, but doesn’t overturn the result.
READER COMMENTS
Andrew_FL
Jun 9 2021 at 4:19pm
I am reminded of several occasions on which commenters who’ve become very taken with these NGDP ideas profess to believe that Christmas is a business cycle.
(Nicholas Kaldor is supposed to have remarked “At last I have discovered the cause of Christmas!” when he discovered that the money supply tends to increase in December, but if that’s true, he was presumably joking)
Scott Sumner
Jun 9 2021 at 4:29pm
Cute. But I prefer making fun of endogenous money people. Columbus discovered America to provide the gold and silver to finance the inflation of the 1500s.
Philo
Jun 9 2021 at 6:23pm
“(Say an epidemic kills 50% of the labor force.)” Just target expected NGDP *per capita*. (Or is that too simple? Maybe a child should not count as a whole person.)
Andrew_FL
Jun 9 2021 at 6:26pm
You want Civilian Non-institutional Population, which doesn’t count 16 and under
Scott Sumner
Jun 9 2021 at 8:54pm
Yes, I’ve always thought NGDP per capita is better, although I have not emphasized that point very often due to the relatively stable growth rate of our population.
Rajat
Jun 10 2021 at 6:51am
Targeting NGDP per capita may be fine for working individuals with personal debts, but firms with nominal debt obligations may struggle if overall NGDP is unexpectedly not rising. Mind you, an inflation or price level target mightn’t work any better if demand and supply were shrinking concurrently.
Scott Sumner
Jun 10 2021 at 12:24pm
I agree, but I’ve always viewed the nominal debt problem as being far smaller than the nominal wage problem. Stabilizing the labor market is by far the most important objective of NGDPLT.
Alex S.
Jun 10 2021 at 1:19pm
When I read Scott’s comment it made me think of a passage from a paper by Jim Bullard and Riccardo DiCecio, which advocated NGDP targeting (https://s3.amazonaws.com/real.stlouisfed.org/wp/2019/2019-009.pdf):
“Sheedy (2014) also provides a model that includes both a NSCNC [non-state contingent nominal contract, i.e. sticky debts] friction as well as a sticky price friction. His calibrated economy suggests that the NSCNC friction is about nine times more important than the sticky price friction.”
Sheedy, K. D. (2014): “Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting,” Brookings Papers on Economic Activity, Spring, 301-361.
Scott Sumner
Jun 11 2021 at 11:28am
I view sticky wage friction as being far more important than either sticky prices or nominal debts.
John Hawkins
Jun 10 2021 at 6:39pm
Reminds me of the classic Earl Thompson paper –
https://www.academia.edu/149710/_Free_Banking_Under_a_Labor_Standard_A_Perfect_Monetary_System_
Scott Sumner
Jun 12 2021 at 1:47pm
Great paper.
Thomas Lee Hutcheson
Jun 9 2021 at 10:06pm
Possibly NGDP trend should not have been rock solid during the early 2020, but surely some price spike would have been appropriate, even if not enough to fully offset the supply contraction. And even then, much of the fall in employment was lower private consumption and investment. The Fed’s job is to make Say’s Law true in practice even though it’s not true in theory.
Market Fiscalist
Jun 9 2021 at 11:40pm
‘In a recent post, I suggested that the Covid recession was one case where NGDP targeting might not have worked very well. ‘
I take this to mean that NGDP targeting isn’t always the right short term policy, and sometimes it would be fine for the CB to fall short of target.
So my question is “How will the CB know when it is OK to miss the target” ?
Presumably the CB could hit any NGDP target it wanted irrespective of whatever supply or demand shocks may be playing out. Is Scott suggesting that whether the CB actually really tries to hit its target or not should be left to the discretion of Central Bankers ?
Scott Sumner
Jun 10 2021 at 12:25pm
No I don’t favor discretion. I’d stick with a stable path for NGDP, but target NGDP a couple years forward.
Michael Rulle
Jun 10 2021 at 8:32am
Do you((Scott) think that it is possible Powell does focus on NGDP—-that perhaps he is even a secret targeter?. My guess is he might have a little bit of that in him. But reality is he explicitly targets inflation—-in a similar way you suggest he target NGDP. As such, I am more (not only, just more) interested in how inflation is impacting his actions.
Scott Sumner
Jun 10 2021 at 12:26pm
Yes, that’s possible.
Michael Rulle
Jun 10 2021 at 8:35am
Inflation just popped at 5%. Have not seen Powell’s explanation. But this does not look good as it relates to his targeting. But have not seen his comments yet.
bill
Jun 10 2021 at 11:58am
What do you think of the timing of the Fed’s switch to Average Inflation Targeting? It seems like a huge error. August 2020. If that’s the starting date, 9 months ago, the inflation rate is 2.6% over those 9 months. I wonder how long of a period they will allow themselves to get the average down to 2%? Right now is literally the best time to have had the prior “bygones are bygones” approach. After a decade of missing to the downside and saying “oh well”, they’ve now committed to hitting an average right when they finally exceeded the 2% target. Or maybe they’ll say that the date for the averaging is prior to the August 2020 announcement? But even the last 2 years average 2.55% already, so it still requires tightening. The 4.9% inflation over the last 12 months is an anomaly that has to be ignored. In fact, they have to go back to some time in 2014 or so to have a starting point where the current price level results from an average that is less than 2%. All of which means that to keep this new target credible means tightening. Personally, I hope they find it in them to just say that 2021 is an anomaly, and pick a date where they can say “and we’ll start the averaging going forward”? From say January 2022? But that doesn’t seem like the sort of announcement they’ll feel good about. The most optimistic I can be is that they’ll just ignore topic. When the questions start coming in 2022, they will be able to point to some date in late 2021 and say, “we’ve averaged 2% since ___ month, and we don’t think the pandemic should count in the average”. Better yet, say that they’re targeting market expectations for average future inflation. And even better than that is obviously NGDPLT.
Scott Sumner
Jun 10 2021 at 12:28pm
I believe they are starting the clock at the end of 2019. I’ve made that assumption in other posts, and I’ve seen Fed officials say the same thing.
bill
Jun 10 2021 at 1:52pm
Thanks. I am interested to see how far they will let the average stray from 2% and for how long. Inflation since yearend 2019 has averaged 2.8%. ie, the price level is up 4% in 17 months.
Michael Rulle
Jun 10 2021 at 2:21pm
Assuming end of 2019 is right starting point, which I have seen too, and assuming Powell prefers PCE ex-food and energy, we have had 2.11% annualized inflation using monthly index numbers thru April. Don’t know why PCE is one month lag to CPI. But Powell is doing excellent. The ex food and energy CPI is 3% yoy—-don’t know how it translates into a monthly index number, but Powell is definitely on target. So when I saws the inflation 5% headline I believed the interpretation. Then the market popped and yields dropped. Like all headlines they need to “sell eyeballs” and fear sells. 😊
bill
Jun 10 2021 at 2:55pm
Good point, I incorrectly used CPI.
Regarding core, my understanding is that it is a better forecaster of future topline inflation than the topline is (due to less volatility perhaps), but that in the end, the target is still the topline.
Scott Sumner
Jun 11 2021 at 11:29am
That’s right.
Stefan Spong
Jun 10 2021 at 2:46pm
Implemented effectively, the NGDP expected path will most certainly be noisier and more variable in near term forecasts but if the monetary authority is credible, should smooth out much farther into the future.
Monetary NGDP mistakes should be resolved quickly, but in the short term large deviations for the examples you illustrated shouldn’t be a good reason to dissuade someone from NGDP targeting that still has much stable NGDP forecast levels 3+ years out. The biggest failure from the great recession – NGDP stability 2-3+ years out took a long time to break after the initial mistakes.
David S
Jun 11 2021 at 1:23pm
Just curious about what Scott thinks about NGDP growth rates in the 90’s. It seems to have run a little bit higher than the 4-5% range you suggest as a potential Fed goal, but I remember that as a good decade economically. Granted, the recession of the early 2000’s balanced things out if you stretch the decade out a bit further (not to imply that was a good thing!).
If I recall correctly, you’ve been critical of Fed policies holding back NGDP in the past decade–particularly the tightening in 2015ish. Could we run at 90’s level NGDP–i.e. 6%– for a few years or would that be too hot?
Scott Sumner
Jun 12 2021 at 1:51pm
That would be too hot to achieve the Fed’s 2% inflation target. Of course you can argue they should change the target, but that’s another discussion.
As for the optimal NGDP target, I don’t think 4%, 5% or 6% would make much difference.
One other point. When looking at historical NGDP growth patterns you need to look at an entire business cycle, not just the expansion phase of the cycle.
David S
Jun 14 2021 at 4:10pm
Scott,
Thanks for the answer. I’ll try to be careful when looking at historical charts.
Jim Cramer was recently using chartism to advocate Bitcoin as a great investment.
Alex S.
Jun 12 2021 at 6:28pm
On sticky wages versus sticky debts…
While sticky wages most acutely impact those who lose their jobs because they are unable/unwilling to accept lower nominal wages, I sense the roll of sticky debts is underestimated as more people will have outstanding debts than are unemployed.
If E[NGDP] = SUM[individual household’s expected nominal income streams] and the latter goes down for the average household, their expected real debt burdens will rise, which may crimp their current spending habits until the central bank acts (at least indirectly) to raise E[NGDP] if it does so at all.
One could tell a similar story for firms since E[NGDP] ~= SUM(Individual Firms’ Expected Revenues], in which they delay investments to cope with higher real debt burdens.
Perhaps I should have first asked why you think sticky wages matter more than sticky debts?
Scott Sumner
Jun 13 2021 at 12:07pm
Sticky wages reduce national income/output. Nominal debts merely redistribute national income. That seems the lesser problem.
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