Market Monetarism Goes Mainstream

David Beckworth summarises who’s bought the idea of NGDP targeting (excerpt):

Do Changes in Potential Output and Data Revisions Make NGDP Targeting Impractical?

Over the past few months there has been increasing chatter about the need for a new framework for U.S. monetary policy. The Peterson Institute for International Economics (PIIE), for example, recently had its Rethinking Macroeconomic Policy conference where, among other things, Ben Bernanke called for the Fed to adopt a temporary price-level target. PIIE also launched Angel Ubide's new book on reforming monetary policy. Similarly, at the AEA meetings there was a session titled Monetary Policy in 2018 and Beyond where Christina Romer again made the case for a NGDP level target. Likewise, the Brookings Institute held a recent conference on whether the Fed should abandon its 2 percent inflation target. There, Jeff Frankel shared the arguments for a NGDP level target and Larry Summers endorsed it. Others at the conference, like San Francisco Fed President John Williams called for a price level target.

I am glad this conversation is happening. It is not new--some of us have been having it since 2009--but I get the sense that it is gaining traction. The turnover at the Fed and the opportunity it creates for new thinking makes this conversation about new monetary policy frameworks incredibly important now.

As this conversation continues to grow, so will the interest in the options available including nominal GDP level targeting (NGDPLT). Obviously, I have much to say here, but for now I want to respond to two critiques often applied to NGDPLT: (1) changes in potential output and (2) data revisions make NGDPLT an impractical rule to implement. I think these concerns are misplaced as explained below.

I’ve liked the idea of market monetarism from the start – it’s intellectually appealing, simple in implementation, and really, just common sense. I do have some reservations, though not the ones David brings up.

My main concern is the choice of growth path, especially when viewed through the lense of a developing economy versus a developed economy, as well as how such a path might evolve for an economy across time. That might not seem like much, given that a central bank no longer has to target a lagged reported variable (inflation) and an unobservable one (the output gap). Inflation and real growth can vary under the limits of the central bank’s growth target. So far so good.

But what governs the choice of the NGDP growth path? NGDP growth of 4%-5% would more or less be compatible with developed economy growth like the US, but what about Indonesia or Vietnam, where nominal growth is typically in the region of 8%-9%?

Second, should that target change as economies converge to the global production possibility frontier, and potential growth rates drop? It’s one thing to have inflation averaging 2% over time, but quite another to have it average 6% or more.

Third, what about the impact of demographic change? As populations age, the dependency ratio rises, and both nominal and real income and consumption growth will naturally slow. How should a NGDP growth rule respond to this? I think for this last point, any such monetary rule should target NGDP per capita or NGDP per worker, rather than NGDP. But I don’t have much of  feel for the solutions to problems 1 and 2.

Nevertheless, we’re seeing real progress here.