Getting the NGDP Debate Out Into the Open
Kelly Evans writes in the Wall Street Journal today that NGDP targeting might not be the monetary panacea its supporters suggest:
There are at least three problems with this strategy, however. First, it assumes that the Fed can sensibly determine the “right” trend for nominal GDP. Second, it isn’t clear that it can actually achieve any such target. And third, doing so would run a huge risk of conflicting with the Fed’s congressional mandate to promote “stable prices”—something that can’t unilaterally be rewritten.
The fact that this doesn’t state the statutory mandate correctly should tip you off that something has gone amiss. The Fed’s actual mandate is a mixed mandate to pursue stable prices and full employment. For decades, however, it’s been a little bit unclear what this should mean in practice. One of the great advantages of an NGDP target is that it combines prices and real output (which is to say employment) in a single index.
....The other objections are worse. Having the Fed do anything assumes that the Fed can sensibly determine the “right” trend for whatever it’s doing. Similarly, any institution with any prescribed mission might fail to achieve the mission. Deploying this as an objection would be like a universal solvent.
I guess I'd read Evans a little more sympathetically. She does mention the Fed's dual mandate (low inflation and low unemployment) in the second sentence of her piece, so the rest of the column should probably be read partly as an opinion about whether the Fed should allow higher inflation right now in order to bring down unemployment. Matt is right that one of the theoretical virtues of NGDP targeting is that it combines both employment and inflation into a single metric, which would make this question moot for policymakers, but it unquestionably does imply that during recessions the Fed would tolerate higher inflation. I think that's a good thing (as does Matt); Evans doesn't. But it's certainly a key issue that deserves plenty of public discussion.
Evans's other two points are worth thinking about too. It's true that the Fed has to pick a target no matter what it's doing, but NGDP is a new one with no track record. That makes it trickier to get a consensus about what the right figure should be, and consensus is important since the whole point of NGDP targeting is that everyone has to believe the Fed is really, truly committed to its target. And the question of whether the Fed can hit an arbitrary NGDP target is critical. Central banks have pretty time-tested mechanisms for hitting inflation targets, but growth targets are something different. There are plenty of economists who are skeptical that monetary policy alone can accomplish this. I'm a little skeptical myself, and as I wrote yesterday, I also feel like some caution is warranted here. Finding some kind of mechanical monetary rule that automatically produces stable growth is sort of the Holy Grail of monetary economics, and we should subject any new proposed rule to plenty of tough questioning.
In the end, I think that for lots of people the issue of NGDP targeting has become sort of a foil for a different question: should the Fed engage in massive monetary easing right now in order to get the economy back on track? NGDP targeting says yes, so those of us in favor of easing are likely to find it an agreeable idea. Conversely, those who are afraid of the consequences of massive easing are likely to play up its problems. That's human nature for you. But regardless, it's good to get all this stuff out in the open.
UPDATE: Bennett McCallum, who's been advocating the idea of NGDP targeting (aka nominal income targeting) since the 80s, has a pretty readable primer on the subject here. Worth a look.