An excellent primer on NGDP targeting

Via Scott Sumner comes the following primer on NGDP targeting.

Its a cool little explanation of the benefits, and the functioning of monetary policy – specifically through expectations.  I also appreciated that Hayek was mentioned – Hayek was a fan of the nominal income rule, a fact many people don’t realise given belief that NGDP targeting is “left wing” and Hayek is “right wing”.  Economists are never as simple as we like them to be 😀

As I’ve said before I don’t agree with NGDP targeting for NZ at the moment.  I see NGDP targeting vs flexible inflation targeting as akin to the level vs growth targeting – and I’m still on the side of rate of change targeting.  However, it is an area where I could easily be turned around … and if NZ was to introduce NGDP targeting I wouldn’t suddenly get all wound up and talking about it being the end of the world, I would assume that we were following the policy rule because our view of what target best represents “good policy” has changed.

For those wondering, if you target a “level” then previous “policy failure” counts – in a NGDP targeting framework, changes in the terms of trade (for example) will be picked up as policy failure in a way that would elicit a response when they “shouldn’t”.  This is why I prefer inflation targeting based on a clear version of inflation like the dynamic factor model the RBNZ has.  However, even in this case we may decide that nominal income growth is a better target than price growth – that is an issue I’d like to spend more time thinking about.

A big thing for me is that we stick to a time consistent rule, instead of falling into the trap of thinking we can hide taxation through central bank actions 😉


  • You *can* do NGDP rate targeting. But otherwise, yeah.  

    •  Yar that is why I said:

      “However, even in this case we may decide that nominal income growth is a
      better target than price growth – that is an issue I’d like to spend
      more time thinking about.”

      Where NGDP growth is really nominal income growth afterall.  I should have probably written NGDP instead of nominal income there to be consistent through the post.

      • Ah, cool. Would also need to think harder about NGDP rate vs our current system. 

        •  Yeah, I’ll tell you my intuition.

          NGDP rate forecast targeting is essential a Taylor rule with equal weights on output and inflation.  Flexible inflation targeting is equivalent to a Taylor rule with weights that are estimated to maximise welfare.  In this way, I can’t see the current system being worse – and I can see it being better.

          However, that is just my current intuition – I’m not saying that I can’t be swayed 🙂

          • So, when are you going to write the PhD thesis showing it?

            [Not meant as snark, meant as – you really should be getting your letters, this could be part of it]

  • Blair

    It is interesting to think about what would have happened if the terms of trade hadn’t been so strong over 2009-11 and the economy had tanked leaving the private sector with impaired net worth vs “sticky” debts. Conceivably CPI may have been towards the lower end of the target range with a lower dollar, while NGDP fell sharply below trend. In this model targeting NGDP forecasts via a rule could have led to much prompter central bank action than inflation targeting (i.e. because NGDP falls much harder off the trend). Under flexible inflation targeting the central bank would have been more likely to go through a 4-5 year learning process like the Fed has arguably had to.

    A counterargument is that the leading US/Euro proponents of NGDP targeting have generally not advocated NGDP targeting for small open economies.

    •  If the TOT had fallen, the RBNZ would have responded more sharply even if inflation expectations were completely anchored in a flexible inflation targeting framework methinks.  Not as much as with an NGDP target to be sure – however a drop in the TOT can also be seen as a negative supply shock, so we “shouldn’t” be looking to return to our old trend.