thanks!

Hi Tom,

Scott is talking about targeting a “level” of NGDP that grows at 5%pa. So if you only achieve 3% one year, you have to have growth of just over 7%pa to reach your level target.

If you are targeting the growth rate instead of the level, then if you have 3% one year, you only target 5% the following year and “ignore the shortfall”

And this is what history dependent means – when you target a “level” you make up for past shortfalls, or tighten policy if you were too loose in the past. With growth targeting you ignore what has happened in the past.

As a result, when we ask whether to target the level of growth, we need to ask what people use for making decisions etc etc, and that is a pretty complicated question that people will need to think about. Back in the day people decided on growth targeting, but that won’t necessarily always be agreed upon.

“It targets levels instead of growth rates – making policy “history dependent”.”

1. What do you mean NGDP targets levels? I thought Scott Sumner likes to refer to a 5% growth rate in NGDP as being desirable. That’s a growth rate, and if he’s selected a number (5%) isn’t he talking about targeting that?

2. Can you expand on what you mean by “history dependent?”

Thanks

“BTW good article by Brian Fallow today – I think he has been reading your blog.”

Hehehe – Brain Fallow’s articles are always great, but today’s was especially good.

I know for a fact he doesn’t read the blog – so I can’t take any credit! He just uses the same sort of framework that I do, and then communicates it a hell of a lot better 🙂

“As long as, one day when the overnight rate hits 0.25%, the RBNZ knows what to do!”

This is very true. I really like the RBNZ, and think they do heaps of good things. But it would be encouraging to see them announce what they would do with policy when the cash rate hit zero – especially after the confusion we’ve seen around the world.

I hope they would take the view that we can use forward guidance, and even a commitment to target a level/higher inflation, in the case of hitting the ZLB – but such a mechanism should be put in place and explained before it becomes as event.

BTW good article by Brian Fallow today – I think he has been reading your blog.
One of the reasons I think NGDPLT is interesting because I as a patriotic Kiwi I like to think the savings-investment imbalance in the real economy (or bias against saving) will one day be fixed and I worry that there won’t be enough demand around. (I lived through the late 80s and early 90s recession, and since then have always had the view that if you want to restructure your economy you need to make sure there is plenty of demand around, otherwise your human capital stock will simply decay).
I remember Lars Christensen saying he thought small open economies should use a NGDPLT with a floating peg exchange rate. That’s one way of doing it, but it’s a very big change. Or, we could take the view, which I think you do, that our current framework can handle it. As long as, one day when the overnight rate hits 0.25%, the RBNZ knows what to do!
I might have a look through the RBNZ’s speeches for hints about this. But I think their attitude to date has been “we’re miles from the ZLB, so it’s a moot point”.

Hi Blair, good points.

“As an investor I suppose I would tend to use an inflation assumption
more often in valuation models, but the success of the investment always
hinges on the revenue line!”

Indeed, it is an interesting question. I’m not sure the idea of what CB management of the money supply is supposed to achieve in terms of certainty has been clearly defined – and that has led to discussions being quite all over the place. Originally I studied microeconomics, so that was just the way I saw things – and in many ways I think the NGDP discussion has made that point clearer to people discussing macro.

” I thought the critique of flexible inflation targeting flowed from
empirics – in short, most countries running it had AD-induced problems
recovering from the GFC. This in turn may stem from the fact that when
AD is too high, the inflation rate (relative to target) usually sends
the CB a very clear message about what to do, but when AD is too low it
sends a weak signal and the CB starts bickering about what to do.”

Indeed this is very much how things are viewed in terms of the “output gap”. If demand falls below potential, sales/output falls and profit margins rise (assumes an upward sloping cost curve) – thinking this is weird, firms lower prices (relative to the inflation targeted increase) to try and sell more and hit their “targeted margin”. In this envrionment, measured inflation will fall. We cut interest rates to get people to bring “demand forward” and close this output gap – this is very a crude explanation, but its the sort of idea.

CB’s do this more broadly by “managing expectations about nominal variables” in order to improve outcomes. The idea is that if they are targeting inflation of “X%”, and they forecast that they will meet that target, then they are forecasting that they are, and will, do what needs to be done in terms of demand management. Now forecasts are always wrong, the key point is that they are unbiased and do work as a way of credibly managing expectations. As a result, it makes complete sense to use market measures to judge the stance of policy (relying on the wisdom of the crowds), in fact this is really the most sensible way to do things.

As you say, at some points in time some CB’s ignored these market signals AND their own models, which didn’t help. Another thing that didn’t help was that the ECB was more incompetent than other central banks had allowed for under Trichet – Trichet forgot that financial stability required a lender of last resort, and he forgot that the advantage of having a well anchored inflation target was lowering the sacrifice ratio … looking only at inflation was never sensible practical policy.

To use the extreme case that proves the rule – if inflation was fixed in the short term, CB policy can be used directly to fix the “quantity” of output in this short term. Anchoring inflation expectations makes CB’s more able to explicitly deal with demand!