What would the “failure” of a NGDP targeting central bank look like?

Nominal Gross Domestic Product is depressed, that leads real GDP to be depressed because it is very difficult to accommodate rapid and large deflation so logically it must be lower. It also leads to the quantity of people employed to be depressed because the same is true of aggregate wages.

I don’t fully understand what critics of NGDP targeting mean when they say they suspect the policy would fail. I think the language NGDP targeting is something of a handicap, because once you start thinking in this language you begin to translate people’s statements and in the process they cease to make sense.

Chris Dillow says…

I fear, though, that economists who invoke “expectations” and “credibility” are making the error of mistaking the tidy maps of models for the messy terrain of reality.

Unlearning Economics says…

This is a clear example of confusing correlation and causation. When looking at two correlated variables, a good question to ask is which one moves first – here, the drop in RGDP clearly precedes the drop in NGDP. This suggests that the decline in RGDP is not a result of the decline in NGDP; rather, its the opposite.

So what happened in 2008? Obviously, the conventional story is true: a large drop in asset prices made many households and firms realise they were less wealthy than they thought; this caused firms to lay off workers; real production decreased; nominal income followed; expectations dropped; this created a spiral. The NGDP-driven story doesn’t withstand scrutiny, else we’d expect the NGDP drop to come first.

First of all, I agree with Chris that relying on expectations is a weak lever. But, if you are powerful enough to not have to rely on expectations, the market should anticipate that and you will be able to rely on expectations. To he that hath shall be given, and we hath in abundance. I think a Bank with a fairly doveish reputation with the printing press combined with the supremacy of parliament, the Royal prerogative and a government intent on re-election is more than powerful enough for the above to hold true.

Secondly, I disagree with UE. In 2007/8 asset prices fell because expectations of future NGDP fell which was priced into current asset prices. This lead to a fall in real GDP contemporaneous with a fall in NGDP, but both were caused by fall in expectations of future NGDP as is argued by adherents (cultists?) of NGDP targeting. Asset prices are forward looking and money is an asset, hence you have to look at expectations of future NGDP rather than looking at which moved first by a few months, RGDP or NGDP.

So what I don’t understand is what non-NGDP monomaniacs think will happen were a central bank to adopt a NGDP targeting regime. Say the treasury ask the Bank of England to adopt NGDP targeting and to catch up entirely to trend from 2008. What does failure look like?

  1. NGDP does not reach trend because the bank lacks credibility and the policy is abandoned.
  2. NGDP fails to reach trend for a long time, and so has little effect on anything important.
  3. NGDP reaches trend but nominal growth consists (almost) entirely of price changes.
  4. NGDP over shoots target massively and cannot be contained because  inflation expectations become unmorred and accelerate upwards: the price level spirals out of control.
  5. NGDP targeting is effective and a la Kalecki capitalists stage some sort of investment strike and must be abandoned for political reasons.
  6. NGDP targeting is effective and workers/voters realise it is a way of moderating their wage demands and must be abandoned for political reasons.
  7. NGDP targeting is effective and we realise we’ve seen a series of unsustainable booms rather than real growth because of a slow down in innovation and all economic growth ends up accruing to land and rents and must be abandoned for political reasons.
  8. NGDP targeting is effective and some combination of 5,6 and 7 occur.
  9. Other?

Can anyone fill me in?

19 thoughts on “What would the “failure” of a NGDP targeting central bank look like?

  1. “I don’t fully understand what critics of NGDP targeting mean when they say they suspect the policy would fail.”

    I am not a critic, I am agnostic about it. However, just because a fall in NGDP implies a fall in real GDP does not mean that a rise in NGDP implies a rise in real GDP. What does follow is that a rise in real GDP implies a rise in NGDP, or at least a steady NGDP.

    Whether the CB can effect a rise in NGDP in a depressed economy is another question. Fairy dust does not always work.

    1. I think the name “Real” GDP is misleading.

      Nominal GDP is the thing that really exists, if what we are capable of measuring and estimating counts as what is real. We then adjust it with information about the price level to get real GDP.

      The quantity of money its velocity determine nominal gdp, and the supply side of the economy determine where the price level/real activity split is. I don’t think it makes sense to trea NGDP as a construct which is driven by changes in real economic activity + prices, it is more concrete than that and it is determined by the central bank.

      I think rapid NGDP growth is easy to achieve because it has been achieved many times before (obligatory citation of Argentina here) I think the most worrying problem for NGDP is not that a commited bank fails to reflate, but that we need a short steep recession to stop reflation accelerating too fast.

      1. A man after my own heart. I am all for operational definitions, which NGDP appears to satisfy.

        If the CB determines NGDP, I am curious about part of the controversy, because it seems that opponents of NGDP targeting do not think that the CB determines it. Surely that question should not be controversial.

          1. Many thanks. :)

            So I guess that the success of NGDP would mean more private bank failures?

      2. “Nominal GDP is the thing that really exists”

        But the problem is that the units of measurement are different in different periods.

        1. How do you mean?

          The one side of a transaction is always different, but the other side is always money and that is what NGDP measures the total value added of money transactions in a year. So it doesn’t have all the hedonic measurement problems of things like CPI etc.

          1. Nope, but NGDP tells you what people have exchanged for what amount of money. It is a crowdsourced answer to “what is all of this worth?”

            There is always the option of claiming radical epistemic uncertainty but its not very useful for getting things done. What implications does the changing value of money have for NGDP targeting in your view?

  2. My answer would be a bit of (1) and (3).
    The only tool the BoE has for targeting NGDP is the one it has for targeting inflation – QE. But QE operates largely by depressing gilt yields – and these would probably hit their zero bound before NGDP hits its target. I guess you could use credit easing to squeeze credit spreads, but as investment isn’t v. sensitive to the cost of capital, this has limits.
    Also, we know from QE1 that QE raises inflation and GDP by roughly similar amounts; the agg S curve, if you like, is roughly 45 degrees.
    Personally, I’m not opposed to NGDP targets. What I am opposed to is a belief in an expectations fairy that allows such targets to be hit. Surely, looser fiscal policy is less of a faff?

    1. “Personally, I’m not opposed to NGDP targets. ”


      “What I am opposed to is a belief in an expectations fairy that allows such targets to be hit. ”

      Boo! I understand your trepidation. Think of a ngdp target as not relying on expectation but as a tool to generate them.

      At the moment the bank has to argue that “we’re going to be expansionary until medium term inflation looks to be roughly 2%” it is difficult to commit to anything with a vague mandate like that.

      When nominal spending is way off, a ngdp target gives a target for people’s expectations. It makes practical policies more effective. QE which will be expanded until a specific target it hit will be more effective than one which is expanded to some predecided size.

      “Surely, looser fiscal policy is less of a faff?”

      Money financed Fiscal policy can be reversed though, so it is a policy that also relies on expectations to work. All macro policy needs to be expected to permanently change the path of the nominal economy to work. I’d love some sort of helicopter drop, but without somesort of commitment to tolerate/welcome higher spending a lot of that extra money will be used to bring actual savings closer to desired savings. It will help, but not as much as a policy based on

  3. I’m reluctant to endorse NGDP targets because of the possibility that it might lead to asset inflation (houses, commodities, oil).

    OK, so RGDP fell because people expected NGDP to fall. But why did people expect NGDP to fall? Because there was a bubble. I mean, the CB could start buying assets – even houses- to ensure that house prices didn’t fall, but what happens when the CB runs out of houses to buy? For me, NGDP targeting rests on a premise that bubbles ‘aren’t real’ or ‘don’t matter’. But history tells us otherwise.

    1. “I’m reluctant to endorse NGDP targets because of the possibility that it might lead to asset inflation (houses, commodities, oil).”

      I think it is possible that assets will boom during a regime change, just because a shift from bygone-be-bygone inflation rate targeting to NGDP level targeting would be very stimulative to begin with and some people would get carried away.

      I think it would ultimately end up being about wages, if we can keep them growing at a steady rate then assets are free to bounce up and down, their inertia plus central bank interventions should lead to bubbles being less damaging. More 1987 than 1929. In 1987 NGDP, wages etc kept on growing even after a huge bubble burst, so it can be done.

Comments are closed.