The idea that the Fed’s monetary policy should focus on stabilizing the growth rate of nominal GDP has been discussed at length by several economists since the Great Recession delivered an attitude adjustment in the land of macro. In fact, it’s an idea that’s been around in formal terms at least since the 1980s. But it’s not obvious that there’s any progress at the central bank, or in policy circles generally, for moving toward this worthy strategy, and so supporters of the concept keep on talking (and writing). The latest comes from David Beckworth, who lays out the reasoning in a concise essay in National Review.
Beckworth explains that
The simplicity of this approach can be illustrated by considering how the Federal Reserve would have responded to the sharp downturn of 2008–09 had it been targeting nominal GDP. During this time, the financial system was in distress and, as a result, there was a rush for liquidity. The rise in demand for highly liquid assets meant less spending and a drop in economic activity. Had the Federal Reserve been targeting nominal GDP at this time, it would have provided enough liquidity to fully offset the spike in liquidity demand. Such a response would have stabilized actual and expected nominal-GDP growth in 2008–09 and prevented the collapse of the economy. It is that simple.
The current Fed policy could be described as a type of ad-hoc approach that leaves plenty of room for confusion in the markets as to what the central bank is planning, or not, at any given moment. That’s not a problem normally, but the stakes are high in times of financial crises a la September 2008. A nominal GDP target would go a long way in keeping the confusion to a minimum, and at the same time optimize the Fed’s efficacy in keeping recessions from turning into disasters.
At its core, nominal GDP targeting is really just an extension of the practical realities of macro. Brad DeLong notes that the details on “how government can intervene strategically in financial markets to stabilize nominal GDP has been the subject of a lot of work–Tobin, Friedman, Kindleberger, Minsky, Hicks, Keynes, Fisher, Wicksell, Bagehot, John Stuart Mill.” He goes on to advise,
The government provides liquidity, safety, and duration by guaranteeing stuff and by buying stuff and issuing its own liabilities in return. The government has to, as Bagehot put it, “lend freely”–and not just lend but buy–and in order to avoid enabling moral hazard for the next time the government has to lend at a penalty rate: and if institutions are not illiquid but insolvent so that the government cannot lend at a penalty rate the government must take equity.
Targeting nominal GDP isn’t a silver bullet, and much depends on who’s running a central bank. But even economists who find glitches aren’t keen on rejecting it outright, if at all. For example, a 1989 study, finds much to like with nominal GDP targeting despite the warts.
But ours is an imperfect world and so waiting for perfection isn’t an option. Perhaps it’s best to call GDP targeting a poor choice, but one that’s less poor compared with the alternatives. Accordingly, the question is whether the Fed could be doing a better job in matters of monetary policy. The answer is almost surely “yes.” In that case, the burden is on critics of nominal GDP targeting to explain why adopting this policy isn’t reasonable.
Skeptics can start with Paul Krugman’s complaint: “targeting nominal GDP growth at some normal rate won’t work — you have to get people to believe in a period of way above normal price and GDP growth, or the whole thing falls flat.”
Then again, the Fed could state its committment to the policy and back it up with action. In time, the makets and the public would believe. That wouldn’t happen overnight, but with the right leadership it’s certainly possible.
Why, then, hasn’t the Fed adopted GDP targeting? Arnold Kling ponders some possibilities:
(a) They do not want to be embarrassed if they are unable to hit a target
(b) This is what Tyler Cowen would call a Straussian situation, in which the insiders must never reveal their true agenda, or horrible demons will be let loose, leading to social breakdown and bloodshed.
(c) They fear that announcing a target would create “lock-in” and cost flexibility.
(d) A target would make many of the departmental functions and rituals (such as FOMC meetings) long cherished at the Fed seem pointless.
(e) The Fed is institutionally more concerned with the stability and profitability of the banking system than with macroeconomic variables.