Inflation Targeting vs. NGDP Targeting

Inflation Targeting came about to solve the lingering inflation problem of the 1970s and to address the breakdown between monetary aggregates and inflation. It brought transparency, accountability and a simpler way of communicating monetary policy to the public.

The supporters of NGDP targeting claim the new monetary policy regime will deliver all that and more. For those interested on how this regime could be modeled McCullum and Nelson (1998) is a good start. Of course like every theoretical model it incorporates assumptions that for some are reasonable and for others are not.

Putting the two regimes against each other one finds  many similar characteristics. In fact, NGDP targeting does resemble a Taylor rule with a twist. In the same way that Inflation targeting rules have been augmented to include more flexibility or exchange rates. The other interesting connection is the way they are introduce into the popular economic culture. Inflation Targeting (IT) was introduced to solve the inflation problem stemming from the 1970 and NGDPT is advocated as a solution to current recession, i.e. help the economy grow.

But as we now know there was a problem with IT.  Once inflation was brought down it has helped create asset bubbles in other sectors of the economy. And this gets me to something that NGDPT does not address in detail. I followed Mr. Nunes’ advice and read Nick Rowe’s piece  on NGDP targeting. Very interesting but this is what I need to know more about:

“Eventually, if the Fed bought up every single asset in the economy, and swapped it for cash, NGDP would rise to the Fed’s target path. Prices would rise without limit as the Fed bought up the last remaining assets because the sellers could name their price. And people would hire the unemployed to build factories which they could float on the stock and bond markets and sell to the Fed at any price they liked. Or sell to the people who had already sold all their assets to the Fed.

But there is no way it would ever get that far. That’s like saying that Chuck Norris will eventually beat up everyone in the room. That’s not an equilibrium.

Some people are just barely willing to hold cash in the current equilibrium. If they expect even the slightest rise in NGDP in even the distant future, they will get out of cash, and into real assets, or claims on real assets like commercial stocks and bonds. And this will increase the demand for goods today, either directly, or because firms find it easier to issue new stocks and bonds to finance investment. Which raises NGDP, and expected future NGDP, even if just a little. Which encourages additional people to exit cash too, and buy real assets and claims to real assets. Which raises NGDP and expected future NGDP still further. And so on. As soon as people figure out what’s going on, and what’s going to happen, expected NGDP rises to the target path. The Fed only has to carry out its threat until people catch on to what’s happening. Then it has to reverse course and sell all the assets it bought, and then some more, to prevent the economy overshooting the new equilibrium.”

The minor criticism is that to have a solid monetary regime agents need more than ”

But the major criticism has to do with the lack of detail about when to cool down the  economy once it growing above the target. Should you wait few quarter to get more data or should you respond immediately? But most importantly will FED be bold enough to stop the economy from overshooting? What if to bring the NGDP to target the economy has to go through a period of recession?
The IT regime had to answer similar questions when inflation fell below target. One great dilemma of inflation targeters was to create an inflationary environment while inflation was below target. To do that they had to lower rates which in an economy growing close to potential would have been dangerous.

I will be open minded about this and will read the incoming research on the subject. But in my view monetary policy cannot do too much right now either in a IT or NGDPT regime.

P.S. Here is a link to a paper by Carl Walsh that proposes improvments for IT regime

And a link to a blog detailing how NGDPT is part of the Taylor rule family


16 thoughts on “Inflation Targeting vs. NGDP Targeting

  1. I read Nick Rowe’s take on NGDP (E[xpected]NGDP as he calls it) yesterday, as I found it accessible enough to be able to follow it. I think in one of his comment replies he addresses your overshooting worry.

    He says that the targeting comes with an implicit threat/promise from the FED that they’ll either escalate or reverse escalate (“negative QE, raise interest rates and shrink its balance sheet”) their intervention.

    1. @florin Bejan
      The problem with implicit promises/threats is that they do not work, especially when times are good. I have yet to find the central banker slamming the breaks when the economy is doing well. I like the spirit of the NGDP people but the regime does not seem to me to improve over flexible inflation targeting. Regarding the MMT, @Lav, I have plenty of issues with them. The main one is the role of the state in the economy and the second one is the way they see money appearing in the economy. I will not bore you here with that though.

  2. I don’t wanna be mean, and anyway is not your fault, but I’ve never thought I can live to read something that stupid. A central bank buying assets in the economy, trying to make us act God knows how. GOD! I’m sure the companies will get really scared and will invest and create tones of jobs, as a result. And they will get really encouraged having the central bank as a direct competition in the market. Day by day is more clear to me that the only real path to follow is taking the central bank out if the real economy game. But in the same time day by day people seam to go more and more crazy. This is communism, and I refuse it.

      1. This is what they see as the market failure and the need for Fed to intervene and buy everything .

        The heavybreliance on public intervention to solve the recessionary period makes me uncomfortable. It could be that I grew up in communist Romania and I naturally am against government intervention. Sent from my iPhone

    1. @Nick
      Now that I got you here I am going to take advantage of you. You use the threat argument also when you talk about correcting overshooting of GDP. But my experience with Inflation Targeting and in the market tells me tha that it would be very hard to implement corrections when times are good. That was the issue with Price Level Targeting also. As I said in my post the weakness of IT regime was clear when inflation lingered below target or close to zero. Isn’t the weakness of NGDPT regime the risk of remaining above target for long periods increasing the probability of overheating the economy?

      1. florincitu: Yep. To hit the target exactly is hard with IT, and will be equally(?) hard with NGDP targeting. Especially if the targeting regime is new, and both the central bank and the public is learning the new regime. But anchoring long run expectations of NGDP will help a lot, since people will know the CB will get it right eventually, and actual NGDP depends a lot on expected NGDP.

        Scott says the Fed should set up an NGDP futures market, and adjust monetary policy until the implied expectation of NGDP on that market equals the target. Target not NGDP but E(NGDP).

      2. @Nick
        I read that about E(NGDP) in Scott’s work. But I wonder how easy is to implement his proposal and how reliable it would be. There are already market estimates for GDP growth rate and traders do transact on them until data is released. They also trade on implications from GDP data releases to prices and interest rates in the economy. Why should the Fed set up the market? It just seems a bit more complicated than in the case of inflation targeting where the data is more reliable and available every months. And I do not see the net superiority over IT through the different development stages of an economy.
        My gut feeling is that NGDP might work to push the economy out of the current slump. But very soon after it will push it into overheating. Just my guess. But I will wait for more applied work to see how people want to model it.
        BTW, my take is that in his last speech Bernanke talks about an improved version of Inflation Targeting for the Fed and not about NGDP targeting.

  3. @Nick

    Unfortunately your article is the same old stuff, that I refuse. Is based on some imagination and assumptions we can’t actually prove to be real, and we can’t actually know in advance. This is how we got here, based on imagination. And some people imagination proved to be wrong, while the rest paid for this.

    This is also a communist mentality: “In the short run, the demand for money can fluctuate, and unless the central bank adjusts the supply of money to accommodate those fluctuations in demand, the result will be monetary disequilibrium with short run booms and recessions.” Sorry, I refuse a Big Brother to adjust my demand as he wishes. I consider the demand adjustment, and the booms and busts, to be the real economy problem, and not the central bank problem.

    Can you prove this? “As we reduce the long run money growth rate, and reduce the long run inflation rate, ” ??? Can you prove that there’s a connection between money growth rate and inflation, and how is this happening? I mean prove it with the statistics, not imagination and theories.

    And although I don’t like deflation and I don’t want it, from this point of view we see things the same, I don’t agree with you when you say people tend to own more money because of the deflation. We face a risk averse environment, and I could saw that people made more and more deposits disregarding the inflation rate. Look on the statistics and prove this to me, plz. Risk aversion is one thing, and this inflation-deflation way of thinking is another :). And let’s not allow ourselves fooled by randomness, or affected by the confirmation bias :).

    1. “Can you prove that there’s a connection between money growth rate and inflation, and how is this happening? I mean prove it with the statistics, not imagination and theories.”

      Yep. Zimbabwean hyperinflation. They were printing zillion dollar banknotes. That’s just one example.

      How is it happening? Supply and demand, for money, in this case.

  4. @Nick

    What about Japan deflation? They also printed money and they god deflation, not hyperinflation.

    And why do we take a really tale event in order to describe the day to day reality?

    1. That’s been explained either by Krugman’s deflationary trap or by others that said that in fact BoJ wanted an inflation that low, that they actually reduced the monetary base (in 2005?) after their own QE in the previous 4-5 years, just to prevent inflation.

      1. I will refuse to respond, because it will be considered too much. If a big economist told so, it is most probably true. And, btw, the Japan deflation has nothing to do with 2005, its a question of around 20 years. And the simple fact that the state has an over 200% debt/GDP, 95% owned inside, should tell us something about money printing.

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