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