As expected, after Goldman Sachs wrote favorably about NGDP level targeting, the subject would be picked up by the media. Today the WSJ has a critical and unfavorable appraisal. They mostly depend on the GS analysis and that can be misleading especially since they provide “precise” quantitative estimates of the required size of the Fed´s balance sheet and the required period for “zero” FF rates. In other words, they don´t subscribe to the “Chuck Norris” principle in the conduct of monetary policy elaborated by Nick Rowe (via Lars Christensen):
Central banks run monetary policy not so much by doing things, but by threatening to do things. If their threats are credible, we never observe them carrying out those threats, and we often observe them doing the exact opposite
A credible central bank is a bit like Chuck Norris. (Apologies to Lars Christensen for stealing his metaphor.) Chuck Norris simply looks at the target variable, and it moves to wherever he wants it to go. It looks like magic. But it works because nobody wants Chuck Norris to carry out his implicit threat. So he doesn’t need to.
The WSJ could do much better by reading Scott Sumner´s Retargeting the Fed, so I´ll not go into detailed comments on the “errors of interpretation” they make (I see Scott has done a post to answer back), and just elaborate on this specific argument (which really invalidates any attempt to get the economy back on track):
First, it is tempting, but probably mistaken, to assume the Great Recession came along and knocked the U.S. off an otherwise sustainable growth track. It wasn’t an external shock, but internal weakness, that led to the economy’s collapse.
Substitute “internal weakness” for “accumulated sins” and you get the “Calvinist/Puritanism view of economic ills. This quote is from Lars Christensen via Doug Irwin:
NYT quote Cassel: “The deeper psychological explanation of this whole movement…can without doubt be found in American Puritanism. This force assembled all its significant resources in what was considered a great moral attack on the diabolism of speculation. Each warning against deflation has stranded on fear on the part of Puritanism that a more liberal monetary policy might infuse new vigor in the spirit speculation.”
Let me, as usual, put some pictures up. In the first RGDP is shown from 1955 to 2011. In the picture, I “identify” 3 growth paths and a 4th which may, or may not, progress. From 1960 to 67 we have “Camelot”. Nice, but it brought up the seeds of the “Great Inflation”. The growth path (always drawn passing through the cycle peaks) shifts down but is maintained all the way to 2000. It seems that after 2000 “potential” output growth slowed and the real economy evolved along a lower growth path until, that is, early 2008 after which it dropped into an “air pocket”.
Maybe the Journal is partly right when it says that “the economy’s real potential growth rate has been slowing for decades”. It´s just decade in the singular. So here we are at a point of decision. Will everyone involved be content with travelling along a much lower level path? (Or should “something” be done to make the traverse from path 4 to path 3? Or even, with the right supply side reforms, try to go back to path 1? In this case, research should be undertaken to measure how much of the fall in “potential” the Journal mentions was due to Bush Jr. policies – fiscal and war?).
That´s where NGDPT comes in. The next graph depicts NGDP from the early Great Moderation period. Again, it seems that after 2000 the growth path was lowered. That reflects “good monetary policy”; one that lowered the nominal growth path to “accommodate” the lower “potential” output path, thus maintaining inflation on “target”!
The drop from path 2 to path 3 has obviously nothing to do with so called “internal weakness” but everything to do with monetary mistakes (that have been amply discussed by all MM´s).
If we can visually “identify” the level path we (at least) should be in – path 2, the sophisticated measuring tools available could give a pretty good numerical target for NGDP to allow the traverse from path 3 (the “bottom of the hole”) to path 2. Here again, the Journal is “too pessimistic”: “even if the Fed were to aim at a particular nominal GDP target, it isn’t clear policy makers could successfully hit it”. I bet they could!