Almost all economists were taken by surprise by the 2008 Financial Tsunami. The few economists who anticipated it failed to gain an audience. They were like the lonely Cassandra of Greek mythology making predictions of eminent economic collapse throughout their careers but never taken seriously by their profession.
Since then, unnoticed by the public, an intense debate has been raging in the blogosphere among economists, involving professors and graduate students, some famous and others less known, on what caused the Financial Tsunami and how to help the economic patient recover. The arguments center on the desirability of changing Fed policy from targeting interest rates to targeting growth in nominal GDP (NGDP).
Then there´s George Selgin putting John Taylor on the “right path”:
I meant to do so weeks ago, but I only just got around to reading the little flurry of posts concerning NGDP targeting that was set off by John Taylor’s critical remarks on the topic. And now, despite the delay, I can’t resist putting-in my own two cents, because it seems to me that much of the discussion misses the real point of targeting nominal spending, either entirely or in part; what’s more, some of the discussion is just-plain nonsense.
Thus Professor Taylor complains that, “if an inflation shock takes the price level and thus NGDP above the target NGDP path, then the Fed will have to take sharp tightening action which would cause real GDP to fall much more than with inflation targetting.” Now, first of all, while it is apparently sound “Economics One” to begin a chain of reasoning by imagining an “inflation shock,” it is crappy Economics 101 (or pick your own preferred intro class number), because a (positive) P or inflation “shock” must itself be the consequence of an underlying “shock” to either the demand for or the supply of goods. The implications of the “inflation shock” will differ, moreover, according to its underlying cause. If an adverse supply shock is to blame, then the positive “inflation shock” has as its counterpart a negative output shock. If, on the other hand, the “inflation shock” is caused by an increase in aggregate demand, then it will tend to involve an increase in real output. Try it by sketching AS and AD schedules on a paper napkin, and you will see what I mean.
Selgin links to Scott Sumner´s reply to Taylor. I´ll link to mine.