NGDP targeting is usually advocated in the context of advocating a “catchup” plan. Because we went through a period of deflation and contraction, the price level is now under trend, and the Fed should commit to remaining maximally loose until we’ve caught up with the price level.
But, if NGDP really is a new framework, and not just a rationale to keep monetary policy loose, to be discarded when conditions change, then we have to look back at how it would have worked in a period of high nominal growth – and high inflation. Moreover, we’d have to look at how “getting back to trend” would have worked once the back of inflation was broken.
And it seems to me that it would have worked disastrously. From 1965 to 1980, nominal GDP growth never dipped below 6%, and got as high as 12%. To return to “trend” would require keeping nominal GDP well below the economy’s potential for years. You remember “Morning in America?” Well, if we were following a nominal GDP target it would never have happened. The Fed would have raised rates sharply in 1984, as nominal GDP growth spiked up from 6% all the way to 10%.
Of course, nobody would have followed such a policy, even if, in theory, there were some advantage to “undoing” the “Great Inflation.” A policy of “opportunistic disinflation” was much more rational, precisely because much more moderate.
That’s obvious. So why isn’t it obvious that the converse is true?
It´s misleading to characterize NGDP targeting as a “catch up” plan. It all depends from where you start. Back in Volcker´s time it would be viewed as a “push down” plan. In the seventies monetary policy was mostly on “go mode”, reflected in the rising NGDP growth trend. For Arthur Burns inflation was the province of “incomes policy” with monetary policy only able to mitigate the employment effects of negative “supply shocks”.
Volcker, on the contrary, viewed inflation as a monetary problem. And he was well aware of the difficult task ahead to bring inflation down. In his first FOMC meeting as Fed Chairman, he said:
“Economic policy has a kind of crisis of credibility. As a result, dramatic action to combat inflation would not receive public support without more of a crisis atmosphere”.
And just a few weeks later, on October 6, 1979, operating procedure changed drastically, from targeting the FF rate to targeting monetary aggregates.
The period I like to call “Volcker Transition” lasted six years, from the last quarter of 1979 to the last quarter of 1986, which is basically the whole of Volcker´s tenure as Fed Chairman.
Things didn´t work out smoothly. The initial tightening of monetary policy (fall in NGDP growth) during the first three quarters of 1980 was accompanied by a rise in unemployment and inflation. The Fed relented and went into “go mode” for the next four quarters. Inflation remained elevated and unemployment didn´t budge.
Volcker must have thought; “I must go about this in a different way, let´s ‘stop the bus and get everyone seated and quiet’ before starting up again”.
And the Fed really stepped on the brakes. Over the following four quarters (from 1981.III to 1982.III) NGDP growth dropped from 14% to 3%. Unemployment soared and inflation began to travel south. The Fed than stepped on the gas and the economy gathered speed. Unemployment and inflation came down.
Curiously, at the end of 1982 at the high point of unemployment and the low point of growth, with inflation below 6%, the lowest level reached since 1974, the Fed discussed NGDP targeting:
MR. MORRIS. I think we need a proxy–an independent intermediate target– for nominal GNP, or the closest thing we can come to as a proxy for nominal GNP, because that’s what the name of the game is supposed to be.
Very wise words indeed. It was nevertheless thought to be too “politically sensitive” to be explicitly adopted. Nevertheless, I think we can infer that the concept influenced decisions. For starters, the monetary aggregate targeting system was abandoned.
To cut the story short, it seems the Volcker Fed managed a soft landing of the economy, taking NGDP to a level from which it began the smooth growth that characterized most of the next 20 years so, contrary to what Noah Millman conjectures, it was not “disastrous”. And given the Fed´s prior NGDP targeting discussion of late 1982, the high NGDP growth in 1984 that Millman thinks would not have been allowed if NGDP were being targeted, was more likely a direct result of the Fed´s NGDP ‘objectives’.
It appears that in 1981-82 the Fed managed to implement a successful “push down” plan after which it managed to reposition the economy so it could progress much more adequately than during the “Great Inflation” years.
By looking at today´s economy “after the fall”, Millman thinks NGDP targeting is advocated as a “catch up” plan. Not so. If it had been actively pursued to begin with or, as ‘as if’ it were being pursued like during the “Great Moderation”, the ‘crash’ of 2008 would not have happened. Now, just like Volcker had to “push down” NGDP growth, Bernanke would have to give it a “push back”.
The above story is illustrated in the charts below.
P.S. At the end of today´s FOMC meeting the Fed appears to have adopted a ‘light’ or ‘no numbers’ version of Chicago Fed president Charles Evans suggestion “that the federal funds rate will not be increased until the unemployment rate falls below 7 percent”. The statement says:
The Committee will closely monitor incoming information on economic and financial developments in coming months. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.
Since everyone knows that to Bernanke ‘price stability’ means 2% inflation, as soon that he feels that threshold is threatened, everyone will expect the program will stop.
Meanwhile, all ‘indicators’ moved in the right direction: Stocks, Long Yield, Gold, UP. Dollar DOWN