Matthew Klein (MCK) could have talked to Ryan Avent (RA) before writing foolish things about NGDP Targeting

This is MCK:

THOSE who want central bankers to focus to changes in nominal incomes (NGDP or NGDI growth) rather than the pace of consumer price increases (CPI or PCE inflation) have made tremendous progress over the past few years, at least when it comes to persuading economists and pundits. Even policymakers seem to be increasingly interested in the idea. In the short term, a nominal income target, coupled with the notion of “catch-up growth,” would provide central bankers with much more leeway to engage in monetary stimulus, particularly by affecting people’s expectations. (The exact nature of how this works is unclear). In general, the theoretical appeal of a nominal income target is that it would do a better job than an inflation target at shielding the economy from supply shocks.

For example, shortages in essential commodities can cause the observed rate of inflation to accelerate while restraining real output growth. A central bank that focused on nominal incomes would avoid an excessively tight policy response compared to a central bank that targeted the rate of consumer price inflation. But a central bank with a nominal income target would also have to be tighter than one with an inflation target during a commodity glut or during a period when the world’s labour supply increased. Worryingly for the advocates of an NGDP target, this means that the emerging consensus may not be politically durable. People have gotten used to the idea of monetary tightening in response to faster inflation. How would they feel if, in the face of higher output growth but falling inflation, the central bank failed to ease, or even tightened, in order to stick to its NGDP target?

And he quotes Jerry Jordan´s doubts. But this is what Greenspan himself had to say at the time:

From the November 17 FOMC Transcript, Greenspan says:

“Let me put it to you this way. If you ask whether we are confirming our view to contain the success that we’ve had to date on inflation, the answer is “yes.” I think that policy is implicit among the members of this Committee, and the specific instruments that we may be using or not using are really a quite secondary question. As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions. I would say in that context that on the basis of the studies,we have seen that to drive nominal GDP, let’s assume at 4-1/2 percent, in our old philosophy we would have said that [requires] a 4-1/2 percent growth in M2. In today’s analysis, we would say it’s significantly less than that. I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that. And I don’t see any change in our view…and we will know they are convinced (about “price stability”) when we see the30-year Treasury at 5-1/2 percent.”

MCK gets it very wrong in the highlighted sentence above. Just as the central bank would keep NGDP growing at the trend level rate if the economy were hit by a negative supply shock, it would also keep NGDP growth ‘on target’ if it were hit by a positive supply shock.

The chart below illustrates.


The positive supply shock shits the AS curve to the right.By keeping AD growing at the target level rate, the economy moves from point 1 to point 2, experiencing higher growth AND lower inflation. If it were targeting inflation, it would increase AD growth, but the result would be instability!

This actually happened in 1998. The positive productivity shock increased real growth and reduced inflation (core). First the Fed reduced rates (afraid of a fallout from LTCM). Then it increased rates because RGDP growth was “too high”. The result was nominal instability. The charts illustrate.




More recently, the FOMC reacted to the rise in headline inflation from oil/commodity shocks (a negative supply shock) and constrained AD growth. The result, given the weakened state of the economy from the fall in home prices, was instability on steroids, i.e. the “Great Recession”.

HT Josh Hendrickson, David Levey

5 thoughts on “Matthew Klein (MCK) could have talked to Ryan Avent (RA) before writing foolish things about NGDP Targeting

  1. “How would they feel if, in the face of higher output growth but falling inflation, the central bank failed to ease, or even tightened, in order to stick to its NGDP target?”

    I think a good question to ask, that we know the approximate answer to from evidence all around us is: How do people feel when the Fed tightens during an oil shock because it has an inflation target? Given the events of the past 5 years, I would say that worry about easing when it might be desirable as extra icing on the cake is a relative non-issue when we have to figuratively don the Rambo gear to get easing when it is NECESSARY. The real core of the problem we have, at least from my point of view, is the discretionary aspect of monetary policy. That should be eliminated even if it means forgoing the extra icing on the cake when possible because the enormity of the crisis we have gone through makes it not worth the risks that come with the central bankers calling the shots. No, I think we’ve had quite enough of that.

    “In the short term, a nominal income target, coupled with the notion of “catch-up growth,” would provide central bankers with much more leeway to engage in monetary stimulus, particularly by affecting people’s expectations. (The exact nature of how this works is unclear). In general, the theoretical appeal of a nominal income target is that it would do a better job than an inflation target at shielding the economy from supply shocks.”

    I don’t know where Mr. Klein is coming from here, but the law says that the Fed shall manage monetary and credit aggregates commensurate with the economy’s long run ability to produce – and it includes aspects of nominal stability: employment, prices and interest rates. There is nothing that says when prices rise, from whatever source, that money has to be tight. And in that regard, it seems quite clear that NGDPLT is more consistent with the Fed’s mandates than the bastardized inflation policy the Fed has been following throughout the Great Recession.

  2. I think the increase in labor supply is a bit more problematic.

    The notion that a commodity glut will require that the Fed tighten (to generate disinflation) is trully odd. The commodity glut leads to lower prices of the particular commodities, and the Fed doesn’t intervene to raise other prices to offset the lower commodity prices.

    If labor supply grows more rapidly, then wages must grow more slowly (and in the extreme, fall) and with the slower growth in costs, prices rise more solwly or even fall.

    Some Market Monetarists advocate targeting per-capita NGDP for this reason.

  3. Excellent blogging. I can’t understand the arguments against NGDP targeting.

    Do people (economists anyway) actually believe that a secretive, opaque central bank that targets zero inflation or minor deflation is actually better than above-board and transparent central bank that targets NGDP?

    On the basis of what? History? Empirical results? Good governance? That’s zero for three, and I call a strike out.

  4. Wow, Marcus, how on earth did you get MCK’s name, he’s not listed in the media directory! And yes, right on with the comments.

    Oh, and I’ve just finished reading your chapter drafts for the new book, I’ll send you my comments tonight.

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