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