Is there are role for NGDP targeting?

In a recent post I discussed Ryan Avent´s comments on Antonio Fatás and Ilian Mihov´s “From recession to normalcy: Recoveries as a third phase of the business cycle”:

We work with a framework that borrows from the academic literature to combine the following elements:

  • The growth path of an economy can be described by a long-term trend.

Business cycles are seen as cyclical (transitory) deviations from this trend.

  • We think of the trend as the maximum level of output.

This is different from the interpretation of potential output as a ‘sustainable’ level of output in the tradition of measures such as the output gap or the non-accelerating inflation rate of unemployment (the NAIRU). Our notion of trend is similar to that of the Friedman’s plucking model (Friedman 1964).

  • Business cycles are asymmetric and driven by negative shocks.

This asymmetry is implicit in the Burns and Mitchell or the National Bureau of Economic Research methodology because of their focus on recessions.1

  • After a trough, there is a distinct phase where the economy returns towards normal levels (trend).

This phase is called ‘recovery’.

This simple econometric model fits well our theoretical framework. The estimation assumes that the cyclical component during expansions is zero, matching our idea that at after the bounce back from the recession is over, the economy is close to full employment and growing at a normal rate. This allows for a very clean and consistent interpretation of the cyclical component in Figure 1 as the gap between actual output and a measure of trend output that can be seen as a maximum, a ceiling.

In our analysis we take as given the recession dates as provided by the NBER (identified by the vertical red and grey lines).3 We then define recoveries as the phase in between the end of the recession (grey line) and the moment when the cyclical component of Figure 1 is close enough to zero.

No Brainer_1

They then present a table showing the costs of recession and recoveries for all postwar cycles. I highlight the two with the highest total costs.

Cost of recessions and recoveries (% previous peak annual GDP)

Recession

Recovery

Total

1981q3

8.65

3.07

11.72

2007q4

5.54

16.57

22.10

Note that in the 1981 cycle the cost of the recession phase was even higher than in the most recent cycle; but what shocks us is the enormous cost of the (still ongoing) recovery.

The usual “excuse” is the meme of “recoveries from financial crisis are slow”! That´s just very convenient for the “powers that be”, which can easily exculpate themselves of any wrong doing.

Assuming that the central bank can closely influence nominal spending in the economy (and please, don´t say “not so in a liquidity trap”), leads me to compare the behavior of spending (NGDP) in the recovery phase in the two cycles (note the recovery phase in the 1981 cycle ends by the end of 1983). I think it´s really a no brainer to see why the present recovery has been so costly!

No Brainer_2

And for the “inflation worriers” there´s no reason to fret. The chart shows that throughout the strong expansion phase of the 1982 recovery (which ended by the end of 1983), inflation (PCEC-Core) declined.

No Brainer_3

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