In a recent post John Taylor leans on Bob Hall to criticize NGDP Targeting:
In his paper at the recent Jackson Hole conference, Bob Hall criticized nominal GDP targeting, citing his 1994 paper with Greg Mankiw. Bob argues that “A policy of stabilizing nominal GDP growth would require contractionary policies to lower inflation when productivity growth is unusually high. Such a policy might easily trigger a spell at the zero lower bound.” No one at the conference objected to this statement, and I do not recall nominal GDP targeting being mentioned at the conference, though policy rules were mentioned quite a bit. This suggests that more policy evaluation research on the new and different proposals is needed to inform the policy discussion, and it is certainly welcome in my view.
That no one objected is a very bad sign! From the point of view of an AD/AS dynamic model, a productivity (or real) shock increases the rate of RGDP growth and LOWERS inflation. Check it out:
Now observe the real world empirical counterpart:
As expected, real growth rises and inflation falls when productivity growth is unusually high!
What should the Fed do in this case? In a Taylor Rule set up the Fed could either lower the policy rate, or increase it, depending on the quantitative changes in real growth and inflation and on the parameter values attached to inflation and the output gap. In Bob Hall´s presentation it seems that ‘too much’ growth trumps the drop in inflation, in which case monetary policy would be contractionary. But if you are increasing the policy rate how does that get you into a spell at the ZLB? (Maybe they´re saying that later, due to the ‘dramatic’ fall in inflation following the initially contractionary policy, the policy rate will have to be drastically reduced, even all the way to zero?).
Market monetarists indicate that NGDP (AD or the growth of M+V) should remain stable, allowing the economy to adjust (or, as Austrians say, reallocate) efficiently.
But what did the Fed do? It ended up first lowering the policy rate (reacting to the drop in inflation) and then raising the policy rate (reacting to the increase in growth). In this way, NGDP growth first rose above the trend path and then fell below it, causing instability (which, incidentally, was only corrected when the Fed adopted forward guidance in mid-2003).
This policy generated instability is clear in the NGDP gap chart.
Another example that policymakers should listen to the “dog that barks”!
PS I see John Taylor made Scott feel “grumpy”!