A long-time Fed economist discusses NGDP favorably

Robert Hetzel, of the Richmond Fed writes “Nominal GDP: Target or Benchmark?”  I highlight two passages.

First:

Previous work by the author in 2008 and 2012 argues that former Fed chairmen Paul Volcker and Alan Greenspan followed a nonactivist rule during the period known as the Great Moderation, the years following the Volcker disinflation through the Greenspan era. Although the FOMC does not explain the rationale for its policy actions within the framework of a rule, since this era, policymakers have recognized the need to behave in a consistent, committed way to shape the expectations of financial markets.

The chart provides the view of NGDP growth and inflation for the last 60 years.

Hetzel Benchmark_1Hetzel Benchmark_2

Initially NGDP growth is highly volatile (but trendless). From the mid-60s to 1980, NGDP growth trends up, and so does inflation. The Volcker adjustment was a period when NGDP growth was strongly reduced with inflation being brought down significantly.

Note that from the start of Greenspan´s Great Moderation, NGDP growth is stable, but inflation continues to come down, only reaching the (implicit) 2% target in the mid-90s.

As Hetzel notes, the Fed, particularly Greenspan, never explained the rationale for its policy actions within the framework of a rule. As such, the Taylor-rule was an attempt by John Taylor to describe (guess, make-up) a “rule” that was consistent with what the Fed was doing. With time, given the highly successful monetary management of that period, Taylor and his followers want us to believe that the “rule” was responsible to the period´s success!

From the chart, it appears much more likely that the “success” (defined by inflation falling and remaining low and stable) was mainly due to NGDP growth remaining stable.

The chart on RGDP growth tends to corroborate that view.

Hetzel Benchmark_3

Throughout the 1954-2007 period, RGDP growth averaged 3.4% (we´ll see below that is true since 1870!). Before the mid-60s, the volatility of RGDP growth is due to the volatility of NGDP growth. During the “Great Inflation”, RGDP growth volatility derives from the inflation volatility of the period (caused by the rising and “chopped” growth in NGDP). During the “Great Moderation”, low NGDP growth volatility translates into low inflation and real growth volatility!

Which leads me to the second passage of Hetzel´s essay I want to highlight:

If trend real GDP growth is stable and policy is credible so that the expectation of inflation is aligned with the FOMC’s inflation target, as it was for most of the 1990s, these procedures translate into stable trend nominal GDP growth. Note, however, that this fact does not imply that the FOMC had a target for nominal GDP.

It would seem that a stable NGDP growth is the outcome, or result, not the driver! That´s the reason for him to suggest that NGDP may be a good benchmark (although not a target).

My first observation is that trend real growth has been stable since the 19th century! It´s not a characteristic of the 1990s. The top chart shows RGDP and trend from 1870 to 2011 (yearly data). Trend growth is 3.4%. The bottom chart, based on quarterly data from 1954 to 2014, shows that trend growth is also 3.4% (up to 2007). Note that following the Great Depression, RGDP reverted to trend. Will the post 2007 period become known in 50 years’ time as “the Bernanke Break”?

Hetzel Benchmark_4

Hetzel Benchmark_5

My second observation is that during the 1990s, since the US did not have an explicit inflation target, policy credibility cannot be defined as the “alignment of inflation expectations with the FOMC´s inflation target”. The FOMC´s “target” was “low” inflation, something vague. In the course of the 1990s, the Fed gained credibility because inflation remained “low”. My conjecture is that that´s the outcome of NGDP growth evolving stably along a level trend path.

The panel below indicates my conjecture has some validity. From the early 90s to early 2008, you could say the Fed “targeted” inflation, not at 2% but in a band of 1% – 2%. You could also say it targeted the price level (PLT) close to a 2% trend growth, but you could also say the Fed targeted NGDP along a 5.5% trend level path.

Hetzel Benchmark_6

The “Bernanke Break” serves to show that what “held everything together” was keeping NGDP evolving stably along a level path. In 2008 it wasn´t inflation or the price level that indicated something was wrong. The “dog that barked” was NGDP dropping significantly and “permanently” below the trend path!

But by all means, if there are reservations to a formal NGDP level targeting, use it as a benchmark. If the Fed had done so in 2008, things would be much less dire in 2014, and we would not be having ridiculous discussions about “GSG”, “SS” or about “June”, “September” or “whatever”! Or see things go topsy-turvy as suggested by this piece by Binyamin Appelbaum ( HT Peter Ireland):

At a hearing in February, Representative Scott Garrett, a New Jersey Republican, complained that Congress and the Federal Reservehad traded places.

During previous periods of high unemployment, members of Congress pressed the Fed to print more money even as the Fed remained wary of the inflationary consequences of such efforts.

After the Great Recession, by contrast, the loudest criticism has come from politicians demanding that the Fed shut down its printing press and raise interest rates.

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