Targeting Nominal Gross Output (NGO) will not provide Nominal Stability

At the closing of 2015, Vincent Geloso proposed that the Fed target Nominal Gross Output (NGO), concluding:

If monetary policy should shift to targeting nominal spending, NGDP is not the best indicator – NGO is.

Nick Rowe did a post (which includes a pertinent comment by Matt Rognlie).

In his comeback, Vincent writes:

When there is a shift of the demand for money, this will affect all transactions, not only those on final goods. Thus, my first point: gross domestic product is not necessarily the best for monetary transaction.

However, Market Monetarists are not on the lookout for the best indicator of monetary transactions, but are focused on Nominal Stability, and that is attained when NGDP follows a stable level growth path.

Vincent shows this chart


And writes:

…total nominal spending did drop massively during the recession (see the fall of wholesale, gross output and retail) while NGDP barely moved while, before the recession, total nominal spending did increase much faster than NGDP.

The chart below is a simplified version


I almost chocked when Vincent says “NGDP barely moved”. In fact, the drop in NGDP was the biggest since the 1930s!

Matt Rognlie´s comment is to the point:

…This confirms the hypothesis that commodity prices played a big role: you’d expect them to push up nominal GO/VA in 2007 and early 2008, then push it down in late 2008, which is exactly the effect that disappears once you control for prices.

And therein lies the problem in trying to target NGO. It is much like trying to target headline inflation (or the headline price level). Those targets are often “polluted” by relative price changes arising from, for example, oil price shocks.

And monetary policy should not react to real (supply) shocks. 2008 is, in fact, eloquent testimony of the Fed´s mistaken reaction to the oil shock. (And it is ironic that that mistake was made by Ben Bernanke who, in 1997 said the impact of an oil shock on the real economy (RGDP) was dependent on the reaction of monetary policy)

The result: Nominal Instability!

These old charts illustrate the Nominal Stability generating power of having NGDP growing close to a target trend path. Although there´s no equivalent NGO data to compare, I doubt the structure of NGO would give rise to an equivalent outcome.