Don’t call it a target: The thing about nominal GDP

March 27, 2013

Ask top Federal Reserve officials about adopting a target for non-inflation adjusted growth, or nominal GDP, and they will generally wince. Proponents of the awkwardly-named NGDP-targeting approach say it would be a more powerful weapon than the central bank’s current approach in getting the U.S.economy out of a prolonged rut.

This is what Fed Chairman Ben Bernanke had to say when asked about it at a press conference in November 2011:

So the Fed’s mandate is, of course, a dual mandate. We have a mandate for both employment and for price stability, and we have a framework in place that allows us to communicate and to think about the two sides of that mandate. We talked today – or yesterday, actually – about nominal GDP as an indicator, as an information variable, as something to add to the list of variables that we think about, and it was a very interesting discussion. However, we think that within the existing framework that we have, which looks at both sides of the mandate, not just some combination of the two, we can communicate whatever we need to communicate about future monetary policy. So we are not contemplating at this date, at this time, any radical change in framework. We are going to stay within the dual mandate approach that we’ve been using until this point.

But Mike Dueker, chief economist at Russell Investments and a former St. Louis Fed staffer, said the Fed already targets nominal GDP, even if it won’t admit to it. The way he sees it, by setting an inflation target of 2 percent and forecasting long-run growth between 2.3 percent and 2.5 percent, policymakers are effectively aiming for an NGDP target in the vicinity of 4.5 percent.

The basic idea behind aiming for NGDP is to allow for some short-term wiggle room on inflation to help boost economic momentum and induce businesses to invest in new production, and hire more workers. Once momentum gets going, policymakers can dial back stimulus.

In a research note entitled “A nominal GDP target in all but name,” economists at Goldman Sachs note that the Fed’s new thresholds policy makes its framework even more similar to an NGDP model. As of December, the Fed promised to leave rates near zero until the jobless rate falls to at least 6.5 percent, as long as inflation is not projected to rise above 2.5 percent – 0.5 percentage point above its formal target – over a one- to two-year timeframe.

From a conceptual perspective, it is equivalent to a nominal GDP level (NGDP) target in which the Fed commits to keeping policy accommodative until a period of ‘make-up growth’ in real GDP and/or prices has pushed NGDP back to a higher path. Although that path is somewhat less aggressive than under other NGDP proposals, including our own, it would amount to a further significant monetary easing. It implies a zero funds rate until unemployment has fallen all the way back to the structural rate, i.e. 6% or less.

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