Sunday, March 11, 2012

NGDP Targeting: What if it fails?

Recently in the economics blogosphere, the monetary paradigm of nominal GDP level targeting (NGDPLT) has been gaining steam.  NGDP targeting takes a departure from the classic regime of inflation targeting by the growth rate in NGDP, allowing for balance between employment and inflation.  This then leads to a wide variety of benefits, as the new regime is robust to supply shocks, can craft stable expectations of overall future growth, and can reduce fears of any specific industry going through a crisis.  It's particularly attractive for financial crises, as if NGDP growth is stable, previously sustainable levels of debt are less likely to become unsustainable.  If the economy's productive capacity is constant, there's no reason for it to be less able to service its debt.

However, this view seems almost too simplistic.  Even though the US economy was incredibly stable during the over the 20 year Great Moderation, it all came down to a screeching halt with the 2008 financial crisis.  Similarly, even though Britain managed to stay out of a major recession for 16 years, NGDP fell by about 4.7% during the crisis.  Given that there had been such a long legacy of stability, how did expectations suddenly become unanchored?  Even if the US Federal Reserve made a bad policy decision at that point to focus on oil prices and other supply shocks to the detriment of nominal stability, why did the expectations of prudent policy in the future not "solve back" the concerns?  In the end, the crisis culminated into the worst disruption since the Great Depression: hardly a desired result for a responsible regime.

The unhappy ending in 2008 seems to suggest that responsible policy can break down into chaos given a large enough of an exogenous shock.  This problem is very close to what Nicolas Nassim Taleb discusses in The Black Swan: in exchange for low volatility, the economy goes along with high fragility, such that one large shock can cause non-linear, disproportionate harm.  So in the end, the question is about credibility.  How is it established?  How is it maintained?  If decades of prudent monetary policy were not enough to anchor expectations, why should we expect the Federal Reserve to be considered "credible" when the next large financial bubble appears?  If shadow banking markets start to grow shadows and systemic risk goes through the roof, why should we expect the Federal Reserve to be considered "credible"?  Especially if non-monetary factors as posited by Bernanke play a key role in recessions, why would nominal stability be enough?  And when everything crashes down, how will we deal with the mess of debt and contracts that were only sustainable under the old regime?  NGDP targeting seems to play on circular logic.  Boost aggregate demand to hold the expectation; with the expectation there's no need to boost aggregate demand.

So when a policy maker messes up, and lets a NGDP crisis unfold, the crisis emerges.  This is where the black swan hides, cloaked by the rhetoric of stable expectations and the "perfect" monetary policy.


  1. Lulu
    Welcome into the "MM fold".
    Some time ago I wrote this up to help me understand NGDPT. Maybe you´ll find it useful:
    PS I linked your blog over at themoneyillusion. Hope you get many visitors and remain encouraged to continue exploring.

  2. "Especially if non-monetary factors as posited by Bernanke play a key role in recessions, why would nominal stability be enough?"

    Because under a stable monetary regime there are no demand-side recessions, and all supply-side recessions are only temporary because the economy is "self-adjusting", as the Classicals said.

    "NGDP targeting seems to play on circular logic. Boost aggregate demand to hold the expectation; with the expectation there's no need to boost aggregate demand."

    NGDP targeting is not circular. It anchors expectations directly: moves that actually affect demand directly are only necessary to make the threat credible. See here:

    You never actually came out and said that you didn't think NGDP targeting would work, and I don't think you actually believe that, either. Scott Sumner has way too much material already on why central banks' "implicit" NGDP targets weren't sufficient to encourage them to follow adequate policy in this recession - I won't repeat it all here. Basically, the fundamental shift was absent - letting go of the interest rate as a mechanism or an indicator and thinking about the economy in more straightforward monetarist terms. Monetarism was discredited because it focussed on the money stock as a target as well as the instrument - Market Monetarism repairs that by telling people to watch the Market as an indicator of the best measure of (expected) AD health - NGDP itself. But crucially, Scott still likes to think in terms of demand and supply for base money as completely determining long run AD, which in turn determines short run AD (getting out of the Keynesian short-run box). So money is still the mechanism, and other factors are distractions. Until more economists see that, we won't resolve your problem - no "legacy of stability" will save us from future downturns.

    1. This threatening concept still seems a bit concerning, as even Scott Sumner's NGDP futures targeting idea is based off of the "hot potato" mechanism of money flowing through an economy. The question then comes down to "what happens if that system breaks down?" I think NGDP targeting is an incredibly elegant idea, but is it a panacea for all nominal instabilities? How does it promote "antifragility" in an economy, and if not, what is its contingency plan?

    2. I think you are confusing money and credit, as most people do. The "hot potato" mechanism cannot break down, not in the long run - it's simply a matter of logic. See here:
      and here:

      Financial failures are fundamentally supply-side problems, and should not be addressed with monetary policy proper, as Cochrane suggests here:
      Also Scott Sumner, but I can't be bothered searching for the relevant posts right now.