The Fed, the Bank of Japan and the Bank of England are said to be moving to adopt an acronym as the next love of their life – NGDPLT.
The notion that monetary policy should aim to ensure steady growth in domestic output, measured in current prices, was first put forward during the 1970s and is enjoying a renaissance. It has been advocated for many years by Sir Samuel Brittan. A new proposal for phasing in such a regime has been made by Jeffrey Frankel and among the passionate advocates is Scott Sumner.
First, some history. Advocates argue that if a regime of nominal GDP level targets (NGDPLT) had been in place in 2008, at the height of the financial crisis, both the US and UK would have embarked more quickly on stimulatory monetary policies. After Lehman Brothers collapsed, the Federal Reserve elected to hold rates at 2 per cent, whereas they should have cut rates and started on more direct measures to boost the money supply. Fed policy was much tighter than the Fed thought at the time – you only have to look at the sharp rise in the dollar and fall in the dollar price of gold in the third quarter of 2008. But the Fed had its eyes focused on the rate of increase of consumer prices, rather than the expected course of output, which was already falling.
Other advantages are claimed. For example, communication of policy-makers’ intentions to the public might in some ways be easier under a nominal GDP framework. Nominal GDP targeting would not require central bankers to make estimates of the extent of the output gap which proved to be one of the most difficult aspects of practical policy-making under inflation-targeting. If central banks targeted monetary policy in an attempt to meet a certain level of GDP, then the private sector might behave in a way that helped achieve these goals – it would tend to increase spending when demand fell below target as there would be an expectation that the authorities would in any case act to lower interest rates.
Problem solved? Unfortunately not. This option is vulnerable to many of the same objections as traditional inflation targeting. It also relies on central bankers and official regulators using the wide degree of discretion afforded them wisely, resisting inevitable political pressures to turn a blind eye to the next mini-boom and generally behaving in a saintly way. For instance, it assumes that if you had a NGDP target of 5%, and the economy quickly recovered to 3% real growth and 4% inflation, then monetary policy would be tightened sharply. Who can believe that policy makers would do that?
In current circumstances, moving to such a system would be seen simply as a call for higher inflation at a dangerous time — retail prices in the UK rose 5% last year.
Even if we had saintly and sturdily independent guardians, the cards would be stacked against them because of the implications of financial and economic interdependence.
Because each country or region would continue to decide its monetary and economic policy for itself – and because its policy stance in the absence of an international standard would be determined by domestic factors above all – capital flows and exchange rates would remain volatile. Because of interdependence, efforts to tighten monetary policy would be offset by capital inflows.That is the way the global financial system (GFS) works at present – and it does not work well.
By pumping even more liquidity into the GFS, this approach to monetary policy would increase its liability to hugely destabilising cross-border asset and currency bubbles.
As argued in my book, the regime would place excessive weight on a single instrument, the interest rate, which affects different elements in the economy at different times, with unknown and variable time lags. To raise interest rates in response, for example, to a rise in incomes due to a credit bubble might cause real output to decline much more quickly than the underlying rate of inflation, so that policy would add to instability.
It looks as if some leading central banks are destined to try this experiment but they should do so with eyes open and warnings buzzing in their ears. Let us hope that at least the ECB resists this fashion. Altogether, nominal GDP targeting does not offer a firm platform for monetary policy-makers. It will prove to be yet another vain attempt to control money one country at a time. It would doom us to yet another damaging boom and bust cycle. It offers no escape from The Money Trap.
Money is far too wild a creature to be tamed by such feeble tools.
Please, don’t fall in love with NGDPLT
It will doom us to yet another boom-bust cycle of despair.
The Fed, the Bank of Japan and the Bank of England are said to be moving to adopt an acronym as the next love of their life – NGDPLT.
The notion that monetary policy should aim to ensure steady growth in domestic output, measured in current prices, was first put forward during the 1970s and is enjoying a renaissance. It has been advocated for many years by Sir Samuel Brittan. A new proposal for phasing in such a regime has been made by Jeffrey Frankel and among the passionate advocates is Scott Sumner.
First, some history. Advocates argue that if a regime of nominal GDP level targets (NGDPLT) had been in place in 2008, at the height of the financial crisis, both the US and UK would have embarked more quickly on stimulatory monetary policies. After Lehman Brothers collapsed, the Federal Reserve elected to hold rates at 2 per cent, whereas they should have cut rates and started on more direct measures to boost the money supply. Fed policy was much tighter than the Fed thought at the time – you only have to look at the sharp rise in the dollar and fall in the dollar price of gold in the third quarter of 2008. But the Fed had its eyes focused on the rate of increase of consumer prices, rather than the expected course of output, which was already falling.
Other advantages are claimed. For example, communication of policy-makers’ intentions to the public might in some ways be easier under a nominal GDP framework. Nominal GDP targeting would not require central bankers to make estimates of the extent of the output gap which proved to be one of the most difficult aspects of practical policy-making under inflation-targeting. If central banks targeted monetary policy in an attempt to meet a certain level of GDP, then the private sector might behave in a way that helped achieve these goals – it would tend to increase spending when demand fell below target as there would be an expectation that the authorities would in any case act to lower interest rates.
Problem solved? Unfortunately not. This option is vulnerable to many of the same objections as traditional inflation targeting. It also relies on central bankers and official regulators using the wide degree of discretion afforded them wisely, resisting inevitable political pressures to turn a blind eye to the next mini-boom and generally behaving in a saintly way. For instance, it assumes that if you had a NGDP target of 5%, and the economy quickly recovered to 3% real growth and 4% inflation, then monetary policy would be tightened sharply. Who can believe that policy makers would do that?
In current circumstances, moving to such a system would be seen simply as a call for higher inflation at a dangerous time — retail prices in the UK rose 5% last year.
Even if we had saintly and sturdily independent guardians, the cards would be stacked against them because of the implications of financial and economic interdependence.
Because each country or region would continue to decide its monetary and economic policy for itself – and because its policy stance in the absence of an international standard would be determined by domestic factors above all – capital flows and exchange rates would remain volatile. Because of interdependence, efforts to tighten monetary policy would be offset by capital inflows.That is the way the global financial system (GFS) works at present – and it does not work well.
By pumping even more liquidity into the GFS, this approach to monetary policy would increase its liability to hugely destabilising cross-border asset and currency bubbles.
As argued in my book, the regime would place excessive weight on a single instrument, the interest rate, which affects different elements in the economy at different times, with unknown and variable time lags. To raise interest rates in response, for example, to a rise in incomes due to a credit bubble might cause real output to decline much more quickly than the underlying rate of inflation, so that policy would add to instability.
It looks as if some leading central banks are destined to try this experiment but they should do so with eyes open and warnings buzzing in their ears. Let us hope that at least the ECB resists this fashion. Altogether, nominal GDP targeting does not offer a firm platform for monetary policy-makers. It will prove to be yet another vain attempt to control money one country at a time. It would doom us to yet another damaging boom and bust cycle. It offers no escape from The Money Trap.
Money is far too wild a creature to be tamed by such feeble tools.
Written on December 18, 2012 at 10:46 am, by robert
Categories: Homepage, News and Comment, Official Money, RP's Diary | Tags: Bank of England, central banking, central banks, global financial system, globalization, Jeffery Frankel, Scott Sumner, The Money Trap