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NGDP targeting: An overview

July 8, 2015

The prolonged recovery that followed the Great Recession has brought about increased support for a monetary policy rule known as Nominal Gross Domestic Product (NGDP) targeting. This form of targeting combines employment and inflation into one metric.

In theory, this would better help the Fed achieve its dual mandate.

NGDP targeting focuses on an economy’s potential output and growth trends. By using these measures, the Fed would pick the NGDP target that coincides with the desired growth rate. Since NGDP does not factor out inflation, this growth could be met by a combination of inflation and real growth. For instance, if the desired growth rate is five percent and real growth is only two percent, the Fed can meet its target by targeting three percent inflation.

Advocates claim that this would allow the Fed to act in a quicker and more aggressive manner and point to the slow reaction of the Federal Reserve in 2008, despite large drops in NGDP and employment. A central bank with an NGDP target would have been forced to act more forcefully and expeditiously to stem these declines.

Had the Fed adopted an NGDP targeting regime in 2008, it could have begun to enact expansionary measures as soon as it witnessed the drop in NGDP, softening the decline and allowing for a quicker rebound.

Scott Sumner, a self proclaimed market monetarist and a leading advocate for NGDP targeting, states that NGDP targeting would have reduced the severity of the recession and eliminated the need for fiscal stimulus. He argues that the national debt would be significantly lower because any attempt by congress to boost aggregate demand through stimulus would be unnecessary, as the Fed would already be pursuing the proper amount of expansionary policy to keep NGDP on the long-term growth trend.

Sumner also argues that since NGDP targeting focuses on a certain level of NGDP growth, it tends to assure low inflation. For example, even if the desired growth was three percent and the real growth was at zero percent, there would be just enough inflation to maintain a three percent growth rate. Subsequently, since the Fed tends to maintain GDP at its potential, it reduces the severity of the business cycle by acting as soon as GDP deviates.

NGDP targeting is an interesting proposition that could offer much needed rules to the Fed’s current monetary policy. According to Thomas Hogan and Alexander Salter , if implemented, NGDP targeting would be a “marked improvement over existing programs for macroeconomic stability, such as inflation (or price level) targeting…which place a significant knowledge burden on monetary policy makers and necessarily confines them to ‘steering the car while looking through the rear window.’

More research is certainly needed, but NGDP targeting clearly shows great promise.

One Comment

  1. gomek916 July 8, 2015 11:06 AM

    Interesting post!