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NGDP Targeting >> Inflation Targeting

Marcus Nunes wrote this excellent analysis of why NGDP Targeting works better than the well-established Inflation Targeting. To put it in layman’s terms, inflation targeting over-stimulates booms and does not react strong enough to downturns. This is because it focuses only on price inflation, not on output growth. The Federal Reserve has a so-called “dual mandate”, i.e. they have to take care both of prices and output. However, recently they behaved like inflation targeters.

Furthermore, as Scott Sumner said several times, they are treating deviations from long-term paths of prices and output as “bygones”, i.e. they are not making up for them. This is the biggest weakness of monetary policy regimes that target changes of values, i.e. growth rates of output or prices. NGDP Level Targeting would take care of levels, too. This is very important in order to prevent market expectations from keeping falling, like they did in the Great Depression, and like they did in Japan in the Lost Decade.

In my last posts, I openly favoured price level targeting over NGDP because I think that there are some (albeit minor) ethical downsides to NGDP Targeting. Of course, this depends on your set of values. As a matter of fact, price level targeting is inferior to NGDP targeting in terms of macroeconomic performance. Marcus Nunes does not specifically mention price level targeting in his article. If business cycle swings are rather smooth, price level targeting would basically behave similar to inflation targeting, with the exception that would overstimulate booms even more, and do even less to dampen downturn shocks, although this would probably depend on its specific modus operandi. However, most importantly, price level targeting would give us an anchor to longer-term expectations in times of extreme economic disturbances (e.g. debt crises), which makes it superior to inflation targeting.

I am still puzzled by the fact that mainstream economists and the media does not seem to be very interested in economic theories of expectations. Instead, they focus on “confidence”, which is sadly only a weak substitute for the “real” thing. This may finally change, if the discussion about NGDP Targeting heats up. That would be change, finally!

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One comment on “NGDP Targeting >> Inflation Targeting

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