Don’t worry. I am not going to write another post arguing that the world’s problems would all go away if its central banks adopted a NGDP level target (it has been over 10 years now, give it a rest!). There are plenty out there already: this one by Sam Dumitriu is a good place to start, this by David Beckworth, or if you are really dedicated, go back to when Tyler Cowen introduced Scott Sumner to the world in 2009 and read on from there.
And if you want a sober, understanding rejection of the idea, this speech by Charlie Bean from 2013 is the place to go.
But recent weeks have seen a series of Conservatives step up to call for a NGDP target*, and I would like to think aloud on what this means about their view of the economy. Here is Bim Afolami with the SMF (where I am on the advisory board); Gerard Lyons et al at Policy Exchange, and now Sajid Javid at the CPS. Ultimately, if people near the room where it happens are calling for this, it is interesting to reflect on how the arguments must be proceeding in the Tory soul.
So what do you need to think if you are calling for a NGDP target?
- You think there is a problem with aggregate demand You have to – that is what monetary policy operates upon. The internet is full of central bankers’ speeches complaining that it is not their fault if the supply side is failing. Go and talk to the Treasury about skills, innovation investment and all that stuff
- That means worrying about insufficient demand Right now, that’s not hard – spending in the economy fell some 20%-plus in April – but longer-standing fans of the idea probably suspect that the economy would have been much healthier this last 10 years if spending had not done this:
That is a £100bn/quarter gap on its pre-2009 trend. Even if you think just a tenth of that was unnecessary, that is a giant amount to leave on the table. A Brexit-sized amount, if you like. Not everyone has always felt this – Charlie Bean clearly didn’t. But this also means…
…you need to think that extra NGDP would mean some extra RGDP Which is not always the case. For much of the postwar period, we were up against the UK economy’s limits. Giving people more to spend – which the combined Bank-Government authorities somehow managed to do – normally just meant prices being higher, and wages too, with the deleterious effects that such inflation brings. Another way of putting this: you feel in some way that simply giving people extra spending might unlock extra real resources – despite all this stuff put out there about a productivity problem. I have always liked the way a man called Howard Bogod put it in a letter to the FT:
My brothers and I run a relatively small family business with a turnover of below £20m. We could easily cope with a 20 per cent increase in business with no extra staff, and even a 50 per cent increase might require only a 10 per cent increase in staff. This would mean a huge growth in productivity, and I strongly the suspect the same is true for most smaller and even many larger businesses across the UK.
So you probably need to agree with Howard. And in a largely services-based economy, it is easier to. An estate agency serving 20 transactions a month doesn’t need twice the shiny-suited employees to serve 40. And in the short run we have seen this in the corona-crisis – employment is far less elastic than production on the downside, so why not on the up?
- You have to believe that monetary policy is not entirely ineffective This is where things get more heated. Opponents of a higher AD policy on the right tend to be those who think you are wrong to want it – it is inflationary, or bound to lead us into some other sinful pathway like credit bubbles. On the left, in my experience they are more likely to deride monetary policy as some kind of evasion from the duties of fiscal policy to keep aggregate demand up instead. It seems to let off the wicked Austerians of 2009-16. There are a dozen reasons to dislike the pace and nature of Osborne’s fiscal approach, but if you want the entire bingo-card, you need a macro one too – “killed the recovery”
- But “effective” does not just mean “capable of boosting the economy when rates are zero”. If you think too tight a Bank of England target might constrain the demand-boost that came from fiscal policy, then you should still worry about the inflation target. Both monetary and fiscal stimulus just contribute towards aggregate demand growth. If one does more, when we were already on target, the other might just do less. That central banks know and take into account fiscal policy has been called The Sumner Critique and a NGDP targeter probably believes in it. This is conventional wisdom for 1993-2007, by the way: the government’s fiscal balance swung around considerably, the Bank kept NGDP growing just steadily (see chart).
- You probably also care about how expectations guide the economy Sajid Javid (and authors) touch on this towards the end of their bit on the Policy
… over time, so long as the Bank’s commitment to keep nominal GDP on a stable growth path was seen as credible and binding, market expectations for inflation and total spending would start to rise, pushing up nominal interest rates. In turn, this would allow the Bank to raise the base rate away from the zero lower bound and reduce its reliance on quantitative easing
Here the maddening circularity of the policy rears its head. An economy convinced of the credibility of the Bank’s commitment to NGDP targeting doesn’t need the Bank to do much to hit that target: expectations cluster around that pathway, and it becomes self-fulfilling. Ultimately this is where the more purist advocates end up – suggesting a target can be so credible that the Bank does not have to do much to meet it. Rather like the way Mervyn King saw the Bank of England in 2005, as a sort of Maradona.
- And you think current members of the MPC are only human. It is uncontroversial that a strict inflation target can cause all sorts of misfiring when negative supply side shocks hit – Bim Afolami hints at this. Inflation rises, some hawk calls for tighter policy (weaker demand) – so a supply shock has a demand shock added to it. Charlie Bean thinks the “flexible” in Flexible Inflation Targeting handles this:
inflation targeting as practised, here and elsewhere, allows for an accommodating response to cost shocks, so long as it is consistent with inflation being stabilised in the medium term. Such flexible inflation targeting can thus look quite similar to targeting nominal income growth.
Maybe. But some MPC members were far from this in the summer of 2008 and the spring of 2011, and market-probabilities of rates rising soon shot up. Because NGDP targeters place great store by expectations and market reactions, they think these mistakes matter. Just because those nutters on the MPC never actually raised rates in those depressed days of 2011, doesn’t mean the small chance they might have didn’t damage economic sentiment.
Could such mistakes be made again? You need to believe they could. We face in the corona-crisis a very confusing mixture of demand and supply damage, and plenty of voices warning about medium term inflation risks. Suppose we recover three quarters of the loss and then the scarred economy starts to send bleeping red signals about inflation … do you think the MPC will tough it out?
There you have it. These people calling for a new NGDP target for the Bank have to believe that there is a significant demand problem with the economy that won’t be resolved within inflation targets, that dealing with it will produce more real growth, and and that you need a different target because otherwise monetary policy might constrain the recovery through an unnecessarily tight stance, no matter what you think of using fiscal policy.
As for whether the Johnson administration is tempted, I just don’t know. They like focus groups. And this sort of thing really struggles in a focus group …
*The last time there was such a kerfuffle was 2012 – read Duncan Weldon’s Touchstone Blog – which was triggered by a few events: the shift in the US monetary approach which inspired talk of Scott Sumner Day, also the UK’s stubborn refusal to grow through austerity, and the advent of Mark Carney at the Bank, he having sort-of called for NGDP targets when back in Canada