There’s nothing very new about the idea that a central bank could target nominal GDP rather than inflation.
Sir Samuel Brittan has been lobbying for this since before the Bank of England was made independent; Giles Wilkes, now Vince Cable’s special advisor, wrote a compelling paper proposing it a couple of years ago. More recently, a number of American bloggers have been waging a campaign for targeting NGDP – which is very simply real GDP (the growth rate most people report) plus the broadest measure of inflation – on the other side of the Atlantic.
But don’t be surprised if you hear a lot more about it in the coming months and years. For it has long been an intriguing idea for the future Bank of England Governor as well. Mark Carney has spoken openly in support of NGDP targeting a number of times, and did so again last night.
The salient bit of Carney’s speech:
If yet further stimulus were required, the policy framework itself would likely have to be changed. For example, adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP.
Of course, this speech doesn’t mean an NGDP target will necessarily become policy in the UK. After all, it’s the Chancellor’s right, rather than the Bank Governor’s, to change the Bank’s remit. Carney’s latest comments on the attractiveness of NGDP targeting were directed towards the Bank of Canada rather than the Bank of England. Plus he’s more equivocal on it than the headlines suggest. And despite having him in office for the past four years, the Bank of Canada still hasn’t abandoned its own inflation target in favour of something else.
But ignoring that for a moment, what would NGDP targeting imply for the UK? The answer a few years ago would have been: not very much. Let’s assume that the Bank had a 5% NGDP target, which is more or less the average growth rate over the past few decades (basically, 2.5% GDP plus 2.5% inflation).
Monetary policy could well have been a touch tighter towards the end of the boom, and it could have been a bit looser around the turn of the millennium, but, presuming the Bank would have been allowed a percentage point of leeway around the target, the Governor wouldn’t have had to write many letters of apology to the Chancellor.
However, the story since the crisis is altogether different. NGDP has been well below this level and, according to the OBR, it will remain below 5% all the way until early 2018. If the UK was following an NGDP targeting policy, the Bank of England should arguably still be stimulating the economy through more quantitative easing. By contrast, the inflation figures, which show prices are still well above target, indicate that the Bank shouldn’t have been carrying out quantitative easing at all in the past year and a half.
So following an NGDP target would have made the Bank’s job of explaining its policy a lot easier – at the risk of driving up inflation even higher. It would also seem to imply more QE in the future.
However, there is a more subtle way NGDP would make a difference, and that’s in conditioning long-term expectations. If people expect that the Bank will do everything in its power to try to get nominal growth back to 5%, they might have more faith that monetary policy will be looser for longer.
A few years ago, well before the crisis, Ben Bernanke gave a speech which has subsequently been dubbed his “printing press speech”. One of the key points was that if a central bank gets to a stage where interest rates are down at zero, the first thing it should do, before getting into quantitative easing or any other radical active policies like that, is to make it absolutely clear to all consumers and businesses that interest rates will stay low not merely for a few months or a few years but, basically, for the foreseeable future.
That way, people can be sure enough that credit will be cheap that they can make long-term investment decisions without the fear that rates will soon be climbing higher. That’s why Bernanke – and for that matter Carney – were been very clear on this front from early on in the crisis that interest rates in the US and Canada respectively would stay low for a prolonged period of time.
And in some senses, having an NGDP target performs a similar function as committing yourself to low interest rates for a long time – at least in times of crisis: that assumption would be a given, based on the central bank’s NGDP remit.
Central banking is, in part, about not merely changing monetary policy but in conditioning expectations. And, as Carney said in his speech last night, those expectations depend, in turn, on not allowing bygones to be bygones: the longer the Bank misses the growth target for, the more it will have to act, cumulatively (although this clearly depends on how any target is constructed).
Anyway, the point is that were NGDP targeting to be adopted here it would amount to the biggest shift in institutional economic policy since the Bank was made independent back in 1997. So don’t expect the issue to go away any time soon.
UPDATE: see Rob’s comment below – which is quite right: the question of precisely how the target is structured (which I glossed over above) is highly significant. If Carney is suggesting that the level of NGDP is targeted that is altogether different, more radical and indicative of potentially more QE, than if it’s only a growth rate being targeted.
Giles Wilkes also tweets to say: if NGDP target 100% credible, LESS QE needed. Velocity would rise.
And Andrew Lilico tweets to say: NGDP-level targeting would be much more similar to price-level targeting than to inflation targeting. See: http://t.co/1cU4qqi4