NGDP Targeting

by Rob Horning

2 November 2011


The continuing economic slump has brought some heretofore heterodox economic ideas about how to manage central banks and the money supply increasing attention. One of those gaining increasingly high-profile endorsement is NGDP targeting: the idea that the Federal Reserve should use nominal GDP as the benchmark in making monetary policy rather than targeting the rate of inflation. Steve Waldman has many links here to economists championing the idea; I found this National Affairs article by Scott Sumner, a longtime apostle for NGDP targeting, to be the best exposition of the pro argument.

Sumner presents NGDP targeting as an approach that might appease Fed critics on the left, who want central bankers to do more to curb unemployment, and the right, who want to protect their rentier-class patrons from inflation, which reduces the value of their wealth. Sumner notes that has become politically unfeasible for the Fed to deliberately stoke a rise in inflation, which can stimulate growth and generate jobs: “Americans view inflation as a process that reduces their living standards, because they take their own nominal incomes as a given when thinking about the impact of higher prices.” (This raises the question of what has led Americans to have this view, which well suits the interests of the creditor classes but often masquerades as a matter of common sense or human instinct.)

NGDP targeting, Sumner argues, “offers a single target that effectively combines both facets of the Fed’s dual mandate, and so should be attractive to those on both the left and the right who argue that the requirement to simultaneously address inflation and unemployment makes it impossible for the Fed to tackle either very well.” This unified metric also would sideline the argument between those who think unemployment is mainly structural (people have the wrong skills for the available jobs in a transforming economy) and those who think is cyclical (economic shocks have created a downward spiral in effective demand): “Advocates of the structural view sometimes lose sight of the fact that we do not have enough nominal spending to launch a real recovery even if the economy had no structural problems at all. Whatever our long-term problem, our immediate problem is poor NGDP growth.”

Sumner covers some of the wonkish ins and outs of the debate over monetary policy, but arguably the most controversial thing he writes is something anyone can understand: “When real shocks occur, it is only fair that debtors and creditors share the loss.” That sounds eminently reasonable: Insofar as these shocks are no one’s fault, society should bear their burden collectively, ideally in ways that distribute the suffering to those that can most bear it. But our society’s bankruptcy law, as Mike Konczal suggests in this post, tend to be a “creditors’ bargain”:

In this idea, the rules should only exist to the extent that they benefit the creditor’s ability to collect money. It’s simple: if a law, custom, norm, or rule helps creditors collect when things go wrong, it is a good one. If it takes into account concerns other than creditors’ return — say, destroyed neighborhoods, whether banks follow the rules, etc. — they are worthless…. The law is just there to protect creditors against the difficulty of collecting on debtors, not to provide a level playing field for those with debt.

The underlying moral idea is that creditors are not responsible for misallocations of capital—they are not required to be diligent about lending or be perspicacious in managing risk. The creditors’ bargain takes care of all that. Debtors are held to be de facto criminals, and creditors can hope for the state’s cooperation in enforcing their ill-conceived contracts, regardless of the realities of economic circumstances. Running the Fed so as to prevent inflation is a kind of creditors’ bargain of monetary policy: preserve the value of the creditors’ claims at all costs, regardless the ramifications for economic growth or the labor market.

But as Waldman argues, NGDP targeting conveys a different set of morals:

It is creditors, not debtors, whom we must hold accountable for patterns of aggregate investment. There always have been and always will be foolish or predatory borrowers willing to accept loans that they will not repay. We rely upon discriminating creditors to ensure that funds and resources will be placed in hands that will use them well. Creditors allocate capital by selecting the worthy from innumerable unworthy petitioners. An economic downturn reflects a failure of selection by creditors as a group. It is essential, if we want the high-quality real investment in good times, that creditors bear losses when they allocate funds poorly. When creditors in aggregate have misjudged, we must have some means of imposing losses without the logistical hell of endless bankruptcies. Our least disruptive means of doing so is via inflation…. NGDP targeting, despite the stench of sugar-high money games that Austrians perceive in it, might actually increase our ability to impose losses on foolish creditors via default and bankruptcy. This would pay a huge moral dividend, in terms of our ability to avoid the unfairness of arbitrary bail-outs.

Banks would not be too big to fail while the little people are driven to fail like crazy.


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