NGDP level targeting and the Fed's mandate
Renee Haltom has an interesting article in the recent edition of Richmond's Fed's magazine Region Focus on "Would a LITTLE inflation produce a BIGGER recover?". Renee among other things discusses NGDP targeting - it is unclear from the article whether it is a reference to growth or level targeting and somewhat surprisingly Market Monetarists such as Scott Sumner is not mentioned in the discussion. Rather Renee Haltom has interviewed Bennett McCallum. Professor McCallum is of course the grandfather of Market Monetarism so Renee is forgiven for not mentioning Scott. What I found most interesting in Renee's discussion was actually the relationship between NGDP targeting and the Fed's legal mandate: "NGDP is everything that is produced times the current prices people pay for it. It is similar to “real” GDP, the measure of economic growth reported in the news, except NGDP isn’t adjusted for inflation. One appeal is that growth in NGDP is the sum of exactly two things: inflation and the growth rate of real GDP (the amount of actual goods and services produced). Thus, it captures both sides of the Fed’s mandate in a single variable." So what Renee is basically suggesting is a that NGDP targeting would be fully comparable with the Federal Reserve's mandate - to ensure price stability as well as to maximize employment. Unlike Scott Sumner I don't think the Fed's mandate is meaningful. The Fed should not try to maximize employment. In the long run employment is determined by factors completely outside of the Fed's control. In the long run unemployment is determined by supply factors. In my view the only task of the Fed should be to ensure nominal stability and monetary neutrality (not distort relative prices) and the best way to do that is through a NGDP level target. However, lets play along and say that the Fed's mandate is meaningful. In his 2001 paper "U.S. Monetary Policy During the 1990s" Greg Mankiw suggested that Fed's policy reaction function (for interest rates) could be seen as a function of the rate of unemployment minus core inflation. Lets call this measure Mankiw's constant. The clever reader will of course notice that we now capture Fed's mandate in one variable. The graph below shows Mankiw's constant and the 'NGDP gap' defined as percentage deviation from the trend in nominal GDP from 1990 to 2007 (the Great Moderation period). The graph is pretty clear - there is a very strong correlation between the Fed's mandate and NGDP level targeting. If the Fed keeps NGDP on trend then it will also ensure that Mankiw constant in fact would be a constant and fulfill it's mandate. The graph of course also shows very clearly that the Federal Reserve at the moment is very far from fulfilling its mandate. Given the very strong correlation between Mankiw's constant and the NGDP gap it should be pretty easy for the Fed to argue that NGDP level (!) targeting is fully comparable with the Fed's target. So Ben why are you still waiting?