On Twitter last week Stephen Williamson wrote that he was “puzzled by the infatuation with NGDP targeting. We have good reasons to care about the path for the price level and the path for real GDP. Idea seems to be that if you smooth Py that you get optimal paths for P and y. That’s hardly obvious, and doesn’t fall out of any serious theory I’m aware of.”
I’m not exactly sure what Stephen means by a “serious theory.” But if he means coherent and thoughtful theoretical arguments by well-respected (and presumably “serious”) economists, then there are all sorts of “serious theories” out there to which he might refer, with roots tracing back to the heyday of classical economics. Indeed, until the advent of the Keynesian revolution, a stable nominal GDP ideal, or something close to it, was at least as popular among highly-regarded economists as that of a stable output price level, its chief rival.
If one of today’s outstanding monetary economists isn’t familiar with these writings, it’s a good bet that many other economists don’t know about them either. So I thought it worthwhile to list here some important theoretical works favoring nominal GDP targeting over inflation or price-level targeting, in chronological order, with brief remarks concerning each, and links to those that can be read online. Those interested in a more complete survey of the relevant literature, albeit one written not quite a quarter-century ago, are encouraged to have a look at my 1995 History of Political Economy article, “The ‘Productivity Norm’ versus Zero Inflation in the History of Economic Thought.”
Astute readers will note that the works I list are ones that compare the fundamental welfare effects of stable aggregate spending to those of other monetary policy objectives. They do more, in other words, than merely suggest that nominal GDP may be a useful intermediate policy target than, say, some monetary aggregate. The articles also reject absolute stability of the price level, real output, or both as “given” policy ideals. In contrast, some other writings favoring nominal GDP targeting (e.g. McCallum 1987, Hall and Mankiw 1994, or Frankel and Chinn 1995) do so because it does a reasonably good job at stabilizing P or y or some weighted average of the two. These writings seem to me to miss the crucial point that output and price level fluctuations are themselves sometimes optimal, and that NGDP targeting is in turn desirable precisely because it allows such optimal fluctuations in y and P to occur. Those critics of NGDP targeting (e.g., George Kahn and Andrew Levin) who fault it for failing to stabilize P and y, as well as some alternative policies, likewise miss the mark. To all of these writers I especially commend the works listed here.
Finally, I leave out works by Scott Sumner, David Beckworth, and other well-known Market Monetarists, because part of my aim is to show my fellow monetary economists that Market Monetarism is but one particular, recent manifestation of a perspective that has had many distinguished adherents, representing numerous different schools of thought, throughout the long history of our discipline.
1837: Samuel Bailey, Money and Its Vicissitudes in Value
A splendid, early tour de force. Bailey may have been the first economist to distinguish between changes in the value of money (and, hence, the general level of prices) “originating on the side of money” and ones “originating on the side of goods” — where by the latter he means changes reflecting innovations to the “facility of supplying” goods, including “the discovery of shorter and more economical processes in the arts, and invention of machinery, [and] the abolition of monopolies and taxes.” Today’s economies make essentially the same distinction when they trace price-level changes to either “aggregate demand” or “aggregate supply” innovations. Using this distinction, Bailey goes on to show that, unlike price level changes originating on the “money” side, those originating on the “goods” side neither distort nominal (“pecuniary”) contracts nor (in the case of downward price movements) discourage industry as a whole.
1918-1933: Debate in the Ekonomisk Tidskrift
In a series of articles in the Ekonomisk Tidskrift, Stockholm School economist David Davidson took his compatriot, the great Knut Wicksell, to task for identifying a neutral (hence ideal) monetary policy with one that achieved a perfectly stable general price level. Davidson instead insisted that a neutral policy would allow the price level to vary with aggregate supply (and, particularly, productivity) innovations. Among other prominent Stockholm-School economists, Eric Lindahl and Gunnar Myrdal (see below), sided with Davidson in this debate, while Gustave Cassel sided with Wicksell. Regrettably, Davidson’s works haven’t been translated into English. But those who don’t read Swedish may consult excellent reviews of the debate by Brinley Thomas and Claes-Henric Siven. According to Thomas, “There can be little doubt that the honours in this contest went to Davidson.” A recent paper by Gunner Örn, also (alas) in Swedish, points out the practical equivalence between Davidson’s norm and recent proposals for targeting nominal GDP. “These two Swedish economists,” he writes (referring to Davidson and Lindahl), “were very early — perhaps even the world’s very first — advocates of what in today’s economics debate is called ‘nominal GDP targeting’.”
1930: Ralph G. Hawtrey, “Money and Index-Numbers”
If this essay were all Hawtrey ever wrote on monetary theory, Scott Sumner might still have had reason for wanting his chair at Mercatus to be called “The Ralph G. Hawtrey Chair of Monetary Policy.” For no-one has ever made the case for preferring a stable level of nominal income (or what Hawtrey refers to as “consumers’ income and outlay”) to a stable price level more clearly and painstakingly than Hawtrey makes it here. The only disturbances to prices that monetary policy should seek to avoid, Hawtrey concludes, are those “affecting the amount of the consumers’ income and outlay otherwise than in proportion to the factors of production.” Spot on, Ralphie boy!
1935: F.A. Hayek, Prices and Production, 2nd. ed.
Let’s be clear: my concern here is with writers who made compelling theoretical arguments for NGDP targeting, or something very close to it, regardless of whether they believed the theory could be put into practice. By this criterion, Hayek must be judged one of the more important historical precursors of Market Monetarism. Although Hayek had been critical of arguments and schemes for stabilizing the general price level for some years before he wrote Prices and Production, it was only in that work, and particularly in it’s 2nd edition, and in several subsequent writings, that he acknowledged the desirability of such money-stock changes as would serve to insulate the price level from velocity (but not real output) shocks. For further details, and a comparison of Hayek’s views on this issue with Keynes’s, see my 1999 HOPE article. Regular Alt-M contributor Larry White has written a good, sympathetic review of Hayek’s monetary thought. Rather less sympathetic is a blog post by “Lord Keynes” pointing out differences between Hayek’s stable MV ideal and his practical policy recommendations during the Great Depression.
1937: Allen G. B. Fisher, “Does an Increase in Volume of Production Call for a Corresponding Increase in Volume of Money?”
Unlike his better-known American namesake, this notable New Zealand economist denied that a stable price level was always desirable. Instead he insisted that, “Apart from increases in population and from changes in the desire of individuals to hold money, economic development which takes the form of increased production per head…does not require any increase in money supply.” In other words, he favored an NGDP target with the target growth rate of NGDP set equal to the population growth rate. It is not falling prices per se but generally falling money incomes, Fisher argued, that “have a depressing effect upon business enterprise” because they disappoint “expectations of normal profit.” A decline in prices reflecting increased productive efficiency is, on the other hand, not only not harmful, but desirable, because attempts to prevent them is likely temporarily to distort profit signals, delaying desirable transfers of scarce resources among different efficient industries. Highly recommended.
1939: Gunnar Myrdal, Monetary Equilibrium
Many people know that Hayek and Myrdal shared the 1974 “Nobel” prize “for their pioneering work in the theory of money and economic fluctuations” (among other things). But relatively few have read Myrdal’s main work on monetary theory, and even fewer realize that it was originally published, in German, for a 1933 volume that Hayek edited. Least well known of all is the fact that Hayek didn’t think much of Myrdal’s analysis at the time, and that he accepted it only as a last-minute substitute for one that Eric Lindahl was supposed to prepare. For that and other (mainly ideological) reasons there was no shortage of bad blood between the two men when they crossed paths again in Stockholm. Still, nothing could excuse Myrdal’s boorish behavior both during and after the event.
Having gotten all that off my chest, the fact remains that, whatever its flaws, Myrdal’s essay is well worth reading. Among other points, Myrdal argues — convincingly, I think — that “If one desires the greatest possible diminution of the business cycle, but at the same time wants a guarantee against too great, and especially unidirectional, price movements, which naturally affect distribution most severely, then one must try to stabilize an index of those prices which are sticky in themselves. This would often lead in practice to a stabilization of wages.” In this regard Myrdal’s argument anticipates some more recent New Keynesian arguments favoring a stable NGDP growth trend over a stable price level or inflation rate.
1963: Dennis Robertson. A Memorandum Submitted to the Canadian Royal Commission on Banking and Finance
For better or worse (the last, if you ask me), Keynes’s General Theory made a clean sweep of the field of monetary economics, brushing aside competing works, including the insightful contributions of Keynes’ s Cambridge colleague. Robertson’s popularity thereafter was largely sustained by his splendid little handbook on Money, first published in 1922 and revised and reprinted many times thereafter. That’s a shame, because Robertson’s less popular works on the same subject are full of brilliant insights, including some exposing fundamental errors in Keynes’s, if not in Keynesian, monetary theory.
Robertson’s “Memorandum,” which he completed in 1962 but which was not published until a month after his death in 1963, was his last important work on monetary economics. In it he asks “how a Monetary Authority should behave in a country which was isolated from the rest of the world, and in which it was desired so far as possible to leave the pace of capital formation to be determined by the unfettered interplay of the decisions of private enterprisers and savers.” His answer is that the authority’s aim should be to stabilize, not the general price level, but the economy’s “money flow,” meaning “the flow of monetary demand for final output.” Doing so, he argues, would better “enable the participants in the growth process — enterprisers, savers and hired workers — to realize their intentions with a minimum of friction and of distortion of the true significance of the monetary contracts which they are making with one another.”
1983: Charles Bean, Targeting Nominal Income: An Appraisal
The monetarist counterrevolution, with its emphasis on targeting monetary aggregates, ultimately helped to inspire a new round of arguments for targeting nominal income, with contributions by James Meade (in his 1977 Nobel address), James Tobin, and Sam Brittan. Bean’s assessment of them is highly analytical, and in that respect at least especially “serious.” He concludes
that a policy of targeting nominal income is an optimal response to demand shocks and to productivity shocks if labour supply is inelastic. Even if labour supply is elastic nominal income targets will still produce a better response to productivity shocks than monetary targets if the price elasticity of aggregate demand is less than unity. Growth rules are less attractive than targets for the level of nominal income.
Given the quality of this early performance, it’s a shame that Bean chose to follow it up more recently with a far less compelling speech pooh-poohing recent arguments for targeting nominal GDP as so much “old wine in a new bottle,” and otherwise attempting to suggest that, had it been pursued during the crisis, such targeting would not really have improved much on the U.K.’s inflation targeting regime. Why “less compelling”? Here’s an example: Bean at one point argues that, because “the financial crisis has led to a fall, possibly temporarily, in the underlying rate of growth of supply,” a given or “fixed” nominal income target would have gone “hand-in-hand with a higher inflation rate, whereas a fixed inflation target would [have been] associated with lower nominal income growth.” Quite correct; and had Bean stopped there he’d surely have been compelled to conclude, as he had in 1983, that NGDP targeting would have been the better option. But instead of doing so he continues: “But this hardly provides an argument in favour of a nominal income growth target. Indeed, in this case one would surely want to set the target growth rate for nominal income lower to reflect the lower rate of growth of supply, though by how much might be hard to judge.”
Huh? What? Here we see the dangers lurking in any comparison of alternative monetary policy norms that assumes (as Bean’s does here) that deviations from some target inflation rate belong in the monetary authority’s “loss function.” The whole point of NGDP targeting is that it allows supply-side developments, and adverse ones especially, to be reflected in higher prices or (in the case of a drop in the growth rate of productivity) a higher inflation rate. A central bank that sets a target for NGDP growth only to revise it in response to supply innovations so as to maintain a constant inflation rate is targeting inflation, not NGDP.
1989: Michael Bradley and Dennis Jansen, “Understanding Nominal GNP Targeting”
Short, simple, and sweet: the framework is good old aggregate supply and demand, with diagrams and all. For a bonus, there’s a nice discussion of Ben McCallum’s NGDP Rule. Read this before you try to work your way through either Bean’s 1983 article or the New Keynesian works listed further on.
1992: William Niskanen, “Political Guidance on Monetary Policy”
Although he’s mainly known for his contributions to the theory of bureaucracy, and to public choice theory more generally, Bill Niskanen, Cato’s long-time chairman, was an all-round original thinker. Nor did he neglect monetary economics, where his thinking led him straight into the nominal-spending stability fold. Like Robert Gordon before him, Niskanen differed from today’s Market Monetarists mainly in preferring a nominal “final sales to domestic purchasers” target to a nominal GDP target. (On the pros and cons of these alternatives, see this excellent Bill Woolsey post.)
2005: Jinill Kim and Dale Henderson, “Inflation Targeting and Nominal-Income-Growth Targeting: When and Why Are They Suboptimal?”
Using “a model of a closed economy with optimizing firms and households, monopolistic competition in both product and labor markets, and one-period nominal contracts,” Kim and Henderson “derive optimal monetary stabilization rules and compare them to simple rules under both full and partial information.” Importantly, by “optimal rules” they mean, not simply ones that minimize an ad-hoc central bank “loss function,” but ones that “maximize the unconditional expected utility of the representative agent.” They find that, while none of the simple rules quite match up to the optimal rule, among them “nominal-income-growth targeting dominates inflation targeting for plausible parameter values.” They also find, not surprisingly, that “the more important are productivity shocks…the greater the advantage of nominal-income-growth targeting over inflation targeting.” There’s nothing new in these particular conclusions, which (as we’ve seen) many previous economists arrived at with relatively little algebra, or with no algebra at all. Still, formal models like this one may prove essential to winning over those NGDP targeting doubting Thomas’s who believe nothing until they see it drop out of a fully-articulated macro model.
2010: Evan Koenig, “The Case for Nominal Income Targeting”
As Senior Vice President and Principal Policy Advisor at the Dallas Fed, Koenig is among a small number of Fed insiders who have added their voices to others drawing attention to the possible advantages of targeting nominal GDP. He starts this article by listing three “desiderata” of a monetary policy rule. These are (1) that the rule should avoid waste that might otherwise result from “sluggish” prices or wage rates and other “frictions”; (2) that it should maintain low and stable long-term inflation expectations; and (3) that it should promote financial stability. He then proceeds to explain how a nominal GDP rule might achieve them all.
Concerning price and wage rigidities, Koenig’s argument is reminiscent of Myrdal’s: “If it is primarily money wages that are sticky, not product prices,” he observes, “then it will be optimal for monetary policymakers to try to avoid surprise changes in the market-clearing money wage and let product prices move up or down as needed to clear the labor and product markets.” Furthermore, “In an economy in which the principal real disturbances are shocks to productivity,” and “the income and substitution effects that productivity shocks have on employment are offsetting — a reasonable rough approximation — then the optimal wage policy is equivalent to targeting the level of nominal spending.” Koenig shows as well that “a nominal-income target for monetary policy distributes risk more efficiently across debtors and creditors than does a price-level target.” His overall conclusion is that “A level target for nominal spending…offers enough potential advantages relative to a simple price-level target that it deserves careful study.”
2014: Kevin Sheedy, “Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting”
Sheedy’s very thorough and carefully-reasoned study is concerned exclusively with the task of identifying a monetary regime best suited to an economy that relies on fixed (“non-contingent”) nominal debt contracts. As such it takes up a theme first addressed in depth by Samuel Bailey 80 years earlier. Notwithstanding the passage of so much time, and Sheedy’s far more formal framework, his conclusion is essentially the same, namely, “that when debt contracts are written in terms of money, a monetary policy of nominal GDP targeting improves the functioning of financial markets.” Commenting on Sheedy’s work, James Bullard writes that it “has considerable potential to sharpen the ongoing debate on nominal GDP targeting, an idea that has not often had an explicit modern macroeconomic model behind it.”
2016: Julio Garin, Robert Lester, and Eric Sims, “On the Desirability of Nominal GDP Targeting”
It’s nice to be able to conclude my survey with a paper written by my former colleague, Julio Garin, and two co-authors. As I observed in reviewing the paper by Kim and Henderson, theirs is only one of a number of papers that use sophisticated macro models to conclude that nominal GDP targeting beats most other simple monetary rules. Garin et al. “compare nominal GDP targeting to inflation and output gap targeting as well as to a conventional Taylor rule…on the basis of welfare losses relative to a hypothetical equilibrium with flexible prices and wages.” In other words, like Kim and Henderson, they don’t simple ask how NGDP targeting stacks up when it comes to stabilizing P or y or both — which isn’t the same thing.
Their findings? Although output gap targeting is generally ideal, nominal GDP targeting performs almost as well, and better than a Taylor rule. NGDP targeting is also a lot better than inflation targeting. Furthermore, it can even outperform output gap targeting if the output gap is observed with noise. Finally, the advantages of NGDP targeting over rival strategies increase as supply shocks become more pronounced, and in situations where wages are stickier than prices. If all this is starting to sound familiar, that’s called robustness.
That last remark compels me to conclude by answering a question that’s bound to occur to many who have read this survey, to wit: if the theoretical case for nominal GDP targeting is so strong, why do so many monetary economists favor price-level or inflation targeting?
There are, I believe, two reasons. One is that these economists have tended to assume, implicitly or otherwise, a world in which (1) aggregate supply innovations, and innovations to total factor productivity in particular, are either non-existent or unimportant; and (2) factor prices are perfectly flexible or, at very least, more flexible than output prices. In such a world, nominal GDP targeting may not have any decisive advantage over price-level or inflation targeting, though it’s also unlikely to be any worse than either.
The other reason is that many monetary and macroeconomists treat fluctuations in the price level or inflation rate as bad per se, most commonly by treating them as arguments in central bankers’ “loss functions.” To say that this procedure lacks solid microfoundations is putting things mildly. A less temperate reply might be something like, “Who cares what central bankers like or don’t like? It’s peoples’ utility or welfare that matters.”
In short, if there’s a shortage of “serious” theorizing about what central banks ought to stabilize, it exists, not among proponents of nominal GDP targeting, but among those who continue to favor price-level or inflation targeting.
 For all their intricacies, there’s at least one respect in which such fully-articulated macro models still fail to provide an adequate framework for assessing the advantages of inflation or price-level targeting relative to those of targeting nominal GDP. So far as I’m aware, no one as yet has constructed a version of such a model in which the responsiveness of actual nominal prices to shocks that alter those prices general equilibrium levels depends on the nature of the shocks in question. In contrast, numerous less formal writings allow, for example, that money prices are much more responsive to supply (unit cost) innovations than they are to changes in demand. This last fact tends to further strengthen the case in favor of a stable NGDP rule.