We considered the theoretical benefits of the approach, but also whether it was desirable, or even feasible, to switch to a new framework at a time of great economic uncertainty. After a lengthy discussion, the Committee firmly rejected the idea. I had been intrigued by the approach at first but came to share my colleagues’ reservations about introducing it at that time. Nominal GDP targeting is complicated and would be very difficult to communicate to the public (as well as to Congress, which would have to be consulted) [Bernanke 2015: 517–18].
Since then, policymakers and others have continued to discuss whether NGDP targeting or other alternative targets could alleviate the constraint of the effective lower bound on nominal interest rates, improve policy robustness, promote greater financial stability, or even address distributional concerns (Koenig 2010; Billi 2014; Azariadis et al. 2015; Garín, Lester, and Sims 2016).n protectionist measures, with other issues addressed by specialized treaties and international organizations.1 For example, Romer (2011) argues that targeting a path for the level of NGDP (NGDP level targeting, or NGDPLT) would encourage the Fed to act more aggressively in downturns, boosting confidence and expectations of future inflation. Temporarily higher expected inflation in downturns would stimulate spending and employment, and inflation expectations should decline as the economy approaches its target path.
NGDPLT could improve not only macroeconomic, but also financial, stability by addressing an important credit market friction known as nonstate contingent nominal contracting (Bullard and DiCecio 2019). That is, many debt contracts specify a fixed stream of nominal repayments, but the future income that will repay this debt is uncertain. Sheedy (2014) shows that with such a friction, NGDP targeting can improve the functioning of financial markets by stabilizing the debt‐to‐GDP ratio, facilitating efficient risk sharing.
Even as the literature on NGDP targeting and optimal monetary policy continues to grow,2 policymakers remain hesitant to abandon the status quo. In 2011, the FOMC thought that the time was not right to switch to a new monetary policy framework. In this article, I suggest that the time is better now. I argue that the status quo is so unpopular and precarious that a new target would do more good than harm for central bank credibility. In the current context, the case for NGDPLT is especially strong.
The Federal Reserve and its peers face what Andy Haldane, chief economist at the Bank of England, describes as the “twin deficits” problem: a deficit of understanding and a deficit of trust. He explains, “Because a lack of trust inhibits understanding, and because a lack of understanding contaminates trust, these Twin Deficits are inextricably entwined” (Haldane 2017).
I discuss evidence of the severity of these deficits, based on my own and others’ research. Then I argue that the interaction of these deficits with a wave populist sentiment could have major implications for central bank independence and the conduct of monetary policy. Central banks around the world are facing intense political pressures to focus less on inflation and more on the real economy. The flexibility of a dual mandate or a flexible inflation target can invite and exacerbate such pressures by allowing “each side of the political divide to latch onto its preferred policy indicator” (Sumner 2012: 19).
In some cases, central banks have already faced legal changes to their monetary policy frameworks. I will discuss the case of the Reserve Bank of New Zealand (RBNZ), the first central bank to adopt inflation targeting. With a 2018 amendment to the Reserve Bank of New Zealand Act, the RBNZ is also the first to abandon inflation targeting.3 The RBNZ now has a dual mandate.
The New Zealand experience holds important lessons for inflation targeting central banks and the Federal Reserve. Like RBNZ, these central banks will increasingly face pressure to put more emphasis on employment and other objectives. Whether through new legislation, through the appointments process, or through informal methods, politicians will make it more difficult for central banks to operate independently within their current frameworks. Central banks may be better off changing on their own terms. Adopting NGDPLT could signal concern for the real economy and willingness to break from the status quo, which could fend off populist impulses to change monetary policy in more drastic and potentially harmful ways. In the long term, an NGDPLT could be easier to communicate, more popular, and less prone to political interference than a flexible inflation target or dual mandate.