There’s a bit of a fuss about a GS report that supports NGDP targeting. Free Exchange shows some of the GS charts, which purport to demonstrate that outcomes would be better under NGDP targeting.
I am not so excited about NGDP myself. It’s worth remembering that we have been here before (well, sort of).
The Fed Greenbook inflation forecasts were of the GDP deflator (the difference between nominal and real GDP) until 1989; and the dual mandate was well established by that time. Additionally, the arguments that justify real GDP targeting for inflation targeting central banks — the (Okun) relationship between growth and unemployment, and the (Phillips curve) relationship between unemployment and future inflation — were old (and flaky) by this time.
So, why did the Fed abandon the GDP deflator for CPI? Because targeting the GDP deflator didn’t work.
Consider a drop in the value of the USD (which increases import prices), or an increase in oil price. In both cases, the price of imports would increase, and CPI and the GDP deflator would move in opposite directions (CPI rises, the GDP deflator falls). Say an NGDP targeting central bank eased monetary policy in this case. I would expect a further decline in the value of their currency, a further increase in import prices, and hence a further decline in NDGP.
An increase in export prices, or an appreciation of the domestic currency would have the opposite effect — it would boost NGDP. No one serious thinks a central bank should tighten monetary policy if the currency appreciates by 25%
Among other things, the 1970s taught central bankers that CPI was a better guide for policy.
I doubt anyone except Chicago Fed President Evans is arguing for an NDGP target. If Bernanke cannot get an explicit inflation target (something most professionals are convinced is clearly beneficial), I cannot see a move to targeting NDGP.
Any move to target the GDP deflator would be a retrograde step. The unemployment part of the mandate justifies further action, and the Fed is taking action.
They are not pointing to inflation and saying ‘at target – we have done well’ – which is behavior that would potentially motivate congress to change the Fed’s Mandate.