NGDP targeting is not about ”stimulus”

Market Monetarists are often misunderstood to think that monetary policy should “stimulate” growth and that monetary policy is like a joystick that can be used to fine-tune the economic development. Our view is in fact rather the opposite. Most Market Monetarists believe that the economy should be left to its own devises and that the more policy makers stay out of the “game” the better as we in general believe that the market rather than governments ensure the most efficient allocation of resources.

Exactly because we believe more in the market than in fine-tuning and government intervention we stress how important it is for monetary policy to provide a transparent, stable and predictable “nominal anchor”. A nominal GDP target could be such an anchor. A price level target could be another.

Traditional monetarists used to think that central banks should provide a stable nominal anchor through a fixed money supply growth rule. Market Monetarists do not disagree with the fundamental thinking behind this. We, however, are sceptical about money supply targeting because of technical and regulatory develops mean that velocity is not constant and because we from time to time see shocks to money demand – as for example during the Great Recession.

A way to illustrate this is the equation of exchange:


If the traditional monetarist assumption hold and V (velocity) is constant then the traditional monetarist rule of a constant growth rate of M equals the Market Monetarist call for a constant growth rate of nominal GDP (PY). There is another crucial difference and that is that Market Monetarists are in favour of targeting the level of PY, while traditional monetarists favours a target of the growth of M. That means that a NGDP level rule has “memory” – if the target overshots one period then growth in NGDP need to be higher the following period.

In the light in the Great Recession what US based Market Monetarists like Bill Woolsey or Scott Sumner have been calling for is basically that M should be expanded to make up for the drop in V we have seen on the back of the Great Recession and bring PY back to its old level path. This is not “stimulus” in the traditional Keynesian sense. Rather it is about re-establishing the “old” monetary equilibrium.

In some way Market Monetarists are to blame for the misunderstandings themselves as they from time to time are calling for “monetary stimulus” and have supported QE1 and QE2. However, in the Market Monetarists sense “monetary stimulus” basically means to fill the whole created by the drop in velocity and while Market Monetarists have supported QE1 and QE2 they have surely been very critical about how quantitative easing has been conducted in the US by the Federal Reserve.

Another way to address the issue is to say that the task of the central bank is to ensure “monetary neutrality”. Normally economists talk about monetary neutrality in a “positive” sense meaning that monetary policy cannot affect real GDP growth and employment in the long run. However, “monetary neutrality” can also be see in a “normative” sense to mean that monetary policy should not influence the allocation of economic resource. The central bank ensures monetary neutrality in a normative sense by always ensuring that the growth of money supply equals that growth of the money demand.

George Selgin and other Free Banking theorists have shown that in a Free Banking world where the money supply has been privatised the money supply is perfectly elastic to changes in money demand. In a Free Banking world an “automatic” increase in M will compensate for any drop V and visa versa. So in that sense a NGDP level target is basically committing the central bank to emulate the Free Banking (the Free Market) outcome in monetary matters.

The believe in the market rather than in “centralized control mechanisms” is also illustrated by the fact that Market Monetarists advocate using market indicators and preferably NGDP futures in the conduct of monetary policy rather than the central bank’s own subjective forecasts. In a world where monetary policy is linked to NGDP futures (or other market prices) the central bank basically do not need a research department to make forecasts. The market will take care of that. In fact monetary policy monetary policy will be completely automatic in the same way a gold standard or a fixed exchange rate policy is “automatic”.

Therefore Market Monetarists are certainly not Keynesian interventionist, but rather Free Banking Theorists that accept that central banks do exists – for now at least. If one wants to take the argument even further one could argue that NGDP level targeting is the first step toward the total privatisation of the money supply.




Leave a comment


  1. “Trying to preserve monetary neutrality” and “trying to prevent monetary disequilibrium” seem to me to be different ways of saying essentially the same thing. But I wish we had a more precise definition.

  2. Nick, you are right. But again I think it is very important that we stop saying “stimulus”. That is not really what we what. We basically want a situation where say’s law rules – without being f…ed by monetary policy.

  3. Dustin

     /  October 18, 2011

    Lars, what would NGDP growth be under free banking? Zero inflation rate? Productivity growth rate?

  4. Alex Salter

     /  October 18, 2011

    Under Free Banking, the profit motive of all the banks of issues leads to a stabilization of NGDP at some specific level. NGDP deviations away from this level would reflect (presumably transitory) real factors, as well as the overall long-run trend due to increasing factor productivity.

  5. Dustin, Alex got that right. I would however add that there are difference between what kind of Free Banking system would be implemented. The historical Scottish Free Banking system was basically a “small open economy” version of Free Banking where the system was linked to the British sterling. Such a system does not automatically created zero inflation or a “productivity norm”. Selgin’s model is a close economy model and in that there would likely be some kind of stable NGDP.

  6. Rob

     /  October 19, 2011

    As a supporter of free banking there is one question that is currently interesting me.

    What would happen in a free banking model if it ever hit a zero-bound condition, where the bank could not lend out its excess reserves and bond were priced so high they were not worth the effort for the bank to buy them?

    In this situation I believe free banks would simply hold onto the reserves, AD would fall , and prices and profit spreads would have to adjust to allow the economy to get back to equilibrium. The existence of this boundary condition seems to me to ensure that the economy stays healthy and flexible and actually is able to avoid the zero-bound condition in the first place.

    I can see that when a CB expands the money supply by interest rate policy and banks increase lending as a result that this is an imperfect but workable version of what happens under free banking under normal circumstances.

    However when this stops working at the zero bound and the CB adopts QE and other unorthodox measure then the CB is in effect subsidizing some sections of the economy to receive free money. My concern is that this will distort the structure of production and prevent the economy from developing mechanisms to address AD issues via supply-side actions in parallel to the function of free banks in stabilizing the money supply itself.

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