NGDP level targeting – the true Free Market alternative (we try again)

Most of the blogging Market Monetarists have their roots in a strong free market tradition and nearly all of us would probably describe ourselves as libertarians or classical liberal economists who believe that economic allocation is best left to market forces. Therefore most of us would also tend to agree with general free market positions regarding for example trade restrictions or minimum wages and generally consider government intervention in the economy as harmful.

I think that NGDP targeting is totally consistent with these general free market positions – in fact I believe that NGDP targeting is the monetary policy regime which best ensures well-functioning and undistorted free markets. I am here leaving aside the other obvious alternative, which is free banking, which my readers would know that I have considerable sympathy for.

However, while NGDP targeting to me is the true free market alternative this is certainly not the common view among free market oriented economists. In fact I find that most of the economists who I would normally agree with on other issues such as labour market policies or trade policy tend to oppose NGDP targeting. In fact most libertarian and conservative economists seem to think of NGDP targeting as some kind of quasi-keynesian position. Below I will argue why this perception of NGDP targeting is wrong and why libertarians and conservatives should embrace NGDP targeting as the true free market alternative.

Why is NGDP targeting the true free market alternative?

I see six key reasons why NGDP level targeting is the true free market alternative:

1) NGDP targeting is ”neutral” – hence unlike under for example inflation targeting NGDPLT do not distort relative prices – monetary policy “ignores” supply shocks.
2) NGDP targeting will not distort the saving-investment decision – both George Selgin and David Eagle argue this very forcefully.
3) NGDP targeting ”emulates” the Free Banking allocative outcome.
4) Level targeting minimizes the amount of discretion and maximises the amount of accountability in the conduct of monetary policy. Central banks cannot get away with “forgetting” about past mistakes. Under NGDP level targeting there is no letting bygones-be-bygones.
5) A futures based NGDP targeting regime will effective remove all discretion in monetary policy.
6) NGDP targeting is likely to make the central bank “smaller” than under the present regime(s). As NGDP targeting is likely to mean that the markets will do a lot of the lifting in terms of implementing monetary policy the money base would likely need to be expanded much less in the event of a negative shock to money velocity than is the case under the present regimes in for example the US or the euro zone. Under NGDP targeting nobody would be calling for QE3 in the US at the moment – because it would not be necessary as the markets would have fixed the problem.

So why are so many libertarians and conservatives sceptical about NGDP targeting?

Common misunderstandings:

1) NGDP targeting is a form of “countercyclical Keynesian policy”. However, Market Monetarists generally see recessions as a monetary phenomenon, hence monetary policy is not supposed to be countercyclical – it is supposed to be “neutral” and avoid “generating” recessions. NGDP level targeting ensures that.
2) Often the GDP in NGDP is perceived to be real GDP. However, NGDP targeting does not target RGDP. NGDP targeting is likely to stabilise RGDP as monetary shocks are minimized, but unlike for example inflation targeting the central bank will NOT react to supply shocks and as such NGDP targeting means significantly less “interference” with the natural order of things than inflation targeting.
3) NGDP targeting is discretionary. On the contrary NGDP targeting is extremely ruled based, however, this perception is probably a result of market monetarists call for easier monetary policy in the present situation in the US and the euro zone.
4) Inflation will be higher under NGDP targeting. This is obviously wrong. Over the long-run the central bank can choose whatever inflation rate it wants. If the central bank wants 2% inflation as long-term target then it will choose an NGDP growth path, which is compatible which this. If the long-term growth rate of real GDP is 2% then the central bank should target 4% NGDP growth path. This will ensure 2% inflation in the long run.

Another issue that might be distorting the discussion of NGDP targeting is the perception of the reasons for the Great Recession. Even many libertarian and conservative economists think that the present crisis is a result of some kind of “market disorder” – either due to the “natural instability” of markets (“animal spirits”) or due to excessively easy monetary policy in the years prior to the crisis. The proponents of these positions tend to think that NGDP targeting (which would mean monetary easing in the present situation) is some kind of a “bail out” of investors who have taken excessive risks.

Obviously this is not the case. In fact NGDP targeting would mean that central bank would get out of the business of messing around with credit allocation and NGDP targeting would lead to a strict separation of money and banking. Under NGDP targeting the central bank would only provide liquidity to “the market” against proper collateral and the central bank would not be in the business of saving banks (or governments). There is a strict no-bail out clause in NGDP targeting. However, NGDP targeting would significantly increase macroeconomic stability and as such sharply reduce the risk of banking crisis and sovereign debt crisis. As a result the political pressure for “bail outs” would be equally reduced. Similarly the increased macroeconomic stability will also reduce the perceived “need” for other interventionist measures such as tariffs and capital control. This of course follows the same logic as Milton Friedman’s argument against fixed exchange rates.

NGDP level targeting as a privatization strategy

As I argue above there are clear similarities between the allocative outcome under Free Banking – hence a fully privatized money supply – and NGDP targeting. In fact I believe that NGDP level targeting might very well be seen as part of a privatization strategy. (I have argued that before – see here)

Hence, a futures based NGDP targeting regime would basically replace the central bank with a computer in the sense that there would be no discretionary decisions at all in the conduct of monetary policy. In that sense the futures based NGDP targeting regime would be similar to a currency board, but instead of “pegging” monetary policy to a foreign currency monetary policy would be “pegged” to the market expectation of future nominal GDP. This would seriously limit the discretionary powers of central banks and a truly futures based NGDP targeting regime in my view would only be one small step away from Free Banking. This is also why I do not see any conflict between advocating NGDP level targeting and Free Banking. This of course is something, which is fully recognised by Free Banking proponents such as George Selgin, Larry White and Steve Horwitz.

PS this is no the first time I try to convince libertarians and conservatives that NGDP level targeting is the true free market alternative. See my first attempt here.


Related posts:

NGDP targeting is not about ”stimulus”
NGDP targeting is not a Keynesian business cycle policy
Be right for the right reasons
Monetary policy can’t fix all problems
Boettke’s important Political Economy questions for Market Monetarists
NGDP level targeting – the true Free Market alternative
Lets concentrate on the policy framework
Boettke and Smith on why we are wasting our time
Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed

Update (July 23 2012): Scott Sumner once again tries to convince “conservatives” that monetary easing is the “right” position. I agree, but I predict that Scott will fail once again because he argue in terms of “stimulus” rather than in terms of rules.

Leave a comment


  1. Jens Nærvig Pedersen

     /  July 19, 2012

    It is hard to question your conclusions about NGDP targeting, when you have not presented your model economy and its underlying assumptions.

    Fx, a common assumption is staggered price setting by firms. Under this assumption any inflation/deflation will distort relative prices since not all firms are able to adjust prices every period. In this case NGDP targeting will lead to a worse outcome than inflation targeting, since inflation targeting, in theory at least, will deliver stable inflation in the short run.

  2. Jens,

    Yes, that discussion is highly relevant for whether NGDP targeting is a good idea or not. However, in terms of whether NGDP targeting applies with general free market position is another question. My argument is that inflation targeting would lead the central bank to distort prices while NGDP will not distort prices. However, that does of course not automatically follow that this will also Pareto dominate inflation or price level targeting.

  3. Becky Hargrove

     /  July 19, 2012

    Good post, your explanations are most helpful. Perhaps it would be fair to say as well that because of neutrality, NGDP level targeting would prevent central banks from reacting to the inevitable fiscal measures that governments take.

    • Becky,


      My answer would be yes and no – Under NGDP targeting the Sumner Critique would apply: Any impact on NGDP of changes in public finances will be “neutralized” by the central bank to keep NGDP on target. However, if fiscal policy has positive (or negative) supply side effects then the central bank will not react to that.

  4. Jens Nærvig Pedersen

     /  July 19, 2012


    My point was simply that it is not possible to evaluate the following statement without knowing what model it applies to.

    “in fact I believe that NGDP targeting is the monetary policy regime which best ensures well-functioning and undistorted free markets.”

    At least this is where I jump of the band wagon 😉

    I would, however, argue that the New Keynesian/Neomonetarist recommendations have presented the true free market alternative in a well-specified model framework.

  5. Diego Espinosa

     /  July 19, 2012

    There is one way in which NGDP targeting has an inherent “bail out” promise. Stabilizing NGDP requires that the Fed not allow the financial system to experience a liquidity event: to allow it would be to risk missing the target. This is essentially a free liquidity put issued to large financial firms. Given a free put, any agent will act in a manner that maximizes its value. In this case, this means reducing days-to-liquidate positions, and generally minimizing liquid reserves. Also, NGDP targeting also involves issuing a less-obvious put on duration risk. This is because abruptly raising interest rates can lead to a system-wide liquidity event. Finally, the existence of system-wide puts can lead to a convergence in financial strategies. The resulting homogeneity of the “ecosystem” renders it fragile, as a shock will affect most agents in the same manner.

  6. Robert

     /  July 19, 2012

    Most people I talk to who endorse Free Banking (though it’s mostly “internet Austrian” types, so I’ve surely got terrible sampling bias) don’t seem to get behind NGDPLT as quickly as I’d expect. They equate it with Keynesian counter-cyclical policy and seem particularly opposed to any case where the monetary base would ever increase.

    While it’s important to remove discretion from the central bank, they seem to miss the vital property of Free Banking where changes in the demand for money are offset endogenously through banks expanding their liabilities, maintaining a stable level of nominal spending.

    When that mechanism doesn’t work due to private note issue being restricted, the central bank needs to do what otherwise would have been done and offset changes in the demand for money.

    I think there are some advantages of it over commodity-standard free banking as well, but I would expect the free banking crowd to be all over NGDPLT, at least as a stepping stone. Down the track they can say, “So you’ve adopted NGDPLT. You know what’d make the central bank’s job much easier? Private note issue. Then most of the time they’d just have to grow total reserves at a constant rate!”

    • Robert,

      I completely agree. I think it is important that many (quasi) Free Banking proponent does not really understand how FB would work – especially that the money supply “automatically” would respond to an increase in money demand. An increase in the money base under a NGDPLT regime is basically an “copy-paste” of what would have happened under FB.

  7. jpirving

     /  July 20, 2012

    So Lars, does this mean that economic interventionists should support fixed exchange rates or inflation targeting? Sumner has shown over the years that the best way to get central planner types into power is to have a long deep deflation…

    Certainly Obama would have had a much harder go in 2008 had the U.S. been level targeting.

    • JP, Yes, I believe that interventionists should “support” fixed exchange rate regimes if they want support for their interventionist policies.

      You mention Obama, but I do not think that is the best example. After all the Bush administration was also extremely interventionist even prior to the the crisis. The best example in my view is the drive toward political “integration” in Europe on the back the euro crisis. There is no doubt that eurocrats actively is using the euro crisis as an excuse for more regulation and political centralization.

  8. Benjamin Cole

     /  July 21, 2012

    Excellent blogging, very well done.

    And I don’t think we should be ashamed to say that, on rare occasion, NGDP targeting has an element of discretion.

    Of course, there are wars and natural calamities, such as earthquake-Fukushima.

    Also, while I concur free markets are wonderful, let’s face it: Free markets are subject to booms and busts (which may have nothing to do with monetary policy).

    We know that money, capital and even gobs of leveraged capital may pour into a sector perceived as harboring giant profits. Then perhaps profits are not realized—so you have a huge bust, and a huge evaporation of capital, purely for free market reasons. It is the nature of man to gamble for huge success. (Free bankers appear to ignore this reality of man and economics).

    Moreover, we see in a free society that investors have the ability to leverage 100-to-1, lose, and then walk away. They do not go to jail, their wives and daughters are not sold into slavery. There is an incentive to leverage 100 to 1. If you bet right you are rich forever, and your great grandchildren too, by wives and mistresses. If you bet wrong, you set up shop again later (LTCM). This is free-market behavior, in a world full of capital seeking higher returns.

    In such scenarios, the central bank must be aggressive not in protecting the guilty, but protecting the general welfare. Not a bailout of the risk-takers, but of the innocent. The truck drivers who haul goods, and never play the markets—really, they are supposed to suffer as some Wall Street hotshots bet wrong and poured capital into the latest boom? And for decades at a stretch (think Japan)?

    Market Monetarism is the most promising an practical approach to sustaining growth in economies. It would not call for major leaks in current behavior of consumers, bankers, investors etc.

    • Benjamin,

      Well, I am much less inclined to believe there is a need for monetary policy to “fix” things. Most major bubbles are a result of failed monetary policies combined with moral hazard. Scaling back government intervention and targeting NGDP will sharply reduce the risk of bubbles.

      But let’s say bubbles occur anyway. In that a bursting bubble might put down pressure NGDP due to a negative shock to money-velocity. In that scenario there would be not need for discretion if the central bank would be following an NGDP rule as the money supply would “automatically” be increased in response to a shock velocity,

      • Benjamin Cole

         /  July 21, 2012

        Excellent reply.

        I concur there is a lack of moral hazard–but in part that is not fixable, we are a civilized society.

        If someone can leverage 100-to-1 (legally, and we believe in free markets), and his positions flops, what can we do? Debtor’s prison? Enslavement of his in-laws?

        The private sector may provide insurance, but we saw what happened to AIG. Really, AIG officials should go to jail? Pose nude in stocks while we throw vegetables?

        We simply lack the means to deter even bold risk-taking, and failed promises of insurance.

        In short, the private sector can and will arrange for spectacular busts. Remember, Wall Street is ingenious at packaging the next “Big Thing.”

        We agree (happily enough) that a central bank should keep NGDP on target, and that is the main point.

        Back to Free Banking (of the very free type, that is fractional), I wonder how depositors would react when they realize that profit-seeking sharpies, who have operated “legally,” are the only guarantee they will ever get their money back. The collapse of AIG tells volumes. Private sector people can only promise that your deposits are sound. A federally insured bank means you will in fact get your money back–they can print it, if need be.

        You need an entity with the power to print money that is accepted universally to really back things up.

  9. Robert

     /  July 21, 2012


    “If someone can leverage 100-to-1 (legally, and we believe in free markets), and his positions flops, what can we do?”

    There’s no need to do anything. The person who made the bet is wiped out and their creditors take a loss, becoming more weary in the future about who they lend to. As long as NGDP is on target we don’t get losses in the financial sector causing unemployment in the retail sector, and all that. The mechanism through which the shock is transmitted to the rest of the economy is a fall in money velocity. The central bank can offset that.

    “We simply lack the means to deter even bold risk-taking, and failed promises of insurance.”

    This links with the point about deposit guarantees. It’s up to depositors to impose restraint on their banks. It’s because deposits are insured that excessive risk taking happens. People don’t put time and effort into choosing a bank, like they would a car or house (or even mobile phone), because they don’t get any of the downside risk. If the bank fails, their deposits are insured. They simply look for the bank giving the highest interest rate. This encourages risky practices in order to attract depositors.

    If deposits weren’t guaranteed, people would have to care about the practices of the bank and take their deposits elsewhere if they felt the bank was undertaking too much risk.

    Also, one thing you could employ for deterring the banking sector from taking excessive risk is unlimited liability. You could make it so that if a bank gets leveraged up and loses, the stockholders are liable to repay that debt, even after the bank is insolvent.

  10. Benjamin Cole

     /  July 22, 2012


    Thanks for your comments.

    I guess we just have to agree to disagree on some points. My experience is that the private sector will take risks—and should take risks.

    Sometimes those risks explode, sometimes systemically. It is hard to make accurate predictions, especially about the future.

    Yet with global capital gluts, there will be pressure of higher returns.

    Side note on AIG: The buyers of bond insurance knew it was privately insured, and not backed up by the federal government. They still took risky (in hindsight only perhaps) positions in bonds. A house of cards was built on private insurance.

    The problem is not the job losses in the financial sector, but the spreading calamity and economic collapse.

    Anyway, I think we agree on the general direction of MM!

  11. Becky Hargrove

     /  July 22, 2012

    One of the reasons NGDP level targeting appeals to me so much: it draws a clear and distinct line in the sand, as to what money should be able to do in the definition of wealth capture, and leaves it to individuals to figure out the rest. Or, it allows a ‘clean slate’ to happen.

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