St. Louis Federal Reserve president James Bullard just came out in support of nominal GDP targeting – or rather he has co-authored a rather interesting new Working Paper, which concludes that NGDP targeting under some circumstances would be the best policy to pursue.
The paper with the ambitious title Optimal Monetary Policy at the Zero Lower Bound Bullard has co-authored with Costas Azariadis, Aarti Singh and Jacek Suda.
As the abstract reveals it is a rather technical paper:
We study optimal monetary policy at the zero lower bound. The macroeconomy we study has considerable income inequality which gives rise to a large private sector credit market. Households participating in this market use non-state contingent nominal contracts (NSCNC). A second, small group of households only uses cash and cannot participate in the credit market. The monetary authority supplies currency to cash-using households in a way that changes the price level to provide for optimal risk-sharing in the private credit market and thus to overcome the NSCNC friction. For succinctly large and persistent negative shocks the zero lower bound on nominal interest rates may threaten to bind. The monetary authority may credibly promise to increase the price level in this situation to maintain a smoothly functioning (complete) credit market. The optimal monetary policy in this model can be broadly viewed as a version of nominal GDP targeting.
I think the interesting thing about the paper is the focus on non-state contingent nominal contracts (NSCNC) as the key rigidity in economy rather wage and price rigidities. Simply stated, essentially NSCNC means that debt is nominal rather than real – and when a major negative shock to nominal incomes (NGDP) occurs then that causes debt/NGDP to rise and that is really at the cure of the financial distress that follows from a major negative NGDP shock (this by the way is why Greece now has a problem).
We can solve this problems in two ways – either by introducing (quasi) real contracts rather than nominal contract or by having the central bank targeting NGDP.
As such the paper is part of a growing, but small literature that focuses on NSCNC and the importance of this for the optimal monetary policy rule.
I was, however, a bit disappoint to see that the authors of the paper did not have a reference to any of the paper on this topic by the extremely overlooked David Eagle. I have written numerous blog posts on David’s work since 2011 and David has even written a number of guest posts for my blog. I list these posts below and I suggest everybody interested in this topic read not only the posts but also David’s papers.
The authors on the other hand do have a reference to the work of Evan Koenig who has done academic work very much in same spirit as David Eagle. I have also written about Evan’s work on this blog over the last couple of years and also list these blog posts below.
Will this change anything?
For those of us deeply interested in monetary policy matters the new paper obviously is interesting. First of all, it is helping deepening the theoretical understanding of monetary policy and second the paper could help further push the Federal Reserve (and other central banks!) toward in fact officially implementing some version of NGDP targeting – or at least I hope so.
That said there is a huge difference between in principle supporting NGDP targeting in a theoretical paper and then actually advocating NGDP targeting the real world and so far as I can see Jim Bullard has not yet done that. But obviously this is a huge step in the direction of Jim Bullard actually becoming an NGDP advocate and that obviously should be welcomed.
I have numerous times argued that the Fed actually from mid-2009 de facto started a policy to NGDP level targeting around a 4% path and this policy effectively has continued to this day (see here and here). However, this has never been articulated by any Fed official, which makes the “policy” much less effective and less credible.
Therefore, it would be great if we not only would get a theoretical endorsement of NGDP targeting from the likes of Jim Bullard, but rather a concrete proposal on how to actually implement NGDP targeting. I hope that will be the next paper Jim Bullard authors.
PS My friend Marcus Nunes also comments on the paper here.
PPS One of the authors of the paper discussed above is Jacek Suda from the Polish central bank (NBP). I would love to see a discussion of introducing NGDP targeting in my beloved Poland!
Blog posts on and by David Eagle:
Two Equations on the Pareto-Efficient Sharing of Real GDP Risk (a paper David and I co-authored in 2012)
Blog posts on Evan Koeing:
UPDATE: Scott Sumner also comments on the Bullard el al paper.
If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: firstname.lastname@example.org or email@example.com.