Constituent policy

Nominal GDP as a policy guide

The Fed repeatedly makes policy mistakes by ignoring wild swings in nominal GDP. Today, two major news outlets published compelling arguments in favor of targeting the NGDP. Here is Clive Crook in the Washington Post:

The Fed has delayed raising interest rates until now as it did not know why inflation had risen and whether the contraction in the labor force due to the pandemic would reverse. An excess of demand over supply drives prices up – but how much of that excess is due to high demand and how much to temporary interruptions in supply?

A central bank that has observed the NGDP may be agnostic about it. It would compare the actual NGDP to its goal and aim to keep it on track. Changes in supply conditions would then determine what happens to inflation and output. . . .

The chart compares the actual NGDP with a benchmark that Beckworth calls “neutral NGDP” – a steadily rising level of demand consistent with medium-term growth and low average inflation, which is neither expansionary nor restrictive. Following the pandemic-induced shock in 2020, demand had returned to that baseline level by the second quarter of 2021. Had the Fed been watching, it would have seen a strong signal to start tightening by summer at the latest. last – and would have been equipped with a simple explanation for the takeoff.

And here is a similar suggestion, from Bryan Cutsinger and Alexander Salter in the National exam:

Monetary policy affects total expenditure, and therefore aggregate demand. To fight recessions, it is appropriate for the Fed to back down when demand collapses, stabilizing both labor markets and the value of the dollar. You can’t have one without the other. The share of employment corresponding to full employment depends on supply, over which the Fed has no control. All the central bank can do is choose the level of demand, and therefore the purchasing power of the currency.

That doesn’t mean the Fed is irrelevant. On the contrary: stable demand is a boon for the economy. Instead, it means that the employment component of the mandate is superfluous at best and dangerous at worst. By keeping nominal income on a stable path, the Fed creates a solid foundation for labor markets to thrive. No micromanagement needed.