2 comments on “Inflation targeting compared to NGDP targeting

  1. The argument that we have good market forecasts of CPI and don’t have good market forecasts of NGDP so its going to be much easier to target CPI forecasts is a good one, though it is also an argument for trying to develop market NGDP forecasts.

    The argument that NGDP will lead to deflation when there’s high productivity growth isn’t good. The basic idea is that deflation due to productivity growth is especially easy to respond to because the producers experiencing productivity growth have all the information they need to lower their prices (in contrast to general deflation, where everyone needs to reduce their prices a little bit). Indeed, they’re already lowering their prices (that’s how we’re getting deflation). Actually, calling this deflation, is misleading. Another way of describing this argument is that reductions in the price level due to productivity changes doesn’t lead to monetary disequilibrium.

    This paper (http://www.cato.org/pubs/journal/cj10n1/cj10n1-14.pdf) on the topic by George Selgin is pretty good.

  2. John, I agree that productivity growth is not sufficient to generate monetary disequilibrium.

    The scenario that worries me involves rapid growth in the amount of economic activity. Let’s say that activity starts growing at a rate that would be 100% per year, using a hypothetical measure of NGDP that counts all goods and services as if the were priced the same as they were last year. That means the Fed would need something like 47.5% per year deflation in order to get actual NGDP growing at 5% per year.

    I’m assuming that productivity growth would not be dramatic enough to produce that kind of deflation while also keeping nominal wages stable. So I expect an NGDP-targeting Fed to initially tighten enough to cause declining nominal wages, then make crude guesses about how to raise NGDP targets.

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