Why John Taylor Is Against Nominal GDP Targeting

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"Several people have asked me to comment on nominal GDP targeting, as recently proposed by Scott Sumner, Christina Romer and Paul Krugman. I did research on nominal GDP targeting many years ago and found that such targeting proposals had a number of problems, which I summarized in the paper “What Would Nominal GNP Targeting Do to the Business Cycle?” Carnegie-Rochester Series on Public Policy, 1985. Although much has changed in the past quarter century I find many of the same problems with the recent proposals.

One change is that, in comparison with earlier proposals, the recent proposals tend to focus more on the level of NGDP rather than its growth rate. This removes some of the instability of NGDP growth rate targeting caused by the fact that NGDP growth should be higher than its long run target during the catch up period following a recession. But it introduces another problem: if an inflation shock takes the price level and thus NGDP above the target NGDP path, then the Fed will have to take sharp tightening action which would cause real GDP to fall much more than with inflation targetting and most likely result in abandoning the NGDP target.

A more fundamental problem is that, as I said in 1985, “The actual instrument adjustments necessary to make a nominal GNP rule operational are not usually specified in the various proposals for nominal GNP targeting. This lack of specification makes the policies difficult to evaluate because the instrument adjustments affect the dynamics and thereby the influence of a nominal GNP rule on business-cycle fluctuations.” The same lack of specificity is found in recent proposals. It may be why those who propose the idea have been reluctant to show how it actually would work over a range of empirical models of the economy as I have been urging here. Christina Romer’s article, for instance, leaves the instrument decision completely unspecified, in a do-whatever-it-takes approach. More quantitative easing, promising low rates for longer periods, and depreciating the dollar are all on her list. NGDP targeting may seem like a policy rule, but it does not give much quantitative operational guidance about what the central bank should do with the instruments. It is highly discretionary. Like the wolf dressed up as a sheep, it is discretion in rules clothing.

For this reason, as Amity Shlaes argues in her recent Bloomberg piece, NGDP targeting is not the kind of policy that Milton Friedman would advocate. In Capitalism and Freedom, he argued that this type of targeting procedure is stated in terms of “objectives that the monetary authorities do not have the clear and direct power to achieve by their own actions.” That is why he preferred instrument rules like keeping constant the growth rate of the money supply. It is also why I have preferred instrument rules, either for the money supply, or for the short term interest rate.

Rules for the instruments are what monetary policy needs, not excuses for discretionary actions. I welcome more research looking for better instrument rules which are explicit and operational enough to be evaluated with empirical economic models. Even an historical comparison of different rules would be welcome, and Allan Meltzer's monumental History of the Federal Reserve would be a good foundation to build on. As he summarized in a speech this week, “Economists and central bankers have discussed monetary rules for decades. A common response of those who oppose a rule, or rule-like behavior, is that a central banker’s judgment is better than any rule. The evidence we have disposes of that claim. The longest period of low inflation and relatively stable growth that the Fed has achieved was the 1985-2003 period when it followed a Taylor rule. Discretionary judgments, on the other hand, brought the Great Depression, the Great Inflation, numerous inflations and recessions. The Fed contributed to the current crisis by keeping interest rates too low for too long.”"