In my preceding blog post, I argued that the developments of the last five years have sharply pointed up the limitations of Inflation Targeting (IT), much as the currency crises of the 1990s dramatized the vulnerability of exchange rate targeting and the velocity shocks of the 1980s killed money supply targeting. But if IT is dead, what is to take its place as an intermediate target that central banks can use to anchor expectations?
The leading candidate to take the position of preferred nominal anchor is probably Nominal GDP Targeting. It has gained popularity rather suddenly, over the last year. But the idea is not new. It had been acandidate to succeed money targeting in the 1980s, because it did not share the latter’s vulnerability to shifts in money demand. Under certain conditions, it dominates not only a money target (due to velocity shocks) but also an exchange rate target (if exchange rate shocks are large) and a price level target (if supply shocks are large). First proposed by James Meade (1978), it attracted the interest in the 1980s of such eminent economists as Jim Tobin (1983), Charlie Bean (1983), Bob Gordon (1985), Ken West (1986), Martin Feldstein & Jim Stock (1994), Bob Hall & Greg Mankiw (1994), BenMcCallum (1987, 1999), and others.
Nominal GDP targeting was not adopted by any country in the 1980s. Amazingly, the founders of the European Central Bank in the 1990s never even considered it on their list of possible anchors for euro monetary policy. (They ended up with a “two pillar approach,” of which one pillar was supposedly the money supply.)
But now nominal GDP targeting is back, thanks to enthusiastic blogging by ScottSumner (at Money Illusion), LarsChristensen (at Market Monetarist), David Beckworth (at Macromarket Musings), Marcus Nunes (at Historinhas) and others. Indeed, The Economist has held up the successful revival of this idea as an example of the benefits to society of the blogosphere. Economists at Goldman Sachs have also come out in favor.