Time for Nominal Growth Targets

ZANZIBAR – It is time for the world’s major central banks to reconsider how they conduct monetary policy. The US Federal Reserve and the European Central Bank are grappling with sustained economic weakness, despite years of low interest rates. In Japan, Shinzō Abe, the opposition Liberal Democratic Party’s (LDP) candidate for prime minister, campaigned for a more expansionary monetary policy ahead of the general election on December 16. And central banks in both the United Kingdom and China are coming under new leadership, which might entail new thinking.

Monetary policymakers in some countries should contemplate a shift toward targeting nominal GDP – a switch that could be phased in gradually in such a way as to preserve credibility with respect to inflation. Indeed, for many advanced economies, in particular, a nominal-GDP target is clearly superior to the status quo.

Central banks announce rules or targets in terms of some economic variable in order to communicate their intentions to the public, ensure accountability, and anchor expectations. They have fixed the price of gold (under the gold standard); targeted the money supply (during monetarism’s early-1980’s heyday); and targeted the exchange rate (which helped emerging markets to overcome very high inflation in the 1980’s, and was used by European Union members in the 1990’s, during the move toward monetary union). Each of these plans eventually foundered, whether on a shortage of gold, shifts in demand for money, or a decade of speculative attacks that dislodged currencies.

The conventional wisdom for the past decade has been that inflation targeting – that is, announcing a growth target for consumer prices – provides the best framework for monetary policy. But the global financial crisis that began in 2008 revealed some drawbacks to inflation targeting, analogous to the shortcomings of exchange-rate targeting that were exposed by the currency crises of the 1990’s.