country exports. Neither an exchange rate target nor a CPI target would allow the currency to depreciate; both would automatically prevent it by calling for sufficiently tight money. An exchange rate target would not allow the depreciation by definition, while a CPI target would work against it because of the upward effect on import prices that would otherwise result. In both cases, sticking with the announced regime in the aftermath of an adverse trade shock would likely yield an excessively tight monetary policy. A nominal GDP target, by contrast, would allow accommodation of the adverse terms of trade shock: it would call for a monetary policy loose enough to depreciate the currency against the dollar. Under a nominal GDP target, adverse supply shocks are automatically divided between real output loss and inflation. This is what one would want. Figure 1. Supply Shocks are More Frequent in Emerging Markets and Developing Countries Levels, or of Change? There is a potentially important question whether real GDP, the price level, and nominal GDP are to be defined in terms of levels or rates of change. The version of NGDP targeting that has been revived in recent years is often a proposal to target the level of NGDP rather than the rate of change. (Recall that the immediate context, in the case of industrialized countries, is an attempt to achieve monetary expansion even when the nominal interest rate is constrained by the Zero Lower Bound.) The argument is that if the expansion turns out to fall short of the target in the first year, and yet the intentions of the authority are ultimately credible, then the shortfall will automatically generate a further boost to public expectations of coming monetary expansion and inflation, a reduction in the real interest rate, and thereby an accelerated movement toward the target. This argument for targeting the level of NGDP rather than the rate of growth is the same that had been offered earlier for proposals to announce a target for the price level rather than the inflation rate. In both cases, the pro argument is a faster return to the goal, provided the policy is credible. In both cases, the con argument is that the public may not understand, and may not believe, a target phrased in terms of the level of NGDP or the price level, as easily as a target phrased in terms of the rate of growth.
country exports. Neither an exchange rate target nor a CPI target would allow the currency to depreciate; both would automatically prevent it by calling for sufficiently tight money. An exchange rate target would not allow the depreciation by definition, while a CPI target would work against it because of the upward effect on import prices that would otherwise result. In both cases, sticking with the announced regime in the aftermath of an adverse trade shock would likely yield an excessively tight monetary policy. A nominal GDP target, by contrast, would allow accommodation of the adverse terms of trade shock: it would call for a monetary policy loose enough to depreciate the currency against the dollar. Under a nominal GDP target, adverse supply shocks are automatically divided between real output loss and inflation. This is what one would want. Figure 1. Supply Shocks are More Frequent in Emerging Markets and Developing Countries Levels, or of Change? There is a potentially important question whether real GDP, the price level, and nominal GDP are to be defined in terms of levels or rates of change. The version of NGDP targeting that has been revived in recent years is often a proposal to target the level of NGDP rather than the rate of change. (Recall that the immediate context, in the case of industrialized countries, is an attempt to achieve monetary expansion even when the nominal interest rate is constrained by the Zero Lower Bound.) The argument is that if the expansion turns out to fall short of the target in the first year, and yet the intentions of the authority are ultimately credible, then the shortfall will automatically generate a further boost to public expectations of coming monetary expansion and inflation, a reduction in the real interest rate, and thereby an accelerated movement toward the target. This argument for targeting the level of NGDP rather than the rate of growth is the same that had been offered earlier for proposals to announce a target for the price level rather than the inflation rate. In both cases, the pro argument is a faster return to the goal, provided the policy is credible. In both cases, the con argument is that the public may not understand, and may not believe, a target phrased in terms of the level of NGDP or the price level, as easily as a target phrased in terms of the rate of growth.
ngdptargetsmidinccbrt.docx