Why the Fed should use NGDP targeting

Good point made by R.A. in The Economist as to why the Fed should target nominal GDP rather than inflation:

One of the strongest points in favour of NGDP targeting, in my view, is that it implied a need for far more action from the Fed far earlier in this business cycle. People remember how aggressively the Fed intervened to prop up the financial system in the fall of 2008, but they forget how slow the central bank was to react to what was obviously a precipitous decline in the macroeconomy. The fed funds rate stayed at 2% from April until October of 2008. The Fed didn’t ramp up its initial asset purchase programme above $1 trillion until March of 2009, at which point the economy had already lost some 6m jobs. Why the delay? One data point worth noting: the monthly core inflation rate was positive throughout 2008 and 2009. NGDP growth, by contrast, was already negative in the third quarter of 2008, and was sharply negative in the fourth quarter of that year, when total spending in the economy shrank at an 8.4% annual pace. A central bank with an explicit NGDP level target would have faced (appropriately) intense pressure to do much more much sooner than one with the Fed’s present, vague focus on an inflation target as a means to broader macroeconomic stability.

If we look at the graph below, it is likely the Fed would have cut the funds rate to near zero by May 2008, when Q1 GDP results were available — possibly earlier if they were using surrogates to give more up-to-date measures of GDP — rather than waiting until November 2008.

Fed Funds Rate, Core CPI & Nominal GDP

But that misses the key point. The Fed would have intervened far earlier with tighter monetary policy — in late 2003 when GDP growth jumped to 6.4 percent — and prevented the bubble from forming.

Source: Monetary policy: Understanding NGDP targeting | The Economist

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