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How To Target Nominal GDP

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"How To Target Nominal GDP"

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Kevin Drum wants to know what, specifically, the Fed should do to target total spending (i.e., NGDP). I think that this is actually not as complicated as Brad DeLong makes it out to be. Rather, following Karl Smith I think the Fed’s most potent tool is the statement. The statement needs to say:

The Committee commits to maintaining extraordinarily low levels for the Federal Funds rate until current value Gross Domestic Product re-obtains the trend level indicates on this chart you can see to the right.

Then you need to say that in order to achieve that goal sooner rather than later, the committee will undertake asset purchases of various kinds and various denominations to ensure that NGDP is on a catch-up path. You should also state that this will get done faster if fiscal authorities cooperate, and that the adjustment will be more on the real side and less on the price side if congress does smart things rather than dumb ones. The really important stuff will happen later in the Chairman’s press conference. You have to answer questions like this:

Q: You’re telling me that if inflation goes up 5 percent next year you won’t raise interest rates?
A: As the statement says, we’ll raise rates if and only if total spending re-obtains its pre-recession trend.

Q: What if we get 4 percent RGDP growth so there’s clearly no recession, but then there’s 3.5 percent inflation on top of that. You’re telling me that with unemployment falling and inflation rising, you’ll stick with zero interest rates?
A: As the statement says, we’ll raise rates if and only if total spending re-obtains its pre-recession trend.

Q: What if Rick Perry wins the election, then threatens to drag you down to Texas to “treat you rough” to staunch inflation?
A: We have an independent central banka and as the statement says, we’ll raise rates if and only if total spending re-obtains its pre-recession trend.

As Nick Rowe argues if everyone raises their implicit and explicit forecasts for NGDP growth, then NGDP will grow. It’s only if people think the Chairman is lying or will somehow be foiled by other actors that this can be stymied.

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