An NGDP rule would limit the Fed’s discretion in return for simplicity, predictability, and a much lower danger of catastrophic monetary mistakes.
The U.S. has a government-issued currency and a central bank. Maybe we shouldn’t have these institutions, but they are likely to be around for the duration. Sometimes they perform better, sometimes worse. My view — brace yourself for this — is that as long as we have them, it would be best if they worked as well as possible: keeping supply in equilibrium with demand, neither generating nor amplifying boom-bust cycles, avoiding the creation of uncertainty that impedes individuals and businesses from making and acting on their plans.
I’ve made the case, most recently in a Washington Post column, that the best way to achieve these goals is for the Federal Reserve to set the money supply so as to keep “the economy growing at a steady rate, as measured by the number of dollars U.S. households and businesses spend and make in a year.”
If total spending, also known as NGDP, grows above the target rate (I suggested 4 percent in the column), it means that the demand for money balances is dropping and the Fed should reduce the growth of the money supply. If spending growth runs below the target, the demand for money is increasing and the money supply should also grow. David Beckworth offered a more extended case for this policy in a 2019 paper. The idea goes back a long way in economic thought but was largely, and unfortunately, swept away by the Keynesian revolution.
John Tamny, the editor of RealClearMarkets, has long hated the idea of targeting NGDP. I was a little surprised, then, to see RCM reprint my column — until I noticed that the website had put on it the misleading headline, “The Fed Should Centrally Plan U.S. Consumption.” Now Tamny has written a rant against NGDP-targeting in Forbes. But the critique misunderstands the idea.
He writes that “the Fed could no more centrally plan consumption than it does production.” That’s true. But it’s also irrelevant, since hitting an NGDP target isn’t the same thing as centrally planning consumption. The Fed didn’t centrally plan consumption from 1990 to 2007 — as Tamny rightly says, it can’t — but it did a reasonably good job of keeping NGDP on track during that period.
NGDP-targeting doesn’t involve product-by-product, service-by-service production or consumption targets, as actual central planning entails. It doesn’t target any level of consumption at all. Tamny oddly assumes that NGDP-targeting somehow privileges consumption over production. But total spending — which, again, is what the Fed would be keeping on target — includes investment, not just consumption. And total spending is mathematically equivalent to total income, which obviously includes all income from production. An NGDP-targeting central bank would not attempt to influence the ratio of consumption to investment within total spending.
Tamny doesn’t go into what he thinks a central bank should do, which may be just as well. But we should keep in mind what the status quo policy is that NGDP would replace. That policy targets 2 percent inflation — maybe Tamny thinks that’s central planning of prices? — but countenances departures from the target based on concerns about the unemployment rate. In making policy, the Fed governors look at everything from the stock market to supply conditions to the foreign exchange market. An NGDP rule would limit the Fed’s discretion in return for simplicity, predictability, and a much lower danger of catastrophic monetary mistakes. So while Tamny calls it “creeping socialism,” it’s more market-oriented than what we have now.