Is Nominal-Income Targeting Effective?
In “Monetary Regime Change” (June 11), David Beckworth and Ramesh Ponnuru suggest that the Federal Reserve should adopt a target for nominal-income growth of 5 percent per annum. An imperfect but informative medical analogy would be trying to cure cancer by making your target some magical increase in life expectancy.
The past three years have demonstrated the futility of the recommended approach, since nominal-income targeting has been the implicit objective of Federal Reserve policy. The authors state, correctly, that nominal-GDP growth has averaged 5 percent per annum over the past quarter-century. However, the high level of variation in that statistic (a standard deviation of 2.1 percent) is far more revealing. Nominal-GDP growth plunged from 8.5 percent in the first quarter of 1989 to 2.8 percent in the second quarter of 1991, from 7.5 percent in the second quarter of 2000 to 2.4 percent in the fourth quarter of 2001, and from 6.6 percent in the second quarter of 2006 to −3.9 percent in the second quarter of 2009.
The levers of monetary policy are the administratively determined discount rate and the federal-funds rate. If these tools could achieve the Holy Grail of 5 percent nominal-GDP growth, the past three years of aggressive Fed policy would have succeeded. Total banking reserves have exploded by 79.9 percent, which has produced increases of 39.4 percent in the narrow M1 money supply, 17.8 percent in the broader M2, and 22.2 percent in paper currency in public circulation. Nominal-GDP growth has lagged not because of a penurious monetary policy but because of a nearly unprecedented drop in money velocity. The root causes of this are structural as well as secular, and they include some concerns that the authors mention.
As every conservative knows, “the fault, dear Brutus, is not in our stars, but in ourselves, that we are underlings.”
Stephen Delos Wilson
The Authors reply: During the Great Moderation, central banks followed no explicit rule to stabilize nominal income. They nevertheless stabilized it better than they had done in the decades prior or have done during the recent economic crisis and weak recovery. To the extent they failed to stabilize it — as, Mr. Wilson reminds us, they failed in 1989–1990 and 2000–01 — the results were bad. This history makes us think that central banks should adopt an explicit policy of stabilizing nominal income.
The money supply has indeed risen since the start of the crisis, but it has not risen as much as the demand for money balances. Contrary to Mr. Wilson’s supposition, central banks have influence over this demand. Had the market expected the Federal Reserve to expand supply to meet any rise in demand, demand would not have risen so far in the first place. We would thus probably have a lower money supply if the Fed had adopted a “looser” policy. Nominal-income targeting would work in large part by stabilizing the demand for money.
We agree that the economy has structural problems. In the National Federation of Independent Business’s survey of small businesses, however, the top complaint is not poor labor quality, bad tax laws, or onerous regulations. It’s lack of sales.