Goldman Advises The Fed To Go Nuclear, And Set A Target For Nominal GDP


Photo: Goldman Sachs

In his latest US Economics Analyst note, Goldman’s Jan Hatzius offers up his suggestion for the next phase of Fed policy.With short-term interest rates near zero and the economy still weak, we believe that the best
way for Fed officials to ease policy significantly further would be to target a nominal GDP path such as the one shown in the chart on the right, indicating that they will use additional asset purchases to help bring actual nominal GDP back to trend over time.  The case would strengthen further if deflation
risks reappeared clearly on the radar screen.

More specifically:

The specific path in Exhibit 1 is calculated as the level of nominal GDP in 2007 extrapolated forward at a rate of 4½% per year.  We can think of this number as the sum of real potential GDP growth of 2½% and inflation as measured by the GDP deflator of about 2%.  The specific numbers matter less than the Fed’s willingness to a target path that is anchored at a point like 2007, when the economy was near full employment, and that they indicate that they will pursue this target aggressively.

Why this move? Basically, Goldman sees it as a natural extension of the Fed’s dual mandate — price stability and full employment — but with a greater bent towards full employment.

It happens to be a pretty sexy idea among economists.

Here’s The Economist talking about the benefits of NGDP targeting:

Advocates of nominal GDP targeting claim that it would achieve greater macroeconomic stability. When recession hits, real output falls but prices tend to adjust more slowly. This means that by targeting nominal GDP, central banks could actually smooth output fluctuations better. They could also react more appropriately to supply shocks. Take the example of an economy that is hit by a negative supply shock through high oil prices depressing output and raising inflation. An inflation-targeting central bank may feel compelled to tighten policy, worsening the slump in output, whereas one mandated to hit NGDP could be more flexible. There could be advantages, too, in the opposite case where a positive supply shock through productivity-enhancing new technology boosts real GDP growth while lowering inflation. An inflation-targeting central bank would respond by easing monetary policy, which could produce asset bubbles, whereas an NGDP-targeting central bank would hold steady. Certainly inflation would be more volatile, but the overall economy would not be.

Even in some inside the Fed are talking about tilting the mandate more towards jobs (at the moment), as the Fed’s Eric Rosengren did at a speech in Sweden last month.

Ultimately, says Hatzius, a shift towards this kind of Fed policy could bring down unemployment much faster than the current path foresees.


Photo: Goldman Sachs

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