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You know that Goldman Sachs is a leading proponent of NGDP targeting by the Fed, and in fact it was Goldman’s call for NGDP targeting that explains why this idea has moved from academic fringes (and blogs) to something that’s been getting discussed everywhere.Anyway, in a note put out tonight, the firm anticipates the next step by the Fed, and it’s not particularly pleased.
It is possible that Fed officials will soon adopt an explicit flexible inflation target. This would only be a small step away from the current framework, in which they talk about the “mandate-consistent” inflation rate of 2% or slightly below. However, we think it would be somewhat counterproductive at the margin because it would cement the asymmetry between the employment and inflation part of the Fed’s dual mandate. This risks solidifying expectations of low growth. A move to a nominal GDP (NGDP) target would stand a better chance of helping the Fed achieve both parts of its dual mandate over time. It would provide a way to strengthen the employment side of the mandate, while allowing for errors in the estimation of potential output. If combined with a commitment to use the remaining tools of monetary policy aggressively, our analysis suggests that it could potentially give a significant boost to growth and employment. An NGDP target does involve some risk of an unwanted increase in long-term inflation expectations. However, this risk would be lower than under other “unconventional unconventional” options such as a higher inflation target because an NGDP target involves a clear exit strategy for when to apply the monetary brakes.
In other words, the beauty of NGDP targeting is that it doesn’t matter the mix you have between GDP and inflation, because the whole point is that if you have enough nominal activity, then the economy can cover its nominal debts more easily.
Goldman’s fear is that a more explicit inflation target will harden this idea that the Fed has to be pulled in two different directions at all times, constantly worrying about price stability and employment, which, frankly, are opposing goals.