For India, in particular, one major exogenous supply shock is the monsoon rains. In the case of inflation targeting IT , by contrast, the full impact of an adverse supply shock or terms of trade shock is felt as a loss in real GDP alone. NGDP targeting arguably achieves the best of both worlds: it automatically accommodates supply shocks as most central banks with discretion would do anyway, while retaining the advantage of anchoring expectations as rules are designed to do.
We outline a simple theoretical model and derive the conditions under which an NGDP targeting regime would dominate other regimes such as IT for achieving objectives of output and price stability. We go on to estimate for the case of India the main parameters needed to ascertain whether these conditions hold, most notably the slope of the aggregate supply curve.
But perhaps other central banks would be better off reforming proactively, on their own terms. In the longer term, the macroeconomic and financial stability benefits that could follow would further improve legitimacy and credibility. How has the Fed implemented its dual mandate in recent years? Figure 3 plots U. PCE inflation and unemployment since , when the 2 percent target for PCE inflation was announced.
In fact, by announcing an NGDPLT now, the Fed could claim that they are merely formalizing a target that they have informally pursued, with great success, in recent years. For the sake of optics, and because consumers tend to have a preference for working with round numbers Binder c , they might wish to announce a 5 percent growth path from this point forward. Either way, merely showing a graph similar to Figure 4 could alleviate some of the confusion and uncertainty associated with a change in target.
There are several reasons to believe that following a transition to NGDPLT, the new target could help to mitigate the deficits of understanding and trust. Some of these benefits come via facilitating communication. Part of the difficulty of inflation targeting is that many people either do not know what inflation is or understand it very differently than central bankers do.
Many people do not understand that higher inflation can be a consequence of higher aggregate demand. On surveys of consumer expectations, for many consumers, reported inflation expectations are really a proxy for their beliefs about the general state of the economy—that is, consumers report higher inflation expectations when economic sentiment is poor Kamdar ; Binder d. This could help consumers form more accurate perceptions and expectations about both real and nominal variables.
Macroeconomic literacy would become easier to teach, because macroeconomic dynamics would be more intuitive. For example, in , the Federal Reserve Bank of New York introduced the Survey of Consumer Expectations SCE , a monthly survey that collects a rich variety of expectations data for a rotating panel of respondents.
The respondents take the survey up to 12 times in a row. My coauthor and I show that the inflation expectations survey responses are subject to large panel conditioning effects Binder and Kim That is, after participating in the first round of the survey, respondents make large downward revisions to their inflation forecasts, so respondents of longer survey tenure have lower and more accurate forecasts than respondents of shorter tenure.
It appears that taking the expectations survey prompts respondents to look up information about inflation. This also suggests that consumers may have an easier time providing aggregate nominal income expectations than providing inflation expectations, though more evidence is needed. This, in turn, would allow the central bank to more reliably monitor their credibility. The single, explicit, numerical target associated with NGDPLT should make it easier for the public to verify whether the central bank is doing what it has promised to do, easier for the central bank to justify the policy stance at any point in time, improving transparency and accountability.
The single target will make it harder for politicians to argue that the stance of policy is too easy or too tight. No central bank target or mandate should be thought of as permanent: they can always be changed, and change is sometimes required to preserve institutional legitimacy.
The New Zealand experience highlights two defining features of the current monetary policy environment. First is that there is a strong political will to change the targets, frameworks, and governance central banks, especially where populist undercurrents are strong. These features, of course, are interrelated, as the twin deficit feeds into the political will to change central banks.
The lack of popular will to defend the monetary policy status quo could reduce the disruption of a transition to NGDPLT. In the longer run, NGDPLT would facilitate communication with the public, improve accountability, and promote sound policy and economic stability.
Afrouzi, H. Alesina, A. Azariadis, C. Louis, Working Paper —A May. Barro, R. Beckworth, D. Bernanke, B.
New York: W. Bholat, D. Billi, R. Binder, C. Binder, S. Blanchard, O. Blinder, A. How Do We Build It? Bullard, J. Louis, Working Paper No. Coibion, O. Davig, T. Fellner, W. Washington: American Enterprise Institute. Goodhardt, C. Goy, G. Gros, D. Haldane, A. Hawkesby, C. Hawkins, K. Issing, O. Eijffinger and D. Masciandaro eds. London: Centre for Economic Policy Research. Kamdar, R. Koenig, E. Kool, C. Louis Review 97 4 : — Krugman, P.
Kydland, F. Masciandaro, D. Matthews, D. McCallum, B. Kansas City, Mo. McDermott, J. Orr, A. Roger, S. Washington: International Monetary Fund. Rogoff, K. Romer, C. Roth, F. Selgin, G. Sheedy, K. Sumner, S. See Selgin for a review of the literature. Contemporaneous work in the burgeoning rational expectations literature bolstered the association of credibility with low expected and actual inflation Kydland and Prescott ; Barro and Gordon In parallel, transparent policy came to mean policy that the public understands to be committed to low inflation.
While expectations of financial market participants and professional forecasters do seem to react to forward guidance announcements, the response tends to be incomplete, limiting the macroeconomic effects Kool and Thornton ; Goy, Hommes, and Mavromatis Live Now. Cato Journal.
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