Thursday, May 10, 2012

NGDP Targeting: Changing Policy Changes Relationships

In response to a post at Unlearning Economics On the Lousy Reasoning Behind NGDP Targeting I commented:
Woj - As long as the CB is reasonably successful at targeting low inflation, NGDP and RGDP will obviously be highly correlated over time. However, if the CB were to target quantity rather than price, I’d imagine that RGDP and NGDP might be less correlated. Is it possible that much of the correlation stems from current CB policy and that changing policy would also change the relationship?
Well, here is a chart displaying the relationship between NGDP and RGDP going all the way back to 1948:
(Source: Does History Support NGDP Targeting Now? by James Picerno)

During the 1970’s the US was plagued by high inflation that at times drifted into the double digits. This led to a brief stint of monetarism at the end of the decade into the early 1980’s. Monetarism, at the time, attempted to target a quantity of money rather than price. As can clearly be seen in this chart, the relationship between NGDP and RGDP is least correlated in the post-WWII period during this time of high inflation and quantity targeting.

For those convinced that NGDP targeting will be successful, the task is to explain why changing policy to promote higher inflation today will not cause a breakdown in the correlation of the past 30 years, similar to the 1970’s. Otherwise it seems perfectly reasonable to expect that NGDP targets will be met with increasing inflation, not real growth. 

Update: Unlearning Economics has a new post following up on my thoughts and the chart above. Read it here: More on NGDP Targeting (and Bubbles) 

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