Tuesday, May 8, 2012

Unlearning Economics - On the Lousy Reasoning Behind NGDP Targeting

The fact is that no rigorous theoretical case has been made that supports NGDP targeting. As evidence, advocates of NGDP targeting offer no more than a graph showing that NGDP declined during the recession, with the implicit assertion that nominal income is what drives the macroeconomy. But is this true? Left Outside’s endorsement of NGDP targeting included this graph, showing that low NGDP is correlated with low RGDP:
This is a clear example of confusing correlation and causation. When looking at two correlated variables, a good question to ask is which one moves first – here, the drop in RGDP clearly precedes the drop in NGDP. This suggests that the decline in RGDP is not a result of the decline in NGDP; rather, its the opposite.
Read it at Unlearning Economics
On the Lousy Reasoning Behind NGDP Targeting

From the comments:

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?

Unlearningecon - That’s a good Lucas-critique style criticism, actually, and one I hadn’t really thought of. It’s an obvious observation that NGDP and RGDP have been correlated in the past, but there’s no reason to presume this will remain the same.
In fact, the situation is eerily reminiscent of the Phillips Curve in many ways.

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