Practical Implications of NGDP Targeting

Kevin Drum offered a post today in which he observed the surge of interest in the idea of Nominal GDP (NGDP) level targeting. This is an idea that people like Scott Sumner have pushed for a long time now–a proposal that the Federal Reserve should abandon its practice of simultaneously targeting low inflation, employment, and GDP growth, and instead, it should explicitly target only one metric: the overall level of NGDP.

In his posting, Kevin wondered aloud what NGDP level targeting would mean. In practical terms, what would the Fed actually be doing if they were targeting NGDP levels?

Following is a slightly-cleaned-up/expanded version of a comment I offered in response to Kevin’s question.



I have been bouncing some of this stuff back and forth with Scott on his blog, and here is how I think it all lays out:

1. The direct value of NGDP level targeting (per se) is that it forces the Fed to clearly state what it is shooting for, and it does so in a way that gives them cover to essentially ignore accelerations in inflation that will inevitably come with any resumption of world-wide growth (temporary accelerations that will come from oil-price increases as worldwide demand begins to grow again if nowhere else).

2. Once the Fed identifies the NGDP level targets it intends to shoot for (and once the Fed announces the growth-rate trajectory they intend to pursue to get us back on track) it will become crystal clear if their mix of actions is being successful or not. (This is a huge deal because, today, we really have little idea what the Fed is actually focused on doing. They give lip service to promoting recovery, but what they really seem most focused on is keeping inflation below 2%, which essentially means they are focused on not allowing the economy to recover–because oil-price increases that will come with recovery will inevitably push inflation over 2%.)

3. With a target clearly identified, the Fed will essentially be forced to start working through its quiver of tools: things like further quantitative easing (purchases of assets like Treasury bills or mortgage backed securities); shifting their policies regarding paying interest on (or penalizing) excess bank reserves; etc. At the end of this line of tools is the use of outright helicopter drops.

Helicopter drops can range from things like putting pressure on banks to refinance mortgages at lower rates even if the mortgage holder has a higher risk of default and/or holds a mortgage that is underwater (an action that puts more dollars in people’s pockets by reducing their monthly mortgage payment) all the way to cooperating with the Treasury along the lines of an idea Matt Yglesius has laid out.

Matt’s idea is that the Fed would buy, say, $300 billion in Treasury bonds and the first thing it would do with those bonds is light a match to them. [Voila, the Fed just created $300 billion out of thin air.] The Treasury now has $300 billion it just raised from their bond sale, and using these proceeds, the Treasury would send a $1,000 check to every man, woman, and child in America. The Fed and Treasury would also announce, up front, that they will continue doing this until they hit their NGDP targets).

Matt’s plan is an illustration of what I would describe as a pure helicopter drop: (first) the Fed can create dollars out of thin air; and (second) with the cooperation of the US Treasury, those newly-created dollars are delivered directly into households’ pockets.

The reality is that, somewhere in the continuum between straight-up quantitative easing and a pure helicopter drop along the lines of what Matt has described, the Fed has a tool that will be guaranteed to work. NGDP level and trajectory targeting will force them (and give them cover) to use all of these tools.

My belief is that, sooner or later, something along the line of pure helicopter drops will be required. I believe this is the case because, when push comes to shove, we still need to face up to the fact that American households are deeply, deeply, deeply in the red.

Compared with previous generations, even when one accounts for higher incomes, households today are holding more than $5 trillion in excess debt (i.e. on an income-adjusted basis, they carry at least $5 trillion of debt burdens over and above what previous generations carried), and most households also face the reality that they have absorbed trillions of dollars of wealth destruction in recent years.

As I have stated before, after 60-plus years of expanding real household debt (i.e. the ratio of household debt to GDP) we have probably reached the end of our expansion phase and are now in a debt-destruction phase–a phase that is dominated by the paradox of thrift (or, more appropriately for our circumstance, the paradox of debt-destruction).

We are witnessing the downward spiral unfold as we speak. Since 2007, household debt is being destroyed, but the process of reducing debt drives down household incomes. In the terms that matter, then, household debt continues to be as crushing, if not more crushing, than the day the process started.

In my view, the only way we get out of this mess is to drive down real debt-burdens, either by getting back to a trend of real increases in wages (which is really tough to do in a world where debt-destruction needs to happen), or via direct injections of purchasing power into households’ pockets (i.e. helicopter drops).

If the Fed were to adopt a regime of NGDP level targeting, I can see a number of ways that could turn around our economic prospects in the short- and medium-term (even without helicopter drops). I suspect, though, that after a period of a few years (after everything settles down) we will come to understand that our central problems of (1) too much debt and (2) over-reliance on debt-creation as the engine that drives expansion of demand will come back to the forefront.

More on that later…

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