The Fed Framework Review: Macro Musings’ Greatest NGDP Targeting Hits

 On this special greatest hits compilation episode our host David Beckworth primes listeners for the Fed Framework Review by highlighting the best snippets from past shows discussing nominal GDP targeting. This episode includes Mary Daly’s thoughts on NGDP targeting, Evan Koenig on the basics of NGDP targeting, George Selgin on Powell’s hesitations with NGDP targeting and how it responds to supply shocks, Jim Bullard on the financial stability of NGDP targeting, Eric Sims on the New Keynesian argument for NGDP targeting, Carola Binder on the benefits of NGDP targeting, Charlie Evans on the prospects of NGDP target, and much more. 

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Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

Beckworth: Hey Macro Musings listeners, this is your host David Beckworth.

Now that the Fed has formally launched its framework review, the Monetary Policy Program here at the Mercatus Center is launching a number of products to encourage the FOMC think about and potentially use nominal GDP level targeting a as benchmark through which to evaluate changes to the Fed’s current framework. 

To that end, we are launching a policy brief series on the framework review with essays from a number of prominent monetary economists.  We also are doing this special show which is a compilation of some of our greatest hits from the podcast on the topic of nominal GDP targeting. We specifically put together clips that can inform and be useful to the Fed framework review process. Our compilation consists of clips from past conversations with Mary Daly, Evan Koenig, Jim Bullard, Eric Sims, Carola Binder, George Selgin, and Charlie Evans. These short segments should be very relevant and useful to the committee when they discuss the framework review. 

We also have added two bonus clips from past conversations with Gauti Eggertsson and Scott Sumner. These outtakes are more ambitious, moon shot-type proposals for versions of nominal GDP targeting. These are really interesting proposals, but they are saved for the bonus portion of this show. 

Okay, let’s get into our greatest hits.

We kick things off with an excerpt from a live podcast recording that we did with Mary Daly, President of the San Francisco Fed, back in May 2024. In this clip, Mary and I discuss whether NGDP targeting will be up for consideration during the 2024-2025 framework review. Here is our exchange:

Mary Daly on Nominal GDP Targeting Considerations for the 2024-25 Fed Framework Review

Beckworth: Well, Mary, you know I'm a big fan and advocate of nominal GDP targeting.

Daly: I do know that.

Beckworth: And I was at a conference where you and a number of other Fed presidents were giving talks. And I remember that Jim Bullard gave a talk on nominal GDP targeting. He was, I know, one of the big champions inside the FOMC for nominal GDP targeting. He has since stepped down. Are there any champions left for nominal GDP targeting at the Fed?

Daly: I don't usually speak about my colleagues, but I'm going to speak about us collectively. Here's something that I really love about working at the Fed— and I know Jim had a model. That was the model that says, imagine people live 200 quarters, and how do we go through that? But seriously, all of these things are useful to think about. There's nominal GDP targeting, there's price level targeting, there's inflation targeting, there's a dual mandate. Some countries are inflation targeters, and we're a dual mandate country. And what's important is that the goals are always the same.

Daly: These are how to achieve the goals. The goals are to create sustainable growth, a healthy growth rate that is not too fast, not too slow against the potential output, and do that with having a price level or an inflation rate that is stable and low, and a labor market where people who want jobs can get them. Those are the goals no matter which technique or methodology you're using. And so, we looked at all of those in the last framework review and came to the one we use, which is inflation and dual mandate, or goals, inflation at 2% and a labor market that has full employment. I still think that's a really winning proposition. It served us well. But I gave you that sticker. I am curious. I am a policymaker and a researcher and voraciously curious. And so, if people come and say, “Look, I have price-level targeting or nominal GDP targeting. Could it produce a better outcome?” Well, then, obviously, we would think about those and consider those things, but there's always advocates for all of the different ways. The goal is to try to get something that works for as many Americans as possible.

Daly: There's two other things to the curious [point]. Be voraciously curious. This is useful for younger people, too, is that if you're doing anything, just be voraciously curious. When I'm looking to hire people, I look for curiosity. I also look for— okay, I've been very curious. Now, you need to take a decision. I want people to be confident in that decision. But then, immediately upon taking it, I want a certain amount of humility to say, what did I miss? How do I get curious again? I have a sticker that says, “be curious, be confident, be humble.” And that, actually, is the way that I think the framework review will go and all of my colleagues share— I don't know if they have my sticker, but I'm happy to give it to them. But the most important thing is that we all share that mindset of, we've got to be curious. We've got to be confident that we've looked at everything, but we also have to be humble enough to ask, again, is this the right thing to do? Should we do something different?

Beckworth: Great. Well, we are putting together a policy brief series on the Fed framework review for, hopefully—

Daly: Terrific. Send it. Yes.

Beckworth: Of course, it has a certain angle to it, so I look forward to you reading it.

Daly: I wouldn't think otherwise, right? Is it titled “Nominal GDP Targeting?”

Beckworth: It is. It's something along those lines.

Daly: I'd be anxious to talk to you about it as we do the framework review.

Beckworth: Yes, well, I’ll be happy to talk to anyone at the Fed who wants to talk about it.

Beckworth: That was a great conversation with Mary Daly and, yes, she will be receiving the policy brief series along with other Fed officials. And I am happy to speak to any member of the FOMC about the role that nominal GDP targeting could play in the framework review. 

Okay, our next clip comes from a 2019 podcast with Evan Koenig, formerly a senior advisor at the Dallas Fed and longtime champion of nominal GDP targeting. Here, we are discussing the 2019-2020 framework review, and here, Evan lays out the basics of nominal GDP targeting and also explains another version of it where the Fed would target nominal PCE expenditures. Here is our exchange:

Evan Koenig on the Basics and Preferred Structure of a Nominal GDP Targeting Framework

Beckworth: Okay, so let's move to one of the topics that's going to be discussed, and that is the framework, the monetary policy framework. So, they're looking at frameworks, tools for communication. I want to zero in on the framework because both of us share an appreciation share an appreciation for a particular framework called nominal GDP targeting. So, what is your definition of nominal GDP targeting, and what is your preferred version of it?

Koenig: Okay. I've actually got a pretty loose definition. I think that there are a lot of details that would need to be thought about carefully insofar as we can rely on models to simulate performance, different versions that would need to be simulated. But I think that the basic idea is that there is an argument for worrying about not just the variability of inflation and the variability of output, but also their correlation, so that one might want prices and quantities to move in opposite directions, that that might be important in macro performance. That's the basic idea behind nominal GDP targeting.

Koenig: If you take it literally, as targeting nominal GDP, if you have a negative output surprise— so, GDP is less than you had thought it was going to be— you would want a positive price level surprise, a movement in the opposite direction in the price level, and vice versa. If you had a positive output surprise, you'd want a negative movement in inflation, or a negative movement in the price level. So, I think that that's the main feature that distinguishes it from past policy strategies.

Beckworth: So, the defining characteristic is that it creates a tendency towards countercyclical inflation?

Koenig: Right.

Beckworth: Okay. Now, you have written in some of your papers— at least one of the papers— that you like a PCE version of it. What does PCE stand for?

Koenig: Personal Consumption Expenditures.

Beckworth: Yeah. Is that right? So, you would maybe have them target that portion of nominal GDP?

Koenig: So, this is one of those details that I think bears further investigation. In some models, if the problem is wage stickiness, that money wages aren't flexible, then you can show— and if there's some wedge between consumption and output, it may be government purchases that is the wedge. It might be investment spending— that you want to pay attention not just to nominal GDP, but also, in particular, to nominal consumption spending.

Koenig: If the friction is nominal debt contracts under some circumstances, you'd want to pay particular attention to nominal consumption spending rather than nominal GDP. As in practical terms, we've got monthly information on personal consumption expenditures. GDP statistics come out quarterly. So, there is some informational advantage perhaps of looking at nominal consumption spending. But I think what might be true in theory and practice— you have to take into account those practical considerations like the availability of information about how much the data get revised. Those things become important.

Beckworth: What have you found to be the best-selling point for nominal GDP targeting?

Koenig: Well, I think that depends on who your audience is. If you are talking with someone who is used to thinking in terms of something like the Taylor rule as a guide for policy, the fact that you can put nominal GDP targeting into the Taylor rule framework, that it's sort of a generalization of the Taylor rule, is something that those people find appealing. So, there's no divine revelation that we ought to be looking at inflation over a one-year period. Certainly, maybe we ought to be looking at inflation over a six-quarter period or over a three-year period instead, and people who are comfortable with the Taylor rule are open to that possibility.

Koenig: Similarly, when it comes to measuring the output gap or the reference level of output, do you necessarily want to use the very most up-to-date estimate of potential GDP or perhaps is there an argument— and this is realistic. We have to base our estimates of potential GDP on lagged information. How important is it that that information be totally up to date? Is it okay for it to be lagged information?

Koenig: For those people, taking that approach works well. I think that if we're talking with the person on the streets, they find it very intuitive and very appealing. If you've got nominal debt obligations— if you've got student loan debt, if you've got a mortgage— having a reliable, predictable stream of nominal income is something that resonates. In fact, that's how I first got into nominal GDP targeting. A colleague back— boy, this must've been in the late 1980s or the very early 1990s. Inflation targeting was still relatively new, and we were talking about different policy strategies that might have been pursued during the Great Depression, and wouldn't it have been great to do price level targeting during the Great Depression? And I thought about this, and I had just purchased a home, had a mortgage payment. I really think having a predictable income stream would be more important to me.

Beckworth: Very interesting.

Koenig: So, I think that any individual who has those sorts of nominal obligations finds it appealing.

Beckworth: That conversation with Evan ended on a very interesting observation: people directly observe and care about their nominal incomes. Moreover, Evan argued that people really want a predictable nominal income stream. Therefore, the Fed should target nominal income or, equivalently, nominal GDP. 

I highlight that because our next clip speaks to this claim. It was an interview with George Selgin on October 2022. I had just brought up Fed Chair Jerome Powell’s recent appearance at the Cato Monetary Policy conference in September of 2022 and the reservations that Chair Powell expressed about targeting nominal income or nominal GDP. 

Here is what Chair Powell said: "I know that Cato is one of the home courts for nominal income targeting along with Mercatus and some others. A lot of well-known experts, many of them at your institution, support nominal income targeting. We've looked at that, I've looked at that, and really come to the view that nominal income targeting is not the right way to go.".

"We've got a dual mandate, maximum employment and price stability, and it comes down to, is nominal income [targeting] really the best way to promote it? We don't think it is. I don't think it is. And part of that is that it would be very difficult, I think, to explain to the public. The relationship between nominal income targeting to those goals is just a level of complexity that even some economists and policymakers struggle with, let alone the general public. So, it seems like it would be a reach to have it to be our fundamental framework." 

So that was Chair Powell’s objection to nominal income targeting in September 2022. I asked George to respond to Chair Powell’s concerns, and here is what he said:

George Selgin on Chair Powell’s Concerns About Nominal GDP Targeting

Selgin: Well, I have several thoughts. The first is that the fact that something seems difficult to explain is, itself, not a very good reason for not doing it, if it's the right thing to do. And the simple fact is that stability of nominal income is really the key to macroeconomic stability. It's not a shortcut, it's not advisable simply because it's a simple rule, which it is, in some respects, even if people don't grasp it quickly. It is an ideal. It's an ideal. And anything that departs from that ideal of a stable level or level path for nominal GDP targeting is asking for trouble, either cyclical or too much inflation or too little inflation or deflation. So when we have a theoretical ideal— and I'm willing to go out on a limb and say that it is ideal, and we could talk more about that— then the question shouldn't be whether it's hard to explain why it's ideal, [but] it should be, how do we communicate this to the public and how do we best try to approximate it in practice? 

Selgin: Those should be the only questions. Now, personally, I don't think that nominal GDP targeting is all that hard to explain, assuming that people understand what inflation targeting is— and one may wonder how many actually do, outside of the economics community. I don't see why it's any harder to explain to people why we want nominal spending to be stable, to not grow excessively, and certainly not to shrink over time. I've done so in a number of places, [and] you have, David. It's just saying that if the average person's and firm's earnings are rising too quickly, you get problems with too much purchasing power and excessive short run profits, eventually causing prices and wages to have to go up too much, as has been happening lately, because of excessive spending, amongst some other factors. And if spending shrinks, why people can't pay their bills and firms can't pay their obligations, their debts— they earn less than they laid out in costs.

Selgin: These seem, to me, rather simple points. It's also not hard to explain why, under certain circumstances, even though stabilizing nominal income growth does not equate with keeping the inflation rate constant, that the movements in the inflation rate that would result from nominal income targeting are ones that reflect the true state of scarcity in the economy. So, the only time you have prices rising exceptionally fast with nominal income targeting is if goods are unusually expensive to produce, as has been the case since COVID and the Russian invasion of Ukraine. And the other time you get falling prices is when productivity is growing especially quickly. These things aren't hard to explain. You only have to make the effort. And so, I don't think that Powell's argument is very good. I'll just add one more thing.

Beckworth: Sure.

Selgin: As far as we know, as far as the public knows, the only study that the Fed has done in its review of its procedures— especially during the Fed's Fed Listens program— addressing nominal income targeting, among other procedures, was the one by Lars Svensson, where Svensson essentially dismissed it on the basis of a number of presumed shortcomings. Well, I've written a piece in Alt-M about this Svensson article where I think I show that there's no validity to any of the arguments he made. They're all based on fallacies of various kinds. So, if that's the best the Fed can do to point to the theoretical flaws of nominal GDP targeting— well, they don't have a leg to stand on as far as I can tell.

Beckworth: Yes, let me give a concrete example where nominal income targeting would've been easier for the Fed. I'm going to go back to QE2. Ben Bernanke was called before Congress. “Why are you doing QE2?” And he said something along the lines of, "Well, we want to get inflation back up." And that didn't go over well with particularly the Republicans. They were just up in arms. "Are you kidding me? The recovery's slow and you want to increase the cost of living now?" And what he really meant was that he wanted to get nominal income or aggregate demand back, is what he really meant to say and had he said that, it would've been a whole lot easier. Same thing [with] the whole post-Great Recession period.

Beckworth: This talk about, “inflation is running too low” to a lot of people is just kind of off-putting as opposed to, “nominal income growth wasn't where it should be.” And the flip side of that is where we are today. We know that, yes, some of the inflation is due to supply side forces— as you mentioned, energy, the war in Russia and Ukraine. But some of it is also due to excess demand that came out of the fiscal stimulus and the Fed putting the gas pedal to the metal for too long. And the question in real time is, well how much do we attribute to each side? And we don't know. But what nominal income targeting does, is it says, look, just look at the level relative some trend or target path, bring it down, and the rest will sort itself out.

Beckworth: We don't need to worry about what percent is supply side and what percent is demand side. So, it would make the Fed's job easier. They could say, "Look, you're right. There's a lot of uncertainty about what's driving inflation. Don't worry about it. Keep your eye on the growth of aggregate demand or nominal income.” So, I think, both in a low growth period or an excess growth period, it's, in some ways, much easier than trying to wrestle through inflation. And we had Carola Binder on— my colleague right now, a visiting fellow here— and her work's been really great on inflation expectations for households, and what drives their thinking is often gas prices, and that's not inflation. There's a lot of confusion, even with inflation targeting, I think, that the central bankers take for granted.

Selgin: Yes, absolutely. I think if you ask most people— perhaps I'm wrong, but what's more important to you, to be able to have some confidence in your earnings being stable over time, or knowing that some index of prices is stable over time or growing at a constant rate over time? To me, it's pretty obvious that the more immediate concern people have is their earnings. And this is true for businesses as well— being able to predict their earnings. Certainly, people would say, "Well, I'd rather earn more than less." But it's easy enough for us to understand that, in the aggregate, of course, having everyone earn, nominally, a lot more doesn't really end up being a source of anything but inflation. But I think it's perfectly, to me, intuitive that stability of earnings is really more important for macro stability.

Beckworth: As usual, George did a thorough job responding to Chair Powell’s concerns about nominal GDP targeting.  I will note that some of our essays in our Fed framework policy brief series that I mentioned earlier will also address these concerns. 

Now, our next clip is from a more recent show with former St. Louis Fed President Jim Bullard. Here, we move from the communication issues surrounding nominal GDP level targeting to the financial stability case for nominal GDP targeting. This is a more recent argument and one, I should note, that is also made by Evan Koenig. And it says that nominal GDP level targeting effectively makes up for the lack of complete financial markets so that one can insure against financial stress in the future. This clip starts with me summarizing Jim’s view and asking him if it is a fair summary. Here it is:

Jim Bullard on the Financial Stability Argument for Nominal GDP Targeting

Beckworth: Now, let me tell what I consider the layman's version of your very sophisticated argument. Correct me if I'm wrong here, but this is how I would tell it. If we had nominal GDP targeting, and in a perfect world, the Fed could implement it and do it perfectly, [then] there would be no demand shocks. Demand would be completely stabilized, growing along some targeted growth path. So, what you would have would be supply shocks. And if you only had supply shocks that created recessions, you would then have counter-cyclical inflation. So, a negative supply shock hits, the economy tanks, [and] inflation goes up. Vice versa, [if there is a] positive supply shock, the economy sores, [and] inflation falls.

Beckworth: Well, if you have counter-cyclical inflation, then you're going to have a pro-cyclical real debt burden. So, you've got these fixed nominal debt contracts. During a recession, for example, the inflation goes up, your real debt burden goes down. During a boom, the flip is true. Inflation falls, your real debt burden goes up. So, you have real debt burdens moving in a way that is stabilizing, and some have said that it's effectively turning nominal debt into something that acts more like equity, because the real debt burdens are shifting. You're sharing risk appropriately between creditors and debtors.

Bullard: That's exactly right. What the monetary policy would be doing is turning non-state contingent nominal contracts into state-contingent real contracts. That's equity share contracting, which is known to be optimal from the literature, at least for homothetic preferences. So, that's exactly what this means. What we should be doing, but we would never do it in the real world, is saying, "I'll pay you back over the next five years, depending on how many raises I get, in real terms, and how well my career goes, and the lender should accept that I'm going to somehow report this accurately” and everything. So, we never do this because I think that there are real frictions to doing that kind of thing, but from a contracting point of view, that's what you should do if there was perfect information. That's definitely the spirit of it, and that's definitely what's going on.

Beckworth: If you're an advocate of state-contingent debt contracts— which many people were after the great financial crisis— [then] you should also be an advocate of nominal GDP level targeting.

Bullard: That's right.

Beckworth: In our next clip, we move on from Jim Bullard’s financial stability arguments for nominal GDP level targeting and move to a more standard new Keynesian rationale for it made by Professor Eric Sims of Notre Dame. This is from a show we did with Eric in 2020. Here is our exchange:

Eric Sims on the New Keynesian Rationale for Nominal GDP Targeting

Beckworth: So, you have a paper with several coauthors that’s called *On the Desirability of Nominal GDP Targeting,* and walk us through your findings. What is desirable about nominal GDP targeting?

Sims: So, this was a paper— and we didn't do this in any kind of strange framework. We basically just did a horse race. We took kind of a standard new Keynesian model and we did a horse race between different kinds of policy rules, and to our surprise, nobody [inaudible] the paper in the context of that kind of model saying, "Well what does nominal GDP targeting look like in a quantitative sense?"

Sims: So, we just posed nominal GDP targeting against things like inflation targeting, output gap targeting, a Taylor rule, et cetera, et cetera. It turns out that nominal GDP targeting works quite well. Now, we kind of knew, and there's been some of the analytical results in the literature, about the desirability of having forward-looking anchors in there, that sort of builds in these— you were describing some of the Woodford results— that builds in some forward guidance.

Sims: So, we found, I guess, somewhat to my surprise, that nominal GDP targeting does really well. For example, in the baseline model that we work with, it’s a whole heck of a lot better than a straight inflation target, which is, if you will— A straight inflation target is sort of more backward looking, less forward-looking, bygones will be bygones, has less of the stabilizing features that nominal GDP targeting does.

Beckworth: Yeah, I was thrilled to see this paper when it came out a few years ago. I do want to highlight one interesting part of your findings. You do mention that output gap targeting sometimes can do better than nominal GDP targeting. However, when there is any kind of uncertainty about the output gap, nominal GDP targeting does better. And this reminded me of Michael Woodford's kind of pragmatic reasons for why he picked nominal GDP targeting in his Jackson Hole paper. He said, "Look, what I really want is an output gap adjusted price level target." That's a mouthful. But he said, "But in practice, nominal GDP level targeting does as good of a job as one could do given our uncertainty of the output gap." And I thought that kind of echoed here with what you guys were showing.

Sims: That is exactly right. So, if we assume that the central bank can perfectly observe what the efficient level of output is, [then], in principle, it could try to implement that and that would look something different than a nominal GDP target. But in practice, I don't know what the efficient level of output is in the US right now, and I don't think you do either. We might have an idea, but it's not observed, and it's difficult to communicate to people. Whereas something like— I think the big advantage of nominal GDP targeting— and it's somewhat difficult to build this into a model, and to be frank, it's not in the model in the JEDC paper that you were talking about— it's just an issue of communication, right?

Sims: We're used to nominal quantities all the time in our daily lives. So, telling people we're going to target a growth rate of nominal GDP of 4% per year, I think, is transparent. I think it's easily understood by folks, and I think it's something that you can easily communicate, and because of that, you can achieve better outcomes. And it kind of gets at some of the ideas of— we would like to do this, as Woodford's terminology, "This efficient output level adjusted price level target," or whatever the mouthful was. In practice, it's getting at that. So, I think it has a lot of desirable features because of that.

Beckworth: In our next clip, we return to a recent show with Carola Binder, associate professor of economics at UT Austin, where she outlines two benefits of nominal GDP targeting. The first one is that it is simple and straightforward: just keep total dollar spending—or, equivalently, total dollar income—on a stable growth path. Had this happened, there would have been a faster recovery after the Great Recession and less overheating after the COVID recession.

The second benefit is one long held by nominal GDP targeting advocates: nominal GDP targeting makes it easier for central bankers to see through inflation caused by supply shocks relative to an inflation target. 

Here is Carola making these points: 

Carola Binder on Two Major Benefits of Nominal GDP Targeting

Binder: But mostly, I think, recent experience does highlight the benefits of NGDP targeting and strengthens the case for adopting it. So, the first thing I talked about was just thinking about the path of NGDP during our two most recent recessions, and I think that if we think about both the Great Recession and the COVID pandemic, together they underscore the benefits of keeping nominal income growing steadily, and the costs of failing to do so.

Binder: So, in the Great Recession, NGDP fell below its pre-recession trend and stayed below trend for a long time, and we know that the Great Recession was associated with just a really slow recovery, that even when the recession was over, the labor market was still weak for many years, inflation was still below target, and, in general, it was just too slow of a recovery. Then, after the COVID recession, we had just the opposite. So, NGDP quickly rose back to its pre-recession trend path and then rose above it and kept above it as inflation rose a lot. So, we had this too-slow recovery, and then we had this overheated recovery.

Binder: Both of them came from not keeping NGDP, [or] the path of NGDP, stable. So, I think that, together, they show that two of the big macroeconomic policy mistakes in recent years came from not keeping the path of NGDP stable, and that maybe by keeping that path stable, we could have avoided those mistakes. So, I think that's one way that you might be able to convince people that NGDP level targeting has a lot of merit. A second benefit of NGDP level targeting is the way that it lets monetary policymakers look through supply shocks, and the recent experience we've had really has demonstrated how important that is.

Binder: There were these big supply chain pressures during the pandemic, there were big geopolitical shocks, so we had high oil and commodity prices, and monetary policy is aggregate demand policy, and it can't and shouldn't offset supply shocks like those. So, when you have an NGDP level targeting policy, the nature of that is that you look through those supply shocks, which is optimal for monetary policymakers to do. If you had a really strict inflation targeting framework that required monetary policymakers to tighten even when there's those adverse supply shocks, that would be highly destabilizing. And I think that everyone saw that the Fed shouldn't have tightened in response to those kinds of supply shocks during the pandemic. And so, that really just highlights that benefit of NGDP targeting. 

Beckworth: So, on the supply shock point, two comments, and then maybe you can give me some feedback on them. So, if you were to ask a central banker, someone who's a mainstream new Keynesian model disciple of sorts, they would say, "Yes, we agree that we need to see through supply shocks and maybe some optimal monetary policy arrangement, we would do that." I guess my pushback would be that it's one thing to say that, [but] it's another thing to actually be able to do that, or be empowered to do that, maybe to be disciplined to do it.

Beckworth: And I think that the pandemic experience illustrates this well, because in 2021, the Fed [and] all of us were still wrestling with, well, is inflation transitory or not? Is it caused by supply shocks or is demand driving it? And so, I guess my response to them would be, yes, it's one thing to say that you will do the right thing and look through the supply shock, but it's just very difficult in practice, unless you're really bound by something like a nominal GDP level target. What are your thoughts on that?

Binder: Right. I agree that discipline is really a big part of it, the discipline on the central bank, which also gives a lot of accountability and transparency. So, the central bank can always say, "Well, yes, we're going to look through supply shocks," but it's hard to know when there's a supply shock or not. If they say that we're going to keep NGDP on this target path, then we can all see exactly what they're trying to do, and what is guiding them, and how well they're accomplishing what they're setting out to do. And so, I think that it gives a lot of robustness there, where even if you don't really observe what part is supply-driven [and] what part is demand-driven in real time, that by keeping NGDP on a stable path, it makes it easier for the central bank to behave as if they're looking through those supply shocks even if they don't see exactly what they are.

Beckworth: In this next clip, we continue our conversation on the benefits of nominal GDP targeting in handling supply shocks. But this time, the focus is on positive supply shocks. More specifically, how nominal GDP targeting would handle a permanent shock to the productivity growth rate from, say, AI. In this clip, George Selgin returns to argue that the Fed should see through all supply shocks with nominal GDP targeting, not just the bad ones. 

Here is my exchange with George Selgin on this point:

George Selgin on How Nominal GDP Targeting Would Handle Supply Shocks

Beckworth: So, George, a lot of times on this show, we talk about nominal GDP targeting in the context of a negative supply shock, like the pandemic. Nominal GDP targeting would have been great helping us see through these negative supply shocks. But what about positive supply shocks? What about productivity surge, which seems like we're now entering or possibly entering? We have talks of AI radically improving the growth potential of the economy. How would a nominal GDP target handle that type of shock?

Selgin: We hear a lot about central bankers saying that they want to see through supply shocks, but they only mean the adverse supply shocks, the negative shocks. And what they mean is that they're willing to allow the price level to rise more than they would in the absence of those shocks, and that's fine. That's a good policy. But I think that they should see through all supply shocks. That means, of course, that when there are productivity improvements, I think they should let prices fall.

Selgin: That is something that a lot of central bankers seem unwilling to do, because the minute you talk about prices falling for any reason, a lot of times there's a knee-jerk reaction that, "Oh, no, that's deflation. That's bad." But in the same way that inflation or rising prices can be good, or at least the best alternative, when there's an adverse supply shock, I think it's equally true that letting prices fall when there are positive shocks— which means innovations to productivity— that's also the best way, typically, to handle those shocks, is to let prices fall.

Selgin: One of the key differences is simply that, by definition, when you have a productivity improvement— and it doesn't have to be general, it can be idiosyncratic in particular industries— that means that the unit costs of production in those industries are declining. So, the only deflation that's being seen through, if central banks allow themselves to see through positive supply shocks, is deflation that goes along with, or even is driven by, falling production costs, unit production costs, in various industries.

Selgin: Of course, if you have a bunch of industries— it doesn't have to be all of them— having positive innovations, [then] that translates into a falling price level or falling inflation, or deflation rather, depending on how much is going on. So, as soon as you think about the fact that the deflation that we're saying is okay in these cases— that I'm saying is okay, but I think you are as well— isn't at all like the deflation that we worry about having adverse effects on the economy—

Selgin: It's not a depressionary deflation, it's not putting people out of work. It's firms finding cheaper ways to make stuff and passing the advantages of that on to their customers. That's all it is. In fact, of course, economists, generally, would say, "Well, yes, if you have an innovation in the computer industry, we should have cheaper computers." They see the argument for specific goods, but many are guilty of a reverse fallacy of composition, where they say, "Well, if it adds up to something that causes the general price level to fall, then we can't tolerate that." Well, why not? If the computers can get cheaper, why can't we let anything that's cheaper to produce get cheaper? And if that results in a lower price level because there aren't that many things that are getting more expensive to produce at the same time, well, so be it. What's the problem?

Beckworth: Okay, so, just to be clear, a skeptic might say, "Well, with the falling price level, one's real debt burden would go up," but I think your point and the context here is that nominal incomes or nominal GDP is being kept stable. We're not seeing a decline in nominal GDP. So, we have stable incomes growing, nominal incomes, but the price level is gently falling, maybe [there is] some disinflation, and so, those higher real debt burdens are also being offset by higher real incomes.

Selgin: People can afford— with the same earnings, the same nominal incomes— they can afford more stuff if prices fall, and so they're better off in this regime. Of course, if the central bank tried to prevent prices from falling, in this case, they would pump up nominal incomes. So, ultimately, the real equilibrium wouldn't look that different. People would have more nominal earnings, and they wouldn't be paying lower prices.

Selgin: However, there's a very important sense in which the deflation solution is actually more, I hate to use the term, equitable, but there's a kind of justice in it, because what letting prices fall in response to productivity gains amounts to is a way to spread the gains from productivity improvements as widely as possible. Everybody gets to enjoy the fruits of improvements in productivity, whether it's technology or something else that's driving it.

Selgin: As far as debtor-creditor relations are concerned, yes, as prices fall, it's true that the money people are paying their creditors is worth more, right? But at the same time, the fact is that that's just allowing the creditors to be among the broad set of persons who benefit from improvements in productivity. Whereas the other policy of stabilizing the price level, or inflation rate, if you like, really leaves the creditors out. It's like saying, "Well, we don't think that they should benefit when productivity improves," and I don't think that there's any reason why they shouldn't. So, I don't see the debtor-creditor argument here as being one that favors trying to keep the price level from changing. You can make a very cogent case— and it has been made by many people— that keeping to a stable nominal income and letting prices fall is, all around, an equitable, or at least not inequitable, solution.

Beckworth: Yes, that's actually the argument that Jim Bullard and Evan Koenig make when they argue for a financial stability argument for nominal GDP targeting, that if you allow prices to move in response to these supply shocks, whether positive or negative, you're effectively turning these nominal debt contracts into something more like equity. And so, during booms, the creditors get to participate in the unexpected windfall. During a recession, the debtors get to share some of their risk, some of their pain with the creditors.

Beckworth: So, you turn some of the challenges of having fixed nominal debt contracts into better risk sharing, like equity, with this nominal GDP approach. I also like your point, though, about the inequality issue or the equity issue, and I think that's such a greatly underappreciated point, that one way that we can spread the economic gains to all segments of society is through lower prices, and again, in the context of stable wages, stable nominal income.

Selgin: There's another way to look at this, David, where we don't have to drag in equity. What we can do— and I do this in my little pamphlet, *Less Than Zero*— we can ask, what would people contract around? What would happen to interest rates if people had perfect foresight? Now, the usual argument is that, well, if people anticipated inflation, they would contract for higher nominal interest rates, and if they anticipated deflation, they would contract for lower rates. That's true if productivity isn't changing.

Selgin: But if you're thinking about a scenario where productivity is changing, and you're asking what's the perfect foresight outcome of that, [then] you have to allow people to have perfect foresight about the real productivity increase or decline and ask how that affects things. Irving Fisher actually talks about this. Irving Fisher, for the sake of your audience members who don't know, is the one who really developed the theory of how interest rates respond to inflationary or deflationary expectations.

Selgin: What Fisher pointed out, in the part of his writing that is not so well appreciated, is that if people anticipate improvements in real income, that is going to make the equilibrium real interest rate go up. And if you think about that, then, if they anticipate that and they anticipate prices falling, the two things cancel out.Therefore, there's no reason to think that if people are surprised by a positive productivity shock, and surprised by prices falling because central banks let them in response to such a shock, that the old interest rates they contracted at when they didn't know about either of these developments happening would turn out to be about right, ex-ante, anyway. So, the best thing that the central banks can do is let the two shocks happen and offset each other.

Beckworth: So, in order to promote macroeconomic stability, keep the targeted path of nominal GDP steady, and don't get distracted by short-term movements in the price level due to these supply shocks.

Selgin: Or, to make it even more terse, see through all supply shocks, not just some of them, not just the ones that you think are bad. See through the good ones. See through them. Let them do their thing to prices, or let prices do their thing to communicate these shocks. And this is a microeconomic argument that we haven't touched upon, but it's very important. Since supply innovations are, more often than not, idiosyncratic— they're not uniform across the economy— we want to have the price system reflect these idiosyncratic innovations in the most transparent, efficient way possible.

Selgin: Now, let's say that you have an innovation that just affects the computer industry and computers get cheaper. Under a price level stability norm or inflation targeting, you have to get that relative price change not by just letting the price of computers fall— let's forget about substitution effects and all of that— you have to let that fall a little less and have all of the other relative prices rise to get where you want to get in the long run, in general equilibrium terms. Well, that's very inefficient.

Selgin: It's much more efficient to let the individual— Because here's the other thing, price flexibility, right? You have an aggregate demand shock. A lot of prices are inflexible to that. They don't adjust quickly. People are waiting to see if the shock is permanent, et cetera. They misinterpret [what it means]. But if you have an industry where they say, "Let's make the computers this way instead of that way and we can do it for 20% less," [then] that instantly gets translated into the costs. There's no hesitation. There's no rigidity there. Why? Because it's planned.

Selgin: These companies are everywhere. People are trying to get their costs down so that they can lower their prices. So, when they do get their costs down, hey, guess what? They lower their prices. Price rigidity arguments of the usual sort do not apply in these cases. It's very important to understand that theories of price rigidity that don't distinguish between how prices of products respond to cost changes and how they respond to aggregate demand changes— those theories are no good. They're simply no damn good, and we shouldn't do macro based on them. We certainly shouldn't have policies based on them.

Beckworth: So far in this compilation of past shows, we have heard arguments for nominal GDP targeting. I want to close out this special podcast episode by going back to a policymaker, in this case a former FOMC member, and that is Charlie Evans.  Charlie was former President of the Chicago Fed from 2007 to 2023 and really understands that culture and norms of the Federal Reserve System. We chatted in late 2023 and I asked him what he thinks about nominal GDP targeting and its chances for consideration during the 2024-2025 framework review. Here is our exchange:

Charlie Evans on the Prospects for Nominal GDP Targeting During the 2024-25 Fed Framework Review

Beckworth: This concern about supply-side driven inflation, in my view, can be best addressed through something like nominal GDP targeting, because if supply-side inflation, output and inflation, typically go in the opposite direction, it's a negative shock— real GDP goes down, inflation goes up, and vice versa. What we're concerned about is demand-driven inflation, broad-based. And I know we still have the sticky price problems you mentioned, but it strikes me as a much easier task simply to focus on total demand. Where is it going? Keep it on a stable growth path.

Beckworth: Eventually, over the medium term, you'll still get stable inflation. I know Michael Woodford, when he argued for nominal GDP targeting, he goes, “Look, we're still effectively arguing for a medium-run inflation target when we're doing nominal GDP targeting.” But I know there's challenges with nominal GDP targeting, and I know there's, for some, a perceived communication challenge with it. So, I have to ask you, Charlie, is there any possibility that the Fed, the FOMC, will discuss nominal GDP targeting as a solution to some of these questions?

Evans: I was right with you until you said solution. Will they discuss it? Yes, I think they will. I think they discuss all kinds of things, and I think, in the current environment, given what we've just gone through, an obvious takeaway, I think, is that you probably need to look at a whole bunch [more] of different indicators of inflationary pressures than you did before. It's hard to imagine that they don't look at everything, so I guess it comes down to putting more weight on certain indicators, and realizing that the historical distribution of shocks, where you thought that these supply disruptions couldn't possibly last two or three years— actually, maybe they can. Very unusual, right? COVID is sort of like a wartime situation where you tell GM they've got to start making tanks and not cars, and then they can go get back to cars and things like that, but paying attention to that.

Evans: And nominal GDP targeting holds open that possibility that it just, more broadly, gets at the issues where supply is having one effect, and demand— they could be offsetting, in which case you wouldn't pay as much attention to it from the funds rate setting, or maybe it does. So, I think, trying to figure out how to use very good targeting indicators and how they would— you might adopt them or how you would consider them in altering the trajectory of your policy. I really prefer outcome-based solutions where a monetary policy is outcome-based. The instrument-based targets, like the Taylor rule, provide you a guide— R-star and all of that— they provide you a guide towards whether or not policy is restrictive or not, but it doesn't tell you, “Oh, yes, but, that intercept term is now so much lower than it used to be,” or does it actually deliver on your inflation objective? Is it calibrated appropriately? It's a hard question that often is sort of elided.

Beckworth: Charlie Evans raises some good questions here about following a strict instruments-based approach to monetary policy with the implication that a more flexible, outcome-based approach, like nominal GDP targeting, might better account for the complex interplay of economic factors facing FOMC members in real time. 

Well, that wraps up our compilation of greatest hits on nominal GDP targeting. Hopefully, it has provided some food for thought on why nominal GDP targeting could serve as useful benchmark for the FOMC as they undertake their framework review. Be sure to check out the policy brief series mentioned earlier that we will be releasing. Links to the series will be provided in the show notes.  Finally, stick around for the bonus segment if you want to hear from Gauti Eggertsson and Scott Sumner on some ambitious, moon-shot ideas for nominal GDP targeting. Thank you for listening.

Bonus Segment: Enhancing the Nominal GDP Targeting Framework

Beckworth: Welcome to bonus segment. If you have made this far, you are true fans of the show, you love nominal GDP targeting, or you just may be gluttons for punishment! But hey, here is where nominal GDP targeting ideas get really ambitious and really exciting. 

Our first bold nominal GDP thinker is Gauti Eggertsson. 

Gauti had a bold proposal in 2020 that he and his coauthors outlined in a VoxEU column where they were responding to the Fed's new framework at that time. The title of the essay was, *The Fed's New Policy Framework: A Major Improvement, but More Can Be Done.*

This essay of theirs drew upon an earlier NBER working paper where Gauti and his coauthors proposed, among other things, not just a nominal GDP level target, but a cumulative nominal GDP level target. 

To make this distinction clear, note that a regular nominal GDP level target says that the Fed should simply return nominal GDP to its targeted level path when there are misses. Gauti’s proposed cumulative nominal GDP level target says that it should do more than simply return nominal GDP to its level target. The Fed should make up for past misses in the level target. That is, if nominal GDP has been running below the nominal GDP level target, it needs to run above the level target for some time. 

To put it differently, a regular nominal GDP level target makes up for past misses in the targeted growth rate of nominal GDP. A cumulative nominal GDP level target makes up for past misses in the targeted growth path of nominal GDP. 

Now, in this paper, the authors call this approach both “average nominal output targeting,” and they also call it a “history-dependent nominal GDP target”. 

The clip that follows comes from an early 2024 podcast where I asked Gauti about his proposal and specifically questioned if it was a step up from a regular nominal GDP level target. Here is his response:

Gauti Eggertsson on the Merits of a Cumulative Nominal GDP Level Target

Eggertsson: Yes. So, now, I need to remind myself of the exact nature of our target. It just turns out that, when we were evaluating a variety of policy rules, this one was one that seemed to just work pretty well. So, that's where the analysis led us. And I guess the key property was that, yes, if you undershot your target, you had to make up for it. If you have been bad and missed your target on one side, you need to make up for it by, you know—

Beckworth: If you undershot your level target, which is distinct from like— because with the level target, you would say, if you undershot your, say, inflation rate, you'd have a higher inflation rate to get to the price level target path. But what you're saying is, if you undershoot your level, you have got to be above your level. So, it's like the integral of a nominal GDP level target of sorts.

Eggertsson: Right, so, it just turned out that this was a— and I think, here, I guess, one thing we didn't develop in detail would be a good way of communicating this. I guess you could say that if you're targeting nominal GDP, and you're below it, you accumulate debt, and then you have to pay off that debt. Similarly, if you go above— I like using the word debt, because people associate debt with being bad. But then you accumulate assets, and you have to spend those assets, I guess. But you're going to keep track of the misses over time. That was the nature of this policy. And it seemed to do remarkably well. Now, what we didn't do there, and there was little excuse for it, except for at the time we were writing it, was to explore the robustness to supply shocks. But I agree with you, that I suspect that this would do quite well there. And I base that not just on complete guesswork, because this was, in a way, our attempt to put, in somewhat simpler terms, a similar proposal that Mike Woodford and I had in 2003, where we did allow for all sorts of shocks, and it seemed to work pretty well. And I think that that also informed Mike Woodford's proposal you referred to, I think, that was in 2012.

Beckworth: Okay, in this final bonus clip, I am speaking with Scott Sumner about his idea for the Fed to help create and target a nominal GDP futures contract. This is from a conversation back in 2022 where I asked him to elaborate on the nominal GDP futures contract idea and how it could be used by the Fed. 

Here is Scott’s answer:

Scott Sumner on Targeting a Nominal GDP Futures Contract

Sumner: Well, it's a futures contract where the maturity value depends on the actual outcome of nominal GDP growth. So, you could have a situation where— Let me give an example of the corridor system I had proposed. The Fed could stand willing to take a short position on any nominal GDP futures contract for 5% nominal GDP growth. In that particular case, if nominal GDP growth comes in under 5%, the Fed profits. If it's over 5%, the person buying the contract profits. And then the Fed would take a long position at, say, 3% nominal GDP growth. So, if nominal GDP growth is above 3%, the Fed profits on the contract. If it's below 3%, the bearish forecaster profits. And in that case, the Fed would be essentially committing to keeping nominal GDP growth within a 3 to 5% range. It would still give the Fed a little bit of discretion for unforeseen circumstances. There's also the question of how far out do you want to go with these contracts. Should it be a year, two years? You can make good arguments both ways.

Sumner: But the basic idea is that these contracts would represent sort of a warning system for the Fed. I analogize it to the beeping noise a truck makes backing up when it's about to hit something. If suddenly, everybody is taking a long position in the NGDP market— as they would've been late last year— the Fed knows that the market thinks NGDP growth is going to go well above target, and the Fed would have two choices. They could either tighten monetary policy until that was no longer the market's expectation, or they could decide they're smarter than the market and take a risk. But I think, over time, the Fed would've learned that it wouldn't want to get too far out of line with market expectations, and it wouldn't want to go before Congress having lost a lot of money in a market by thinking it was smarter than the market. So, the Fed would adjust monetary policy to try to keep market expectations of nominal GDP growth within that 3 to 5% range. That’s the basic idea.

Beckworth: Now, this contract does not yet exist, and if there's anyone out there who wants to pursue it, you can get in touch with Scott. He can talk to you more about it. But we have had some fun with the idea. We had this Hypermind market set up while you were here at the Mercatus Center, which was kind of an approximation. It wasn't really a futures contract, but people could bet on where the nominal GDP numbers were going to go in the future. And there's been a few other places that have picked up this idea and ran with it in terms of a betting market. But what you would like to see is an actual financial asset that's traded in the markets and would be providing useful information to the Fed going forward.

Sumner: That's right. All of these prediction markets are interesting, but they almost never involve any real money or any significant real money. So, I’m talking about something where the Fed would provide unlimited liquidity, in a sense. People could take as strong a long or short position as they wished. So, that would make it a much more serious market price. Now, sometimes people say to me, "Well, what if nobody traded this contract?" Well, that would be fine. Then, that would be an indication that the market thinks NGDP growth will be on target. So, a lot of people, in analyzing my proposal, I think, think about it in the wrong way. They think about it this way. Well, suppose we set up a NGDP futures market at the Chicago Mercantile Exchange or something, and there was very little trading on it, because traders weren't interested in NGDP. Then, it wouldn't be very useful as an indicator to the Fed. And that's right, but that's actually not what I'm proposing.

Sumner: I'm actually proposing that the Fed make the offer to take an unlimited long or short position at these two price points. Then, you'd automatically have, essentially, as much liquidity as you wanted, if you wanted to trade that contract, and it would represent a meaningful constraint on the Fed. Now, hopefully, there would never be much trading, because that would mean the Fed's policies are roughly on target. But if they got well off target, as they were, clearly, late last year, [then] there would obviously be enormous trading, because it would be an easy way to earn large profits for people, [and] in the case of late 2021, for people taking the long position.

Sumner: Now, I should say that my proposal on level targeting is similar in this respect. It also provides market discipline in this way. Suppose the Fed had been doing level targeting of nominal GDP late last year, and it became clear that nominal GDP was running well above the 4% trend line. Markets would've anticipated a sharp increase in interest rates as the Fed had to tighten up to get back onto that trend line. And those increases would've occurred immediately in the credit markets— automatically tightening monetary policy at a time when the Fed was slow to see the problem. So, in a sense, level targeting has markets work towards the process of stabilizing monetary policy in much the same way as an NGDP futures market would. Maybe not quite as effectively, but still, in my view, relatively effectively, if the Fed's commitment is sincere.

Beckworth: Now, Scott, just to flesh this out a little bit more, if the Fed were using nominal GDP futures contracts, and let's say the economy was expected to be heating up— growing too fast— then what would happen, effectively, is that money would flow from the public back into the Fed and vice versa, is that right? Through these contracts?

Sumner: Well, the original proposal I made was one where it was an automatic system where the money supply adjusted automatically to these purchases, maybe like the gold standard or something. But over time, I developed a more flexible approach, a sort of corridor system. I call it guardrails, I guess, where the Fed agrees to take these long or short positions, but the Fed still has the discretion to do monetary policy as it wishes. The constraint is really more on the Fed not wanting to take large losses. That's what disciplines the Fed. It doesn't really control the money supply in an automatic way any longer. Now, the Fed could still, if it wished, do money supply targeting, interest rate targeting, exchange rate targeting. It could use any policy instrument it wanted to control aggregate demand with a proviso that if aggregate demand got very far off course, and the public saw this, and took either very strong, short, or long positions, [then] the Fed could lose a lot of money. So, it would be a way to use financial markets to nudge the Fed towards a policy that the financial markets themselves felt would be consistent with the Fed's goal [of], say, 4% NGDP growth.

Beckworth: So, this instrument would actually provide a means to adjust the amount of dollars in circulation. Though, with the guardrails, it would be less blunt, or it'd only be used in extreme situations when you hit the guardrails. But it would provide, though, an automatic mechanism of some sort. Now, my question would be, then, would monetary policy work because of that or because of the expectation management that this futures contract made, or would it be both?

Sumner: I would combine it with level targeting. So, I think both tend to stabilize monetary policy. How well it works— there's trade-offs here. So, you can make the guardrails narrower. Instead of 3% and 5%, you can go [with] 3.9 and 4.1%, and the Fed has less discretion in that case. So, I was trying to propose something, in my more recent proposal, that would be more pragmatic, more likely to be acceptable. But if you want to be a real hardcore rules proponent and take away all discretion from the Fed, you could set up a system where, essentially, these nominal GDP futures contract trades automatically adjust the monetary base until the base is at a level and, implicitly, interest rates are at a level where the market expects NGDP growth to be right on target.

Sumner: There's also issues of possible risk premium and so on, and that's another reason why I thought it made sense to have some corridor system or guardrails where there's some flexibility there, in case something was distorted in the trading in that market. If you had one major player that was taking a short position or a long position, but nobody else, [then] the Fed could ignore that and say, "Well, that's just one person. Maybe they're trying to manipulate the market, so, we won't dramatically change monetary policy on that basis," for instance. So, there's a lot of issues that would have to be fleshed out, but that's the basic approach that I would favor

Beckworth: And that is wrap for the bonus section. Thanks for sticking around to hear these two ambitious ideas for nominal GDP targeting. Maybe one day we will have cumulative nominal GDP level targeting that is implemented with nominal GDP futures contracts. Until that time, we will see you in the Fed framework review conversations. Thank you for joining us today.