Tuesday, July 16, 2013

Targetting NGDP III

Rob raises an interesting point in the comments to the previous post on this topic:
My thermostat runs a simple algorithm along the lines of "temperature below 78 turn on heater, temperature above 78 turn on a/c" (actually its a bit more complex than that but you get the idea)

If the fed ran a similar algorithm (I'm sure they could pay the manufacturers of my thermostat to build a device to do this) "NGDP growing less than 5% increase money supply, NGDP growing more than 5% decrease money supply" would this still fall foul of Goodheart’s law? 
So, let's say a nation's central bank was replaced by a computer running the above algorithm. Would this work as well as a home thermostat? Rob's thermostat is solely Rob's servant. He gets to set the temperature he wants for his house, and the thermometer keeps it there.

But targeting NGDP is not the same thing at all. Some of the "residents" of the central bank's "house" would like NGDP to be lower than the bank's target. (They are called creditors.) Some would like it to be higher. (They are called debtors.) And they can act on their own in the economy, whatever the central bank is doing.

So, to make Rob's analogy more accurate, we have to stuff his house full of people all of whom desire different temperatures, and all of whom can act to try to get their preferences realized. So, we have a thermostat trying to keep the temperature at 78, and scores of people opening windows, running space heaters, turning on the oven, putting heat packs on the thermostat, and so on. My hunch is that, due to analogous actions in the economy, targeting NGDP will turn it from a good tool for measuring macro stability into a weak tool for achieving it.

But, I admit, this is just an intuition.

1 comment:

  1. What I like about NGDPT is that it seems a viable way of stabilizing the value of money through time and eliminating what many economists see as the main cause of recessions.

    I do worry that

    1. At some point in the future whatever target has been chosen will turn out to be inappropriate for some unforeseen set of circumstance and this will have serious consequences that a more flexible policy would have avoided


    2. People will try and get the target changed to suit their own ends and find ways of manipulating the measurements.

    However I still think the benefits of minimizing recessions outweigh the costs of having to be vigilant against these potential downsides, though they clearly need to be considered if such a policy is ever implemented,



"If your approach to mathematics is mechanical not mystical, you're not going to go anywhere." -- Nassim Nicholas Taleb