NGDP targeting is more suited to developing economies..

Pranjul Bhandari and Jeffrey Frankel make a case for NGDP targeting in developing economies.

They say NGDP is more suited to developing world:

Central banks, especially in developing countries, still seek transparent and credible communication. Yet signalling intentions through forward guidance or commitment sometimes creates undesirable constraints. This column argues that central bank pronouncements phrased in terms of nominal GDP are less likely to run afoul of the supply and trade shocks so common in developing countries, compared to pronouncements phrased in terms of inflation.

The recent revival of NGDP targeting has focused on the case of countries that seek to achieve a credible monetary expansion, including usually an increase in expected inflation (Woodford 2012). The motive has been to address economic weakness in the US, UK, Eurozone, and Japan, in the aftermath of the severe negative demand shock that hit them in 2008. Most developing countries do not particularly need monetary expansion or higher inflation at present. But NGDP targeting, viewed in a wider perspective, is a way to achieve any monetary setting, not just expansion. When it was originally proposed by Meade (1978) and Tobin (1980) and supported by many other economists in the 1980s, the motive was to achieve credible monetary discipline, particularly a decrease in the inflation rate, rather than credible monetary expansion and an increase in inflation. Disinflation is still needed in some developing countries, such as India, Indonesia, South Africa, and Turkey. Regardless, the attractive feature of NGDP targeting, its robustness to unknown future shocks, is similar whether applied at times when the medium-term objective is a monetary setting that is easier, tighter, or unchanged.

Emerging markets and developing countries tend to be more exposed to trade shocks because they are more likely to be price takers on world markets and, in many cases, to export agricultural and mining commodities. They tend to be more exposed to supply shocks because of physical exposure to natural disasters such as earthquakes and windstorms, social instability such as strikes, the importance of agriculture in their economies, and productivity changes. Productivity shocks are likely to be larger in developing countries. During a boom, the country does not know in real time whether rapid growth is a permanent increase in productivity growth (it is “the next Asian tiger”) or temporary (the result of a transitory fluctuation in commodity markets or domestic demand). The trend growth rate in emerging market countries is highly uncertain (Aguiar and Gopinath 2007).

Weather fluctuations, natural disasters and terms-of-trade shocks are particularly useful from an econometric viewpoint, because these supply shocks are both exogenous and measureable, and so can be used to estimate a two-equation supply-and-demand system. Exogenous productivity shocks – the staple of theoretical models — are much harder to pin down empirically.

Hmm…as there are supply shocks it hits the NGDP more compared to developed world.

Not sure. Take India’s case. NGDP has been consistently growing at around 13-14%. Earlier the composition was 8-9% growth and 5-6% inflation. Now we have the reverse relationship. On pure NGDP front, it looks ok as we are growing at 13-14%. But we know this is not right. And then can we have central banks targeting NGDP when growth is in double digits?

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