Nominal GDP Targeting as “Optimal Monetary Policy for the Masses”

St Louis Fed President James Bullard in this speech says NGDP targeting is an optimal mon pol for the masses.  The speech is based on this co-written paper.

In this blogpost, he explains the essence of the paper. The current models are silent on how mon pol leads to distribution and inequality:

Since the financial crisis, the topic of income inequality has become more important in monetary policymaking circles. In particular, monetary policy has been criticized as redistributing income to various parts of the population.

Along with income inequality among households, consumption inequality and financial wealth inequality are important considerations. Wealth inequality tends to be higher than income inequality, which tends to be higher than consumption inequality.

Many models used to assess the aggregate implications of monetary policy assume a representative agent. That is, a single household is meant to represent the distribution of households, and that household could be the median or average along some characteristic, for instance.

By construction, these models are silent on the redistribution effects of monetary policy. Instead, our model includes substantial heterogeneity (or differences) among households in terms of consumption, income and financial wealth and allows us to study the distributional effects of monetary policy.

In their paper, they work around addressing inequality:

The model in our paper is an extension of the model in a paper with Aarti Singh.2 In these models, private credit markets play an important role in reallocating uneven income across the life cycle so that people can consume smoothly. As a practical matter, we can think of privately issued debt as similar to mortgage-backed securities.

However, there is a problem with the credit markets—households borrow in nominal (rather than real) terms and pay a nominal interest rate, neither of which depends on the state of the economy. This imperfection in the credit market is referred to as “non-state contingent nominal contracting.” This is an issue because optimal allocations of resources require contracts to be tied to the realization of aggregate productivity shocks.

Monetary policy fixes this problem in the credit markets by adjusting the aggregate price level in response to aggregate productivity shocks, which makes the nominal contracts real and state-contingent. The optimal monetary policy in these models is something very close to nominal GDP targeting because it calls for countercyclical price-level movements. To keep nominal GDP on its targeted path, the monetary policymaker would follow a policy rule whereby inflation would be relatively high when growth is low and it would be relatively low when growth is high.

In our recently released paper, the new aspect is the substantial heterogeneity among households. The amount of consumption, income and wealth inequality generated by our model is close to that in U.S. data, as measured using Gini coefficients. Nevertheless, in this environment, the optimal monetary policy—nominal GDP targeting—fixes credit markets for all agents.



One Response to “Nominal GDP Targeting as “Optimal Monetary Policy for the Masses””

  1. Anantha Nageswaran Says:

    There is another word in English for all this. It is called ‘bullshit’. The plain English equivlaent of the problem with “non-state contingent nominal contracting” is that interest and debt are paid back in nominal dollars and that is problematic if there is low inflation or deflation. Therefore, we want to help borrowers. Hence, nominal GDP growth targeting comes in handy.

    A longer backgrounder to this:

    “We are an indebted country and we will continue to create debt to create growth. We will keep interest rates low to ensure that debt growth continues and we will ensure that they repay in weaker real dollars by creating inflation. Since we have failed in creating inflation with zero interest rates, QE and forward guidance, we next turn to nominal GDP targeting.

    Also, wait for our next paper on ‘Modern Monetary Theory’ wherein we argue that unconstrained fiscal expansion, in an environment of constrained inflation, takes advantage of the low interest rates that our moentary policy engenders and, in turn, supports the success of nominal GDP target of monetary policy. Thus, our propoasl will align fiscal and monetary policy towards a single goal of economic growth created by more debt taken on by public and private borrowers and financed by printed money which, in turn, is facilitated by low interest rates. It will also complete the redistribution of wealth away from savers, pensioners, widows and widowers towards corporate borrowers, speculators and enrich investors in our asset markets. That, in turn, will attract overseas money to finance our current account deficit which will keep balooning with our perpetual debt-financed consumption.

    In the East, during Gautama Buddha’s times, it was called ‘Policy Nirvana’ and America will have rediscovered and invoked the Eastern traditons for modern economic policymaking.”

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