What is nominal GDP level targeting?

A nominal GDP (NGDP) target (often called a nominal income target) is an alternative to an inflation target. The central bank would try to keep NGDP growing at a predetermined rate. An NGDP level target is the same thing except that the central bank would remember any previous deviations of NGDP growth compared to the target and try to make up for them in later years. If the target is 5% and NGDP comes in at only 4% one year, they would aim for 6% the next year.

Why should we do nominal GDP level targeting?

NGDP level targeting has the last few years been promoted in a number of blogs by a group of economists (usually referred to as market monetarists) as a solution to our current recession. They focus on rational expectations, the quantity theory of money, and sticky wages.

• Rational expectations and the quantity theory of money shows us that changes in market expectations of future base money will affect NGDP today, no more long and variable lags.
• Sticky wages and the fact that falling NGDP causes downward pressure on wages leads market monetarists to recommend that central banks target NGDP growth instead of inflation.
• Level targeting is recommended to better shape market expectations of future NGDP.

How can a central bank target nominal GDP?

The central bank could continue to use the same tools as today. However, most market monetarists seem to prefer that central banks should give up on interest rates and lending and instead focus on managing the monetary base.

• A McCallum Rule for the NGDP level. Such a rule would increase the growth rate of base money if NGDP is above trend and reduce the growth rate if NGDP is below trend.
• Target the forecast. A central bank could look at past NGDP, current asset prices, TIPS spreads, and forecasts of economists to guide their policy. This type of policy suffers from the circularity problem.
• Target the market forecast. Create an NGDP futures market and use it as a guide.
• Make the currency convertible to NGDP futures.

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