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Wednesday, March 28, 2012

"The Close Connection Between Nominal-GDP Targeting and the Taylor Rule"

From the Dallas Fed:

All in the Family: The Close Connection Between Nominal-GDP Targeting and the Taylor Rule, by Evan F. Koenig: Abstract: The classic Taylor rule for adjusting the stance of monetary policy is formally a special case of nominal- gross-domestic-product (GDP) targeting. Suitably implemented, moreover, nominal-GDP targeting satisfies the definition of a "flexible inflation targeting" policy rule. However, nominal-GDP targeting would require more discipline from policymakers than some analysts think is realistic.

I've been asking this for some time now, but I viewed nominal GDP targeting as a special case of the Taylor rule (when the coefficients are set just right), but it's the other way around -- the Taylor rule is the special case:

Note that the Taylor rule is a special case of nominal-GDP targeting... The chief difference between the two policy approaches is that under nominal-GDP targeting, policymakers look at a longer history of price changes than they do under the Taylor rule when deciding on the appropriate policy setting. Secondarily, the estimate of potential output that enters the nominal-GDP-targeting rule is less sensitive to short-term supply shocks than is the estimate that enters the Taylor rule.

The last point about temporary supply shocks is important as I tried to emphasize here (the post talks about why policymakers should not respond to temporary supply shocks under a Taylor rule, I didn't mention nominal GDP targeting as a solution).

Finally:

One might think that nominal-GDP targeting's ability to work around the zero-bound constraint would appeal to monetary policy doves and that its tighter control of inflation expectations would appeal to monetary policy hawks. Why hasn't nominal-GDP targeting received more widespread support? The main issue is credibility.[14] Some analysts are concerned that future FOMCs may fail to follow through on promises of accommodation, while others fear that future FOMCs may back away from nominal-GDP targeting should it call for tighter policy than the current approach. To the extent that the public shares the former concern, an announced shift to nominal-GDP targeting would do little to accelerate the economy's recovery. To the extent that the public shares the latter concern, an announced shift to nominal-GDP targeting might be seen as a relaxation of the Federal Reserve's commitment to price stability rather than an enhancement to that commitment.

NomGDP

    Posted by on Wednesday, March 28, 2012 at 09:20 AM in Economics, Monetary Policy | Permalink  Comments (5)

          


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