Jeff Frankel takes up the question of inflation targeting versus nominal GDP targeting, and concludes that nominal GDP targeting has many advantages:
Nominal GDP Targeting Could Take the Place of Inflation Targeting, by Jeff Frankel: In my preceding blogpost, I argued that the developments of the last five years have sharply pointed up the limitations of Inflation Targeting (IT)... But if IT is dead, what is to take its place as an intermediate target that central banks can use to anchor expectations?
The leading candidate to take the position of preferred nominal anchor is probably Nominal GDP Targeting. It has gained popularity rather suddenly, over the last year. But the idea is not new. It had been a candidate to succeed money targeting in the 1980s, because it did not share the latter’s vulnerability to shifts in money demand. Under certain conditions, it dominates not only a money target (due to velocity shocks) but also an exchange rate target (if exchange rate shocks are large) and a price level target (if supply shocks are large). First proposed by James Meade (1978), it attracted the interest in the 1980s of such eminent economists as Jim Tobin (1983), Charlie Bean (1983), Bob Gordon (1985), Ken West (1986), Martin Feldstein & Jim Stock (1994), Bob Hall & Greg Mankiw (1994), Ben McCallum (1987, 1999), and others.
Nominal GDP targeting was not adopted by any country in the 1980s. Amazingly, the founders of the European Central Bank in the 1990s never even considered it on their list of possible anchors for euro monetary policy. ...
But now nominal GDP targeting is back, thanks to enthusiastic blogging by Scott Sumner (at Money Illusion), Lars Christensen (at Market Monetarist), David Beckworth (at Macromarket Musings), Marcus Nunes (at Historinhas) and others. Indeed, the Economist has held up the successful revival of this idea as an example of the benefits to society of the blogosphere. Economists at Goldman Sachs have also come out in favor.
Fans of nominal GDP targeting point out that it would not, like Inflation Targeting, have the problem of excessive tightening in response to adverse supply shocks. ...
In the long term, the advantage of a regime that targets nominal GDP is that it is more robust with respect to shocks than the competitors (gold standard, money target, exchange rate target, or CPI target). But why has it suddenly gained popularity at this point in history...? Nominal GDP targeting might also have another advantage in the current unfortunate economic situation that afflicts much of the world: Its proponents see it as a way of achieving a monetary expansion that is much-needed at the current juncture.
Monetary easing in advanced countries since 2008, though strong, has not been strong enough to bring unemployment down rapidly nor to restore output to potential. It is hard to get the real interest rate down when the nominal interest rate is already close to zero. This has led some, such as Olivier Blanchard and Paul Krugman, to recommend that central banks announce a higher inflation target: 4 or 5 per cent. ... But most economists, and an even higher percentage of central bankers, are loath to give up the anchoring of expected inflation at 2 per cent which they fought so long and hard to achieve in the 1980s and 1990s. Of course one could declare that the shift from a 2 % target to 4 % would be temporary. But it is hard to deny that this would damage the long-run credibility of the sacrosanct 2% number. An attraction of nominal GDP targeting is that one could set a target for nominal GDP that constituted 4 or 5% increase over the coming year - which for a country teetering on the fence between recovery and recession would in effect supply as much monetary ease as a 4% inflation target - and yet one would not be giving up the hard-won emphasis on 2% inflation as the long-run anchor.
Thus nominal GDP targeting could help address our current problems as well as a durable monetary regime for the future.
It's hard to figure out how to fix the world if you don't have a reliable model that can explain what went wrong. The optimal money rule in a model depends upon the the way in which changes in monetary policy are transmitted to the real economy. Is it because of price rigidities? Wage rigidities? Information problems? Credit frictions and rationing? The best response to a negative shock to the economy varies depending upon what type of model the investigator is using.
Thus, for the moment we need robust rules. Inflation targeting works well in models with Calvo type price-rigidities, and a Taylor type rule often emerges from models in this general class, but is this the most robust rule in the face of model uncertainty? We don't know the true model of the macroeconomy, that ought to be clear at this point. Does inflation targeting work well when the underlying problem is a breakdown in financial intermediation or other big problems in the financial sector? I'm not at all convinced that it does - some of the best remedies in this case involve abandoning a strict adherence to an inflation target in the short-run.
So, in the best of all worlds I'd prefer to have a model of the economy that works, find the optimal policy rule for that model, and then execute it. In the world we live in, I want robust rules -- rules that work well in a variety of models and in the face of a variety of different types of shocks (or at least recognize that the rule has to change when the source of the problem switches from, say, price rigidities to a breakdown in financial intermediation). One message that comes out of the description of NGDP targeting above is that this approach does appear to be more robust than inflation targeting. It's not always better, in some models a standard Taylor type rule is the best that can be done. But it's becoming harder and harder to believe that the Great Recession can be adequately described by models of this type, and hence hard to believe that we are well served by policy rules that assume price rigidities are the main source of economic fluctuations.