UK NGDP Targeting, circa 1989
After the UK left the ERM in 1992, HM Treasury had to adopt a new nominal anchor for monetary policy fairly quickly. Before entering the ERM the Government had ostensibly used money supply growth rate targets as the framework for monetary policy, though they were not good at hitting the targets.
One anonymous civil servant discusses alternative frameworks in internal Treasury correspondence from 1992; an inflation target was ultimately picked. Included are sections of something called “the December 1989 Chevening paper”, covering the relative merits of inflation targeting, a “price/output” framework, and an NGDP framework.
Below is a transcription of the section on using an NGDP target (growth rate presumably):
45. In recent versions of the MTFS the aim has been to use money GDP to provide this [nominal] anchor. This is the best measure we have of the total activity in the economy in the prices of the day – and it has become the centre piece of our nominal framework.
46. The implicit view of how the world works is the same as in the price-output approach. The essential principle is that over the medium term, output growth is determined by the supply potential of the economy and any persistent growth of money GDP above this rate will be reflected in faster inflation. In the short term it is likely to be reflected in a faster growth of real output but subsequently inflation will rise and output revert to trend.
47. Bringing down inflation means bringing down the growth of money GDP closer to the underlying rate of output growth. In the short-run this is likely to mean a period when real output growth falls below its underlying rate but in time we would expect output growth to return to trend and inflation to stabilise at a lower rate.
48. Of course these are only tendencies; in practice there are no hard and fast rules because changes in money GDP can be brought about by a number of factors, both internal and external, which directly affect prices.
49. Again we can interpret recent events in this framework (see Chart 10). Money GDP growth accelerated to almost 10 per cent in 1997 and 11 per cent in 1988 before appearing to decline slightly this year (1989). Not suprisingly, in both 1987 and 1988 real GDP growth was significantly in access [sic] of supply potential (say 3 per cent). Inflation picked up in 1988 and rose further in 1989.
50. If the underlying rate of growth is 3 per cent, reducing inflation from its current rate of 6 per cent plus requires bringing the growth of money GDP below 9 per cent on a sustained basis. The extent of the reduction of inflation will depend on how far money GDP growth is reduced.
51. There are also problems with this approach:
- the initial data is poor and money GDP growth can only be controlled in a rough and ready way taking one year with another; if it departs significantly from its desired path it takes time to bring it back into line;
- we have a record in recent years of underestimating the growth of money GDP which has affected the credibility of this approach;
- presentationally it has unattractive features. A frequent criticism is that it is a curious magnitude to target, being the addition of inflation, which is bad, and output, which is good.
Even so in my view it is a useful framework. It enables Government to concentrate on the financial framework and take a ‘hands-off’ approach to the division between real output and inflation. In principle it is easier to relate to the behaviour of monetary aggregates; it is consistent with the approach followed throughout the 1980s; and avoids getting tangled up in the web of fine tuning output and inflation. In theory it is entirely consistent with the price-output approach. Being from the same stable they are complementary – different ways of looking at the same problem; one is easier to understand intuitively, and throws light on short-term movements; the other is probably a better control procedure from a medium term perspective. It also possesses presentational advantages.
The “MTFS” is the “Medium Term Financial Strategy” published by the Treasury in the 1980s.
Other hints at the use of NGDP as a not-quite-explicit target in the 1980s can be found in Hansard:
The Government are pursuing a responsible path for the growth of money demand. During the past few years it has grown by 8 per cent. a year. That is more than adequate for any reasonable increase in demand in the economy. It provides ample scope for both inflation and unemployment to fall. There might be an inadequate real demand, but the notion that the solution is an increase in money demand is a profound fallacy. Money demand is the only instrument on the demand side that the Government can manipulate.
That was Nigel Lawson, then Chancellor of the Exchequer, speaking in the House of Commons after the 1985 Budget.