Home > Monetary Policy > Tories Should Embrace Nominal GDP Level Targeting

Tories Should Embrace Nominal GDP Level Targeting

It’s slightly depressing to see push-back on NGDP level targeting from British Conservatives, who should know better.  See for example what Mr Redwood had to say (HT Duncan Brown) – a horrible confusion of the demand-side and supply-side, cause and effect.

The Tories were demand-side revolutionaries when we needed a demand-side revolution – after the 1970s.  Not just supply-side reformers.  Here (again) is Nigel Lawson in 1985, “money demand” means nominal demand, nominal GDP:

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.

Or here is a view of 1980s UK macro policy articulated by a Treasury civil servant (name censored!) in 1989, discussing the appropriate choice of nominal anchor:

45.  In recent versions of the MTFS the aim has been to use money GDP to provide this 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 principal 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 will revert to trend.

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 involves getting tangled up in the web of fine tuning output and inflation.

(Transcription errors my own.)  The “MTFS” referred to was the Medium Term Financial Statement, a multi-year macro policy framework.

This is what nominal GDP looked in the years following the famous 1981 budget decried by 364 Keynesians who wanted looser fiscal policy:

UK Nominal GDP in the 1980s

UK Nominal GDP in the 1980s.  Source: ONS.

Lawson may have been shooting for circa 8% NGDP growth rate; over the period the UK fairly closely followed a level path of 9% annual growth, up to 1988 where that Chancellor’s eponymous boom pushed demand growth well above trend.  Between 1981 and 1991 annual RPI inflation averaged 6%, real GDP growth averaged 3%.  And Redwood is worried about inflation today?  UK nominal GDP has grown a little over 9% in total since 2008.  An average annual growth rate of 2.3% over four years.

After the ERM debacle we then switched to a inflation-targeting regime under Ken Clarke in 1992.  Again, the results very closely approximated a nominal GDP level target – this time a lower circa 5.4% growth path.

UK Nominal GDP Since 1992

UK Nominal GDP Since 1992 plus OBR Forecasts.  Source: ONS, OBR

We’re about 15% below the old trend.   We can’t fill all that gap, but shooting for a new 5% level path starting from the depth of the 2009 recession would seem reasonable; that’d be a couple of years of 7% NGDP growth and then 5% forever.

Categories: Monetary Policy
  1. Rajat
    December 18, 2012 at 12:34

    I’m new to this blog, so not sure if you have mentioned this before: There’s a long discussion of potential nominal anchors (including NGDP) in Nigel Lawson’s memoirs, “The View From No.11”, chapter 33, entitled “My Monetary Principles”. It’s amazing how prescient he was.

    After outlining the strengths and weaknesses of a NGDP objective under the sub-section “A Nominal Framework”, he says:

    A simple price-level objective may be more dubious when there are powerful recessionary tendencies. In the modern world, with its wage and price rigidities, it is possible that an unnecessarily severe recession could occur without prices actually falling. The monetary authorities might find a nominal GDP guideline more helpful in telling them when they can support activity by reducing interest rates without running an inflationary risk.

    And later under “Principles and Practices”:

    At the international level, say that of the Group of Seven, nominal GDP might come more into its own – especially when there is a serious risk of deflation or contraction, perhaps through the weakness of the banking system.

    Then finally under “Reaction to Shocks”:

    A more vigorous monetary policy [in the US in 1931] might have prevented or reduced the fall in prices that took place and thus have mitigated the severity of the Great Depression. But it would be pedantic to treat an anti-depression financial policy simply in terms of the price level. It should, rather, be aimed at maintaining the national income, but still in nominal terms. (emphasis in original)

    • December 18, 2012 at 12:43

      Hi! Oh, that’s brilliant. Thanks for that. I’ve found lots of references in Hansard to “money GDP” from Lawson and some of his colleagues at HM Treasury, but nothing that explicit. Excellent find, Rajat, thanks a lot! I think Lawson was strongly influenced by Samuel Brittan.

  1. December 13, 2012 at 23:57
  2. December 14, 2012 at 10:06
  3. December 28, 2012 at 20:02

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