Afternoon Must-Read: Simon Wren-Lewis: In Defence of NGDP Targets

…I want to stay close to the academic literature, at least as a starting point…. Tony should be very worried that one of the supporters of NGDP targets is Michael Woodford, who literally wrote the book on modern monetary theory. He rightly focuses on the big plus for any levels based target, which is that it can mimic the optimal but time-inconsistent policy…. The welfare gains from following the optimal time inconsistent policy are large… so to wave those away as ‘difficult to communicate’ seems–if I may say so–terribly old school central banking…. One final argument Tony uses… is that simple models show that inflation variability is about twenty times more important than output variability in assessing welfare, and therefore NGDP targets give too great a weight to output….

Having said all this, it is great that Tony is opening up the discussion on the correct level, so we can get away from what often seem like faith-based arguments for NGDP targets…. My one last plea is that arguments make clear whether a NGDP targeting regime is being compared to some form of optimal policy, or policy as currently practiced: as I suggest here these are (unfortunately) different things.

…in the modern sticky price macro model that optimal policy involves stabilising a weighted sum of inflation and output… with a weight an order of magnitude greater attached to inflation than other things…. This weight is controversial. Many… would say that they doubt its literal truth…. The main point is that this weight has to come from a grasp of the frictions in the model…. To dig into the intuition… unplanned inflation erodes their real wage or relative price that they would ideally prefer, and, as a result, firms and consumers end up experiencing volatility in the hours that they work, or the amount they have to produce, and therefore volatility in the wages/ profits that they recoup and the amount they can consume…. That said, in a democracy, one can only give so much weight to opinion of a bunch of math-loving technocrats, and, ultimately, policy choices of all kinds, central bank mandates included, have to be anchored to what people want…