How is NGDP targeting different from inflation targeting?

This is basically a note to myself, but may be of interest to some of you. I have been thinking lately about nominal GDP targeting. The idea in itself is old, but it has received a lot of attention in the blogosphere post 2009. I want to know under which conditions NGDP targeting produces different results than an inflation targeting regime.

So, to get a first intuition about this, I took the standard ASAD model from the shelf. I transformed everything into growth rates or, if you want to look at it differently, into deviations from the steady state equilibrium. Then I plugged in simple characterizations of the two different policy regimes. And the result is this: A minimalist ASAD analysis of NGDP targeting.

The basic insight is that NGDP targeting requires that any shock to aggregate demand (positive or negative) be completely offset by monetary policy while supply side shocks be neglected. In other words, NGDP targeting fixes the position of the AD curve and doesn’t worry about the position of the AS curve. Inflation targeting, on the other hand, demands that monetary policy takes into account both AD and AS shocks. As my little modelling exercise shows, there is a tight correspondence between the two regimes in the sense that for every given NGDP target there is an inflation target that produces the exact same path of real output and inflation as the NGDP target, and vice versa. I also show that if there were no supply side shocks, only demand shocks, the two regimes are equivalent. The difference between the regimes lies only in how they react to AS shocks: an inflation target tends to amplify the effects of AS shocks on output, the NGDP target doesn’t. Hence NGDP targeting tends to produce smaller fluctuations in real output growth than an inflation target.

So, if you believe macroeconomic shocks are mainly due to aggregate demand, you should be indifferent between the two regimes.


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