The Problem with the Fed's Targeting

By James E. Miller

The monetary policy of targeting nominal gross domestic product (NGDP) is starting to come into vogue in mainstream economic and political circles.  Christina Romer, the architect behind President Obama's first stimulus failure and professor of economics at the ideology vacuum known as the University of California, Berkley, recently penned a New York Times editorial on the issue:

 

Mr. Bernanke needs to steal a page from the Volcker playbook. To forcefully tackle the unemployment problem, he needs to set a new policy framework - in this case, to begin targeting the path of nominal gross domestic product.

Nominal G.D.P. is just a technical term for the dollar value of everything we produce. It is total output (real G.D.P.) times the current prices we pay. Adopting this target would mean that the Fed is making a commitment to keep nominal G.D.P. on a sensible path.

More specifically, normal output growth for our economy is about 2 1/2 percent a year, and the Fed believes that 2 percent inflation is appropriate. So a reasonable target for nominal G.D.P. growth is around 4 1/2 percent.

Sounds simple enough, right?  All Ben Bernanke and the technocrats at the Federal Reserve need to do is simply leave the switch to the money-printer on "high" setting and watch prosperity flow as dollars engulf the world.  Problem is, Bernanke is already printing at roughly a rate of 15% annually for the past 6 months.  The Consumer Price Index, which was fixed in the late '90s to undervalue the inflation rate so much that PIMCO head Bill Gross famously called it "a haute con job," is already running at 3.5% for the year.  A recent report from Mail Online out of the U.K. showed that Brits can save 50% on their Christmas shopping by hopping across the pond to the U.S. -- a clear sign of an ever-weakening dollar.

Romer, like many neo-Keynesians, is convinced that if inflation could just be ginned up a little more, we could all feed on a free economic lunch.  Pesky things like speculative asset bubbles (housing, anyone?) don't concern her, despite the fact that newly created money always enters the economy through different sectors.

Another issue with "targeting NGDP" is what economist and Nobel laureate Friedrich Hayek called "The Pretense of Knowledge."  Alan Greenspan famously dropped interest rates to historically low levels to fight the dot-com bubble burst he created with the same policies in the late '90s.  This easy credit financed a housing bubble in turn.  Greenspan was often labeled the "maestro" during his time as Fed head because of his supposedly wondrous skills at "guiding" the economy through interest rate manipulation.  One deep recession later, and we can all see how apt a term that is now.

The idea behind targeting NGDP assumes that Bernanke, after failing to boost the economy for over three years, can somehow hit a target that's dictated by the actions of billions acting homogenously.  Putting money in the hands of banks and individuals doesn't guarantee that said money is spent in a fashion to boost NGDP.  As financial blogger Mike "Mish" Shedlock puts it, "[f]or starters the Fed cannot spend money, it can only lend it. Thus the Fed has at best an indirect affect on GDP."  The real danger lies in the overshooting of a target which can lead to out-of-control inflation.  To think that just a few men are capable of coordinating the independent spending habits of hundreds of millions is sheer idol-worshiping at the altar of governmental central planning.

In the end, businessmen and entrepreneurs don't keep their eyes on potential nominal gross domestic product.  The owner of my preferred local pizza shop isn't scanning national economic statistics to see if NGDP has a possibility of hitting 5% a year from now.  He monitors a number of factors including input and output prices, tax rates, regulations, and profitability potential in order to decide if he should expand business or pack up shop.

Targeting NGDP is just an excuse for the only tool the Federal Reserve has in its monetary belt: inflation.  After an unprecedented increase in the monetary base in response to the financial crisis, it's hard to believe that more money-printing is the answer.  All it accomplished was the illusion of prosperity through the stock market and increased food and gas prices.

If further impoverishing the middle and lower classes is the Keynesian agenda, consider it fulfilled.  NGDP targeting will just be more of the same as it sets the stage for another economic bust.