I wrote post not too positive about NGDP the other day in response to the posts by Lars Christensen and Scott Sumner about how allegedly Greenspan back in 1992 talked about doing NGDP. My reaction to that was if the Great Moderation was the age of successful NGDP targeting then it has been over-advertised by Sumner and company.
I really don't think the Great Moderation was so great. During the Great Moderation we saw median wages stagnate. While creditors got to enjoy their vaunted "price stability" most Americans went backward. So if we have in fact had NGDP targeting for 30 years it is not the answer.
However, I did read an archive piece from David Eagle at Lars Christensen's blog that made as good a case for NGDP as I've seen.
The first thing it does right is distinguish between what an NGDP regime could look like and the inflation targeting regime of the Taylor Rule. For Eagle there are two "Fundamental Welfare Principles of Monetary Economics:
Principle #1: When all individuals are risk averse and RGDP remains the same, Pareto efficiency requires that each individual’s consumption be unaffected by the level of NGDP.
Principle #2: For an individual with average relative risk aversion, Pareto efficiency requires that individual’s consumption be proportional to RGDP
Ok so there are the Two Fundamental Welfare Principles of Monetary Economics. Here is an application:
"However, assume the central bank successfully targets either inflation or the price level so that the price level at the time of this loan payment is as expected no matter what happens to RGDP. Then the real value of this loan payment will be constant no matter what happens to RGDP. That would mean the lenders will be guaranteed this real value of the loan payment no matter what happens to RGDP, and the borrowers will have to pay that constant real value even though their other net real incomes have declined when RGDP declined. Under successful IT or PLT, borrowers absorb the RGDP risk so that the lenders don’t have to absorb any RGDP risk. This unbalanced exposure to RGDP risk is Pareto inefficient when both borrowers and lenders have average relative risk aversion as the Second Principle states."
At the very minimum, this is a good critique of of inflation targeting or level inflation targeting. This is why I have always been skeptical of the very concept of inflation targeting-if done successfully it ensures that the debtor bears all the costs if the economy weakens-in the form of real GDP (RGDP). Eagle claims taht NGDP would not put all the risk on the shoulders of the borrower/debtor. If this is so then it could give us a regime much superior to the Great Moderation.