Nominal GDP Targeting and the Taylor Rule on an Even Playing Field

Abstract

Some economists advocate nominal GDP targeting as an alternative to the Taylor Rule. These arguments are largely based on the idea that nominal GDP targeting would require less knowledge on the part of policymakers than a traditional Taylor Rule. In particular, a nominal GDP targeting rule would not require real‐time knowledge of the output gap. We examine the importance of this claim by amending a standard New Keynesian model to assume that the central bank has imperfect information about the output gap and therefore must forecast the output gap based on previous information. Forecast errors by the central bank can then potentially induce unanticipated changes in the short‐term nominal interest rate, distinct from a standard monetary policy shock. We show that forecast errors of the output gap by the Federal Reserve can account for up to 13% of the fluctuations in the output gap. In addition, our simulations imply that a nominal GDP targeting rule would produce lower volatility in both inflation and the output gap in comparison with the Taylor Rule under imperfect information.

Climate Change and Monetary Policy: Dealing with Disruption

“…For example, using a New Keynesian model with imperfect information, Beckworth and Hendrickson (2016) show that the Fed's output gap forecasts over 1987-2007 explain only 13 percent of the fluctuations in the actual output gap. Estimates during periods of unusually persistent and unpredictable productivity shocks, as would be the case with increased climatic disruption, could be even worse.…”

Rules Versus Discretion: Assessing the Debate Over the Conduct of Monetary Policy

“…There has been a great deal of renewed interest in nominal GDP targeting as suggested by Sumner (2014). Beckworth and Hendrickson (2015), for example, have examined interest rate rules where the central bank reacts to nominal GDP rather than to the inflation rate and GDP separately. They stress that such a rule has the advantage that the central bank does not have to estimate potential GDP, reflecting concerns raised by Orphanides (2003).…”

The monetary policy origins of the eurozone crisis

“…Although economists disagree about how much emphasis to place on each deviation, the basic Taylor rule framework continues to be used by many economists—and policy makers—as a benchmark . Building on Koenig's () observation that a Taylor rule is just a special case of a nominal GDP (NGDP) targeting rule, this paper follows Beckworth and Hendrickson () and Selgin, Beckworth, and Bahadir () in applying a Taylor rule that responds to deviations of total money spending from a targeted growth path. Using NGDP to measure total money spending, this Taylor rule takes the following form: where i t is the target interest rate, is the market‐clearing or equilibrium nominal interest rate, and is the percentage difference between the actual and the targeted growth rate of NGDP.…”

“…Responding to the average of past misses gets around the thorny problem of constantly reestimating the trend growth path of NGDP. 27 For more on this point, see Beckworth and Hendrickson (2016). 28 Setting i * t equal to 1 plus the inflation forecast implies a real natural interest rate of 1%.…”