I have supported more aggressive action from the Fed throughout the crisis, though perhaps with a bit less confidence that such action would have big effects than some others, and I have supported nominal GDP targeting. It's a way for the the Fed to be more aggressive without running into political opposition. After all, the Fed is simply stabilizing… people's incomes, and the real/nominal distinction will be lost on most people. But I haven't jumped fully onto the NGDP bandwagon…. The theoretical underpinnings of this particular rule are not clear. I have asked supporters to answer a question, more than once, "in what class or classes of models is NGDP targeting the optimal policy rule?," but there was no response…. So where are the limits? When is this the best policy rule?>Fortunately… Michael Woodford notes that he has looked at this question, and guess what? It turns out that NGDP has desirable properties, and sometimes it is the optimal policy, but not always. What's important… is the inclusion of both growth and level variables in the policy rule (which to include, output growth, output levels, price growth -- we call this inflation -- or price levels depends critically on the nature of the underlying friction in the model, there is no set rule, which leads one to ask about robust rules across various models, and here I think NGDP targeting might do well, but someone needs to check…). This is Woodford….
I didn’t specifically prefer to use that formalism of a nominal GDP target, which is why I’m not particularly associated with that specific proposal. What I’ve been writing about for quite a while… is the desirability of committing to rules where there’s a nominal level variable rather than purely referring to the rate of growth of a nominal variable. The idea was that if the nominal growth in the economy undershoots or overshoots, either one, there should be a commitment to getting back to the target path…. The idea that purely forward looking approaches are undesirable is something I’ve been emphasizing in various papers since the 1990s….
Some people seemed to think Woodford was saying in his Jackson Hole paper that NGDP targeting is optimal, but he wasn't. Sometimes it is, but more generally he was saying that it's a step in the right direction, but there are often better ways to conduct policy. However, it may be the only politically feasible proposal:
the most practical version of such a proposal that you can imagine the Fed adopting is an NGDP target. That is a compromise relative to the theoretical ideal….
He also talked about other rules that are a step in the right direction such as the one proposed by Charles Evans… links the target interest rate to the state of the economy (e.g. buy a certain quantity of bonds each week until inflation or unemployment crosses a predetermined threshold). After reading Woodford's paper, I pushed the Evans proposal over NGDP targeting (which brought some very critical responses from the blogosphere, oh well, all I'm asking is to ground proposal in theory) because I thought it was (1) also a step in the right direction, as Woodford notes, and (2) politically feasible in ways NGDP targeting is not….
The Fed has not performed as well as I'd hoped (which is not to say it has performed poorly, only that there is room for improvement), and I am very much in favor of investigating alternative monetary policy rules…. My view is that the Fed needs to be nudged in this direction in, to use Fed terminology, "measured steps," so I will continue to push at the margin…. But please understand we are all basically on the same side of this question, and working toward the same goals.