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Nominal GDP as a Fed Target

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agrippa1
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I read this article on NYTimes and was working through a rebuttal argument when I realized that it actually has some merits, not the least of which is that is reestablishes Gibson's Paradox artificially...

http://www.nytimes.c...oment.html?_r=1

Setting the currency value to target a fixed rate of GDP growth requires the Fed to raise interest rates when the economy heats up, and to lower them when the economy cools, exactly as the Gold Standard did. The difference with this policy is that it can't be gamed (or can it?) like the Gold Standard was with surreptitious currency debasement. If the Fed were to maintain a fixed nominal GDP rate it would mean that inflation and deflation would be accepted as monetary policy under certain conditions. The choice of nominal GDP rate would fix the long term inflation rate for a given long term growth rate. Gov't would be powerless to manipulate the currency to arbitrary ends (as they always could with the Gold Standard). The diversion of precious resources to the mining, extraction, processing and administration of gold reserves would be eliminated (a finite inefficiency in any Gold-based economy). My guess is that the economic result would be long term growth rates greater than 4.5% and a general deflation of prices over time.

The argument that the nominal rate could be changed or softened is true also under a gold standard. But in this case, nominal growth would always be with us, providing an inherent optimism in the economy. The currency would be tied to the economy as a whole, rather than to one commodity arbitrarily chosen (arbitrary, from an economic standpoint, given that the choice factors, preciousness, scarcity, homogeneity, divisibility, etc. are disconnected from larger economic factors).

This would, in a sense, establish a currency that uses the entire stock of goods and productive capacity as the standard for currency, letting markets set the total value of those goods and assigning a set amount of currency to that "basket of [all] commodities."

What at first seemed utterly objectionable, at longer thought may be an ideal a workable solution to currency standardization. Interested to hear thoughts on this.

Edited by agrippa1
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Well, given that the Fed exists as a central planning agency and has to choose some goal, I think this is among the better ones, but I certainly wouldn't argue for it over a commodity standard. This policy still requires the government to consciously target a particular level of the money supply, rather than allowing the market to coordinate activity. We have all the massive informational problems here that central planning always has, meaning that the Fed will always be responding to outdated and inaccurate GDP numbers.

One further problem is that the Federal Reserve as it is currently structured cannot credibly commit to a given automatic policy. When looking at the effects of monetary policy, it makes a huge difference whether the monetary meddling is anticipated or unanticipated. In short, unanticipated monetary shocks will have much larger effects than anticipated ones. This means that if the Federal Reserve does gain some credibility in its track record of following some fixed policy, it then has a much higher incentive to deviate from said policy, because it can catch people by surprise and temporarily boost GDP by much more. There is a huge economics literature studying precisely this problem of credible commitment, and there is no easy solution.

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  • 2 months later...

One further problem is that the Federal Reserve as it is currently structured cannot credibly commit to a given automatic policy. When looking at the effects of monetary policy, it makes a huge difference whether the monetary meddling is anticipated or unanticipated. In short, unanticipated monetary shocks will have much larger effects than anticipated ones. This means that if the Federal Reserve does gain some credibility in its track record of following some fixed policy, it then has a much higher incentive to deviate from said policy, because it can catch people by surprise and temporarily boost GDP by much more. There is a huge economics literature studying precisely this problem of credible commitment, and there is no easy solution.

Good point, but it's true for a commodity standard as well, as we saw in the period from 1917 to 1929. The real answer is to let the Fed do whatever it wants, but allow us to use other, private, competing forms of currency. Coercive monopoly is the problem with our money.

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The real answer is to let the Fed do whatever it wants, but allow us to use other, private, competing forms of currency. Coercive monopoly is the problem with our money.

More and more I'm thinking that that's what we should do, and all we need to do, and plus it's much more politically feasible than simply ending the Fed.

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