Charles Hugh Smith On The Futility of NGDP Targeting

Charles Hugh Smith On The Futility of NGDP Targeting
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About a week ago, I wrote an article for the American Thinker entitled “The Problem With the Fed’s Targeting” which outlined the kind of knowledge problems behind the push to have the Federal Reserve drop its focus on inflation and the unemployment rate and target nominal gross domestic product to boost economic growth.  So what is NGDP targeting exactly?  From my article:

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.

Anyone skeptical of the Federal Reserve, as most Austrian-minded thinkers are, should instantly see the risks associated with such a proposal.  One of the big issues behind the “targeting NGDP” proposal rests on the faulty assumption that Bernanke and co. are actually capable of hitting a predetermined target.

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.

The targeting NGDP policy has been popularized by Chicago school quasi-monetarist Scott Sumner (the impeccable Robert P. Murphy did a take down of his anti-Rothbard theory on what caused the Great Depression today over at Mises Daily) and is becoming fashionable and seriously considered by many prominent economists.   It’s easy to see why this is after reading Charles Hugh Smith’s great article “Inflation by Any Other Name” that was published in The American Conservative just a few days ago.  Smith is a novelist and economic commentator who runs the blog and contributes regularly to  On targeting NGDP, he writes:

If we scrape away the econo-speak, we find that nominal GDP targeting is simply code for “let’s stop worrying about inflation and crank up the printing press, baby.” While its proponents are coy about exactly what they’re suggesting the Fed do after targeting nominal GDP growth of, say, 5 percent per year, the basic idea is to flood the economy with even more low-interest money.

The hidden assumption here is insidious: once inflation kicks up—and at 3.9 percent it is already well above the Fed’s “comfort zone” of 3 percent—then Americans will stop trying to save or pay down debt and will instead go back to borrowing and spending freely.

In other words, instead of Americans acting prudently to lower their unprecedented levels of debt and build some capital, the advocates of targeting GDP want us to go back to the go-go days of the housing bubble and borrow and spend more, more, more, all because they believe the key problem is lack of consumer demand.

Smith goes on to show why using inflation to boost NGDP doesn’t actually lead to “real” growth, the risk that such a policy has in inducing stagflation, and the declining bang-for-the-buck on debt financing:

A 5 percent nominal GDP with an inflation rate of 4.5 percent yields real GDP growth of only 0.5 percent. It’s entirely possible to get inflation really fired up and have a 6 percent nominal GDP and a 7 percent inflation rate—in other words, a negative growth rate that is masked by the positive nominal GDP.


The nightmare scenario that proponents don’t mention is one in which the Fed unleashes a torrent of money into the economy, inflation leaps up, but employment stays subdued. Then, to fight the roaring inflation it created to boost the nominal GDP, the Fed has to raise rates—not by a quarter point, but by a lot, and for a long time. Not only would that tightening suffocate the debt-based “growth”—actually, more inflation than actual growth—it would also trigger new declines in employment. We would end up with the worst of all possible worlds: high inflation, high interest rates, and rising unemployment.

The entire notion that incentivizing more borrowing will lead to growth is suspect. Indeed, if we divide real GDP by the increase in debt (both public and private), we find that the return on debt has been declining for decades and has now fallen to a negative number: in effect, we’re borrowing trillions of dollars—roughly 11 percent of GDP on the federal ledger—each and every year just to stay even.

Each additional dollar of debt added about 70 cents to GDP in 1970. By the early 1990s, the yield had fallen to 50 cents, and when the housing bubble was largest in 2006 it was less than 30 cents. With the explosion of federal debt to bail out the banks and provide fiscal stimulus, we’ve reached a point where real GDP has barely budged from pre-recession 2007 levels, yet we’ve poured roughly $6 trillion in new federal borrowing into the economy.

Don’t expect the “target NGDP” advocates to change their minds over Smith’s article despite its thorough debunking.  With last week’s announcement on lowering the cost for foreign central banks to use its dollar swap lines, the Fed reiterated its position that it stands ready to print in order to prevent a much needed market correction.   Though printing can give the appearance of economic growth, it by no means provides a cure to the real ailments preventing a robust recovery.  Smith’s conclusion is devastating:

The problem with targeting GDP is not just the reality-distortion field required to believe it would work, but also what the proponents dare not ask: what if the U.S. economy is facing structural headwinds that can’t be fixed by more borrowing and more Fed goosing of financial markets (i.e., “quantitative easing”)? What if the fundamental problems are precisely what the GDP targeters propose as solutions: indebtedness, zero-interest rates, rising inflation, and a clueless Federal Reserve that only has two levers to pull—Fed funds rate and quantitative easing—and has been yanking on them for four years?

The supporters of targeting GDP dare not consider this, because they would be revealed as not only lacking answers but also lacking a context for grasping the question.

The conventional fixes haven’t worked; they’ve only deepened the nation’s debt hole and rendered our financial system exquisitely dependent on constant Federal Reserve intervention and “easing.”

“Target NGDP” = more inflation; simple as that.

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James E. Miller is editor-in-chief of Mises Canada and a regular contributor to the Mitrailleuse . Send him mail

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