Note To Charles Goodhart: Europe Is Flatlining Under Inflation Targeting

Includes: FXE
by: David Beckworth

Charles Goodhart has an op-ed in the Financial Times and a piece at VoxEu where he comes out swinging against nominal GDP level targeting ((NGDPLT)). He mistakenly thinks NGDPLT implies targeting real variables and having no long-run nominal anchor. He also thinks flexible inflation targeting (FIT) has been a smashing success, so why abandon it now?

Like you, I too am puzzled after reading these pieces. Surely Goodhart recognizes that NGDPLT is a money-denominated (i.e., nominal) target and that by definition it is bounded because it is a level target. If anything, it creates a firmer long-run nominal anchor than a "memory-less" FIT. And surely Goodhart is aware that the Great Recession in the United States and the eurozone crisis occurred under the watch of FIT-type regimes. If FIT is so amazing, then why has there been sustained drops in aggregate nominal expenditures in these two large economies?

It is especially surprising that Charles Goodhart can still be singing the praises of FIT after seeing what it has failed to do in the eurozone. The figures below, which show the eurozone less Germany, illustrate this point very clearly. The first one shows that the broad money supply (M3) has flatlined in this region.

Unsurprisingly, the flatlining of the broad money supply in the eurozone less Germany region has led to NGDP that has flatlined too (after an initial drop).

If this is the best the eurozone can do with FIT, then maybe one should reconsider its viability, no? As alluded to above, it is not just that FIT is flawed, it is that NGDPLT is so much more than Charles Goodhart understands.Here is but one of his confusion over NGDPLT:

Adopting a nominal income (NGDP) target is viewed as innovative only by those unfamiliar with the debate on the design of monetary policy of the past few decades. No one has yet designed a way to make it workable given the lags in the transmission of monetary policy and the publication of national income and product.

Actually, only someone unfamiliar with the literature on "targeting the forecast" (see Lars Svenson and Michael Woodford) would make this outdated claim about lags. By targeting the forecast, a central bank manages expectations and operates with a lead. Big difference there. Needless to say, there is much more wrong about Charles Goodhart's NGDPLT critique and the untiring Scott Sumner lays out it here and here. (Also, see here for why NGDPLT provides a strong nominal anchor.)

PS: Maybe Goodhart is simply confused about FIT's performance in the eurozone. Maybe he has been talking to his German friends and generalizing from their experience. FIT seems to be working rather well for the German-portion of the eurozone:

Update: Saturos nails it on the confusion of NGDP as a nominal variable.