Thank you for inviting me.
Let me say, first, that I think inflation targeting did improve things quite a bit, especially in Canada, but I think the current recession shows there are some flaws in inflation targeting and that we can do better. I have to admit, though, that probably right now the biggest advantages would be in the U.S. and Great Britain, but perhaps in the future in Canada as well, and even now it would benefit somewhat.
It seems to me that nominal GDP targeting is the logical next step in the process of improving our control of the macroeconomy. It would be more expansionary during recessions than inflation targeting. It would be more contractionary during booms than inflation targeting. It would tend to smooth out the business cycle somewhat. And very importantly, you could still maintain the same long-run average rate of inflation. So if the real GDP growth in Canada were 2.5% per year, on average, you could set a 4.5% nominal GDP target and still hit the same long-term inflation trend. It's really long-term inflation that matters in terms of the welfare effects of inflation.
Over the short-term business cycle, you could argue that what matters most is stabilizing employment, and for that, nominal GDP targeting does better. It especially does better in addressing disequilibrium in the labour market, so a sharp rise in oil prices with inflation targeting might require some contraction, which could hurt the manufacturing sector of the economy and increase unemployment there.
With nominal GDP targeting you have more flexibility dealing with things like supply shocks. It's also a better tool for dealing with liquidity traps. When interest rates hit zero, it can be difficult for a central bank using conventional techniques to stimulate the economy. Generally during that sort of period, nominal GDP has fallen much more sharply than inflation, so it gives you a much more aggressive nominal growth target. It allows the central bank to be much more aggressive in setting expectations, and that can be a valuable tool in escaping a liquidity trap.
We can see recently in Great Britain one strong advantage over nominal GDP. There are some rumours that it's an informal target of the Bank of England, and right now inflation in Britain is well above the official 2% target, yet almost everyone in Great Britain thinks that the economy is still depressed, and if anything, needs more stimulus. In fact, the fiscal austerity is quite controversial in Great Britain for that reason. So with nominal GDP targeting, because not all GDP growth is currently below 5% in Britain, that would allow the Bank of England to be expansionary, which is what people think is needed right now.
Another advantage of nominal GDP is that it's a simple, single target. Admittedly, there are versions of inflation targeting that are flexible, that deal with real shocks, to some extent, but that leads to a lot of ambiguity in monetary policy setting, and in some cases it allows the central banks to hide behind a very vague mandate. Admittedly, that's more of a problem in the United States right now than in Canada, but it becomes a problem if inflation targeting seems to be giving the wrong signals.
It's also easier to communicate to the public what you're doing. One recent example from the United States is that in mid-2010 our inflation rate had fallen well below the Federal Reserve's implicit goal of about 2% and the Federal Reserve announced that quantitative easing was going to be done to boost the inflation rate. But that turned out to be a very difficult sell politically because most people assume that a higher cost of living is something that hurts them. And most people don't understand macroeconomics well enough to understand how inflation can actually provide macro-stability in certain situations.
In contrast, if you are targeting nominal GDP, the Federal Reserve could have announced that they're not trying to boost Americans' cost of living, they're trying to boost Americans' incomes, because those have been depressed by the recession. Not all GDP is essentially national income. It makes it easier to communicate to the public what you are actually trying to do in a macro-stabilization sense.
So I think it has both technical advantages and political advantages, particularly in unusual circumstances like liquidity traps or supply shocks, where inflation targeting might not do as well.
Thank you.