The NGDP Dilemma

A blog about business and economics.
Sept. 28 2012 2:23 PM

The NGDP Dilemma Is a Good Dilemma

Via Karl Smith, a critique of NGDP targeting that I think helps underscore the merits of the approach:

Think about it like this. Your boss tells you that NGDP is surging and wants to know if it will be profitable to hire more workers and expand the business. To give a good answer, as I’ve just illustrated, you absolutely want to know WHICH COMPONENT, P or Y is surging.  If you just go by the NGDP aggregate, you are really hurting your chances of keeping your job.

Hiring workers is probably the wrong thing to think about. Let's worry about hiring capital goods. Some extra space for your business or some extra production equipment. You know the price of said capital and you know roughly what it does, but you're not sure whether you should buy it or not. You look to your left and you see a stack of dollars. You look to your right and you see a bunch of machines. Do you want to trade the dollars for the machines? It's a close call.

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Now a little birdie from the Bureau of Labor Statistics shows up and tells you that the price level is going to surge over the next three years. Suddenly your decision is made for you. That stack of dollars isn't as valuable as you thought it was. Buy the machines!

But no, a second little birdie arrives this time from the Bureau of Economic Analysis and it's here to tell you that the level of real output is going to surge over the next three years. Suddenly your decision is made for you. That pile of machines is more valuable than you thought it was. So go buy them!

The point is that any information pointing toward higher NGDP at the margin points in the direction of marginally more investment. Either the investment is less costly in real terms than it previously looked like, or else the investment is more lucrative than it previously looked like. Now note that this isn't a magic trick. Real resource constraints still bind. If everyone tries to obtain more structures and capital equipment and the economy literally doesn't have the capacity to produce any more of that stuff, then at the end of the day you're just going to see higher prices for everything. But if there is excess capacity in the economy—if there's vacant office space and idle workers and factories that aren't at full tilt and construction equipment that's not in use—then increased demand for investments will, in fact, produce more output.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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