David Beckworth and Josh Hendrickson have a new working paper at Mercatus. Here is the abstract:
Some economists advocate nominal GDP targeting as an alternative to the Taylor rule. These arguments are largely based on the idea that nominal GDP targeting would require less knowledge on the part of policymakers than a traditional Taylor rule. In particular, a nominal GDP targeting rule would not require real-time knowledge of the output gap. We examine the importance of this claim by amending a standard New Keynesian model to assume that the central bank has imperfect information about the output gap and therefore must forecast the output gap based on previous information. Forecast errors by the central bank can then potentially induce unanticipated changes in the short-term nominal interest rate, distinct from a standard monetary policy shock. We show that forecast errors of the output gap by the Federal Reserve can account for up to 13 percent of the fluctuations in the output gap. In addition, our simulations imply that a nominal GDP targeting rule would produce lower volatility in both inflation and the output gap in comparison with the Taylor rule under imperfect information.
It seems to me that this argument is becoming increasingly persuasive over time. Both the natural rate of interest and the output gap are increasingly difficult to estimate, as both the natural rate of interest and the trend rate of growth seem to be becoming increasingly unstable.
Speaking of David Beckworth, I’ve enjoyed listening to his podcasts of people in monetary economics/finance. The latest with Narayana Kocherlakota is particularly interesting, as it gives listeners a perspective on what things seem like for someone on the inside of the Fed. (He recently retired as the Minneapolis Fed President.)