Central banks are a bit like doctors charged with getting their patients back to health armed only with medications, but with little else to influence physical health. But what if the medications are not working, do you just increase the dosage?
I have written about nominal GDP targeting before, which at a very simple level is based on a belief that low GDP growth is a function of insufficient money supply growth, as opposed to excess debt and an inability of fundamental real demand dynamics to drive the economy forward. In other words real economic growth is being hampered by tight monetary policy.
If monetary policy is framed by nominal GDP targeting then monetary policy ceases to be concerned directly with inflation. The problem here is that if the nominal GDP target is based on an incorrect estimate of potential economic growth and growth capacity, then the amount of money supply growth may well end up being totally at odds with real relationships, with potentially serious inflationary consequences of unknown magnitude. And this is essentially what this recent VOX article is discussing.
But, there is one instance where I can see the need for higher a monetary base, and that is where overall private sector economic leverage declines (but one where debt is paid off and not defaulted) and where the transition to a lower growth environment is managed via an exchange of private sector for public sector debt. In this case the velocity of money supply declines, while real economic activity barely grows but does not deflate. I can see the rationale for a large increase in narrow money supply in a deleveraging scenario where the consequences of deflation (large declines in broad monetary aggregates without a compensation in narrow money supply) are too large for institutions charged with financial stability and social welfare to stomach. This is essentially what has been happening.
But, I do not see how the same can be used to stimulate real relationships beyond an attempt to avoid sharp negative reversals in expectations. That is, the paradigm we are in is one bordered by lower real growth potential at the upside and significant risks on the downside. Monetary policy may only be effective in supporting the downside and the transition, but it can do little to impact the long term growth potential of the economy.
I too fear that blind NGDP targeting may be a dangerous experiment.