Advocates of nominal GDP targeting claim that it would achieve greater macroeconomic stability. When recession hits, real output falls but prices tend to adjust more slowly. This means that by targeting nominal GDP, central banks could actually smooth output fluctuations better. They could also react more appropriately to supply shocks.
"It would be a big step for the Fed," says Ryan Sweet, a senior economist at Moody's Analytics. "There seems to be gathering a lot of support. Given where the economy is right now, it could provide a boost. That said, it's unclear what the economic impact will be. In theory, it would help the economy perform better, but I don't know the Fed wants to go down that road this year."
Targeting nominal GDP has been garnering support. Last weekend,
U.S. economic analyst Jan Hatzius said that "the best way for Fed officials to ease policy significantly further would be to target a nominal GDP path," which would result in "additional asset purchases to help bring actual nominal GDP back to trend over time."
To illustrate the point, Hatzius offered a chart that shows actual nominal GDP is 10% below the trend line of nominal GDP prior to the financial crisis in late 2008. The easily graspable idea that we need to return to the trend line is something that would resonate with Americans who may not know the intricacies of monetary policy, economists says.
"People understand it better," Swonk says. "What Ben Bernanke is laying the groundwork for is a different kind of targeting. If you target the unemployment rate, you'd tolerate a little higher inflation for a while. But you need to change people's view of it. It's a subtle difference to target nominal GDP, but in the message it's something that markets can understand if you say we're trying to recoup the losses."
Swonk says the move would make sense because now, even with a dual mandate, the Fed would tighten interest rates if inflation gets too high. The fear that the Fed will raise rates at the first sign of faster inflation has kept investors in Treasuries and out of more productive investments for fear the economy could collapse again.
The Fed has already taken drastic steps to change that notion. The Federal Open Market Committee has said it would anchor interest rates near zero until mid-2013. That was followed by Operation Twist, in which the central bank said it will take maturing short-term Treasuries and invest the money in longer-term notes, drive yields lower.