John Carney says
The advocates of NGDP targeting view it primarily as a communications strategy. It’s a way of telling the markets that the Fed will stay very loose for an extended period of time, even if this looseness becomes inflationary.
Of course, in conjunction with communicating the goal, the Fed would have to communicate a credible strategy to achieve the goal. How exactly will it pursue the goal of higher nominal growth? Most likely it would have to commit to a very aggressive, open-ended asset purchasing program. No more QE with limited dollar amounts. This would be a throw-open-the-vaults policy.
It’s not clear, however, that this will lead to growth. In fact, some of the proponents seem to think that the announcement of an NGDP target would just magically lead to growth.
I suspect John is being cute, but the idea is not that magic is at work but expectations.
To show people how this works I thinks its best to just forget about Quantitative Easing. Maybe that’s the tool – maybe its not – but it will be easier to think in terms of interest rates.
So, if you are a bank and you are thinking about lending someone money. Or, you are a business and you are thinking about borrowing money your key question is this: Will I make enough money to pay back the loan, with interest and still have something left for myself.
Well, if you know for a fact that interest rates are going to be zero until either people start buying more stuff or they start paying more for stuff then you are now facing a no-lose proposition.
Suppose you borrow the money and the new demand doesn’t appear. Well then by construction you can roll the loan over at 0% because rates are not going up.
If spending does rise then you may not be able to roll the loan over at no cost, but you will have increased revenue so you can repay the loan.
Either way you can’t lose.
This means that it’s a no brainer to take out a loan.
This is why a specific statement that said
The committee judges that economic conditions are likely to warrant exceptionally low levels for the Federal Funds rate until current value GDP exceeds $19.5 Trillion.
is likely to have an immediate effect.
I know that many of the hard core guys want to jettison the Fed Funds talk in favor of NGDP futures, but baby-steps fellas. I think NGDP can work as a communications vehicle but we don’t need to get crazy with largest central bank.