November 30, 2011
Targeting the level of nominal GDP (the total number of dollars spent/earned in a year) has become the fad of the year, partly because it is a strong argument in favor of further Fed stimulus. Paul Krugman, Goldman Sachs, and The Economist have all said nice things about it. A professor at Bentley University seems to have dedicated the past few years of his life to it.
Of course, the idea is not new. Far from it—nominal income targeting actually goes back to the 1970s. Over subsequent years it got attention from several big-name economists including Martin Feldstein, Greg Mankiw, Robert Gordon, John Taylor and Robert Hall. It was even championed by my favorite Fed governor of the 1990s: Larry Lindsey.
The point of this post is not to review the literature or consider why nominal income targeting was not adopted earlier. I also do not want to return to the question of whether monetary stimulus alone is capable of healing the economy. Rather, I want to see what the Fed would have done in the years before the big slump if it had carefully targeted nominal income. The answer might surprise you.