Nominal GDP Targeting Rules: Can They Stabilize the Economy?

s from the important role that expectations of future events, such as policy adjustments, play in the problem of time inconsistency. 8 Some analysts argue for rules that adjust another instrument of monetary policy, the monetary base, to keep nominal GDP on target (McCallum 1987, 1988). Interest rate-based rules offer the advantage that they involve little change from the Fed’s current policy-setting practices. Currently, when policymakers wish to change the stance of monetary policy, they typically do so by adjusting short-term nominal interest rates. 9 Hall and Mankiw (1993) suggest a closely related type of rule, under which policymakers would adjust the interest rate in response to not only the gap between actual and targeted nominal GDP growth but also to the gap between actual and simulated shocks through the selected model to create artificial data on real GDP growth, inflation, and the interest rate for 1989-98. Following Feldstein and Stock (1993), on one pass of this step the historical policy equation is used as the policy rule to construct artificial historical data. On the other pass one of the policy rules is imposed in lieu of the historical policy equation, to construct the counterfactual data which would be observed if the rule were imposed. The ten years of artificial data are then used to compare the volatility of the economy under the policy rule to volatility under historical policy. To gauge the average effects of the policy change, this comparison is made for each of 1,000 simulated 1989-98 data sets (again, following Feldstein and Stock). Tables 1 and 2 report the median (over the 1,000 data sets) percentage changes—from historical policy to the rule—in the standard deviations of growth and inflation. 22 FEDERAL RESERVE BANK OF KANSAS CITY