Can anyone think of a single historical example, in any country, at any time, where NGDPLT would have failed as a guard dog?
Is targeting the level-path of Nominal GDP a perfect monetary policy? Almost certainly not. I would be really surprised if something as crude as NGDP turned out to be the very best of all possible targets in all possible circumstances. There are just so many different possible target variables and so many different possible circumstances. And I can imagine a world in which NGDPLT wouldn't be the best possible monetary policy, and build a model to "prove" it. But I want to ask this as an empirical question about the real world.
Even as an empirical question, perfection is a lot to ask. There may be no candidate who is ideal in all real world circumstances. All we can reasonably hope for is that we choose the candidate who is less imperfect than all the other candidates, and who makes fewer mistakes and smaller mistakes.
But I'm going to ask for empirical perfection anyway, just to see what happens.
In my previous post, I made the analogy between monetary policy target variables and guard dogs:
"What we are looking for in monetary policy is some target variable, and
some numerical target for that target variable, so that deviations of
the target variable from target act as a good guard dog that barks
loudly and clearly when, and only when, there are undesirable real
effects from the interaction between monetary policy, nominal
rigidities, and whatever other shocks happen to be hitting the economy.
(And that target variable has to be a nominal variable, of course,
because of long run neutrality.)"
There are two ways a guard dog can fail: it can bark when there is no burglar; it can fail to bark when there is a burglar. Type 1 errors; type 2 errors; (and type 3 errors, when you forget which is which.)
For example: the 1987 stock market crash, which was not followed by a recession, is an example of a type 1 error made by stock prices as a possible target variable for monetary policy. The guard dog barked loudly, but there was no burglar. Monetary policy was not too tight, despite what that guard dog said.
A second example: the 2008-9 Canadian recession, where the inflation rate failed to fall below target, is an example of a type 2 error made by the inflation target. There was a burglar, but the guard dog failed to bark. Monetary policy was too tight, despite what that guard dog said.
Can anyone think of a single historical example, in any country, at any time, where NGDPLT would have failed as a guard dog?
Let's see how much dirt we can find on our candidate.
Worthwhile Canadian Initiative 
How long do you think it would take for NGDPLT to become subject to Goodhart’s Law (in any of it’s related forms)? Is there something about NGDPLT that would prevent that fate? Could this be what happened to inflation targeting? (It used to work then gradually lost its information content as people adjusted to the perceived behaviors)
I don’t see how Goodhart’s Law even applies. What would that look like? Inflation expectations becoming a self-fulfilling prophesy so that it just happens to be the difference between real GDP and the NGDPLPT?
“I don’t see how Goodhart’s Law even applies. ”
Noah Smith at noahpinion disagrees:
“This seems to me to be an application of the second version of Goodhart’s Law. If you set interest rates mechanically (i.e. according to some rule) based on current market expectations of inflation, you will change those expectations, and markets will move, requiring you to set interest rates differently according to your policy rule. It’s possible that markets and policy might converge to some stable equilibrium, but also possible that market volatility might increase once it was known that policy was being set based on market prices themselves.
To link this to Goodhart’s Law, if the Fed targeted the prices of inflation-linked assets, those prices would mostly contain information about expectations of Fed policy decisions (which the Fed already knows better than the asset market), rather than about non-Fed economic forces that might affect inflation or people’s utility of stable prices (i.e. the things the Fed wants to use the asset prices to ascertain).
So Goodhart’s Law, in its obviously true form, seems very important for policymaking. ”
http://noahpinionblog.blogspot.co.uk/2013/04/two-versions-of-goodharts-law.html
Frank Restly,
I didn’t say anything about trends.
Andrew F,
Where did I mention inflation? I said “absolute nominal wage cuts, or even big cuts in nominal wage growth.”
In the mid 2000s Australia had pretty stable 4% wage growth and NGDP growth that peaked at 10%. To keep to even a 6% NGDP target and maintain the same real outcomes would therefore have required 0% wage growth. Implausible.
John Dougan: I think it is maybe possible that Goodhart’s Law destroyed inflation targeting. Inflation targeting made inflation so sticky it could no longer signal monetary disequilibria. Could something similar happen to NGDP? I can’t think why it should, but I can’t rule it out either. But nihilism doesn’t seem like a viable policy option.
Declan, I don’t think that follows. I could be wrong. Why do you hold that wages would have to absorb all the difference in NGDP? Why not changes in investment?
Andrew,
I said “maintain the same real outcomes”. To get NGDP growth down from 10% to 6% would require 4 % points slower growth in the NGDP deflator, therefore to keep real wages the same would require 4 % points slower wage growth.
Wages are not absorbing all the difference in NGDP, in the sense that nominal profits are also cut in the same proportion.
John and Nick,
Isn’t downwards nominal wage rigidity enough to explain the current absence of deflation without bringing in Goodhart’s Law? I struggle to see Goodhart’s Law working at the level of individual price setters, but maybe that’s just me.
Sometimes our guard dog would bark at plastic bags blowing down the street . . .
I could think of Inflation targetting as a “smooth” modern-age illustration of the European Exchange Rate Mechanism (obviously in the way by which it can be broken). And I would say not that I can’t see why it should, but that I can’t see why it could not.