June, 2015

Suboptimal Equilibria from Nominal GDP Targeting

  • Thomas L. Hogan

    Fellow in Public Finance, Baker Institute Center for Public Finance, Rice University
  • William J. Luther

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We use a simple model to illustrate that nominal GDP targeting might produce a suboptimal equilibrium if there is a growth-maximizing rate of inflation. Following a shock, we find that targeting nominal GDP may result in lower real GDP growth than the economy could sustainably produce given its long-run potential. Importantly, our argument does not depend on problems with forecasting or implementation. We assume the monetary authority has no trouble hitting its nominal GDP target. So long as a growth-maximizing rate of inflation exists, the suboptimal outcome results under the best-case scenario where the rule is followed.

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