Suboptimal Equilibria from Nominal GDP Targeting

Abstract

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 might 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 when the rule is followed.

Keywords: Monetary Policy, Nominal GDP targeting, Inflation, Economic growth

JEL Classification: E42, E52, E41, E31