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Nominal GDP Targeting and the Taylor Rule on an Even Playing Field

24 Pages Posted: 9 Jun 2016 Last revised: 4 Oct 2016

Joshua R. Hendrickson

University of Mississippi

David Beckworth

George Mason University - Mercatus Center

Date Written: June 7, 2016

Abstract

Some economists have advocated nominal GDP targeting as an alternative to the Taylor Rule. These arguments are largely based on the idea that nominal GDP targeting would require less knowledge on the part of policymakers than a traditional Taylor Rule. In particular, a nominal GDP targeting rule would not require real-time knowledge of the output gap. We examine the importance of this claim by amending a standard New Keynesian model to assume that the central bank has imperfect information about the output gap and therefore must forecast the output gap based on previous information. Forecast errors by the central bank can then potentially induce unanticipated changes in the short term nominal interest rate, distinct from a standard monetary policy shock. We show that forecast errors of the output gap by the Federal Reserve can account for up to 13% of the fluctuations in the output gap. In addition, our simulations imply that a nominal GDP targeting rule would produce lower volatility in both inflation and the output gap in comparison with the Taylor Rule under imperfect information.

Keywords: Nominal GDP Targeting, Imperfect Information, Monetary Policy

JEL Classification: E52

Suggested Citation

Hendrickson, Joshua R. and Beckworth, David, Nominal GDP Targeting and the Taylor Rule on an Even Playing Field (June 7, 2016). Available at SSRN: https://ssrn.com/abstract=2791588

Joshua R. Hendrickson (Contact Author)

University of Mississippi ( email )

Oxford, MS 38677
United States

David Beckworth

George Mason University - Mercatus Center ( email )

3434 Washington Blvd. 4th Floor
Arlington, VA 22201
United States

HOME PAGE: http://macromarketbusiness.blogspot.com

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