There are basically three general arguments for NGDP targeting:
1. It will reduce labor market instability.
2. It will reduce credit market instability.
3. It will lead to more pr0-market public policies.
I am looking for links to previous empirical research in any of these three areas, but especially the last two. The first is obviously important, perhaps the most important argument, but it’s also been researched fairly extensively.
Here I’ll sketch out what interests me about the second and third topic:
Financial instability: It seems like financial crises are often associated with declines in NGDP. Think about the US and Europe in 1931, Argentina in 2001, the US and Europe in the period after mid-2008. But that’s just casual empiricism. I’d like to see rigorous academic studies that look at many different financial crises. How often are they associated with falling NGDP? Does this correlation only show up in certain countries? What about a slowdown in NGDP growth where it still remains positive? (For instance, did the slowdown in NGDP growth during the 1980s and early 1990s contribute to the S&L crisis?)
Statist policies: It seems like free market policies do fairly well when NGDP growth is fairly stable (1922-29, 1953-64, 1985-2007) and statist policies do better when NGDP growth is unstable (1913-21, 1930-52, 1965-81, 2008-10). Obviously there are lots of issues here. In the case of WWI and WWII, you may have reverse causality—government spending causes the NGDP instability. But there’s also lots of plausible examples going the other way—the Great Depression leading to the NIRA, the Great Inflation leading to wage and price controls, the Great Recession leading to bailouts, etc.)
It would also be interesting to look at this question from an international perspective. Out of curiosity, I took a look at the Heritage Economic Freedom scores for the US and Australia, before and after the crisis:
Country Score(rank)2007 2015
Australia 82.7 (3) 81.4 (4)
USA 82.0 (4) 76.2 (12)
Australia had much less NGDP instability, at least in a “level targeting” sense (this may not be easy to quantify.) Is that why the economic freedom score for the US slipped much more than for Australia? Perhaps, but Australia does slide behind New Zealand, which moved up to number 3, and which nonetheless had a worse recession than Australia. Another problem is that smaller economies (and commodity exporters) “naturally” have a more unstable NGDP, indeed this is probably desirable. So you’d need to control for a number of factors.
I seem to recall that the average Heritage Economic Freedom score was rising during the Great Moderation, and began falling after somewhere around 2008. Is that correct? I also wonder whether it depends on which regime (statist or market-oriented) is viewed as the plausible alternative. In the US in 1930 the alternative was statism. Today in Greece the alternative may be market-friendly policies. That underlies the conservative fear that NGDP targeting might allow Greece to avoid the needed “tough choices.”
In any case, these are obvious three big issues that need looking at. I’d guess there’s already some research on these topics, but mostly for labor market instability. Again, I’d greatly appreciate links to any research on how NGDP instability is correlated with problems like unemployment, financial crises, and statist policies.
Update: E. Harding sent me a graph showing the average Heritage ranking. It rose to a peak at 60.2 in 2008, then fell to a trough of 59.4 in 2010, then rose again to an even higher peak of 60.4 in 2015. Thus the US decline is not typical.