Can Nominal GDP Targeting Rules Stabilize the Economy?
Because the Federal Reserve has shown interest in making price stability an explicit goal of monetary policy, examination of potential nominal anchors has become particularly relevant. A target path for nominal gross domestic product (GDP) growth is a possible nominal anchor that has received considerable attention since Bennett McCallum proposed an implementable nominal GDP targeting rule. Numerous researchers have run simulations of McCallum's rule and have generally concluded that rule-guided manipulation of the monetary base could greatly stabilize the growth of nominal spending and could, by implication, be used to foster price stability. Unfortunately, virtually all of these studies regarding the stability of the velocity relationship between the monetary base and nominal income have been too optimistic. In this article, Michael Dueker tests and rejects the hypothesis that the income velocity of the monetary base has been stable. He then estimates a velocity model that has time-varying parameters to account for structural change. Subsequent simulations of McCallum’s rule use a calibrated version of the velocity model to generate data. In the simulations, McCallum’s rule is still able to stabilize nominal GDP growth, but less stringently than simulations using fixed-coefficient models have suggested. This finding suggests that a nominal GDP target can serve as a long-run nominal anchor so that prices might be predictable in the long run, but short-run variability will persist.