Targeting interest rates only affects demand, not supply

The argument

Nominal GDP is, simply put, a nation's income. Central banks should target nominal GDP trend growth instead of inflation, because by targeting interest rates in pursuit of an inflation number, only demand — and not supply — becomes affected. That asymmetry is the heart of the argument: the instrument reaches spending, while a good deal of what moves the price level does not originate in spending at all. The difference shows most clearly in how each rule responds to the same event. If a central bank targets inflation, it will tighten monetary policy whenever inflation rises, regardless of why it has risen. If a central bank targets nominal GDP trend growth, it will either loosen monetary policy or not alter it at all. So when prices rise because the cost of inputs has risen rather than because demand has run ahead, central banks that target inflation will reduce the economy's real GDP as those input costs increase — tightening into a contraction they cannot cure, since no interest rate restores a supply that has been disrupted. Central banks that target nominal GDP, on the other hand, help support growth in spending, thereby preventing falling nominal GDP and high inflation rates. Another reason central banks should target nominal GDP growth is that several countries in the global economy have high instances of nominal debt to nominal GDP. Debt is fixed in nominal terms while the income available to service it is not, so the ratio between them is what determines whether the burden is manageable. If central banks focus on inflation, monetary policy will be tightened, thereby decreasing a country's nominal debt without much control over nominal GDP growth. This can be a problem if a country faces supply shocks such as political instability.

Premises

Counter-arguments

The argument's central observation is one inflation targeters already act on. Practising central banks distinguish demand-driven from supply-driven price rises and explicitly look through the latter: that is what core measures excluding food and energy are for, what 'flexible' inflation targeting means in the mandates themselves, and why banks respond to supply shocks by extending the horizon over which inflation returns to target rather than by tightening into a contraction. The failure described — mechanically tightening whenever any price index rises — is a caricature of strict targeting that no major central bank has operated under. That matters because it collapses the distinction the position needs. Under demand shocks, nominal income and inflation targeting prescribe the same action; the frameworks diverge only under supply shocks, which is precisely the case flexible inflation targeting already handles. The advantage claimed is therefore smaller than presented, and the argument does not engage the practical objections that have kept nominal-income targeting a minority proposal: the series is published with a long lag and revised substantially afterwards, so a bank would be steering by a number it will not know for months and which will later change, and the public understands a price-rise target in a way it does not understand a nominal-income path — which matters because expectations anchoring is most of what the framework is for. The debt argument also runs both ways. Stabilising nominal income does stabilise debt-to-income ratios, but it does so by permitting higher inflation after adverse supply shocks, transferring value from creditors to debtors. That may be desirable, but it is a distributional choice being presented as a technical improvement, and it is the reason the proposal is contested rather than obvious.

Rejecting the premises

[Rejecting P1] The premise conflates targeting interest rates with targeting inflation and attributes to inflation targeters a mechanical response no major central bank operates: flexible inflation targeting explicitly looks through supply shocks via core measures and by extending the horizon for return to target, so the failure described is a feature of strict targeting rather than of the frameworks in use. [Rejecting P2] Because the two frameworks prescribe identical action under demand shocks and diverge only under supply shocks — the case flexible targeting already handles — the claimed advantage is narrower than stated, and it is offset by nominal GDP's long publication lag and substantial subsequent revisions, which would have a bank steering by a figure it cannot yet know and which will later change. [Rejecting C] Stabilising nominal income stabilises debt-to-income ratios by permitting higher inflation after adverse supply shocks, which transfers value from creditors to debtors — a distributional choice presented here as a technical improvement — and a target the public understands less readily weakens the expectations anchoring that is most of what such a framework is for.