Nominal GDP targeting – a new method in the Chinese monetary policy madness?

By:
Euromoney Skew, Sid Verma
Published on:

HSBC's chief economist Stephen King and Yu Yongding, a former academic adviser to the People's Bank of China, debate the allure of nominal GDP targeting as a possible anchor for monetary policy in China.

The allure of nominal GDP targeting as a post-Lehman anchor for monetary policy has gained favour, in recent years, among blogging economists and, most notably, with the incoming Bank of England governor Mark Carney, who has touted its theoretical allure in economies faced with prolonged output gaps and policy rates at the lower bound. Meanwhile, the US Federal Reserve has articulated explicit employment thresholds to anchor its monetary policy, a move that is in keeping with the spirit of nominal GDP targeting.

Although Carney, in his testimony to a UK Treasury Select Committee, was cool on the prospect of removing inflation targets until nominal growth reaches a given level, citing communication challenges and the risks of the expectations hypothesis failing, the NGDP crowd has gained newfound respectability with the partial backing of the Economist, among others.
Yu Yongding was president of the China Society of World Economics. Source: World Economic Forum
While much has been said about the transatlantic tide flowing towards NGDP, this monetary framework, in some respects, could yield benefits in export-led emerging markets, held under siege by perennial terms-of-trade shocks. In this context, many emerging central banks have been forced to pro-cyclically hike to meet inflation targets even if the origins are exogenous.

However, little has been said about the utility of the NGDP debate for developing economies. In a sense, China’s monetary and fiscal policy has in recent history been anchored through the explicit lens of GDP expansion in the order of around 8%, but the transmission of policy stimulus and contraction relies on non-market tools, principally by controlling the quantum of credit flowing through the state-owned banking system. Granted, it’s difficult to criticize a growth model that has yielded eye-wateringly high growth rates during the past two decades but many have still derided the country’s monetary framework based on a system that penalizes consumption and de facto outsources its policy to the US by an effective dollar peg.

So, here’s a suggestion: one way to resolve global imbalances is through disorganized rebalancing, with China recognizing that continuous rises in inflation is needed to see its currency float up further. The tool to do this could be nominal GDP targeting, which would encourage the floating of the RMB and a structural contraction of the US current account. Granted, although it would structurally resolve global imbalances, it could prove very disorderly in the short-term.

In this context, we asked two eminent economists about their views on the NGDP targeting in China. Stephen King, chief economist at HSBC, said via email:

“Years ago, I suggested that it might be quite a good thing for China to embark on this path as a replacement for its currency regime. That’s largely because inflation is dominated by volatile components and money supply is distorted by social credit and the like so if China is so big that linking to US monetary policy is no longer in China's own interests, nominal GDP targeting seems like an interesting alternative.”  


This rationale earned a stinging rebuke from Yu Yongding, former member of the monetary policy committee at the People’s Bank of China:

“China's monetary policy objectives are multiple growth, price stability and exchange rate stability. Money supply is a reference target, which has never been abided by strictly. Fortunately, there is trade off between growth and inflation, hence for the policymakers in China, the difficulty is how to strike a balance between growth and inflation. With a time lag, a relative satisfactory trade off can be obtained. You can say that China's monetary policy is inflation targeting of a weak form.

"The view that inflation is based on volatile components is true but the old policy works. Over the past 30 years, with a growth rate of 10%, China's average annual inflation rate is about 3%. There has no serious problem for China to contain inflation by using traditional monetary instruments including credit control. Why should China change its policy that has bee effective though not perfect, to try something entirely untested? With a growth rate of about 8%, I cannot see the virtue of adopting nominal GDP in China. Nominal GDP targeting in China means free-wheeling for both inflation and growth.”  

And his strident comments against NGDP, more generally:

“This is a dangerous idea, which means that the money supply should accommodate any rate of inflation. This is against all conventional wisdom without any solid theoretical and empirical foundation. Suppose that inflation is 3% and GDP growth rate is 2%, that you make the growth rate of money supply 5% is OK. But if the growth rate is 2% and inflation is 6%, what are you going to do? if the you feel the inflation rate is too high, and you make the growth rate of money supply less than 8%, this means that you actually have an inflation target. If you allow the growth rate of the money supply to grow at 8% to accommodate the inflation at 6%, you are destroying the fabric of the society.

"What about those helpless pensioners and fixed-wage earners? If you try to compensate them, what about acceleration of inflation and inflation expectations, which had beset us in 1970s and 1980s?

"Furthermore, you can expand the central bank balance sheets, but are you sure you can manipulate the growth rate of the money supply? Japan has tried all the tricks but failed. I do not think what had failed in Japan will be successful in UK, Unites States and eurozone. The culprit of the current crisis is over-leveraging. Until the leverage rate falls into an acceptable level, I do not think the economy can rebound in a sustainable manner.

"The policy of nominal GDP targeting is not only questionable in its feasibility and usefulness but also immoral, which punish the poor, the diligent and frugality. I do not think the Chinese government will be so stupid as to adopt this kind of policy. The real problem all countries are facing is political rather than economic. That is: how to distribute the burden of deleveraging fairly across social strata within a country and among countries.”