Monday, October 3, 2011

A Reaganite Monetary Policy

While reviewing Scott Sumner's rather modest proposal to raise the growth path of nominal GDP to 6%-6%-5%-5%, (something he considers to be as much as is politically possible,) another approach came to mind.

Why not adopt the growth rates of nominal GDP from Reagan's 1983 and 1984 recovery from the recession of 1982?

Looking at monetary policy in the Reagan administration is especially appropriate because it was at the end of Reagan's second term that nominal GDP reached the growth path of what would become the Great Moderation.

Getting to that growth path involved some quite rapid growth in nominal GDP. The average growth rate of nominal GDP for 1983 and 1984 was nearly 10%.

This rapid growth in nominal GDP and the shift of nominal GDP to the growth path of the Great Moderation appeared closely associated with the return of real GDP (the actual production of goods and services) to potential GDP, (the productive capacity of the economy.)

Suppose the Fed was willing to replicate the growth rates of nominal GDP from 1983 and 1984 and then went to a 5% growth rate. What would nominal GDP look like?

The new growth path starts in the third quarter of 2013 with a nominal GDP of $18,609 billion. It then grows at the desired rate.

At the end of the Reagan administration, the U.S. was on the trend growth path of nominal GDP for the Great Moderation. The growth rate was approximately 5.4%. With the productive capacity of the economy growing at 3% over the period, the result has been inflation of slightly more than 2%. While Reagan failed to completely extinguish inflation, the result was much better than the highly inflationary seventies.

Perhaps with this Reaganite monetary policy, the final step towards ending inflation could be taken. Rather than a 5% growth path, a noninflationary growth path of 3% could be instituted. If the productive capacity grows at 3% as it did during the Great Moderation, the result will be a stable price level and zero inflation.

However, this stable price level would be a long run average. A poor harvest or a disruption in oil markets would both reduce production and result in temporary inflation as the price level shifts up to a higher level. On the other hand, unusually rapid productivity growth would lead to a lower price level, and temporary deflation.

Still, a 3% growth path for nominal GDP would not be consistent with persistently high, much less increasing, inflation. Further, this "Reaganite" monetary policy would help avoid disasters like the lesser Depression.


  1. Nice post. I would shoot for 7 percent nominal GDP for at least three years.

    I am a small business guy. I make cabinets, furniture, tables for sports bars. Give to me real growth of five percent a year, and I will eat inflation for breakfast.

    Too much namby-pambyism out there. Time to run the printing presses wide-open.

  2. Could this be a successful rallying cry if GOP wins the presidential election?

    Reagan recovery and then ZIP (zero inflation policy)!

  3. I would prefer that some Republican candidates take this approach immediately. Why wait until after the election?

  4. Bill, I agree completely. Just thought it could be a useful slogan in case we are still stuck in the mud after the election. Two simple slogans. Who in GOP would dare to argue against it? Is it good enough to work even now?

  5. Bill
    "Mind reading". In a presentation yesterday I showed why the recovery from the deep 1981-82 recession, where unemplyment went to almost 11% was so different from the present one. Obviously some pointed that this was a "financial crisis" and that according to Rogoff & Reinhart, recoveries are "naturally" slow and protracted. The graphs I showed were similar to the ones you post, with NGDP growth of close to 10% for a couple of years and decreasing when the "GM" path was reached. What is amazing was that the "GM" persisted despite Greenspan not having any idea that in practice he was "Targeting NGDP" along a level path!

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