Evan Soltas
Jun 4, 2012

Israel Targets NGDP

Shh...Don't look now, but Stanley Fischer, who has run the Bank of Israel since 2005, is targeting the level path of nominal GDP.What gives the Bank of Israel's NGDP level target away, to me, is the temporary increase in inflation in 2008 and 2009, which cancels out the slowdown in real growth such that NGDP growth is constant through the recession, and the tendency of monetary policy to correct for past errors to maintain a 6.5 percent year-over-year growth path; see the swing between 2006 and 2007. As real growth has slowed since the first quarter of 2011, inflation has been allowed to rise.

The idea that Israel may now be pursuing a de facto NGDP target is very exciting -- more real-world examples of the policy are needed, especially since the Bank of England has fallen off the bandwagon. Even better, Fischer has written several papers about monetary policy in which he appears more than a little sympathetic to the idea:

"It is also generally agreed that in the long run monetary policy should play a stronger role in the economy, with perhaps explicit adoption of monetary growth targets." ("The Inflationary Process in Israel," NBER, 1984)
"In the short run, monetary policy affects both output and inflation, and monetary policy is conducted in the short run--albeit with long-run targets and consequences in mind. Nominal- income-targeting provides an automatic answer to the question of how to combine real income and inflation targets, namely, they should be traded off one-for-one...Because a supply shock leads to higher prices and lower output, monetary policy would tend to tighten less in response to an adverse supply shock under nominal-income-targeting than it would under inflation-targeting. Thus nominal-income-targeting tends to implya better automatic response of monetary policy to supply shocks...I judge that inflation-targeting is preferable to nominal-income-targeting, provided the target is adjusted for supply shocks." ("Central Bank Independence Revisited," AER, 1995)
If the Bank of Israel is indeed de facto targeting the path of NGDP under Fischer, the results are impressive. The Israeli unemployment rate, over 9 percent when Fischer took charge, stands just above 5 percent today, having only increased 2 percentage points -- from 6 to 8 -- during the most recent recession, and the labor market recovery post-recession was swift. Civilian employment grew right through the recession.

Private final consumption expenditures were barely dented by the recession and quickly returned to their path, as have total retail sales. Manufacturing or industrial production has also grown steadily, without the pronounced unit-root drop seen in other developed nations whose central banks target the rate of inflation. (If anything, it seems that Israel's construction sector is growing a little too fast.)

Israel is a shining example of how successful monetary policy is at macroeconomic stabilization when it targets NGDP.