What Is The Optimal NGDP Growth Rate?

I often get commenters asking my opinion on the optimal NGDP growth rate. This is a difficult question, which can be addressed from a number of perspectives.

Josh Hendrickson has a new policy brief at Mercatus, which advocates the “Friedman rule” for NGDP targeting.This would involve setting the growth rate for NGDP at a point where risk free short term interest rates would be close to zero and there would be no opportunity cost of holding currency. Because currency can be produced at near zero cost, economic efficiency suggests that nominal interest rates should be low enough that the public doesn’t waste resources trying to economize on the use of currency, which doesn’t pay interest.

I’d encourage people to look at Hendrickson’s policy brief, which is very clear and well written.For those who want a more technical analysis, Josh also has a Mercatus working paper.

I see two arguments for keeping NGDP growth low enough to insure near-zero nominal interest rates:

1. A low trend rate of NGDP growth minimizes the opportunity cost of holding currency, which (as mentioned above) is the rationale behind the Friedman rule.

2.A low rate of NGDP growth lowers the effective tax rate on capital income (interest, dividends, rents, capital gains, etc.) because in the US and most other countries the income tax applies to nominal capital income, not real capital income.(Ask me what happened when I sold my 2-family house in Newton MA, back in 2017.)Because capital income taxes are inefficient, faster NGDP growth discourages capital formation and slows economic growth.

I can see three arguments for slightly faster NGDP growth:

1. Faster NGDP growth reduces the risk of the zero bound problem with interest rates.I actually don’t think the zero bound is a problem, but as long as central banks are obsessed with interest rate targeting, the zero bound does make monetary policy a bit less effective.

2.Faster NGDP growth reduces the problem caused by money illusion, the reluctance of workers in declining industries to accept nominal wage cuts, even though they would be perfectly willing to accept the exact same real wage cut achieved via inflation.

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