The alternative explanation as- private capital formation (see References Federal Reserve Bank of Cleveland ISSN 0428·1276 sumes that wage- and price-setting box). Without complementary poli- Fellner, William. Towards a Reconstruction May 21,1984 institutions have an inflationary cies, it is doubtful that a decelerat- of Macroeconomics: Problems of Theory and Policy. Washington, DC: American bias. This bias arises because labor ing target path of nominal income Enterprise Institute, 1976. markets adjust slowly to changes could be achieved over a period Gordon, Robert]. "Using Monetary Control in economic conditions. Wage rates short enough for such a strategy to Dampen the Business Cycle: A New often fail to reflect the availability to be credible. Thus, if nominal Set of First Principles;' NBER Working of unemployed workers, either income trageting were to be a suc- Paper Series, No. 1210 (October 1983). Hall, Robert E. "Macroeconomic Policy because of established relation- cessful strategy during disinflation, under Structural Change;' Industrial ships between employers and their it would need to be part of an over- Change and Public Policy. A Symposium wor kers or because of a lack of all economic policy that included sponsored by the Federal Reserve Bank competitive pressure-sometimes a consistent set of micro- and macro- of Kansas City, Jackson Hole, WY: shielded by foreign trade barriers. economic reforms. Otherwise, the August 24-26, 1983. Meade, James. "The Meaning of 'Internal Some advocates of nominal income Federal Reserve would risk losing Balance' ," Economic Journal, vol. 88 targeting who hold this view of the credibility it has already estab- (September 1978), pp. 423-35. ating targets, and policy instru- the strategy of monetary policy- labor markets propose such target- lished with annual targets for Stein, Herbert. Agenda for the Study of ments. The ultimate goals of also provides a statement to the ing as part of a broader economic monetary and credit aggregates. Macroeconomic Policy. Washington, DC: Nominal Income economic policy-price stability public about the intent of policy in strategy that includes some form of Reducing inflation without unfor- American Enterprise Institute, 1982. and high-employment economic the period ahead. Tobin, James. "Stabilization Policy Ten Targeting labor-market reform or policies tunate labor-market consequences Years After," Brookings Papers on Eco- growth-are prescribed in the Full Intermediate targets, like ulti- that would lead to more competi- has proven to be extremely diffi- nomic Activity, 1, 1980, pp. 19-71. by John B. Carlson Employment and Balanced Growth mate goals, cannot be controlled tive behavior. "This involves in- cult. Without actually adopting ___ . "Monetary Policy: Rules, Targets, Act of 1978. Commonly called closely in the very short run. Con- creasing the power of the econom- nominal income targets, it would and Shocks;' Journal of Money, Credit In recent years prominent econ- Humphrey-Hawkins, this act re- sequently, the Federal Reserve also ically disenfranchised outsiders, be unwise to claim that the nomi- and Banking, vol. 15, no. 4 omists from diverse schools of quires the Federal Reserve to report establishes operating targets for var- (November 1983), pp. 506-18. whose availability for work has nal income target framework is Vo1cker, Paul A. "We Can Survive Prosper- thought have urged policymakers to Congress annual financial objec- iables that it controls closely, such little impact on the wages paid superior per se to any other mone- ity." Remarks at the Joint Meeting of the to establish long-term targets for tives-targets for monetary and as reserve aggregates. The operat- insiders or the prices set by their tary policy strategy. Nevertheless, American Economic Association- nominal income} The common aggregate credit growth-consis- ing targets provide guidance for employers" Tobin (1980, p. 66). nominal income targeting offers an American Finance Association, San thread that emerges from these pro- tent with these ultimate goals. the trading desk as it attempts to important advantage to policymak- Francisco, CA, December 28, 1983. posals is to extend the announced The reported monetary and credit achieve the intermediate targets Conclusion ers com pared with monetary aggre- policy horizon beyond one year, objectives are intermediate targets through open-market operations, The Federal Reserve has no direct gate targets alone, especially after thus clarifying the longer-run that provide guidance for policy a policy instrument. Operating authority over labor markets, disinflation has been achieved. Per- intent of policy. In this Economic action. While not themselves the targets must be reliably related to nor can it prevent trade barriers. haps one use of a nominal income Commentary, we describe the ultimate concern of policymakers, intermediate targets, just as inter- Neither does it choose the amount of guideline would be to serve as a current framework for monetary the behavior of the intermediate mediate targets must be reliably the economy's resources claimed by framework to explain adjustments policy and suggest that a multi- target variables provides informa- related to ultimate goals. The oper- government, a ratio that in part to monetary targets. year nominal income target could tion about the current and future ating targets thus provide imme- determines the rate of our nation's be viewed as a practical extension levels of economic activity. Having diate feedback as to the consistency of current policy procedures. To be intermediate targets is useful, of policy actions with achievement useful, a nominal income target for because the transmission of mone- of the intermediate objective. The monetary policy would need to be tary policy to ultimate policy targets specification of operating targets is credible and hence achievable over is slow and uncertain. Another sometimes called the tactic of mon- Federal Reserve Bank of Cleveland BULK RATE a reasonably predictable period advantage to using some interme- etary policy, to be distinguished Research Department U.S. Postage Paid of time. In this article we also iden- diate targets is that they can be from strategy (i.e., the specification P.O. Box 6387 Cleveland, OH tify some potential problems for observed more frequently than of intermediate targets). Cleveland, OH 44101 Permit No. 385 nominal income control, particularly ultimate goals and hence provide Since the fall of 1982, the oper- during periods of disinflation. more immediate feedback about the ating target has been discount- effectiveness of policy actions. If window borrowing. To achieve the Semantics of the intermediate targets are relia- targeted level of borrowings, the Monetary Policy bly related to ultimate goals, policy Federal Reserve conducts open- The current framework for mon- actions that attain intermediate market operations (the instrument) etary policy is hierarchical, defined target values will therefore be that directly change the level of in terms of ultimate goals, inter- compatible with ultimate goals. non borrowed reserves. Total re- mediate targets, short-run or oper- Specification of annual interme- serves not supplied by open-market diate target values-often called operations are created through

John••B. Carlson is a monetary economist at ••1. See Meade (1978), Tobin (1980, 1983), Stein the Federal Reserve Bank of Cleveland. Kim (1982), Fellner (1976), Gordon (1983), and Hall Kowalewski, Mark Sniderman, and Ed Stevens (1983). Gordon essentially advocates a final provided valuable comments throughout the prep- spending target. The various proposals also Address Correction Requested: Please send •• aration of this article. differ on whether to target levels or rates corrected mailing label to the Federal Reserve The views stated herein are those of the author of change, an issue that is not considered here. Bank of Cleveland, Research Department, and not necessarily those of the Federal Reserve P.O. Box 6387, Cleveland, OH 44101. Bank of Cleveland or of the Board of Gover- nors of the Federal Reserve System. discount-window borrowing. The That is, price stability is defined Nominal Income as are made for three or more years. effects on nominal income are much level of borrowings affects the in terms of the economic impli- a Policy Strategy When parties to these contracts fail less direct. Consequently, the time' Caveat Deficit to anticipate correctly the status horizon over which the Federal opportunity cost of funds and, in cations of expected price changes. Given the current framework for Another problem raised by opponents turn, the growth of several mone- Volcker 's concept stresses the future monetary policy, it is not surprising of nominal income targeting concerns of the economy in future years, they Reserve may be expected to control tary aggregates (intermediate tar- as opposed to the past and sug- that advocates of nominal income the composition of real output. Ideally. often are required to make adjust- nominal income reliably is consid- gets). The Federal Reserve believes gests the importance of anticipated targeting would seek the benefits policy makers seek to create an envi- ments in output that frustrate ered longer and more variable than its monetary growth paths are con- future influences on the economy, that might result from a credible ex- ronment that generates adequate incen- the goal of high-employment eco- it is for money. This does not, how- tives for saving and capital formation. nomic growth. Credible targets for ever, imply that the Federal Reserve sistent with price stability and high including economic policy. tension of the announced interme- New capital increases the capacity of employment (ultimate goals). This The Federal Reserve currently diate target horizon. Adoption of a the economy to produce, allowing addi- nominal spending could provide cannot strongly influence nominal policy is referred to as a monetary announces its monetary and credit nominal income target would seem tional output with less risk of infla- better indicators of the future income over periods of two or more aggregate strategy with a discount- objectives for at most 18 months a natural extension of the current tion. In principle. nominal income tar- status of the economy, particularly years. Furthermore, if the current window-borrowing tactic. ahead. The announcement-made hierarchical, multistage struc- gets would be chosen to accommodate concerning price stability, and monetary policy framework (or any sufficient demand over the longer term thereby improve public and pri- other framework) were effective in To summarize, the hierarchical by the chairman of the Federal ture for monetary policy decisions. to encourage capital formation. Other structure of monetary policy pre- Reserve to Congress in luly- Like the behavior of monetary government policies would also affect vate decision making. achieving enduring high-employment sumes imperfect, indirect, dynamic indicates preliminary intermediate measures, the behavior of nominal capital formation. For example. when Nothing inherent in choosing a growth with price stability, then it links between instruments and targets for the coming year. The income is easy to explain to the federal government expenditures claim nominal income target suggests simultaneously would achieve a ultimate goals. Targets, both oper- Federal Reserve is not obligated to public and to Congress. Multiyear a greater share of output. and hence the that it in fact would, or even nominal income target consistent resources used to produce this output, should, be achieved precisely in with these ultimate goals. ating and intermediate, are useful adopt those targets at the begin- nominal income targets thus could fewer resources are available for pri- only insomuch as they provide a ning of the next year if new infor- serve to aid the public in under- vate use. If the central bank maintained every specified year. As with the Nevertheless, achieving any standard against which the Federal mation indicates that the prelim- standing the intent of complex policy an unchanged nominal income target. current intermediate targets, nom- multiyear target during a period of Reserve can assess the actual be- inary targets are inappropriate. decisions. Because the economic then additional government spending inal spending is affected by deter- disinflation appears problematic. havior of the operating and inter- Thus, the specified policy horizon benefits of price stability depend on would come from either private con- minants beyond the immediate Empirical models are of little help sumption or investment. If such spend- and direct control of the Federal in suggesting how to formulate mediate variables. When these var- is interpreted as annual. the public's confidence that real ing displaced investment, then the iables deviate from their target To reduce uncertainty about and nominal values will be substan- future capacity of the economy would Reserve. Nor is there reason why a an optimum decelerating path for paths, the Federal Reserve system- price stability, it would seem useful tially the same over suitably long be reduced. nominal income strategy would nominal income. There are two atically will conduct open-market to specify intermediate targets and horizons, it is essential that the It is not clear that a higher nominal preclude the consideration of other common explanations for this prob- operations in a manner designed to perhaps policy objectives several public clearly understand the intent income target would resolve this prob- guides to policy action. lem. One view holds that the for- lem. As resources become fully em- mation of expectations about wages realign variables with target set- years into the future. For the targets of policy in terms of a nominal ployed. nominal income would approach tings. In pursuing its targets, the to be credible, however, they would variable over the longer term. its longer-run path. Raising (or even Qualifications and prices is essentially adaptive. Federal Reserve takes into account need to be adopted with an expec- Multiyear targets for nominal abandoning) the nominal income target Advocates of nominal income tar- Once the underlying rate of infla- all information, including behav- tation that there would be a high income need not be irrevocable. A may temporarily .attract additional geting propose it not as a panacea tion increases, the public eventu- ior of nominal income, relevant to degree of reluctance to revise them. high degree of reluctance implies resources into production. but prices but as a practical improvement ally expects inflation at the higher ultimately would accelerate. The prob- achieving high-income growth A major factor contributing to that targets should be revised lem is not one specific to nominal to current practice. If a nominal rate. Under this hypothesis, a dis- and price stability. revisions in monetary targets is (although infrequently) under jus- income targeting, but to any noninfla- income target were to serve any inflation policy affects price expec- unanticipated changes in velocity, tifiable circumstances. For exam- tionary monetary policy when govern- useful purpose, it must be credible. tations only after actual inflation Price Stability i.e., the ratio of nominal income to ple, nominal income targets might ment spending crowds out resources Thus, the Federal Reserve would slows. But, inflation slows only if Federal Reserve Chairman Paul A. money. Recent experience indicates be revised in the face of sizable available for private investment. need to achieve targeted values for economic growth slows relative to Volcker has defined price stability that the behavior of velocity is cur- supply-side shocks of the type nominal income in a reasonably potential growth of the economy, as "a situation in which expecta- rently not sufficiently reliable as experienced in the oil markets in only because of an unanticipated predictable amount of time. i.e., unemployment rises. Some tions of generally rising (or falling) a basis for a multiyear policy strat- 1973 and 1979, but not for more change in the trend of real output. Some opponents of nominal economists with this view argue prices over a considerable period egy using monetary aggregates. readily reversible shocks such as Credible policy-specified over income targeting argue that the that the appropriate long-run are not a pervasive influence on But, some observers have noted that those related to typical harvest a multiyear horizon-should reduce Federal Reserve lacks sufficient con- target for nominal income should economic or financial behavior. deviations from monetary targets variabilities. Advocates argue that uncertainty about future economic trol over nominal income to make it seek only to promote a rapid return Stated more positively, 'stability' since 1979 can be accurately inter- maintaining nominal income targets performance, especially when policy a credible target. Whereas Federal to the potential growth path. Such would imply that decision making preted as reflecting offsetting de- over multiyear horizons should is stated in terms well understood Reserve actions-open-market a target could be inconsistent with should be able to proceed on the viations in the velocity of money enhance the Federal Reserve's cred- by the public. Many public and operations and discount-window the ultimate goal of price stabil- basis that 'real' and 'nominal' from its trend.' This experience ibility in controlling inflation. If private decisions are based on as- policies-directly affect deposito- ity as it has been defined, if the values are substantially the same suggests velocity-adjusted monetary controlling inflation were the only sumptions about future policy. ries that supply money and credit, current underlying inflation rate over the planning horizon-and targets would be a reliable strategy. ultimate objective, a nominal in- Contracts, particularly labor con- is substantial.' that planning horizons should be Conceptually, a velocity-adjusted come strategy would imply that the tracts and fixed-yield securities, suitably long" (Volcker 1983, p. 5). monetary target is indistinguishable intermediate target would be revised from a nominal income target.

••2. See Karen N. Horn. "Monetary Policy in the 3. Furthermore, many economists do not accept case, the wide divergence of views militates ••the hypothesis of adaptive expectations as an against choosing a credible path for nominal 1980s;' Economic Commentary, Federal Reserve Bank of Cleveland, February 27, 1984. adequate basis for forming price expectations. income that assumes inflation expectations are The sharp drop in wage settlements during the simply the current actual rate. past two years may indicate that price expecta- tions have been revised downward by more than adaptive expectations models suggest. In any