The Best of Rules and Discretion: A Case for Nominal GDP Targeting in India

Pranjul Bhandari and Jeffrey Frankel

No 284, CID Working Papers from Center for International Development at Harvard University

Abstract: The recent revival of interest in nominal GDP (NGDP) targeting has come in the context of large advanced economies. We argue that the case for NGDP targeting is even more appealing for mid-sized developing countries, because they tend to be more susceptible to supply shocks and terms of trade shocks. For India, in particular, one major exogenous supply shock is the monsoon rains. NGDP targeting splits the impact of supply shocks automatically between inflation and real GDP growth. In the case of inflation targeting (IT), by contrast, the full impact of an adverse supply shock or terms of trade shock is felt as a loss in real GDP alone. NGDP targeting arguably achieves the best of both worlds: it automatically accommodates supply shocks as most central banks with discretion would do anyway, while retaining the advantage of anchoring expectations as rules are designed to do. We outline a simple theoretical model and derive the conditions under which an NGDP targeting regime would dominate other regimes such as IT for achieving objectives of output and price stability. We go on to estimate for the case of India the main parameters needed to ascertain whether these conditions hold, most notably the slope of the aggregate supply curve. We find that under certain plausible conditions, nominal GDP targeting is indeed better placed than IT, especially in the face of the supply shocks that developing countries tend to experience.

Keywords: Central Bank; Developing; Emerging Markets; GDP; Income; India; Inflation; Monetary Policy; Monsoon; Nominal; Shock; Supply; Target; Terms of Trade (search for similar items in EconPapers)
JEL-codes: E52 F41 (search for similar items in EconPapers)
Date: 2014-07
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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