On the Welfare Implications of Nominal GDP Targeting

Abstract

This paper examines the welfare implications of Nominal GDP level targeting (NGDP-LT), Nominal GDP growth rate targeting (NGDP-GT), Taylor rule and inflation targeting within a New Keynesian DSGE model. The paper finds that the ranking of policy rules depends on the measure of welfare, the degree of price stickiness and households’ risk aversion. In general, NGDP-GT is either the preferable policy or the second-best regime. NGDP-LT and a traditional Taylor rule are dominated by NGDP-GT in the policy pool. Specifically, when using consumption equivalence as the welfare measure, inflation targeting outperforms other policy rules regardless of the levels of the price stickiness or households’ risk aversion. NGDP-GT is proved to be the second-best regime. When using weighted sum of variances of inflation and output gap as the standard, the article finds no conclusive ranking. But when NGDP-GT is proved to be the best policy, inflation targeting turns out to be the least desirable regime. This paper contributes to the literature by employing two welfare measures to examine policy regimes more comprehensively; meanwhile, the simulation result renders as solid evidence to policy makers in the advantage of nominal GDP growth targeting.