The line’s fine between credit booms and busts

THE Bank of England’s current monetary policy rule is inflation targeting – they use the tool of interest rates (and more recently quantitative easing) to target a particular level of consumer price inflation (2 per cent). This is common practice among contemporary central banks, but the continued lack of recovery has meant that people are questioning its validity.

Rather than target inflation, some economists argue that the central bank should target nominal GDP (NGDP), which is the price level multiplied by real output. The idea is that they choose a particular target level of growth and then adjust monetary policy in order to reach it. If 2 per cent inflation is seen as fairly typical, and the trend rate of growth for real GDP to be about 3 per cent, then an NGDP target of 5 per cent would be appropriate.

I’ve previously argued in this column that the Bank of England might already have replaced its price level target with an NGDP one, and there is evidence that more and more central banks are taking NGDP targeting seriously. But its advocates would point out that the target should be a path, not a growth rate. In other words if NGDP has been below 5 per cent for several quarters it should grow by more than 5 per cent until it catches up to where it would have otherwise been.

In our current quarterly report, Kaleidic Economics (a London-based business roundtable that I organise) has highlighted the dangers of choosing the wrong level, (you can read the full report here:

The chart shows “money GDP” from 1997-2016. If NGDP grew at 5 per cent per year it would follow the path of the red line. The actual NGDP (including admittedly dubious official forecasts) is shown in blue. It is clear how NGDP rises at a higher rate in the early 2000s until the credit crunch and recession pushes it significantly below trend. Although it is growing again the fact that the blue line remains consistently below the red line shows evidence of an “output gap” that some economists are wont to close through additional quantitative easing.

But consider the green line, showing a slightly lower NGDP level target of 4.5 per cent. If we chose this as our trend line, rather than 5 per cent, it points to an even bigger inflationary boom prior to 2007 but also that future monetary policy is expected to be re-inflating it.

In other words, even if you believe that NGDP level targeting is appropriate, you still need to choose a level. And it may be the case that the economist’s benchmark is a permanent inflation.

Anthony J. Evans is associate professor of economics at ESCP Europe Business School. His website is, and you can email him at