Economists are famous for claiming that there’s no such thing as a free lunch.
Unfortunately (since I believe that is true), economists also think lots of things are free lunches. For example, I’ve written that the mainstream theory of free trade is that it is a free lunch, despite historical evidence that the effects of free trade are more nuanced.
The internet overflows with commentary from economists on how to run a central bank. One thing seems clear: mainstream economists seem to believe that running a central bank that borrows in a currency and prints the same currency is a free lunch.
If you print the stuff that your debts are issued in, you don’t really have debts do you? At least that’s the theory. Free debts for all! And since debts are just money that we print, we can have free money for all!
Prosperity ensued. Er, not exactly.
There has been at least one constraint on this free lunch for a while. The constraint has been that everyone agrees that too much money printing leads to inflation and that once inflation gets started, it’s very difficult to stop. IMHO, if everyone stops believing this, we’re screwed.
(Incidentally, I was looking around and I can’t find any discussion of whether it would be harder to stop inflation in modern welfare states. For example, the US debt/GDP is about 100% today. When Paul Volcker stopped inflation in the ’70s, the same ratio was around 30%. Today, if interest rates were pushed up to 18% to fight inflation, USG would almost certainly be unable to pay it’s debts as interest payments would surge – this was not really a concern in the ’70s when the amount of debt was much lower. Could we even fight inflation anymore?)
This brings us to the economic topic du jour: NGDP targeting. Modern central banks are supposed to keep inflation low and (sometimes) keep unemployment low. As discussed above, the main constraint on money printing is that once you start it’s hard to stop. Central banks therefore want to err on the side of keeping inflation in check. At least until a new academic theory came along.
As I see it, NGDP targeting is designed to remove this final constraint on printing money. Instead of targeting a low rate of inflation, NGDP targeting says you should target a level of NGDP. NGDP is GDP unadjusted for inflation. So, let’s say last period’s GDP is 100 and this period’s GDP is 90. NGDP targeting would direct the central bank to print money until this period’s GDP was 100. Until that point, the central bank should ignore the actual level of inflation.
(NGDPers don’t say how the central bank will do this beyond saying that it will "buy stuff" which seems woefully inadequate to me, but it apparently makes sense to them, so we’re all good.)
Note that this allows you to print a huge amount of money. Theoretically, you’d want inflation to be 10% in one period if there was a big drop in GDP.
What happens when everyone stops believing that once inflation gets started it will be hard to stop?
My guess is that the results won’t be pretty.