Wednesday, March 18, 2009

Is the BoE reading the Money Illusion

I was reading the March BoE minutes when I came across the following statement:
"There was a high degree of uncertainty over the appropriate scale of purchases
necessary to keep inflation at target in the medium term. The Committee noted
that their February Inflation Report projections suggested that a significant
shortfall in nominal GDP was possible over the forecast period. Nominal GDP had
grown by, on average, around 5% since the inception of the MPC – a period over
which inflation had been close to the target on average. In contrast the
Committee’s February projections implied a small decline in nominal GDP in 2009,
with growth remaining below 5% in 2010. Therefore the projections suggested a
shortfall in nominal GDP of at least 5%."

The BoE is basically saying that they chose the amount of assets to purchase under the APF by figuring the gap of nominal GDP relative to the historical average. Since nominal GDP in 2009 will be close to 0% and the average is 5%, they should buy assets equal to 5% of GDP. Barclays has already noted (in MPC Watching) some of the problems with this methodology (like the money multiplier), but I was struck at how similar this is to Scott Sumner's nominal GDP targeting idea. You usually don't hear central banks talk about nominal GDP gaps.

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