Thread by @MacRoweNick

Short thread on "automatic stabilisers"
(properties of a policy regime that reduce the effect of shocks (especially AD shocks), even before the policymakers observe that shock, respond to it, and their response offsets the shock).

We need "automatic stabilisers" because of lags.

Fiscal policy regimes can have automatic stabilisers.

Monetary policy regimes can have automatic stabilisers too.

But if I say "automatic stabilisers", you are probably thinking "fiscal policy" (stuff like unemployment insurance and progressive taxes), and not "monetary policy", right?
I wonder why that is?
The same concept applies to *both* fiscal and monetary policy regimes.

The automatic stabiliser properties of a monetary policy regime depend on 2 things:
1. Which instrument? (Because that's what stays constant until the CB responds to the shock.)
2. Which target? (Because that's what people expect to stay constant despite the shock.)

Targets:
Inflation Target: people expect shocks to inflation to be temporary not permanent.
Price Level Target: people expect shocks to price level to be temporary not permanent.
NGDP Target: people expect shocks to NGDP to be temporary not permanent.

It's understood that a Price Level Target is a stronger automatic stabiliser than an Inflation Target.
(Because expected inflation moves in the right direction, to move expected real interest rates in the right direction, for a given nominal interest rate.)

What's less understood (I think) is that the automatic stabiliser properties of an NGDP Target are qualitatively different from those of a Price Level Target.

We can decompose shocks to NGDP into:
1. shocks to Price level
2. shocks to RealGDP
(Relative magnitudes of P shock vs RGDP shock depends on slope of Short Run Phillips Curve.)

For the P shock part of an NGDP shock, the automatic stabilisers of an NGDP Target work the same as those of a Price Level Target. Via real interest rates.
But for the RGDP shock part of an NGDP shock, it's a totally different mechanism. Via expected future income & sales.

And ISTM that makes an NGDP Target a stronger & more reliable automatic stabiliser that a Price Level Target.
An NGDP target's automatic stabiliser is less reliant on the slope of the SRPC and real interest-sensitivity of expenditure.

An NGDP Target works as an automatic stabiliser because households' and firms' consumption & investment depend on expected future (nominal) income & sales.
You get a smaller multiplier & accelerator if NGDP shocks are expected to be temporary not permanent.

Anyway, I'm old & retired, so I'm gonna stop there.
Time for you young people to do all the work, and figure it out properly.