April 22, 2020

Measuring Monetary Policy: the NGDP Gap

The nominal gross domestic product (NGDP) gap is a new benchmark measure created by the Mercatus Center at George Mason University to determine whether monetary policy is expansionary or contractionary.

In order to create this measure, a neutral level of NGDP (the level at which NGDP is neither inflationary nor deflationary) is established by averaging the forecasts of nominal income for a given quarter from the preceding 20 quarters. These forecast data come from the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters.

The NDGP gap measures the percent difference between this average forecast and the actual level of NGDP. If actual NGDP is below the neutral level, then monetary policy is contractionary. If actual NGDP is above the neutral level, then monetary policy is expansionary.

The figure above illustrates the NGDP gap from 1997 to the present. In the second quarter of 2000, the NGDP Gap was 4.38 percent, which means that nominal income was 4.38 percent higher than expected and that monetary policy was effectively too easy. In the fourth quarter of 2008, the NGDP gap was −5.53 percent, which means that nominal income, therefore, was 5.53 percent less than the public expected it to be and that monetary policy was effectively too tight.

This measure is important for two reasons. First, people make many economic decisions based on forecasts of their nominal incomes. Examples include households’ decisions to take out mortgages and car loans or firms’ decisions to finance with debt and commit to multiyear contracts on plants, raw materials, and labor. Second, actual nominal incomes may turn out very different from what people expect and, as a result, may be disruptive for households and firms that are not able to adjust their economic plans quickly. These disruptions can be avoided by maintaining NGDP on the growth path expected by the public.

To ensure robustness, a data series is created using real-time actual NGDP data (which were revised later). This series is called the “vintage NGDP gap,” and it uses initial-release NGDP data for each quarter to construct an NGDP gap. In other words, it shows the NGDP gap policymakers would have seen in real time, given the initial NGDP data.

Each quarter, the Mercatus Center will update these series with the latest available data and provide a report for what the updates mean for monetary policy.

For more information on how the NGDP gap measures are constructed and how they may be used to understand policy, please see “The Stance of Monetary Policy: The NGDP Gap,” a policy brief by David Beckworth.

To download the data, click here.