- | Monetary Policy Monetary Policy
- | Policy Briefs Policy Briefs
- |
The Neutral Level of NGDP and the NGDP Gap: Q1 2021
By way of comparison, the Congressional Budget Office (CBO) output gap reveals that the real economy was 2.13 percent smaller than its true potential in the first quarter in 2021 (see table). Also, relative to the previous quarter, actual NGDP grew by 2.58 percent (10.72 percent on an annualized basis) over the same period. NGDP growth in the first quarter of 2021 was up compared to the previous quarter but still needs additional gains to close the negative NGDP gap.
A Closer Look at the NGDP Gap
As noted, the NGDP gap requires an estimate of the neutral level of NGDP. The neutral level of NGDP is estimated by taking an average forecast of NGDP, or equivalent total nominal income, for a given quarter based on forecasts for that period from the preceding 20 quarters. The forecast data used here are taken from the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters.
The NDGP gap measures the percentage difference between this average forecast and the actual level of NGDP. If the actual level of NGDP is less than the neutral level, then monetary conditions are contractionary. If actual NGDP is greater than the neutral level, then monetary conditions are expansionary.
The rationale for this understanding is twofold. First, members of the public make many economic decisions, such as whether to take out a mortgage or a car loan, on the basis of forecasts of their nominal income. Similarly, firms may finance with debt and commit to multiyear contracts on plants, raw materials, and labor on the basis of forecasts of their nominal income. Second, actual nominal incomes may turn out to be very different from what are expected and, as a result, may be disruptive for households and firms that are not able to quickly adjust their economic plans. These disruptions can be avoided by maintaining total nominal income or NGDP on the growth path expected by the public. In other words, the Federal Reserve should aim to close the NGDP gap in order to keep monetary conditions neutral.
For more information on how the NGDP gap is constructed and how it may be used to understand policy, please see “The Stance of Monetary Policy: The NGDP Gap,” a policy brief by David Beckworth. Also, see the NGDP gap web page hosted by the Mercatus Center that provides access to current and vintage data on the NGDP gap.
Download the publication PDF.