Rather than sweating over complex institutional reform to break ZLB, raise inflation target

Postscript to the previous post on the ZLB.

The practical challenges of devising watertight legal reform to eliminate cash and its near substitutes, both currently invented and yet to be, or to reform them so that a variable negative interest rate can be set, seem like a tall order.

Much easier is simply to raise the inflation target, as suggested previously by Olivier Blanchard, Krugman and others.  Perhaps by 2 percentage points.  To be done when interest rates would otherwise – under the old target – lifted clear enough of the zero bound that the new target can be achieved within a realistic time frame.  And perhaps reviewed at low frequency as evidence on changes in the natural rate accumulates.

Higher inflation imposes extra costs on the economy as the private sector struggles to insulate themselves from it.  And hits the poor hardest, since they are typically less adept at indexing themselves.

But then part of this cost – erosion of the value of money – is imposed by negative rates anyway.

And to conclude with a rather woolly argument, though felt keenly myself, higher inflation would be a much easier thing to explain and communicate than innovative, invasive reform of monetary institutions that not all on the econosphere grasp readily.   And being more easily communicable, I conjecture that it would be easier to build a lasting constituency for higher but stable inflation.

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4 Responses to Rather than sweating over complex institutional reform to break ZLB, raise inflation target

  1. Benoit Essiambre says:

    Yes! And I disagree that it hurts the poor as it makes more and better jobs available to them. If it happens too unexpectedly, it could hurt those who have contractual assets priced in money who didn’t take the higher rate into account when they negotiated. This should be done in gradually and in the open so that contracts can be negotiated accordingly.

  2. JP Koning says:

    Your point makes sense for countries not yet at the zero lower bound. But for countries like Europe, Japan, and the US that are already at the zero lower bound, how do they make the new and higher inflation target credible? Expanding the money supply won’t get them to their target, the interest rate on reserves cannot be reduced (much), and promising to keep interest rate on reserves too low in the future may not be believed. For countries already at zero, something like Miles Kimball’s cash storage fee may be the only option.

    • Tony Yates says:

      Yes, I agree. I have said in these posts, and earlier, that the higher target should be set for when there would otherwise have been ample clearance from the zero bound. But right now, I’d prefer extra stimulus, of which there can be a great deal more, than any messing with the zero bound.

      • Benoit Essiambre says:

        So you people don’t believe in the expectation channel at all? The central bank announces a higher target. Don’t you think people will tend to move out of cash in preparation for when its devaluation comes? Doesn’t this alone raise inflation?

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