Higher inflation target is preventative, not a cure

I had 3 comments on recent posts taking me as having recommended a higher inflation target now as a cure for the current zero bound episode.  That’s not my position.  A higher inflation target would help avoid the next episode, but probably not help this one.  The Fed, despite the options of talking down future rates and undertaking QE are still struggling to achieve their current mandate.  (And the same goes for the BoE, the ECB and other central banks too).  Raising the target now, without a means to exert the concerted stimulus to achieve it, may simply set the Fed up to fail.  One might speculate ‘off model’ that a higher target now would raise expected inflation all by itself, but, equally, if the Fed simply undershot this higher target for longer than it would undershoot the current target, that could undermine confidence in the Fed’s competence, or its honesty.  These views were made clear in a post back in May last year.

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6 Responses to Higher inflation target is preventative, not a cure

  1. Benoit Essiambre says:

    So if the fed already had a 4% target and there was a shock large enough that we still hit the ZLB, would you advocate for lowering the target to 2% in order to prevent “undermining confidence in the Fed’s competence, or its honesty”? Should Japan lower its target to something they can definitely reach to maintain credibility?

    Or why not raise the target to something sensible and then if the fed is not sure they can reach it in a timely manner, they can explain to people that they will do their best but there might be some variation in what is achievable in a short period of time with current conditions. You don’t think people are reasonable enough to understand?

    Isn’t it better to be in a world where there is a path to prosperity that we are not sure we can reach than in one where the central bank promised to block us before we get there?

  2. Benoit Essiambre says:

    Also have you considered that a too low inflation target may inhibit a large part of the effect of fiscal stimulus? The multiplier could be much higher with fiscal maneuvers if the inflation target was higher.

  3. The Fed is not struggling very hard to meet even its inflation target. If it were, it would not be cutting back on QE when average inflation has not returned to target (which is probably better thought of as a price level trend target.)

    An inflation target greater than 2% is probably needed, though because if there were a positive supply side shock that would otherwise push labor productivity growth above 2% the target would require real wage deflation to maintain full employment, That is one advantage of a, say, 5-6% NGDP target, that real growth could increase to the top without requiring deflation.

    • Benoit Essiambre says:

      I’m not completely sold on NGDP targets but the benefit of not “requiring inflation” comes from using a higher target not from going to NGDP.

      There is however an additional benefit to an ngdp target which is that if deflation happens, it will be in a period of unprecedented real growth, a time when deflation isn’t a problem and could even be positive by being an automatic redistribution of wealth instead of capitalists capturing all unexpected gains.

      • Benoit Essiambre says:

        [requiring deflation] *sight*

        But also a positive supply shock would lower prices without leading to generalized unemployment. I read that as negative supply shock. Words make me derp.

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