In a recent talk at the U.S. Monetary Policy Forum, Bank of Canada Governor Mark Carney argued that there wasn’t much to be gained from moving away from a low inflation target:
Finally, some have argued that an inflation target consistent with price stability is too low for a post-crisis world.
While the recovery is proceeding in crisis economies, it remains weak, particularly relative to the depth of the recession. This is consistent with the historical experience following financial crises. Indeed, it is only with justified comparisons to the Great Depression that the success of the U.S. policy response is apparent.
Read that last line several times, and just think about what he is actually saying. Do you feel better now?
As Woodfordian logic would have it, a key appeal of NGDP-level targeting is that by compensating for past deviations from desired levels–i.e., by introducing more dependence on history–it would better harness the power of expectations to stabilize the economy.
In normal times, these greater stabilization benefits are not likely to be particularly important. As part of the work leading to the renewal of our inflation control agreement, the Bank of Canada analysed the benefits of price-level targeting (PLT) which, like nominal GDP targeting, is a way to introduce history dependence. Our research shows that, apart from lower bound episodes, the gains from better exploiting the expectations channel are likely to be modest.
Hence the title of this post. Bill Woolsey pointed me to this gem:
In addition, under NGDP-level targeting, the central bank would seek to stabilize the GDP deflator in order to achieve price stability. But the GDP deflator measures the price level of domestically produced goods and services, which may not match up well with the cost of living that the CPI measures and that matters most for welfare, particularly in small, open economies where imports make up a substantial share of the consumption basket.
Looks like we need to modify our textbooks where they cover the “welfare costs of inflation.” Now we need to add: “Stuff costs more when people go shopping.”
Just so I don’t come across as too negative, let me congratulate the Canadians for avoiding the iceberg that we struck, and for successfully managing a flexible inflation targeting regime for several decades. I still think NGDP targeting would be slightly better for Canada, but concede it’s a close call. So there’s always the “if it ain’t broke don’t fix it” argument. But for America it’s not even a close call. We are doing significant fiscal stimulus that is highly costly (such as the payroll tax cut) precisely because our monetary policy regime is widely seen as producing inadequate nominal expenditure. In America it is broke. We are likely to hit many more zero bounds, as the Wicksellian equilibrium real rate seems to have shifted to a permanently lower level in this century. And yet the Fed still doesn’t seem to understand that fact.