Clarida on price level targeting

David Beckworth directed me to a Richard Clarida speech from a few months back:

Five features of the new framework and September FOMC statement define how the Committee will seek to achieve its price-stability mandate over time:

1. The Committee expects to delay liftoff from the ELB until PCE (personal consumption expenditures) inflation has risen to 2 percent on an annual basis and other complementary conditions, consistent with achieving this goal on a sustained basis and to be discussed later, are met.4
2. With inflation having run persistently below 2 percent, the Committee will aim to achieve inflation moderately above 2 percent for some time in the service of having inflation average 2 percent over time and keeping longer-term inflation expectations well anchored at the 2 percent longer-run goal.5
3. The Committee expects that appropriate monetary policy will remain accommodative for some time after the conditions to commence policy normalization have been met.6
4. Policy will aim over time to return inflation to its longer-run goal, which remains 2 percent, but not below, once the conditions to commence policy normalization have been met.7
5. Inflation that averages 2 percent over time represents an ex ante aspiration of the FOMC, but not a time-inconsistent ex post commitment.8

The first point is defensible, as long as “expects” means expects, but the explanation Clarida provides later is a bit fuzzy on this point:

First element
A policy that delays liftoff from the ELB until a threshold for average inflation has been reached is one element of a TPLT strategy. In our September FOMC statement, we communicated that, along with other complementary conditions, inflation must have risen to 2 percent before we expect to lift off from the ELB. This condition refers to inflation on an annual basis. TPLT with such a one-year memory has been studied using stochastic simulations of the Fed’s FRB/US model by Bernanke, Kiley, and Roberts (2019).

Now “expects” becomes “must have risen to 2 percent before we expect to lift off”. (Note TPLT is temporary PLT, and ELB is the effective lower bound on interest rates, roughly zero.)

So why is this bad? Because I worry that people will focus on the “must”, and not the “expect”.

But haven’t I been saying that central banks need to make firm commitments about monetary policy? Yes I have, but interest rates are not monetary policy; they are a tool of monetary policy. The commitment should be to set the policy tools at whatever level is necessary in order to be expected to reach the policy goal.

After a period of disinflation, the Fed needs to commit to keeping the fed funds target below the natural rate of interest as long as necessary to assure that it expects to achieve the desired make-up inflation. But that does not necessarily mean it must keep the target rate at zero; it depends what is happening to the natural interest rate.

As a practical matter, this may not matter very much in the near term, as inflation is so well anchored that I’m not particularly concerned about an overshoot. But monetary policy should be forward looking and one can imagine scenarios where a low rate commitment becomes highly inflationary.

For instance, in 1949 and 1950 the inflation rate averaged zero. At the time, the Fed was committed to a low interest rate policy. In 1951 inflation shot up to 7.9%. Not surprisingly, in 1951 the Fed reached an agreement with the Treasury Department that ended its commitment to keeping interest rates very low.

I don’t see any 1951 scenarios on the horizon (the Korean War raised the natural interest rate in 1951), but this is why Clarida should emphasize “expects” rather than “must”. I’d prefer a commitment to set rates at a level that insures an average inflation rate of 2%, then let the markets decide what interest rate path will achieve that objective. Better yet, target market forecasts of 4% average NGDP growth.

Point 5 is a bit perplexing, but if Clarida is nodding to the Fed’s dual mandate then it’s acceptable.

For example, the Fed might want to use core inflation as an intermediate target. Because deviations between core and overall inflation are not forecastable ex ante, a policy that is expected to produce 2% core inflation, on average, will also be expected to produce 2% headline inflation, on average. And it’s OK if any core/headline deviations are not trend reverting, as the Fed’s dual mandate suggests that it should also care about unemployment. (Of course in this case they should probably just target core inflation.)

But . . . and this is very important . . . any flexibility should be symmetrical. Thus if you allow positive (and permanent) oil price shocks to permanently move the price level a bit higher, then you should allow negative (and permanent) oil price shocks to permanently move the price level a bit lower than the previous trend. Flexibility should not lead to a policy that is expected to produce above 2% headline inflation, on average.



28 Responses to “Clarida on price level targeting”

  1. Gravatar of Joshua Miller Joshua Miller
    15. January 2021 at 12:22

    I will confess this comment is unrelated to this specific post, but I wrote an article recently advocating for nominal GDP targeting. Your work was of enormous help in my research. Keep doing what you do! Here is the article:

  2. Gravatar of Clarida on price level targeting – FX Journo Clarida on price level targeting - FX Journo
    15. January 2021 at 12:48

    […] Original Article […]

  3. Gravatar of marcus nunes marcus nunes
    15. January 2021 at 13:55

    Clarida and the Fed have no idea about what a level target means. If they did they wouldn´t have chosen PLT (desguised as AIT).

  4. Gravatar of Garrett Garrett
    15. January 2021 at 16:59

    That last paragraph is worrying. Hopefully the 2030s and 40s aren’t just the 1960s and 70s again

  5. Gravatar of Thomas Hutcheson Thomas Hutcheson
    16. January 2021 at 02:59

    Should only supply shocks change the price level trajectory?

  6. Gravatar of Michael Sandifer Michael Sandifer
    16. January 2021 at 03:08

    Good advice on how the Fed should deal with negative oil price shocks. It’s truly striking how much influence such shocks have had on our economy, particularly since the Fed started compounding the problem with inflation targeting.

    Almost all US recessions in recent decades involved such a shock.

    Also, note the timing of the shock that began in the early 2000s. How much of the productvity slowdown since can we really attribute to demographics or shifts to a service economy in light of this? I think demographics are a factor, but are overrated as such.

  7. Gravatar of Postkey Postkey
    16. January 2021 at 03:49

    “Hopefully the 2030s and 40s aren’t just the 1960s and 70s again”

    ‘We’ may wish they were?

    “ . . . our best estimate is that the net energy
    33:33 per barrel available for the global
    33:36 economy was about eight percent
    33:38 and that in over the next few years it
    33:42 will go down to zero percent
    33:44 uh best estimate at the moment is that
    33:46 actually the
    33:47 per average barrel of sweet crude
    33:51 uh we had the zero percent around 2022
    33:56 but there are ways and means of
    33:58 extending that so to be on the safe side
    34:00 here on our diagram
    34:02 we say that zero percent is definitely
    34:05 around 2030 . . .
    34:43 need net energy from oil and [if] it goes
    34:46 down to zero
    34:48 uh well we have collapsed not just
    34:50 collapse of the oil industry
    34:52 we have collapsed globally of the global
    34:54 industrial civilization this is what we
    34:56 are looking at at the moment . . . “

  8. Gravatar of Spencer B. Hall Spencer B. Hall
    16. January 2021 at 06:30

    re: “keeping the fed funds target below the natural rate of interest as long as necessary to assure that it expects to achieve the desired make-up inflation”

    The Taylor Rule has already been denigrated. Interest is the price of loan-funds, viz., the price of credit; on the other hand, the price of money is the reciprocal of the price-level. Chairman Powell just errored by guaranteeing that, by dismissing in the longer-run, the legal distinction between deposit classifications (gated vs. un-gated accounts).

    What’s behind the recent surge in the M1 money supply? | FRED Blog (

    Obviously aggregate monetary purchasing power cannot measured by the level of market clearing rates. M*Vt = AD or our means-of-payment money times its transaction’s velocity.

    Interest rates may either rise or fall during the short-run, in response to FOMC policy, depending upon #1) the “arrow of time”, and #2) the monetary fulcrum (the thrust of inflation).

  9. Gravatar of Spencer B. Hall Spencer B. Hall
    16. January 2021 at 07:07

    re marcus nunes’ summation: “Nominal stability means a stable growth of aggregate nominal spending (NGDP). To get that result, it must be that money supply growth closely offsets changes in velocity (the inverse of money demand).”

    AD (≠) N-gDp. AD = M*Vt. Rates-of-change in monetary flows, volume times transactions’ velocity, equals roc’s in all physical transactions P*T in American Yale Professor Irving Fisher’s truistic: “equation of exchange” where N-gDp is both a subset and proxy. Roc’s in R-gDp have to be used, of course, as a policy standard, as the scientific nominal anchor.

    Economists will never “money demand” right because they don’t know the difference between money and liquid assets, between a debit and a credit. To understand that is to understand why Dr. Philip George’s equations work: “When interest rates go up, flows into savings and time deposits increase” ( the ratio of M1 to the sum of 12 months savings ).”

  10. Gravatar of Spencer B. Hall Spencer B. Hall
    16. January 2021 at 07:31

    re Beckworth: “So, how would you reconcile what appears to be a ratcheting up of central bank balance sheets.”

    Economists just don’t get it. Banks don’t loan out deposits. Deposits are the result of lending. The larger the volume of saved bank deposits, the slower the velocity of circulation.

    In 1961 economists thought that the residual ungated bank deposits would offset the gated deposits (essentially interest bearing). That was true up until 1981 (the apex in the evolution of the monetization of time deposits).

    It’s just that the Japanese save more, keep more of their savings impounded in their payment’s system.

  11. Gravatar of David S David S
    16. January 2021 at 08:08

    Garrett might turn out to be right, but I’ll argue consistently against a build-up to stagflation in the next several decades because so many workers now are paid subsistence wages. What bargaining power do Amazon delivery workers have?

    If we can avoid a war and keep immigration positive for the next few decades we can avoid the 1970’s and turning into a Japan. And it would probably help to have some NGDP inspired guardrails for monetary policy.

  12. Gravatar of ssumner ssumner
    16. January 2021 at 10:26

    Thanks Joshua, That’s a very good article.

    Marcus, Thanks, I like that Poole quote.

    Thomas, Yes, I think so.

    David, I mostly agree, although we might get a modest wage shock if a $15 minimum wage is enacted.

  13. Gravatar of Dan Dan
    16. January 2021 at 12:29

    Given that a $15 minimum wage seems likely (if not now, then sometime in the next 2 to 4 years), perhaps the Fed should be shooting for 5% inflation for the next while. Make money illusion work for all of us!

  14. Gravatar of Gene Frenkle Gene Frenkle
    16. January 2021 at 14:46

    Dan, I would tend to agree with Marco Rubio that our primary focus should be increasing disposable income for parents with young children. So Biden does that by increasing the CTC and make it fully refundable. I would wait a little while to see how Florida is impacted by the $15 minimum wage although it is phased in so it will take a few years to see its full impact. So I thought the Obamacare Medicaid expansion could have had negatively impacted the job market but because some states chose to expand and other chose to not expand everyone saw that the Medicaid expansion had very little impact on the job market—in 2021 Americans want good jobs with benefits and younger Americans continue to move in big numbers to states that haven’t expanded Medicaid like Texas and Florida and NC and SC and TN.

  15. Gravatar of Ray Lopez Ray Lopez
    16. January 2021 at 17:16

    Ship of Fools this site is…

    FYI re Nunes, how smart can this guy be if he hired Ben Cole as a writer? Further, a data series needs at least 30 independent points to have an error rate of less than about 5%, and more like 300 or more if the system is not Gaussian, like the stock market is not. Graphs going back to 1990 to prove something are weak, though I did like Nunes’ “monetary regimes” graph as a mnemonic. Re Spencer B. Hall, the Equation of Exchange is nothing more than a tautology. It is backward looking. As a savant once criticized Sumner, you cannot prove anything with a backward looking tautology. Money is largely everywhere and always neutral (except maybe in hyperinflation). Re Postkey, the link interview was slow and for slow people. Something about Hubbert’s Peak.

    Am I the only smart fellow here? Seems so.

  16. Gravatar of Postkey Postkey
    17. January 2021 at 01:32

    “Re Postkey, the link interview was slow and for slow people. Something about Hubbert’s Peak.”

    Play the wo/man, not the ball? Very smart?

  17. Gravatar of rayward rayward
    17. January 2021 at 07:07

    A reminder: during the pandemic, personal income spiked while spending (on services but not stuff) tanked, the difference reflected in a surge in savings (a 173% increase from 2019, with a spike in the savings rate of 33.7% in April, the highest since 1959). Where is all that savings? Currency in circulation is up by 14% since April, commercial bank deposits are up by 19% since March, and increased investment in the stock market has resulted in a 16% rise in the S&P 500 for 2020 and a sharp rise in home prices. What if, in response to the distribution of the vaccines and the end of the public health crisis, what happened in 2020 is flipped, the savings rate turns negative, and consumers go on a spending binge? How will the Fed respond to a sudden surge in inflation, including in wages due to a labor shortage (e.g., it will take a while to get restaurant workers back on the job)? I mention this because all these projections for interest rates and inflation seem to ignore this. The problem is that the Fed may overreact to what is only a temporary rise in prices as the economy returns to “normal”.

  18. Gravatar of Gene Frenkle Gene Frenkle
    17. January 2021 at 11:02

    rayward, that is why Larry Summers opposes a $2k check delivered willy nilly. I also remember reading an interview with Summers in which a Keynesian was shocked when Summers dismissed orthodox Keynesian views on never ending unemployment benefits based on “empirical evidence” in the decades since Keynes’ death.

  19. Gravatar of Michael Sandifer Michael Sandifer
    17. January 2021 at 15:32

    Gene Frenkle,

    Yes, the way the unemployment benefits are structured does seem to slow the return to work for many. It is not the only such program. This was emphasized most by Casey Mulligan after the Great Recession, though I think it took some points too far.

    That said, coupled with the oil shock beginning in the early 2000s, which didn’t end until 2013 or 2013, could explain much of the fall in productivity over the period, though likely not all of it.

  20. Gravatar of Michael Rulle Michael Rulle
    18. January 2021 at 08:35

    As I understand the 2% inflation rate target, it is meant to be an average over time. So, for example, we should hope to observe some time frame look back period and inflation should be about 2%. But I don’t understand the desired path. I assume we want to keep it at a low variance to the target, while maintaining the target.

    I do not know how they are thinking of this in “rolling time frame terms”. I believe I understand the concept of targeting ‘expected” inflation and symmetry.

    But what is the method to determine if 2% is met over time? Meaning how do we determine success? 1 year rolling time? 3 year rolling time? Does variance matter?

    NGDP has the same issue from a measurement point of view.

  21. Gravatar of Gene Frenkle Gene Frenkle
    18. January 2021 at 10:11

    Sandifer, in searching for the Larry Summers quote about never ending unemployment possibly undermining the job market I came across a transcript of Ezra Klein interviewing Summers in January of 2014 in the WaPo. Now we know the strong economy started in Q2 2014 but in January 2014 Larry Summers was saying this:

    “In November, former Treasury secretary Larry Summers took the podium at the International Monetary Fund’s annual conference and delivered a speech that shook the economics world. The weak recovery, he hypothesized, isn’t just the hangover from the financial crisis. It’s evidence of a sickness that predated the crisis. Looking back over the last decade, he argued that the economy, even in the seemingly good times, has been incapable of creating enough demand absent bubbles or extraordinary stimulus. And that problem is getting worse by the day.”

    I definitely believe the dysfunctional economy of 2001-2008 was the product of an energy crisis, but the suboptimal economy of 2010-Q1 2014 was a little different because the engine of that economy was fracking (first for natural gas and then for oil), and the price of oil started dropping in Q3 2014 while the strong economy started before the price of oil started dropping. Btw, in 2000 the price of oil was an issue during the presidential campaign AND natural gas was expensive with the dot com bust and 9/11 delaying the inevitable energy crisis. And the big economic event that happened right after 9/11 was China entering the WTO in December 2001 and as someone watching the news during that time I believe Goldie Hawn of all people was one of the few voices of dissent about thinking China entering the WTO would be all “rainbows and lollipops”. So the price of oil was an issue before the Chinese economic boom…so everyone knew what was coming.

  22. Gravatar of Effem Effem
    18. January 2021 at 11:11

    Unrelated, but you seem like a good person to ask. How would you explain to a hypothetical “Econ 101” class that household net-worth increased significantly due to the pandemic? Clearly, loss of life and reduced activity cannot be additive to a nations wealth, yet the accounting suggests it was.

  23. Gravatar of ssumner ssumner
    18. January 2021 at 11:34

    Effem, Wealth can be considered the discounted expected future flow of consumption. The discount rate has recently dropped, which allows wealth to increase even as the expected future flow of consumption has not increased.

  24. Gravatar of Spencer B. Hall Spencer B. Hall
    18. January 2021 at 23:21

    re: “backward looking tautology”

    Ray Lopez, you’re an idiot. The equation of exchange is a forward looking, i.e., ex-ante extrapolation. The BCA almost had it right. Why? Because it employs the distributed lag effect of money flows. It meets all statistical causes and effects.

  25. Gravatar of Spencer B. Hall Spencer B. Hall
    18. January 2021 at 23:29

    “There are three kinds of lies: lies, damned lies, and statistics.”

    As Dr. Stephen A. DeLurgio taught me in 1979, See his book:
    “Forecasting Principles and Applications”, correlation sometimes depends upon distributed lag effects.

  26. Gravatar of Spencer B. Hall Spencer B. Hall
    19. January 2021 at 06:29

    re: ” It’s evidence of a sickness that predated the crisis.”

    It is a confusion of stock vs. flow (enclosure “Savings and Investment”), as explained by Dr. Leland Pritchard on Nov. 27, 1959 to Friedman from Carol A. Ledenham’s Hoover Institution archives of Dr. Milton Friedman). Friedman was Pritchard’s classmate at Chicago in 1932.

    Monetary savings have a zero payment’s velocity. Dr. Philip George’s equations confirm this, his “Corrected Money Supply”.

  27. Gravatar of Spencer B. Hall Spencer B. Hall
    20. January 2021 at 00:43

    re: “Because I define “money” as the monetary base, and because most base money is held as a store of value, I view that use as more important than the medium of exchange role.”

    How funny.

    Gresham’s law: “a statement of the least cost “principle of substitution” as applied to money: that a commodity (or service) will be devoted to those uses which are the most profitable (most widely viewed as promising), that a statement of the principle of substitution: “the bad money (IBDDs) drives out good (total checkable deposits)”.

  28. Gravatar of Michael Sandifer Michael Sandifer
    20. January 2021 at 03:04

    Gene Frenkle,

    Yes, Summers can be amazingly inconsistent in his public statements about macroeconomics.

    I recall people assuming Chinese growth in the early 2000s would drive up commodity prices, but don’t know why it was assumed that supply would be outstripped by demand. I didn’t look into at at the time.

    One thing that seems apparent though, since 1950, at least, oil price spikes, especially when frames as the ratio of the spot price over NGDP, has been a better predictor of US recessions than the inverted yield curve. It’ll be interesting to see how much that continues to be the case under vague average inflation targeting.

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