Some thoughts on Selgin’s productivity norm

Now that George Selgin has placed his almost legendary “Less Than Zero” essay online, I thought it was a good time to discuss his ideas.    I’m going to nitpick a few points, so it might be useful to first lay my cards on the table—do I support the productivity norm or not?
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Support for the Thompson/Selgin approach to monetary policy

David Stinson recently sent me an interesting article on monetary economics written by Peter Howitt.  The author reminds me of people like Nick Rowe and David Laidler, as he can be sympathetic to mainstream new Keynesian ideas, but also understands the importance of older monetarist traditions.  The entire paper is worth reading, but this passage on page 22-23 caught my attention:

Moreover, it is not just the policy makers that are learning from monetary theorists. Often the conduct of monetary policy is way ahead of the theory, and we academic economists often have more to learn from practitioners than they have from us.  I came to realize this when I was a participant in monetary-policy debates in Canada in the early 1990s. The Bank of Canada was moving to inflation targeting at the same time as the country was phasing in a new goods and services tax. The new tax was clearly going to create a problem for the Bank by causing an upward blip in the price level. Even if the Bank could prevent this blip from turning into an inertial inflationary spiral, the immediate rise in inflation that would accompany the blip threatened to undermine the credibility of the new inflation-reduction policy.

The bank dealt with this problem by estimating the first-round effect of the new tax on the price level, under the assumption that the path of wages would not be affected, and designing a policy to limit the price blip to that estimated amount.  It announced that this was its intention, and that after the blip it would stabilize inflation and bring it down from about six percent to within one percent band over the coming three years.

At the time I was very skeptical.  Along with many other academic economists I thought it was foolish for the Bank to announce that it was going to control something like inflation, which it can only affect through a long and variable lag, with such a high degree of precision.  To me the idea reeked of fine-tuning, and I thought the Bank was setting itself up for a fall.  But I was wrong.  In the end the Bank pulled it off just as planned.  The price level rose by the amount predicted upon the introduction of the new tax, and then inflation quickly came down to within the target range, where it has been almost continuously ever since.

Two things struck me about this passage.  The first is that economists often overestimate the problem of “long and variable lags,” especially when the goal is to stabilize a nominal aggregate.  If the policy is credible, lags do not prevent the central bank from hitting short term targets, as the short run is strongly influenced by expected longer term outcomes (as Woodford has shown.)
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