When should the inflation target be raised?
Here’s The Economist:
There may be a benefit in the short term, too, to raising targets now. Reducing stubbornly high inflation requires cooling the economy, which generally involves raising the unemployment rate. The lower the inflation target, the more unemployment central banks need to generate to get there. If the costs of inflation at 3% really are not much different from inflation at 2%, central banks will be generating additional unemployment for little benefit. . . .
Set against this, however, are the consequences of reneging on a 30-year promise. The experience of the past year has made clear that the public detests inflation; both finance ministries and central banks are being excoriated for losing control of price growth. To shift the goalposts now could give the impression of giving up the fight entirely. . . .
As long as inflation is so far off-target, such considerations seem likely to stay the hand of any would-be monetary reformers. Yet once it peaks, restoring a degree of central banks’ credibility, the pain of further disinflation, together with the promise of well and truly escaping the zero lower bound, could just start to make the idea of higher targets more alluring.
I’m not convinced that raising the inflation target is a good idea. But let’s say I’m wrong and that the benefits of moving to a 3% inflation target outweigh the costs. When should the target be raised?
The Economist suggests that it might be wise to do so in the near future, when inflation has fallen to 3% and further disinflation would lead to higher unemployment. I disagree.
If we are to move to 3% inflation, then we should wait until inflation has fallen back to 2% before making that intention public. At that point the Fed should announce that it will keep the 2% inflation target for immediate future, but plans to shift to a 3% inflation target during the next recession. That would make it seem more like a principled decision, and less like an expedient to avoid unpleasant choices, which would reduce policy credibility. If we make the change when inflation is overshooting the Fed’s target, why would anyone believe the new target would be adhered to?
PS. You may want to check out the 22nd Amendment to the Constitution, which was enacted before America became a banana republic. (Or the 27th Amendment). When people say they want to expand the Supreme Court, I respond, “As long as the new rule doesn’t take effect at a time which would benefit the current administration.”
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31. July 2022 at 16:22
Yes, making many changes to procedures etc only apply after the next election is a pretty good rule that aide steps a lot of the problems with politicians eg setting their own pay.
(Most of the concrete problems with pay are only in public perception. But fixing public perception is very important in politics, too.
In the public perception politicians are always overpaid, even though Singapore illustrates that perhaps really overpaying your politicians might be a good idea.)
31. July 2022 at 16:36
Scott, something I might have asked before, but I don’t remember whether I ever got your answer.
So suppose we have a situation like now in the US: a central bank that professes to target inflation at 2%, but recently has let inflation run high.
Now image that tomorrow the Fed announces that immediately from now on they will switch to nominal per capita wage level targeting. To make it really simple, they’ll target a constant level (no nominal growth per capita.) (They could also target ngdp for this scenario.)
Assume they have 100% credibility and will hit their target.
This policy will presumably massively cut down inflation. Perhaps making it negative (like in George Selgin’s Less than Zero).
Would this policy cause a recession? Or does keeping nominal wages from falling also prevent a recession?
I would imagine that even if this policy avoids a recession, we would see a difficult adjustment period for a while. Just like the time after the Brexit referendum saw an adjustment period in the British economy, but no recession.
As an additio: how would your answer change if the Fed instead moved to something less extreme than a constant level, and instead target a level of wage growth that was roughly in line with 2% inflation (but that still much less inflation than the US recently had)?
The mildest version is: can we cut inflation expectations (and more importantly nominal income expectations) without causing a recession, if we do that cutting in a principled way so as to avoid overshooting below?
31. July 2022 at 19:39
I could only imagine the outrage and further erosion of trust that would occur if the Fed abandoned 2% right now. I agree any plans to do so must appear thought out and not be enacted until the public sees the Fed isn’t just doing this to get out of their job early.
31. July 2022 at 21:44
Matthias, You said:
“Would this policy cause a recession?”
If they did it immediately then it would cause a depression. You’d need a really tight money policy, which would cause falling NGDP.
Your second option would be much better, merely causing a slowdown or mild recession.
31. July 2022 at 23:27
Scott, thanks for answering.
Yes, I agree that what I proposed would need a tight money policy. But it needs to be exactly tight enough to freeze the level of spending. If ngdp would actually drop, the Fed would loosen again. (And if we assume credibility, the market will anticipate those moves and help the Fed.)
Are you saying that the Fed would not be able to stabilise ngdp at a fixed value? Or are you saying that this policy would cause a recession, even if ngdp never actually dropped? Or something else?
1. August 2022 at 03:12
I never really understood why targeting 0% inflation would not be optimal. As I have learned from reading this site, gold backed money averaged 0 percent but with high volatility——still it was AIT in a way.
But we had higher growth—-(of course other factors may have been at play). A zero inflation target, at the minimum, would have the benefit of maintaining constant real tax rates—-as legislators cannot be trusted to pass inflation adjusted tax rates—-since they do not. (Our tax code is completely absurd in all ways).
I admit to being fooled by Powell into thinking he could hit his target inflation rates—whether 2, AIT 2, or 3—-although our political/societal reaction to Covid was so outside expectations perhaps errors can be forgiven.
I am willing to be fooled again—-I think inflation will be much closer to 2 within a year.
P.S. I have been watching YouTube videos of Milton Friedman. He was a remarkably persuasive man. For example, he naturally spoke of the ubiquitousness of opportunity costs into his discussions of economic policy without ever using the term.
I grew up in the Paul Samuelson generation, who unfortunately—-with his calculus driven models—- became the dominant influencer of government driven solutions.
1. August 2022 at 04:59
Supreme Court: Context matters. When senators of one party say it’s unacceptable to vote on a new justice in the year before of an election, then the same senators approve a new justice a couple of weeks before an election, then it can be acceptable to do something unusual to restore the balance.
1. August 2022 at 05:56
re: “Reducing stubbornly high inflation requires cooling the economy, which generally involves raising the unemployment rate.”
Economists are running the economic engine in reverse. It is an incontrovertible fact, banks aren’t intermediaries. It’s stock vs. flow. The 1966 Interest Rate Adjustment Act is prima facie evidence. The unemployment rate fell.
https://fred.stlouisfed.org/series/UNRATE/
Dan Thornton is correct. “Money Supply and Inflation: Where’s the Proof?” WSJ July 21, 2022
“The relationship between the growth rate of M2 and inflation has been extremely weak; as often as not negative, rather than positive; and most often not statistically significant.”
That just proves Dr. Philip George’s “The Riddle of Money Finally Solved”
Banks don’t loan out deposits. Deposits are the result of lending. I.e., it’s virtually impossible for the DFIs to engage in any type of activity involving its own non-bank customers without an alteration in the money stock.
All bank-held savings are frozen until their owners so decide. There is one and only one way to activate monetary savings, income not spent, and that is for their owners to spend/invest either directly or indirectly outside of the payment’s system. Ergo, all bank-held savings are frozen, unused and unspent, lost to both consumption and investment, indeed to any type of payment or expenditure.
1. August 2022 at 06:07
I still don’t understand the basic principle: why is swapping lower real wages for less unemployment (in theory) a clear benefit? I could argue either way and probably come out thinking unemployment is less bad (at least at reasonable levels) as we have a built-in safety net and switching jobs is probably a net-positive for many.
1. August 2022 at 07:14
Your argument works far better with monetary policy than with courts, as the physics of court expansion, using current rules, should be intolerable. Under the current rules, where a justice serves for life, or until they decide to retire strategically, the bigger the numerical advantage for the winning party, in absolute terms, the better. In practice, a Supreme Court seat isn’t a term, but full control over your lifetime, and significant control over your replacement. A smart enough justice, who cares about his legacy and that doesn’t have the ego the size of the Statue of Liberty, would look at actuary tables, their own circumstances, and retire when they expect to have at least 15 years left, if not more.
Now that we have ideologically distinct parties and a system that allows us to identify what a prospective justice is going to be like, the only source of major ideological change in any single seat is accidental death while a different party is in power. Without reform, if all justices retired at their earliest possible opportunity when their favorite party is in office, the court has an over 75% chance of keeping its direction for the next 200 years, if we expect senate and presidential replacements that resemble recent history. The model isn’t hard.
Therefore, if we went for the “changes only when the party in power isn’t winning a seat” plan, the party in the minority is better off with a supreme court of one justice, as the only thing that can help them is variance. Having 3/9 isn’t that much better than 0/1, but they could get lucky.
Either way, the right reform is the one where strategic retirements wouldn’t let a minority extend their advantages forever. With the same model, claim the one party has a 6 justices of 9, they pick justices in their mid 40s, and they all religiously go away the first time they can be replaced after 65. On top of that, assume that party who is winning the courts was very unpopular: winning the presidency 25 percent of the time. Then see what’s the median length of their advantage in the court. It’s still multi-generational.
1. August 2022 at 08:32
Matthias, I assumed you meant targeting hourly wages, which would require a reduction in NGDP. If it’s total wages, that’s different. But you’d still want some growth.
Effem, Are you talking about monetary policy or minimum wage laws?
1. August 2022 at 08:38
There’s no reason to raise the inflation target if asymmetric FAIT+ is better specified. For example, the Fed could publicly announce that inflation will average a minimum of 2%, but not exceed 2.5%, for example, over a ten year period. That gives them a lot of short-run flexibility while reducing the risk of losing the inflation anchor. Of course, there’s no inflation targeting regime that I like, but this would be the best regime the Fed had adopted.
Under NGDP-level targeting, this wouldn’t even be a question, but the way the Fed’s set up its current regime seems to be an indication that they really want to defend their ability to use discretion when it comes to monetary policy, despite many of us thinking the discretion is precisely the problem.
1. August 2022 at 09:39
If wages are not keeping up with inflation, then there’s no need to raise an inflation target.
1. August 2022 at 10:19
@Bob
That’s not what Scott wrote. Read again what Scott wrote and see the fundamental differences in both statements.
Scott is right, of course. His approach is the smart one. His idea is a great basis for most news rule, especially those rules that influence democratic processes such as the composition of parliaments, courts, etc.
1. August 2022 at 12:47
Scott, in practice the inflation target has been raised…significantly. The decision to ignore “transitory” overshoots will probably have a much larger impact on the future price level than 2% vs 3%. The future price level may largely be a function of the size and frequency of such inflation outbursts. For such a consequential decision, we have essentially zero visibility on when, why, or how it was made…
1. August 2022 at 12:52
pertaining to my comment above:
I’m talking about monetary policy. I’m guessing the proponents of a 3% target suggest the rationale is something along the lines of it being good for labor. Yet, monetary policy suggests it’s simply a tradeoff: good for unemployment, bad for real wages. I can easily argue either side of that and I fail to see why the 3% inflation crowd is so enthused.
I suppose there is a zero-bound rationale but that looks pretty weak these days.
1. August 2022 at 13:36
Effem, OK, then I reject the idea that that trade-off exists.
1. August 2022 at 14:03
It’s not economics. It’s politics. The American Bankers Association is responsible for secular stagnation. It’s not “don’t fight the fed”, it’s don’t fight the ABA.
The FED’s technical staff doesn’t know a debit from a credit. They don’t even know how the system works. Their countless errors demonstrate the alarming truth. All the recessions since WWII were both predictable and preventable.
It’s not whether the inflation target should be higher. Rather than bottling up existing savings, the monetary authorities should pursue every possible means for promoting the orderly and continuous flow of monetary savings into real investment.
1. August 2022 at 15:56
Impeaching Thomas and packing the court would be fine, politically, if the court did things like overturn Citizens United, for example, which has greatly undermined the legitimacy of the federal government. Even Milton Friedman was greatly concerned about corporations being free to donate to political campaigns. Most Americans think the federal government is too corrupt to preserve, hence much of the nihilism.
That said, I like the idea of packing it and making the number of Republican and Democratic nominees even so that every decision is bipartisan or non-partisan. That might restore some legitimacy, while preventing hard right or left turns in a country that’s very much divided.
Justice Roberts seems to be a true jurist, though I disgree with some of his decisions, but I’m not encouraged by the comments written by other justices on the right and left that accompany recent rulings. This is an extremely ideological court, as opposed to a set of 9 impartial jurists.
The idea that packing the court would further politicize it is a joke. The Court has been politicized for a very long time. Those who oppose packing the court live in a fantasy land, and want to fight fascism with principles. The opportunity to do that is long gone. Historically, fascists leaders are typically removed from office by force, often in ruins of the aftermath of wars. They aren’t collecting guns to bow to principles, I assure you.
1. August 2022 at 16:30
Michael (Rulle), why would you want to target 0% inflation?
George Selgin showed in Less than Zero that you shouldn’t stop at 0%.
Less than Zero is available for free online and our gracious host, Scott, even wrote a foreword to the new edition, if I remember right.
At the risk of extreme oversimplification: Less than Zero’s argument is basically that ngdp level targeting is great and that the best level trajectory to target is a constant.
If you have real growth, but a fixed ngdp, you’ll naturally get deflation.
And in fact, that’s what happened some times under the very gold standard you mentioned.
A prime example is what’s misleadingly called the ‘Long Depression’ in the 19th century, which was turns out to be a depression of the price level only. Real economic activity picked up a lot.
Another (partial) example is how prices for electronics have dropped for decades on the back of extreme rises in productivity. Crucially, total spending on electronics mostly went up, apart from occasional times of actual economic distress.
(I say partial, because electronics are a smart part of the economy. But they illustrate already that total spending is more important than the price level.)
2. August 2022 at 03:26
Scott, do you agree that by making its inflation target asymmetric (overshoots are not made up for), the Fed has de facto increased the inflation target?
If so: 1) how much do you think this increases the 2% target in practice?, 2) what (if any) are the real effects of this change?
2. August 2022 at 04:51
The policies are driven by the ABA. See Barron’s:
1) “Forgotten Man? Washington Again Is Threatening to Penalize the Thrifty” Jun. 6, 1966
2) “Up the Down Staircase, The New Economics Doesn’t Know Whether It’s Coming or Going” Sept. 26, 1966
3) “Ceiling Zero. The U.S. Must Take the Lid Off Money Rates” Nov. 26, 1967
4) “Men and Money, Savers of Modest Means Deserve a Decent Return” Jan. 19, 1970
5) “Q Marks the Spot. All Ceilings on Interest Rates Should Be Lifted” Dec. 28, 1970
6) “Maximum Mischief, Ceilings on Interest Rates Must Go” Mar. 13, 1973
7) “Supreme Interest. The Banking Agencies Have Finally Done Something Right” Jul. 23, 1973
8) “No More Wild Cards, Congress Has Dealt Savers Out of the Money Game” Oct. 2, 1973
9) “Poor Joe DiMaggio. It No Longer Pays to Save at the Bowery”” Sept. 22, 1975
The ABA was behind the Depository Institutions Deregulation and Monetary Control Act (which destroyed the thrifts, caused the Savings and Loan Association crisis, or “the failure of 1,043 out of the 3,234 savings and loan associations in the United States from 1986 to 1995”; and created the U.S. July 1990 –Mar 1991 economic recession). As predicted in May 1980, the GSE’s picked up the slack.
2. August 2022 at 04:55
The FED doesn’t know a bank from a nonbank:
See: Toward a More Meaningful Statistical Concept of the Money Supply
Leland J. Pritchard
The Journal of Finance
Vol. 9, No. 1 (Mar., 1954), pp. 41-48 (8 pages)
2. August 2022 at 04:58
@ Matthias
Yes, NGDP targeting alone can lead to deflation——which I assume is fine (putting aside politics and “the money illusion”.)
So you make a good point. And I did make the same point on gold (really the price of commodities—although money was gold backed) which I read here. Average inflation was zero until the old gold standard was eliminated. It de facto was a FAIT style monetary policy—-seemingly naturally achieved—-even as it did not formally target zero inflation (as I understand it) nor NGDP.
My primary point on zero inflation targeting (In the absence of the “full Scott prescription” of NGDP, NGDP futures, and the Fed trading those futures) is that inflation targeting is Scott’s go to idea, I believe, in the absence NGDP targeting.
So, within that framing, any inflationary target gives too much room for pols to mess round with——unless we believe the Fed can play chess against the Government using monetary offsets. This Fed could not.
I also drifted into making a point about tax policy as an example of corruption——which is disastrous in this country and elsewhere. And when I think of that, I do think “Banana Republic”. Scott tends to use the latter term to describe nationalism etc. That’s true too at extremes——-but politicians are dumb and/or corrupt by and large as are our lobbyists (i.e., most of us)—-but it’s likely humanly unavoidable—-but it certainly can be lessened.
2. August 2022 at 06:51
Targeting N-gDp will inevitably lead to higher rates of inflation, and slower rates of real growth.
It is the biggest mistake in the history of the world. Banks don’t lend deposits. Deposits are the result of lending. An increase in bank-held savings shrinks R-gDp (as predicted by Dr. Leland James Pritchard, Ph.D., economics, Chicago 1933, in 1961). I.e., it’s stock vs. flow, the impoundment of monetary savings causes secular stagnation.
Thus, the monetary offset, an increase in the velocity of the remaining deposits, ended in 1981 (with the completion of the “monetization” of time deposits, the end of gated deposits).
2. August 2022 at 08:31
Apparently, Pelosi has landed in Taiwan.
https://youtu.be/cFxnCssrvl0
https://youtu.be/ZNUP4Dcslyc
Fascinating. These two bloggers lived in China for a while. Their perspective might be interesting 🤨.
2. August 2022 at 08:36
Why do you think that it takes increasing infusions of Reserve Bank credit to generate the same inflation adjusted dollar amounts of GDP?
2. August 2022 at 10:23
Effem, The TIPS spreads suggest just a small increase above 2%.
Edward, On the second video, I gave after one minute. Life is too short for that sort of nonsense.
3. August 2022 at 07:13
You shouldn’t raise the inflation target with stagnating incomes:
Real personal income excluding current transfer receipts (W875RX1) | FRED | St. Louis Fed (stlouisfed.org)
2021-10-01 14440.2
2021-11-01 14463.1
2021-12-01 14465.3
2022-01-01 14441.0
2022-02-01 14484.3
2022-03-01 14442.9
2022-04-01 14490.2
2022-05-01 14512.0
2022-06-01 14471.9
3. August 2022 at 07:32
Economists should have taken their lead from Dr. Milton Friedman: “The Lag from Monetary Policy Actions to Inflation: Friedman Revisited” 2002
“We reaffirm Friedman’s result that it takes over a year before monetary policy actions have their peak effect on inflation… Similarly, advances in information processing and in financial market sophistication do not appear to have substantially shortened the lag”
The rate-of-change in long-term money flows (the distributed lag effect), the proxy for inflation, has never been higher. It wasn’t even higher during the response to the GFC. It won’t approximate the GFC response until November this year. And that is still too high.
3. August 2022 at 16:03
I tend to agree that a lot of the questions that have been debated on this blog for the past year have their roots in the lag issue. I agree with Scott that a truly 100% credible monetary policy will have little if any lag. But there are in reality large and variable lags because market participants view future monetary policy as 90% (perhaps 99%) dependent on difficult-to-predict future political realities, with the Fed’s actions serving only to inform the masses, well after the fact, of how those political realities have unfolded. The Fed’s forward looking statements are given even less weight since they have revealed themselves to be little more than a paper tiger, and in fact, in their current position, have terribly strong institutional incentives to *mislead* market participants as much as possible about their future intentions.
4. August 2022 at 05:28
re: “there are in reality large and variable lags”
It all depends upon how a metric is used. If you watch something long enough, you get a feel for it.
The world’s leading guru on bank reserves is Dr. Richard G. Anderson.
Sent: Thu 11/16/06 9:55 AM
“Spencer, this is an interesting idea. Since no one in the Fed tracks reserves”
The distributed lag effect of required reserves are mathematical constants. Now the FED is operating without an anchor or a rudder.
4. August 2022 at 07:03
– The only thing the FED does is follow the 3 month T-bill rate, nothing else. Anything else is just a “dog & pony show”.
4. August 2022 at 08:57
“The neutral rate is the theoretical federal funds rate at which the stance of Federal Reserve monetary policy is neither accommodative nor restrictive.” Dallas Fed
Link: Further Evidence on Greenspan’s Conundrum | St. Louis Fed (stlouisfed.org)
“During his February 2005 congressional testimony, Alan Greenspan identified what he termed a conundrum. Despite the fact that the Federal Open Market Committee (FOMC) had increased the federal funds rate 150 basis points since June 2004, the 10-year Treasury yield remained essentially unchanged.”
4. August 2022 at 12:46
“Scott Sumner is insane but not stupid – which makes him even more dangerous!”
The Fallacy of Market Monetarism – Robert Murphy
https://www.youtube.com/watch?v=3p46EFMScDU&t=2405
Enjoy the compliment! 🙂
4. August 2022 at 21:22
Slightly off topic, watching the Bank of England tighten a bit (market rates moved up a little on the rate rise) with these projections (Table 1A) makes me think the question for U.K. monetary policy is: “how much inflation (or NGDP growth) do we need to prevent a recession?” And is it worth it?
https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-report/2022/august/monetary-policy-report-august-2022.pdf?la=en&hash=0F0E2DC12F8C853F2D604B75B620D03FD58BC07D
5. August 2022 at 10:42
Jim, That sounds accurate.
James, I certainly hope that’s not the question they are asking. That was the attitude of policymakers in the 1970s.
5. August 2022 at 12:54
Jim Glass,
After all these years, Murphy still doesn’t understand market monetarism, or even how free markets actually work, despite being an “anarcho-capitalist.”
He has the nerve to say Scott was late to the money is too loose party during the pandemic recovery, which has nothing to do with market monetarism, while failing to mention how he predicted high inflation for years after the Great Recession.
5. August 2022 at 13:22
My mistake was assuming the Fed was serious about FAIT.
5. August 2022 at 16:15
Those using the S&P 500 as a proxy would have known NGDP growth expectations exceeded the pre-pandemic trend by March of 2021. I knew it, but underestimated the risk involved to macro stability. That said, I’m still not entirely convinced I was wrong.
5. August 2022 at 20:35
“My mistake was assuming the Fed was serious about FAIT.”
I tried to make the point here that the Fed’s stated policy objectives are irrelevant, and the Fed can only be judged by how it acts or reacts.
The Fed has been entirely passive for a decade, failing to add sufficient stimulus when the economy was weak, and now, failing to withdraw stimulus in a timely matter. The Fed should have been talking about tightening monetary policy A YEAR AGO. This Fed has lost credibility, and I have little faith that they will make a significant reduction in inflation in 2023. People will say that at least inflation isn’t accelerating and call that a win.
5. August 2022 at 21:40
In the 1970s RGDP was higher than these days. The 1970s have a bad press.
I agree a gentle tightening with a light recession (like in the US now) as a risk is no bad thing.
If only we were all like Japan and respond to commodity price rises by voluntarily cutting wages we’d have little inflation like them. At the end of the day, the burden has to be shared somehow. Deflation or inflation.
5. August 2022 at 23:38
>In the 1970s RGDP was higher than these days. The 1970s have a bad press.
My hunch is that lower long-term RGDP growth forecasts mean you also should reduce your NGDP growth target.
The inflationary component is like icing. It can smooth out some bumps in the cake, but a cake that is mostly frosting is garbage. It ruins it and you want to spit it out.
My sense is that policymakers have the exact opposite instinct. Lower RGDP forecasts make them want to ramp up inflation to maintain the simulacra of growth.
7. August 2022 at 08:06
Michael, I don’t recall you making that argument.
James, The low inflation in Japan is 100% due to their NGDP growth rate, it has nothing to do with wage policies.
Jeff, You said:
“My hunch is that lower long-term RGDP growth forecasts mean you also should reduce your NGDP growth target.”
I’ve written ad nauseam on that subject.