From Fiscal Times

Many economists think the Fed could bring about this positive trend simply by announcing that it has raised its inflation target from two percent to three or four percent. If people believe the Fed means it will take actions to bring it about, then it becomes a self-fulfilling prophecy.

It’s a neat theory and it might work, but it hinges critically on the Fed finding a way, institutionally, of raising its inflation target and having the credibility that people will believe it. I have serious doubts on both counts.


Getting the Fed to adopt a more expansionary monetary policy is a theoretical, institutional and political problem. What it will take to force action at this point is anyone’s guess. The one thing that unambiguously would help is to get the board to full strength so that there will be more voices at the next FOMC meeting urging action to counter those that fear inflation like little children fear the boogeyman.

Having this conversation is the important first step. I am happy to hear Bruce’s voice. I’d argue that inflation targeting per se has long been a topic of interest in monetary policy. I wouldn’t think of it as a fad or neat theory.

Nor, does the Federal Reserve have an explicit inflation target. Various officials have from time to time framed the issue as a comfort zone. But, more typically the Fed itself makes opaque comments about “the level consistent with price stability.”

These differences may seem esoteric but they matter. A Fed which takes inflation as an indicator is different than one which makes a commitment to the market that it will do everything prudent to achieve a specific goal.

Lastly, not to start a nerd food fight, but I would say the dispute between  inflation targeting, price level targeting and NGDP targeting generates more heat than light.

As former Fed Governor Mishkin points out  market participants tend to think of inflation as a long run trend rather than a month to month indicator. The data are noisy and participants understand that the central bank will respond to threats to growth over the short term. Adopting a meaningful inflation target is largely equivalent to adopting a medium term price level target.

A true distinction only emerges over long time periods, of four to five years or more. In such cases I believe the Fed can meaningful and credibly discuss the extent to which inflation has run below expectations and that there is a need to make up for that. At the heart of the matter is the desire  that long term contracts be made with the least uncertainty possible.

Lastly, and I know I may be stepping on some toes here, but I am not sure there is an enormous practical distinction between NGDP targeting and a well applied Taylor Rule.

Unless we think the Fed is influencing productivity or the growth of the labor pool then functionally NGDP is a composite of the rate of inflation and the rate of unemployment. If you want higher NGDP you either have to make more stuff or that stuff needs to cost more. That means more employment or more inflation.

Where a difference could arise is if you move to a formal scheme of targeting NGDP futures as Scott Sumner suggests. This is an interesting proposal and it warrants a thorough discussion. However, at this moment our primary concern is to induce expansionary monetary policy. I believe that is most plausibly framed as a temporarily higher inflation target.

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