The New York Fed blog, Liberty Street, has a post today entitled: “Has the Fed Stabilized the Price Level?” Unfortunately, it seems it has:
Since the early 1990s, the PCE deflator has remained remarkably close to a 2 percent trend line. It has continued to track this trend since the beginning of Chairman Bernanke’s tenure in January 2006, despite a dramatic financial crisis and the Great Recession. By committing to stabilizing inflation over the long run, the FOMC is de facto at least partially stabilizing the price level around a trend line. Such a policy should thus reap some of the benefits of price-level targeting.
It´s ‘unfortunate’ because there are really no benefits to be reaped from price level targeting (PLT)!
The picture below shows the 2% trend and both the headline and core PCE since the early 1990s.
While the headline PCE has come back to trend after the ‘separation’ induced by the oil shock of 2007-08, the Core measure, which was just about to ‘hug’ the trend level was pushed down when the crisis hit.
Bernanke and the Fed may feel comfortable that they are hitting at least the stable price part of their mandate. But the other part, maximum employment, is only a dream. And the reason is that, as shown in the next chart, nominal spending (NGDP) is far below trend.
Note that before the crisis both PLT and NGDPT were ‘observationally equivalent’. I venture to say that that´s because NGDP was kept close to the trend level. Once monetary policy failed in keeping demand (spending) growing at the requisite rate, nay, allowing it to crash, the idea of stable prices is hard to defend given that, excluding volatile elements, prices have remained also far below trend.
In fact, it´s quite likely that the spending crash came about because the Fed was paying too much attention to oil price developments, and felt it was necessary to constrain demand to bring headline PCE down.
PLT may be better than IT, but it fails miserably when there´s a supply shock (such as the oil price rise) to the system. And it fails because it fosters the wrong action by the central bank, pushing it to constrain demand i.e., forsake nominal stability (which contemplates both prices and output, P*Y).
PS To my american readers, an enjoyable Thanksgiving.