“IT” or “NGDPLT”?

In “Euphemistic at the IMF”, Krugman writes:

In all of this, the IMF has played a somewhat strange role. It is, institutionally, the very model of respectability; historically, its main role has arguably been to impose austerity of one kind or another. Yet it has a sophisticated, fairly Keynesian research department — and management that actually listens to that department (as opposed to, say, the European Commission, whose attitude seems to be,”If I want your opinion I’ll tell you what it is.”) You might imagine that the IMF would therefore take the lead in challenging respectable opinion when it’s dead wrong. But it obviously feels constrained; its rebellions against respectability have to be discreet.

And the result is a proliferation of euphemisms.

There’s a fine example in the latest World Economic Outlook, which makes a strong case that “normal” real interest rates have fallen substantially over time, and not just because of the financial crisis:

What does this imply for policy? Here we go:

With respect to monetary policy, a period of continued low real interest rates could mean that the neutral policy rate will be lower than it was in the 1990s or the early 2000s. It could also increase the probability that the nominal interest rate will hit the zero lower bound in the event of adverse shocks to demand with inflation targets of about 2 percent. This, in turn, could have implications for the appropriate monetary policy framework.

What does that actually say? Well, my subtitled version says thisRaise the inflation target to 4 percent, dummies. But the IMF wouldn’t,and presumably can’t, say that outright. And I suspect that the people who need to hear that won’t at all get what the Fund is really saying.

Secular stagnation, here we come.

David Beckworth´s subtitled version says something different (from Twitter): “Funny, Paul Krugman sees IMF paper as call for 4% inflation whereas my first reaction was this is why we need NGDLT.”

Given the “in the event of an adverse shock to demand” qualifier of the IMF, I believe David has the right conjecture. In any case, if the Central Bank is targeting NGDP (level target) it shouldn´t react to a supply (real) shock at all. But it would be obliged to do so in case of inflation targeting. Note that the IMF says “it could have implications for the monetary policy framework”. That indicates the need to change the framework, not just the target rate of inflation.

By changing the inflation target because circumstances would so require, the target becomes a “moving goalpost”, in which case it will not command the credibility necessary for it to coordinate expectations successfully. An NGDPLT framework would not have those deficiencies.

Update: This is the sort of thinking mode that prevents one from thinking outside the box:

“Inflation targeting did not prevent financial instability before the Crisis nor did it provide sufficient stimulus after the Crisis.”

Change it to: “Inflation targeting did not prevent nominal instability before the Crisis nor did it provide sufficient stimulus after the Crisis” and the ‘solution’ becomes clear!

6 thoughts on ““IT” or “NGDPLT”?

  1. This is great stuff. But I think it moves well past the problem at hand that the central banks are not targeting 2% inflation, but something much lower than that. I’d love to see the framework change to NGDPLT. But if they don’t get serious about whatever their target may be, it won’t do that much good. This seems to be as much a political problem as a monetary one, as the people in a position to change the behavior of the central banks allow that behavior to continue.

  2. Krugman states “In any case, if the Central Bank is targeting NGDP (level target) it shouldn´t react to a supply (real) shock at all. But it would be obliged to do so in case of inflation targeting”. This is nonsense! IT does not imply central bank does not react to supply shocks. This shocks translate into a temporary rise in the pricel level which may contaminate/destabilize/unanchor inflation expectations. This is one reason IT central banks inflation reports and/or monetary policy are plagued with the idea that this is one reason they may opt for an increase in the policy rate. Unfortunately, the closest thing the FED has to an IT framework is forward guidance, which by the way has not been sucessful, precisely because of an explicit IT or NGDPT framework. Regarding the porposal to the target for the inflation rate to 4%, it fully undermines the credibility of the IT framework. This is not a sensible statement because it implies IT is still a useful framework. If ain’t broken, do not try to fix it. Otherwise, you better move to NGDPT: output would hopefully move to trend and inflation would be determined endogenously according to the rate of NGDPT. I just hope such a NGDPT is not kept too high when output returns to normal.

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