Four years and things haven´t changed much

That´s what one would think by reading this Gavyn Davies piece from four years ago:

The minutes of the September meeting of the FOMC suggest that the Fed is considering how to communicate its policy message more clearly to the markets.

If you substitute the word “minutes” for “statement” you would think the piece was about now!

But that´s not all. In his piece Gavyn discusses proposed changes to the policy target, specifically he discusses William Dudley´s suggestion of adopting a price level target (PLT) and concludes:

Third, what happens if the Fed is simply unable to hit its PLT, so that the shortfall of the price level relative to target just keeps getting bigger, year after year? I can see that proponents of the PLT might like this, because it would shift the balance of the argument on the FOMC towards more and more QE as the price shortfall kept getting larger through time. But the Fed’s wider credibility would not be enhanced if it were demonstrated repeatedly that it could not actually hit its own chosen price target. In fact, this could backfire, by highlighting the impotency of monetary policy at a time when the economy is stuck in a liquidity trap.

In face of uniquely difficult circumstances, the Fed is being forced to use some very unfamiliar new weapons. A price level target would be one too many.

Fast forward 4 years. In commenting on a post by Lars Christensen, Greg Mankiw qualifies his “Taylor-type” rule as a guide to monetary policy given present circumstances and adds:

There is another (related) argument for not raising rates now to offset shortfalls in the past. It is not about the interest rate. It is about the price level, the ultimate goal of monetary policy and measure of its performance.

If you plot the PCE deflator, there is a clear shortfall relative to a 2% price-level target. A 2% price level target fits very well during Greenspan’s time. By the end of 2008, we were exactly on the 1992-target. But when I look at that plot starting in 2009 until the most recent data I see a gap.

A price-level target rule is optimal in normal times (Ball, Mankiw, and Reis) but is also an optimal policy in response to the dangers of the zero lower bound (Woodford). We have to catch up for the shortfall in the price level right now. And if you look at inflation expectations from surveys or markets, there seems to be no catch up expected, indicating that policy is still too tight.

But exactly nine years earlier, in 1994, Mankiw argued:

Although nominal income targeting is not a panacea, it is a reasonably good rule for the conduct of monetary policy. Simulations of a simple macro model suggest that, compared to historical policy, the primary benefit of nominal income targeting is reduced volatility in the price level and the inflation rate.

Under conservative assumptions, real economic activity would be about as volatile as it has been over the past forty years. If the elimination of spontaneous shifts in monetary policy improves forecasts markedly, real activity could be much less volatile [and it had already become 50% less volatile].

Question: why should we fiddle with start dates for the trend? Mankiw argues that by the end of 2008 we were exactly on the 1992 target, but if the plot starts in 2009 we see a gap. Presumably this would justify higher catch-up inflation (i.e. keep rates low for longer).

In his answer to Mankiw´s comment, Lars puts the start date for the price level trend in 2001, and finds it is now below trend.

There is a good reason for starting the trend in 1992. The year marked the beginning of the second leg of the Great Moderation following Greenspan´s so called “opportunistic disinflation” during the 1990-91 recession, with inflation being brought down to the desired 2% rate.

The chart shows the price trend starting in 1992. After deviating significantly from the 2% trend during the oil shock of 2007-08, the price level is back on trend. No “price gap” exists!


In fact, it was exactly because of the FOMC´s “inflation paranoia” in 2008 (see here) that things went astray. It´s as if the Fed were pursuing a price level target and didn´t stand for any deviation (a bad move when the economy is subjected to supply shocks).

The consequence can be observed in the next chart. It would have been much, much better if, instead of “defending to the death” a price level target, the Fed had defended a NGDP level target.


In “normal times” they appear to be observationally equivalent. But when significant supply shocks hit PLT shows its intrinsic weakness!

Update: From Michael Woodford´s interview with The Region (Sept 16):

…Now, the specific form of the statement they made was not quite what I had suggested in my lecture, and not really what I would have preferred. But, of course, they had to announce a policy that they thought they could follow.

Region: At Jackson Hole, I believe, you said that nominal GDP target policies were more consistent with what you had in mind.

Woodford: Yes. I had specifically suggested that announcing a target path for nominal GDP would be a desirable way to make an advance statement about the criteria that you would be looking at later.

Now, I wasn’t saying that to suggest that that’s the onlyformula that would be valuable, but I thought it was useful to give a concrete example showing how the thing that I was talking about could be undertaken in practice. It was a simple proposal that nonetheless incorporated the key elements of what I thought was a desirable form of commitment. I also thought it could be understood by a fairly broad public. It incorporated what I thought were key considerations that people on the FOMC were likely to be concerned about, although it turned out that evidently it didn’t address their concerns as much as I was trying to, because it didn’t get much traction with them. (HT: James Pethokoukis)

Previously from Woodford:

Q: What was the thought process that led you to support nominal GDP targeting?

A: Actually, it’s an approach I’ve been advocating for at least a decade, though in my earlier writing about this I referred to a more technical variant of the proposal (what I called an “output-gap-adjusted price-level target“) rather than to nominal GDP targeting. The idea is to have a target criterion with two qualities: It must focus on the level of a nominal variable rather than its growth rate, and it should involve some combination of prices and economic activity. I settled on nominal GDP — the dollar value of all the goods and services produced in the economy — because it’s a measure that a central banker can talk about and be understood by the general public, and it avoids contentious issues such as the correct definition in practice of the “output gap.”

2 thoughts on “Four years and things haven´t changed much

  1. The illusion that the FOMC can’t hit its target is because either an inflation target or a PLT is situational, I think, to the circumstances of maintaining equilibrium. But if in the situation of disequilibrium, with lots of slack, it’s a bit of a problem. NGDPLT, on the other hand does not produce such an illusion and is better for smoothing out adjustments if it is “always on” nor does it compromise credibility.

  2. Marcus,

    Correction to your post: Ricardo Reis said “If you plot the PCE deflator, there is a clear shortfall relative to a 2% price-level target,” not Greg Mankiw.

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