The Inflation Target “two-step”. It sure isn´t one of the world´s wonders

Central bankers are proving to be the gang that can’t shoot straight.

A quarter of a century since New Zealand opened the era of inflation targeting, policy makers from the U.S., euro area, U.K. and Japan are all undershooting their consumer-price goals. Of the Group of Seven, only Canada is currently meeting its mandate.

Rather than lowering their sights to make things easier, the misses are fanning calls for targets to be increased from the 2 percent most aim for to perhaps as high as 4 percent.

While a similar idea was pitched five years ago by International Monetary Fund economists led by Olivier Blanchard, and endorsed by Nobel laureate Paul Krugman, this time around it may be the central-banking community itself proposing a rethink.

Former Federal Reserve Chair Ben S. Bernanke last month suggested he would be open to an increase in the U.S. Federal Reserve’s 2 percent goal, saying there is nothing “magical” about that number.

Fed Bank of Boston President Eric Rosengren said the same month it could be the case “inflation targets have been set too low.” His colleague from San Francisco, John Williams, told the New York Times that if the future is one of weaker growth because of demographics and productivity then it’s worth asking “is the 2 percent inflation goal sufficiently high in that kind of world?”

But if they can’t hit 2 percent, why lift the targets?


A better solution would be for future central bankers to be as worried when targets undershoot as they have been when they overshoot, said David Lipton, the IMF’s No. 2 official.

Standard Life’s Lawson is unconvinced.

One wonders how many more years of failure it will take before the consensus surrounding current inflation targets begins to rupture and more radical policy objectives are considered,” he said.

Now consider this paper from the NY Fed that recently came out: “Inflation Expectations and Recovery from the Depression in 1933: Evidence from the Narrative Record”.

The abstract reads:

This paper uses the historical narrative record to determine whether inflation expectations shifted during the second quarter of 1933, precisely as the recovery from the Great Depression took hold. First, by examining the historical news record and the forecasts of contemporary business analysts, we show that inflation expectations increased dramatically. Second, using an event-studies approach, we identify the impact on financial markets of the key events that shifted inflation expectations. Third, we gather new evidence—both quantitative and narrative—that indicates that the shift in inflation expectations played a causal role in stimulating the recovery.

That´s a very sensible conclusion. Does that mean the Fed could increase inflation expectations today by announcing a higher inflation target? Given that inflation has been way below target for a long time, that´s quite unlikely.

What happened in early 1933 to change expectations?

1 FDR announced a price level target

2 To get the price level up, spending had to increase. To get spending to rise, monetary policy had to be expansionary. To make monetary policy expansionary, FDR delinked from gold and devalued the dollar.

The outcome:

No need for higher IT_1

Today, a more “radical” policy objective would be a NGDP – Level Target! At least the economy wouldn´t have remained “splashing” far underneath the “surface”!

No need for higher IT_2

HT Becky Hargrove

5 thoughts on “The Inflation Target “two-step”. It sure isn´t one of the world´s wonders

  1. Marcus, Thanks so much for flagging this important paper from the NYFed. I am going to read it carefully ASAP, are the three graphs relating to the 1933 recovery taken from the paper?

  2. Marcus, Thanks, I think I have figured out what is going on in the graphs. Are you using the St. Louis Fed data series for NGDP, industrial production, and producer prices? What I don’t get is what you mean by gold sterilization, and how you are measuring. Sterilization is a very tricky concept. I have tried to make sense of it in some posts I have done on currency manipulation. I don’t think that there is a straightforward definition or measure of sterilization, though I could be wrong.

  3. Pingback: Sunday notes – Three working papers and three prediction markets | The Market Monetarist

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