A James Alexander post
I was pleased to report some traction in the Market Monetarist campaign to see inflation targets substituted by, or added to, an NGDP growth target.
One common pushback I’ve received recently is if the central bank can’t hit a 2% target how can it hit a tougher target? It’s a reasonable question.
First, central banks in the US, UK, Euro Area and Japan, don’t want to hit their 2% targets. An odd claim, I know. But on closer inspection they now actually operate a 2% medium term target, crucially based on their own forecasts of inflation. Any time their medium term forecast approaches 2%, or worse moves above it, the noise level about interest rate paths gets very loud. The Fed even raised rates!
This targeting a target has been discussed before here, and is very depressing to economic activity, real and nominal. It ends up with actual inflation consistently below the 2% target. It is rather like most people’s two year out plans, they never seem to quite come off.
Shoot higher, achieve more
Second, moving to a 4% inflation target and missing it by 1-2% is far less damaging than missing a 2% target by 1-2%. Modest 2-3% inflation is consistent with 5% nominal growth, i.e. trend nominal growth. Stable nominal growth is the proper target for central banks, agreed by most people, even central banks.
Central banks wouldn’t have to hit 4% but turning it into a target would enable the market to believe the central banks were happy with 2-3% inflation now. Even four percent inflation, if achieved, would not be terribly damaging either. Market Monetarists are not crazy inflationists, just dull-sounding moderate inflationists, and very hostile to missing lowflation targets. The truth of the matter is that they don´t like the word “inflation”.
Third, simply moving the target obviates the need for the sort of oxymoronic “responsibly promise to do something irresponsible” thing Paul Krugman again suggests in a response to a Tony Yates blog post. No one in markets takes such nonsense seriously.
Central banks do not operate like that, and if they did markets would be worried about other stuff pretty quickly. Just change the target to something more ambitious, but still credible and responsible. It would also end the ridiculously unnecessary, frankly idle, chatter about helicopter drops.
Last an NGDP growth target is a different animal to an inflation target. NGDP is simply aggregate demand or aggregate income. It is what the central banks have almost exact control over. Inflation is a terrifically hard to calculate residual of the difference between easy to calculate nominal demand and terrifically hard to calculate real demand.
The exact balance of any nominal growth between real and inflationary growth is very difficult to divine in real time. It is, nevertheless, very important to understand and to fix if the balance is too much inflation and not enough real. That debate is no concern of the central bank. Inflation is simply the wrong target for them. They control money and therefore the other half of all economic transactions, not output. It’s a powerful tool, use it!
Historinhas 
James – if what you are saying is, let inflation rise above 2% and say that you are happy if it goes to 3% or so, I wouldn’t have a problem with that. But that only looks relevant to the US (where core inflation appears to be headed higher). I agree – in the case of the US, simply tolerating a higher rate of measured CPI would be sensible (also CPI is probably overstated). Why do you say at the end that CBs have “exact control over aggregate demand”. They clearly don’t – or if they do it is via helicopter drops, which you have oddly dismissed.
AD is just nominal demand. Nominal demand is just money x output. You can make AD whatever you want, but you do have to want to do it, as judged by the market. You don’t need helicopters, just the market to believe you. The market thinks the US, UK, ECB and BoJ all now target 2% (max) 2 yrs out. The Fed just tightened, proving the market right. Carney talks tough any time his fan chart average peeks above 2%.
And anyway inflation is the wrong target. Cen banks don’t know how fast productivity growth is so why tgt the the residual? (NGDP less producitivity)
Nice post. Some central banks use an inflation target band. The hysterical squeamishness of the Fed every time it approaches 2% inflation results in monetary suffocation.
They may say they use a band, but do they really? Some say their target is a flexible, but is it really? “Once below, let’s stay below” seems to be the reality.
Great post, this is a great way to direct the discussion to what is meaningful. I believe it is important also to stress that central banks projections have failed miserably. Why target them, then ? (pardon the cacophony)
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