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

It appears there will never be a R.I.P. for Inflation Targeting!

Benyamin Appelbaum has a survey in “2% Inflation Rate Target Is Questioned as Fed Policy Panel Prepares to Meet:

The cardinal rule of central banking, in the United States and in most other industrial nations, is that annual inflation should run around 2 percent.

But as the Federal Reserve prepares to start raising its benchmark interest rate later this year to keep future inflation from exceeding that pace, it is facing persistent questions about the wisdom of the rule and the possible benefits of significantly increasing its target.

Higher inflation could disrupt economic activity, but it also would enhance the Fed’s power to stimulate the economy during recessions. And some experts say the struggles of the Fed and other central banks to provide enough stimulus since the Great Recession suggest they could use more room for maneuvering.

“Most developed countries’ central banks have experienced difficulty in providing sufficient monetary stimulus to spur a robust recovery in their economies,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said in a recent speech in London. “This may imply that inflation targets have been set too low.”

IT has been “dead” for seven years but a “burial ceremony” is never planned! Instead, applying “CPR” is the “solution” most discussed.


When “theory” placed inflation targeting at the “center” and interest rate targeting as the “mechanism” to accomplish it, they simultaneously took money out of the equation.

Give IT the R.I.P. it deserves, and bring out “nominal stability” to centerfold. Money will naturally become the “accomplishing mechanism”.

What would we be hearing from the Fed if, instead of 0.3% headline 1.4% core, we had 2.9% headline 1.7% core?

Any doubt they would raise rates immediately (through a Conference Call)? However, that was the combination that existed in September 2011 (“9/11”), when QE3 was still to come!

Today both headline and core are far from target, but Yellen is all the time “justifying” the need for a rate increase soon:

“Policy makers cannot wait until they have achieved their objectives to begin adjusting policy,” Fed Chairwoman Janet Yellen said last week in a speech:

“I would not consider it prudent to postpone the onset of normalization until we have reached, or are on the verge of reaching, our inflation objective.”

The “heartbeat” of nominal and real growth has not changed during this time, remaining close to 4% and 2.2%, respectively year on year.

Yellen´s Fetish_1

Overall, both measures of inflation have been well below target for most of the time since 2008.

Yellen´s Fetish_2

What has changed is unemployment, which has dropped from 9% in September 2011 to 5.5% in February 2015 and is getting “dangerously close” to her latest “estimate” of NAIRU (5% – 5.2%)!

Yellen´s Fetish_3

She should remember James Tobin, her thesis adviser at Yale who, on the year she was awarded her PhD, 1971, wrote “Living with Inflation”. Only now she wants to change that a bit and push for “Living without inflation”!

So I find Tony Yates´ “insistence” on raising the inflation target “romantically naïve”!