P248 inflation targeting(2)

Is inflation targeting dead? Central Banking After the CrisisPresumably the target for nominal-GDP growth would the medium-run, non-inflationarygrowth rate plus 2% for inflation. 5 The problems are: i) we don’t know the right growthrate, especially in the shadow of a massive financial crisis; ii) central banks have notools to influence real growth; and iii) GDP data comes out with a lag and is oftenrevised – much more so than price data.The greatest peril, according to several of our authors, is the simple question: “Sincethe strategic goal of monetary policy is low and stable inflation, why not just stick to aninflation target in a flexible inflation targeting regime?” Market participants asking thisquestion may conclude that a switch to nominal GDP could end up disguising effortsto create unexpected inflation. In other words, the switch could undermine confidenceand thus make the whole exercise counterproductive.The final contender for a new target is a simple boost in the targeted inflation ratefrom 2% to 3% or 4%. Karl Whelan opines: “I believe recent experience points to 2%being too low. … We know now that the liquidity trap is not a theoretical curiosity.Economies that operate at a 2% average rate of inflation are one recession away fromthe difficulties associated with falling into that trap. Set against these dangers, I don’tknow of a single study that can explain how the social costs of a steady inflation rate of3% or 4% would offset the reduced risk of deflation due to such a low target rate.” SeeBlanchard et al (2010) for detailed analysis.The I-theory of monetary policyA more radical solution to the ineffective monetary policy problem is set forth by MarkusBrunnermeier and Yuliy Sannikov. They use their ‘I-theory of money’ (the I stands forintermediation) to argue that price, financial and fiscal stabilities are intertwined due tofinancial frictions. In downturns, optimal monetary policy should identify and unblock5 Some authors discuss the relative merit of price or GDP targets set in levels rather than growth rates, but so far centralbanks appear unwilling to formally embrace targets defined in levels.20