P248 inflation targeting(2)

Nominal-GDP targets, without losingthe inflation anchorJeffrey FrankelKennedy School of Government, Harvard University, and CEPRInflation targeting’s golden lustre was tarnished by the Global Crisis in many ways, butits anchoring of inflation expectations is not one of them. This column argues for a twophaseswitch to nominal-GDP targeting. This would deliver some stimulus now when itis needed, while keeping a cap on inflationary expectations.Central banks announce rules or targets in terms of some economic variable in orderto communicate their intentions to the public, ensure accountability, and anchorexpectations. In the past, they have fixed the price of gold (under the gold standard),targeted the money supply (during monetarism’s early-1980s heyday), and targeted theexchange rate (which helped emerging markets to overcome very high inflation in the1980s, and was used by EU members in the 1990s, during the move toward monetaryunion). Each of these plans eventually floundered, whether on a shortage of gold, shiftsin demand for money, or a decade of speculative attacks that dislodged currencies.Conventional wisdomThe conventional wisdom for the past decade has been that inflation targeting – thatis, announcing a growth target for consumer prices – provides the best frameworkfor monetary policy. But the global financial Crisis that began in 2008 revealed somedrawbacks to inflation targeting, analogous to the shortcomings of exchange-ratetargeting that were exposed by the currency crises of the 1990s.One problem with a consumer price index target is lack of robustness with respect tosupply shocks and terms-of-trade shocks. In July 2008, for example, just as the economy90