Is inflation targeting dead? Central Banking After the Crisis - Vox

Is inflation targeting dead? Central Banking After the Crisisbeen enough to restore much growth since the Crisis (the economies of the UK and theEurozone are still 3% smaller than they were at their pre-Crisis peaks, five years ago).The regime’s critics have therefore become more vocal: inflation targeting (it is said)has meant that monetary policy was too easy before the Crisis and insufficiently sosince. A few, it seems, are ready to consign it to history.But in my view this risks the same attribution error that some were tempted to make, moreflatteringly, ahead of the Crisis. In what follows I’ll briefly address a longer-standingcriticism – namely that an inflation target is too inflexible in the face of movements inthe terms of trade or other disturbances to costs. I’ll then explain why, at least in theUK, I do not think tighter monetary policy (and a lower rate of inflation) ahead of itwould have made much difference to the scale or consequences of the financial Crisis,at least as felt in this country. I’ll end with a few remarks about where we are today.Inflation versus nominal-GDP growth: don’t exaggerate thedifferencesInflation targeting had its critics even at its inception. Unlike, say, an objective tostabilise the growth of nominal GDP, a rigid inflation target compels a central bankto tighten monetary policy in the face of shocks that raise consumer prices, but alsoeither fails to increase domestic output prices and/or has a depressive effect on realactivity. These include higher oil prices or other deteriorations in the terms of trade. Toa degree that depends on the extent of real-income resistance, a slowdown in total factorproductivity growth has the same properties. If these shocks are significant, volatility ofoutput growth will be higher under rigid inflation targeting.There is an offsetting benefit: under inflation targeting, medium-term inflationexpectations are likely to be more stable in the face of such disturbances. But Frankel(2012), for example, argues that inflation targeting involves ‘perverse’ responses toterms-of-trade and supply shocks, citing as an example the ECB’s decision in mid-200852