Scott Sumner  

Why stop at price level targeting?

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In a recent post, Atlanta Fed President Raphael Bostic advocated a price level target:

I want to start my discussion in this post with two points I made in the previous two macroblog posts (here and here). First, I think a commitment to delivering a relatively predictable price-level path is a desirable feature of a well-constructed monetary framework. Price stability is in my view achieved if people can have confidence that the purchasing power of the dollars they hold today will fall within a certain range at any date in the future.

My second point was that, as a matter of fact, the Federal Open Market Committee (FOMC) delivered on this definition of price stability during the years 1995-2012. (The FOMC formally adopted its 2 percent long-run inflation target in 2012.)

On one level, I'm glad to see another Fed official advocate level targeting. But when I read his rationale for price level targeting, it actually better fits NGDP level targeting.

Notice that Bostic argues that the Fed did achieve something close to price level targeting during 1995-2012. What he doesn't say is that monetary policy was clearly far too tight during 2008-12, and that growth in aggregate demand was much lower than desirable during this period. Indeed so much so that Ben Bernanke was calling for fiscal stimulus to help boost AD. Bernanke certainly did not believe that aggregate demand was adequate. So why not chose a monetary regime that would have delivered an appropriately expansionary policy during 2008-12?

One other point. Bernanke has called for a price level targeting regime that kicks in when the Fed hits the zero bound. If that had been in effect in 2008, then the price level would have been too low during 2008-12. This illustrates a very important point; it's difficult to evaluate a policy alternative like price level targeting without knowing the specifics of where the Fed would set the trend line, if they did decide to adopt the policy. Whether the policy of 2008 was consistent with a 2% price level target depends entirely on where you set the baseline. Under Bernanke's proposed regime, actual policy was too tight during 2008-12. In contrast, Bostic thought policy was just fine, as he set the trend line at a lower level than the actual price level in 2008.

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HT: David Levey

Comments and Sharing

COMMENTS (5 to date)
Thaomas writes:

My question is sort of the reverse. Why "go beyond" PL targeting as the "prices" portion of the Fed's dual mandate? What do yo see as the costs and benefits of one vs the other?

Scott Sumner writes:

Thaomas, See my new CapX article.

Rajat writes:

Here is my understanding of what you're getting at. With Bostic's starting point, monetary policy was basically fine over 2008-12, because the inflation undershoot over that period broadly offset the earlier (2006-08) overshoot. Under Bernanke's proposed regime, policy was too tight over 2008-2012. That's because the Fed only reached the ZLB (Bernanke's trigger for PLT) in late 2008 - immediately after a period of high inflation due to the oil price shock of 2008. From late 2008 onwards, prices undershot a 2% level path for the next 4 years.

But the fact policy was too tight under Bernanke's rule was almost coincidental - it relied on a prior negative supply shock that had pushed up inflation so as to create a high level price path to follow during the ZLB period. If the US instead had experienced a negative demand shock in early 2008, the ZLB could have only been reached after prices had fallen. Under these conditions, the triggering of a PLT could have meant policy was too loose during 2009-12. That doesn't make sense.

Scott Sumner writes:

Rajat, Bernanke would argue that even in that case, under current policy the inflation rate would be likely to undershoot 2% once you hit the zero bound. So PL targeting would still be better than the current regime.

Of course I prefer NGDPLT, partly for the reason you provide.

Justin writes:

I don't think price level targeting looks quite as bad if you look at the Core PCE index.

If you start level targeting on Jan2004, then actual PCE Core is only 0.8% above target on Jun2008, but by Mar2009 it is already below target, and 1.7% below target by year-end 2012 and rising, reaching 3.9% below target today (114.507 vs. 118.956 targeted).

A price level target using the less volatile Core PCE deflator would have called for significantly more inflation over the past economic cycle than we actually experienced.

The advantage of price level targeting, particularly a zero inflation price level target, is that it makes financial planning easier, eliminates menu costs, etc. I've grown to like Miles Kimball's proposal of an electronic money standard that would allow for negative rates. I have to admit that NGDPLT would by definition target a stable NGDP trend whereas a price level target (esp. 0% inflation) would allow falling NGDP in the event of a recession. That being said, I suspect either policy would have made 2008 substantially less severe.


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