Nobody wants a monetary policy that creates nominal shocks. "Don't do random stuff with monetary policy for no reason at all!" is clearly sensible and uncontroversial advice. But finding a monetary policy that separates real shocks from nominal shocks, so that real shocks don't also create nominal shocks, is harder. But that is exactly the sort of monetary policy we want.
The most important thing I have learned from the data over the last few years is that inflation targeting does not work as well as I thought it would. The most important thing I need to figure out is why inflation targeting doesn't work as well as I thought it would. Inflation targeting does not separate real shocks from nominal shocks as well as I thought it would. But I don't really know why inflation targeting failed to separate real from nominal shocks as well as I thought it would.
Macroeconomists like to distinguish between real shocks and nominal shocks.
We can use our imaginations to think up examples of a purely nominal shock. "Suppose the central bank, for no reason at all, unexpectedly doubles the money supply/doubles the price of gold/doubles the exchange rate target/doubles the inflation target etc." Those are all nominal shocks. That nominal shock will no doubt (given sticky prices) have real effects, but it is a purely nominal shock.
It is much harder to use our imaginations to think up an example of a purely real shock.
Any real world example of a shock will nearly always be a mixture of both a real shock and a nominal shock.
And whether a real shock is also a nominal shock will depend on the monetary policy regime.
A discovery of a new and better way to mine gold is a real shock to technology. It will cause the equilibrium real price of gold to fall. Under the gold standard, it will also be a nominal shock. It will cause the equilibrium price level to rise, because the nominal price of gold is fixed. Under inflation targeting it might still also be a nominal shock (is the price of gold jewelry part of the CPI?) but it would be a much smaller nominal shock than under the gold standard. Inflation targeting does better than the gold standard at separating nominal shocks from real shocks to gold mining technology.
What we ideally want, if possible, is a monetary policy that ensures that real shocks are purely real shocks, and never also nominal shocks. We want a monetary policy that separates all real shocks from nominal shocks.
The global financial crisis was a real shock. It disrupted the financial markets that allow lenders and borrowers to get together. But it was also a nominal shock. It caused very similar real symptoms to the symptoms we normally associate with a negative nominal shock. It became harder to sell goods and labour. Unemployment increased. All the classic symptoms of the sort of recession we normally associate with the real effects of a negative nominal shock. Except, globally, inflation did not fall. In some countries (like the US) inflation fell; in some countries (like the UK) inflation rose; and in some countries (like Canada) inflation went up and down a bit but stayed roughly the same.
For some reason, inflation targeting failed to separate the real shock from the nominal shock. Inflation targeting failed to prevent a real shock from being a nominal shock too. But I don't really know why it failed.
[I had a draft of this post written, wondering if I should extend it, and if so how, and then I read Scott Sumner's good post on a closely related topic, and decided to join in the conversation.]