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I'm not sure I understand why that is an argument against price level path targeting, especially when the price level is following the expected rate we're currently using. Doesn't it just serve to remove some of the noise and make the price level less of a random walk in the long run?

Makes sense to me.

Another factor creating inflation inertia in the 70's and early 80's was, I think, inflation compensation clauses built into union contracts. Then the wage costs of firms tend to go up according to inflation in previous periods (when the inflation that is being compensated for in this period was measured).

Turning that around once it got moving was tough.

On the other hand, someone (I think it is Jeffry Sachs but I can't find the book) gives examples of cases where hyperinflation has been stopped in days or weeks just by halting the money creation process. Perhaps inflation needs to be a moderate enough to be institutionalized to exhibit such momentum.

Isnt targetting NGDP a bad idea since it would have different effects depending on if real GDP is growing or shrinking? If you targeted NGDP to be 5% but we were in recession and RGDP was falling by 3% wouldnt that be an inflation rate of 8%? Seems like it misses the point of managing inflation expectations.

I don't know whether you're aware of it, Nick, but your idea of targeting the stickiest prices resembles Gunnar Myrdal's in his book on _Monetary Equilibrium_. He however (logically, in my view) sees it as implying the stabilization of _factor_ prices, rather than output prices (the usual idea). Factor prices, and wage rates especially, would seem to be relatively more sticky today than output prices, just as was the case when Myrdal wrote (in the '30s). So why not carry your argument to a similar, logical conclusion? That would, of course, mean letting output prices _fall_ when there's rapid productivity growth. So, are you willing to go there?

Have you read Selgin's work on the productivity norm (roughly targeting NGDP per capita)? It has a somewhat different perspective, and has some discussion about how firms change their prices and why they might be nominally sticky (http://www.cato.org/pubs/journal/cj10n1/cj10n1-14.pdf). The basic idea is that firms like to change their prices about when their costs change. This is a theme I have also seen elsewhere. This kind of theory seems to me significantly more plausible as a source of nominal rigidity than staggered price changes (calvo models, right?).

Andrew: the argument that price level path targeting makes the long run price level more predictable than inflation targeting (where you get a random walk) is a good one. There are lots of good arguments I have ignored here. I just wanted to focus narrowly on one argument. Inflation inertia is an argument for inflation targeting, and I wanted to spell it out.

Paul: I have never managed to get my head around the argument that wage indexation creates inflation inertia. That's because the alternative to formal indexation is not spelled out. The idea that firms and workers would keep nominal wages fixed during inflation doesn't seem plausible as an alternative, since both care about real, not nominal wages.

Ian: I think it depends on what causes the shocks to real GDP. If they are supply-side shocks, then presumably you want GDP to vary, but don't want inflation to vary, so why target NGDP? If they are demand-side shocks, then does real GDP fluctuate because P diverges from P*? If so, then is that because P has inflation inertia? If so, it's presumably best to target inflation, to prevent P* diverging from P.

George: the idea that monetary policy should target the price that is sticky is an old one. I don't know where it came from originally. Maybe Gunnar Myrdal? If you think wages are stickier than prices then targeting wage inflation would be better. (Though it would be politically tricky, given economic illiteracy; "The BoC is trying to stop workers getting a better wage!!") I'm not sure if wages or prices are stickier.

jsalvati: No I haven't. I should. Thanks for the link. There are two types of staggered price setting: Calvo and Taylor. Calvo has firms change prices at random; it does not generate inflation inertia. Taylor has the oldest price change first; it generates inflation inertia. My little model is a Taylor model. Nearly all NK models use Calvo, because it's analytically tractable. The Bank of Canada uses Taylor in its main model, and uses a very large computer to solve it! The BoC is right to do this.

Too much Fed: you are totally off-topic, again.


Building upon Selgin's point, if you target wages then one ends stabilizing income and you are back at something like a nominal income target or nominal GDP target. Scott Sumner has said ideally he would target wages, but given the diffficulties in doing he favors targeting NGDP instead. For this reason and the one I mentioned in my post--the central bank should only respond to AD shocks, not AS shocks--I favor a nominal income type rule.

On a micro level, when a sales tax directly paid by the seller is increased, the supply curve shifts to the left, and the gross price rises and the quantity falls.

Money expenditure targeting would allow this to appear at the macro level--the price level rises (gross prices) and real output falls.

It seems to me that you advocate having the central bank increase the quantity of money enough so that the equilibrium price level rises enough so that the net prices consumers pay remain the same. The equilibrium gross price level rises, and the net price level is unchanged. The demands of everything increase enough to keep quantities unchanged.

Of course, the point of the tax is to get revenue to spend and shift the allocation of resources from the things people buy to what the government wants.

And as the government spends that revenue the demands for particular goods that the government buys should rise. As resources are reallocated, the quantities of the things government buys increases. Real output should recover.

How does this work with money expenditure targeting? The net prices of the things that the government doesn't want fall, and they rise for the things the government does want. The shift in resources occur.

Your argument is that money expenditure targeting require... I think slower aggregate growth in money wages to return to equilibrium. Is that right?

Wages grow more slowly, the supplies of various goods rise, so that prices, both gross and net drop. The relative prices are still shifted, with the government demanded goods having higher prices and everything else having lower prices. If the trajectory of wages is sticky, then this creates a recession. The expanded government spending creates a smaller demand for output than the resources that are freed until the net prices fall. (The ordinary growth in productivity only allows for lower money prices if wages grow more slowly than productivity for a time.)

Solution? Isn't it obvious? When you measure final sales of domestic product, you measure the funds received by the firms, rather than what the buyers pay. In other words, indirect taxes shouldn't be included. (You know, I don't think they are included.)

By the way, it is _wrongheaded_ to see money expenditures targeting as a target for the product of a price index and a measure of real output. Think about it. Money expenditure targeting targets money expenditures. Now, you can come up with a price index and get an estimate of real expenditures by dividing. But do you really think that real output is determined, and the price level is determined, and then there is some multiplication going on?

If you really think money causes prices and prices cause output, then price level or inflation targeting is great. If money causes nominal expenditure, and money expenditure impacts prices and output at the same time, then stabilizing money expenditure makes sense.

The stickiest prices are surely wages, and I favor stabilizing their equilibrium trajectory. This is suboptimal if there is a shift in the income share between labor and capital. Stabilizing wage growth would work better. The indirect tax story above comes to be the same thing, with the indirect tax being like an increase in equilibrium capital incomes. The growth path of money wages needs to be lower if money expenditures are targeted. But while I think an economy that uses sales tax maybe should stabilize expenditures firms receive net of the tax, (my solution) I don't favor trying to stabilize wages and let profits fluctuate, as flexible as profits may be. I don't see that as creating the best environment for micro adjustment.

If there is a big sales tax that changes a lot, then.. OK, I must admit, having every tax increase result in a recession that requires slower growth in wages, isn't so bad to me. But... I guess I am confusing my support for impediments to excessive government taxation and spending with my improved coordination norm.

Imagine a price is stuck. If you target that price, then that works great. You are always on target. Of course, there are surpluses and shortages. If you target wages and they are really, really sticky, well, you stay on target, but there are surpluses and shortages of labor. So, what do you really do? Target employment? Target unemployment?

Money expenditure targeting is imperfect, but it looks to be the least bad option.

David: "Building upon Selgin's point, if you target wages then one ends stabilizing income and you are back at something like a nominal income target or nominal GDP target."

Bill: "Imagine a price is stuck. If you target that price, then that works great. You are always on target. Of course, there are surpluses and shortages. If you target wages and they are really, really sticky, well, you stay on target, but there are surpluses and shortages of labor."

No and no. You are both making the same mistake. I think you have both missed the point. (Which makes it my fault, since you are both bright enough to get it ;-) )

Suppose, for example the nominal wage is sticky. It doesn't want to move. It will only move, and then slowly, if there's a difference between the actual wage W and the equilibrium wage W*. Now, the equilibrium nominal wage W* depends on monetary policy. By varying monetary policy the central bank can move W*. If it is targeting nominal wages, it will make sure that W doesn't move, which means the Bank has to move W* to where W is. So the labour market stays in long run equilibrium, with no shortages or surpluses. But wage income, both real and nominal, which is WL, or (W/P)L will certainly vary over time, as the demand and supply of labour changes, and the equilibrium real wage and level of employment, (W/P)* and L* will vary. But by varying W*, the Bank can keep W/P=(W/P)*, and so keep L=L*, even though W is sticky.

Why is replying to Paul Friesen off topic?

The stickiest price is the contractual interest rate in a long term financial contract. My hunch is that such contracts work best with NGDP level path targeting.

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