The politics of NGDPLP targeting, redux

Back in November 2011, there was a part of the world that I didn't understand. The politics of monetary policy didn't make sense to me. Now the world is starting to make more sense. It's not that my understanding has changed. It's the world that has begun to change.

Specifically, John Quiggin has come out in favour (HT Marcus Nunes) of Nominal Gross Domestic Product Level Path Targeting. And John Quiggin is a lefty. That helps resolve my puzzle back in November 2011. I didn't understand: "Why isn't NGDP targeting a lefty thing?". Now that NGDPLPT is becoming a lefty thing, the world is starting to make sense to me again. I think it's only a matter of time before Canadian lefties join this Australian lefty. (We don't pay enough attention to Australia, because it's so far away, but Australia is just like Canada except it's hotter and nobody speaks French.)

John Quiggin's arguments for NGDPLPT make a lot of sense to me. The only substantive difference is that he wants the fiscal authorities to sign on too, and do their bit as needed to help the monetary authority to hit the target. Within the Canadian context this is not a big deal. The government signed on to the original inflation targeting agreement, so it is only natural it should sign on to an NGDPLP targeting agreement. This can only help credibility. We could quibble about whether a countercyclical fiscal policy really would be needed to help hit the NGDPLP target. But against a backdrop of a long-term policy of fiscal sustainability (I mean in Canada, not the US), this isn't such a big deal. If you want to keep fiscal policy as an insurance, OK.

It's in the Marketing Department that I think John Quiggin needs some help:

"The abandonment of inflation targeting would, of course, be an admission of failure. But central banks have failed, disastrously, and admitting this would be the first step towards a sustainable recovery."

Oh dear. That's not the best way to sell the policy to the Bank of Canada. Nor is it totally fair. Because:

1. Inflation targeting (in Canada and elsewhere) has always in practice been flexible inflation targeting. The Bank of Canada does not try to bring inflation immediately to the 2% target under all circumstances. It brings inflation slowly back to target if it deviates, precisely because it knows that bringing it back too quickly would cause undesirable fluctuations in real output and employment. And it focuses on core inflation as an "operational guide" to help it "see through" one-time shocks like oil prices and indirect taxes. NGDPLPT would help make the "flexible" bit of flexible inflation targeting more transparent.

2. Inflation targeting was designed to provide a "nominal anchor". But as is well known, it's an anchor that can drift over time unless the Bank of Canada gets it exactly right and hits the 2% target exactly every single year. Switching from an inflation target to a Price Level Path target makes the real value of long-term nominal contracts more predictable. An NGDPLP target has the added bonus of ensuring that debtor and creditor share the risks of uncertainty about real growth (if bad things happen to long run real growth, creditors would bear some of the pain too).

Try this instead:

'We are not abandoning inflation targeting; we are refining inflation targeting to provide greater transparency and a better long-term nominal anchor. Inflation targeting has not failed; but there is room for improvement in implementing the same underlying vision.'

Doesn't that sound better?

And have a second look at this graph Stephen did for me:

Don't you think the Canadian economy would have performed better, especially recently, if the Bank of Canada had been trying to keep the Canadian economy on the dashed red line?

Comments

[Too Much Fed]

+5% NGDP target.

Let's say there is +4% price inflation and +1% real GDP growth (approximation)

Productivity growth is +2% or higher and employment falls.

Now what?

[Nick Rowe]

TMF: Let's say there is 105% inflation, and 100% productivity growth?

Now what?

[Kevin Donoghue]

"We could quibble about whether a countercyclical fiscal policy really would be needed to help hit the NGDPLP target."

Do I detect a certain fiscal-policy begrudgery? If the right way to think about fiscal policy is in terms of rules, you really ought to be open to the possibility that the optimal rule will be countercyclical. It doesn't help the cause of NGDP targeting that so many of its proponents seem happier in a world where the big decisions are made by unelected people with close ties to the banking industry.

[Ralph Musgrave]

A thought provoking post from Nick, as usual. Some thoughts…..

1. Why aren’t lefties pushing for fiscal to be included in NGDP targeting? A far more pertinent question along the same lines is, “Why aren’t lefties pushing for full reserve banking?" Full reserve involves much tighter control of the money supply by the state than fractional reserve. You’d think lefties would jump at it.

I think the reason is that lefties have become too self- satisfied with what they perceive to be their moral superiority over the rest of humanity. It doesn’t occur to many of them that they need to THINK. And the full reserve versus fractional reserve argument his HORRENDOUSLY complicated. Too much like hard work for them, probably.

2. I mentioned on David Beckworth’s blog a few months ago that including some fiscal in NGDP targeting would be an idea, and got a grudging acknowledgement that I might have a point.

3. This paper (its only 1,000 words) suggests allowing central banks to do some fiscal. It’s worth a read.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1977688

4. As with the Bank of Canada, the Bank of England is closet NGDP targeter. E.g. it has not raised interest rates over the last year despite inflation being at least double the 2% target because it thinks inflation is largely cost push.

[Determinant]

Thanks for the Australia bit, Nick. I thought I was alone in this. They have a GST! The interesting parts of Oz are that there income tax is completely Federal thanks to a [pliant] High Court decision and thus the States are even more dependent on transfers than Provinces are. Also they have a preferential ballot and have had since the 1930's.

Even better for me, their churches are just like ours. They even have the Uniting Church of Australia, which is exactly the same as the United Church of Canada, only their merger was in 1977 and ours was in 1925. It's like looking in a mirror.

[Scott Sumner]

Nick, John Quiggen correctly pointed out that fiscal policy is ineffective with inflation targeting. But he failed to note that fiscal policy is also ineffective with NGDP targeting, FOR THE EXACT SAME REASON.

People keep telling me I should be nicer to the Keynesians, as they are coming over to our side. But I can't stand irrational arguments, and it's irrational to claim that inflation targeting makes fiscal stimulus ineffective but NGDP targeting doesn't make fiscal stimulus ineffective.

[J. V. Dubois]

I consider myself as "leftist" and your argument makes sense to me too. Including you "begrudging" the fiscal policy as a tool for macro stabilization. What I would say is that fiscal policy should just reflect long-term sustainability. That means that it should be used for projects where we believe in returns in-par or above the interest level that is used to finance them (for long-term projects benefiting multiple generations) and other within-generation transfers should be financed by taxes. Yes and did somebody mention that fiscal policy is, contrary to monetary policy, a lot less reversible?

I would actually come even farther and say that NGDPLP targeting is neutral from the point of left-righ worldview. Difference between left and right that makes sense is just about the appropriate level of taxation for transfers, and about discussion weather private or government services are better at providing some necessary services (healthcare, education, long-term social insurance). But in a sane world they should be macro neutral. That is why you can gather support from Austrians and MMTers alike (albeit not for the same article)

What is not neutral is accepting the NGDPLP targeting from the point of view of winners and losers at certain point in time. If now we have too tight monetary policy, that may seem to be in favor of creditors. The change you propose may in a sense make them feel to loose their bargaining power, even if society as a whole would benefit from such a change. And this is a problem. It has nothing to do with ideology, but it has everything to do with vested interests that support these respective ideologies, and that do their best to confuse discussion in order to reach their goals.

[Kevin Donoghue]

Via Simon Wren-Lewis here’s a a good post by Jonathan Portes on his evolving view of fiscal policy.

[Kosta]

Coupling fiscal policy to NGDPLP targeting is certainly an improvement, particularly if there is a commitment by the government to try to cushion the losses suffered by those who will inevitably lose by the change in monetary policy.

But I have a different comment. Nick closed by writing "Don't you think the Canadian economy would have performed better, especially recently, if the Bank of Canada had been trying to keep the Canadian economy on the dashed red line?"

One has to agree that Canada would have been better off if the Bank of Canada had managed to keep the Canadian economy on the dashed red line. But is it reasonable to assume that the Bank of Canada could succeed at such a task, especially recently? Specifically, the trajectory of the Canadian economy these past few years has been a near mirror image of the U.S. economy's trajectory (in particular with a large output gap). If the U.S. continues to have a large output gap, is it reasonable to assume that a change in BoC monetary policy would be sufficient to close the Canadian output gap (i.e. to get the Canadian economy back on the dashed red line)?

This isn't to say that pursuing NGDPLP targetting isn't a good idea. But rather, should we not expect to be underwhelmed by its effect until the U.S. adopts similar policies?

[Jacques René Giguère]

At some point you have to take into account your own size relative to the real forces at hand. Just think how high would the Luxemburg Central Bank would have to tighten to keep inflation stable if the price of oil rose to $ 300 a barrel...

[Jacques René Giguère]

And in Oz they dont speak english either...

[David]

"Don't you think the Canadian economy would have performed better, especially recently, if the Bank of Canada had been trying to keep the Canadian economy on the dashed red line?"

I'm not sure, to be quite honest. Can you give us your take on the UK, Nick? I understand that inflation has held up much "better" there; and I presume that people must therefore be making the argument that the recession there has been much more muted than it otherwise might have been. And in the event that NGDP is lagging trend in the UK as well, I guess some might be calling for even higher inflation to make things better? Just curious...

[Nick Rowe]

Kevin: "Do I detect a certain fiscal-policy begrudgery?"

Yep. But remember, for at least 20 years, up until 2008, most macroeconomics shared that "fiscal-policy begrudgery". And for good reason: lags; plus fiscal policy has other jobs to do, and monetary policy has got no other job to do. So monetary policy should do the one job it can do (get AD right) and let fiscal policy do the other jobs only it can do.

Ralph: over the last couple of years, the BoE has been much closer to NGDP targeting than the BoC. UK inflation still surprises me though.

Determinant: I spent a very nice sabbatical year in Australia once. Yep, very similar countries. Stuff does seem to happen later there though. I'm not surprised to see that repeated in church matters.

Scott: "Nick, John Quiggen correctly pointed out that fiscal policy is ineffective with inflation targeting. But he failed to note that fiscal policy is also ineffective with NGDP targeting, FOR THE EXACT SAME REASON."

You are right. I totally missed seeing that. But you need to re-phrase the point: fiscal policy is ineffective if monetary policy is already doing either inflation or NGDPLP targeting. The choice of target and the choice of who does the targeting seem to me to be orthoganol questions.

JV: I agree with you on fiscal policy. The choice of NGDP vs inflation targeting ought to be neutral politically. But you do tend to notice that lefties tend to talk more about AD policy focussing on employment than righties do, even though that difference doesn't really make any sense, at some deeper level.

"What is not neutral is accepting the NGDPLP targeting from the point of view of winners and losers at certain point in time."

Yep. It's the old rules vs actions distinction. E.g. creditors and debtors ought to have the same views on the optimal inflation rate to target as a rule. But when it comes to policy actions the creditors will always want lower inflation and the debtors will want higher inflation.

Kevin: thanks. Remember the two questions though: does fiscal policy affect AD; should we use it (or is monetary policy enough?

Kosta: "Coupling fiscal policy to NGDPLP targeting is certainly an improvement, particularly if there is a commitment by the government to try to cushion the losses suffered by those who will inevitably lose by the change in monetary policy."

Why is it an improvement to couple fiscal with monetary policy? Who would lose from a switch from IT to NGDPLPT?

"But is it reasonable to assume that the Bank of Canada could succeed at such a task, especially recently?"

That's the big question, I agree. I think the answer is (roughly) yes. It could not have hit the red dashed line exactly, but it could have come closer to the red dashed line if it had wanted to. First, it is uncontroversial that the BoC could have had looser monetary policy if it had wanted to over the last year or so since it raised the overnight rate above 0.25%. Second, the expectation that the BoC would be trying to keep the economy on the red line would by itself have caused the economy to move closer to the red line. Current NGDP depends on expected future NGDP.

Remember we have a flexible exchange rate. We cannot help the real effects of US monetary policy affecting the Canadian economy on the supply side. But we still have policy independence on the AD side. Put it this way: if the BoC wanted hyperinflation, it could do it, even if the Fed wanted 0% inflation.

Jacques: Luxembourg could do whatever it wanted with the Luxembourgois price of oil, if it had its own currency.

David: I don't really understand the UK Phillips Curve recently. OK, the price of oil and VAT increases must have had something to do with it. But I wonder too if there weren't some supply shocks causing disruptions. Eurozone? The banking system failures? I don't know.

[Kevin Donoghue]

Nick,

In other contexts you seem quite willing to argue that economists have been getting things wrong for the last 20 years, so you can’t really rest your case on the conventional wisdom. Anyway even John Cochrane seems to have discovered that he was always in favour of automatic fiscal stabilizers, so are you quite sure that this solid consensus really existed? It’s not unheard-of for economists to think they are in agreement only to discover that they have different versions of just what’s agreed.

Asking “Is monetary policy enough?” is tantamount to saying I’d prefer not to use fiscal policy unless I absolutely have to. You say that the right way to think about fiscal policy is in terms of rules; Bénassy has been thinking about it that way for years and in some models at least the implication is that fiscal policy rules should be counter-cyclical. Simon Wren-Lewis’s Lessons From Failure (PDF file) argues for the need to take a fresh look. I agree with his contention that ideology is shaping this and I don’t think it’s just leftist ideology.

[Edmundo]

Trust the Aussies to stand something on its head and make it work.

[Paine]

Great post nr

The new year seems to be good for your pragmatic side

The rather obscure gestures toward amerikan exceptionalism to this level targeting
Must be clear if one reads u more diligently

Btw
The whole game of macronautics is about comparative dynamics

The target is often far less problematic then the closing speed

Here in the states we all want to get to nairu as well as retain a tame price level

But the acceptable time to target for arrival at nairu and the acceptable time to retstore the fetish 2% inflation rate

Seems oddly asymmetric

If we are below nairu..er actually we pre empt that outcome

If we are above nairu we seem to accept a slow clipping pace

If we ate below 2% ...yikes we donating to get back to target let alone do it at flank speed

If above target inflation ?

There only do we seem to have a reasonable acceptable time to closing on target

Now I admit since the volckerdammerung
We have had very little volatility in the inflation core rate
And a bit more in the UE flux

But let's get some explicit time frames here for the four different deviations

Trade gaps and budget deficits etc could use a look at too

Thru forex dynamics and and GDP/debt ratio adjustments

[Paine]

My I pad corrects my typos

One line above is quite a caution

If we ate 2%

If we are at 2%

Yikes we donating

Yikes we don't even seem to care about getting back to target

[Paine]

Never look back
you only compound the f up

Intended

If we are below 2% fed never in a hurry to get back to 2%
unless the sucking sound of deflation s ares em

[Scott Sumner]

Nick, I agree.

[Kosta]

Nick wrote: "Why is it an improvement to couple fiscal with monetary policy? Who would lose from a switch from IT to NGDPLPT?"

Didn't we have this discussion in November ? A switch to NGDPLPT would result in periods of higher inflation. The losers would include people whose income would fail to keep up with the increase in inflation. One group of losers would be those who are living off of fixed income investments (that is seniors). The other would be workers whose pay raises fail to keep up with inflation, which would arguably be the majority of employees working at transnational companies such as G.M. and Caterpillar.

I realize that Quiggin and you view the addition of fiscal authorities to the NGDPLPT as adding extra firepower and/or insurance to the policy. The addition of the fiscal component could also help ensure that the costs of the targetting are mitigated, which would make the policy more palatable to lefties like me.

[J. V. Dubois]

Kosta: If (and when) there are periods with high inflation (and weak growth of real GDP) should there not also be periods with low inflation (when real growth is strong)? I thought that it is the core mechanism for what the last two letters in NGDPLP stand for. So in the medium to long run the balance between interests of debtors and creditors (as seniors are basically creditors living on fixed income from debtors) should be maintained.

[Kosta]

J.V.: I'm not so sure that there will be very many periods of low inflation coupled with high growth. In my (admittedly simplistic) view of inflation, would not high growth lead to higher inflation all on its own?

In the example Nick has in his post, Nick's arguing that NGDPLPT would push nominal GDP up about 10% to its trendline growth rate (the dashed red line on the figure). The NGDP would be raised through inflation. Are you suggesting that at some time in the future, there will be a period where NGDP growth would be 10% above trendline, and that through NGDPLP targetting, NGDP will be reduced to trendline by removing the inflation? Is that what you are arguing by suggesting that there will be periods of low inflation with high growth?

I don't think it is going to work that way. In the future, if NGDP growth is above trendline, the BoC will increase rates to reduce growth, which will reduce inflation.

Your point about seniors being creditors is factually true. However, are you sure that we should be treating people who work in Canadian society all their lives and save for own retirement as creditors whom are haircut?

[Determinant]

Jacques wryly observed:

And in Oz they dont speak english either...

Jacques, I am shocked, shocked I tell you that would would say such a thing. I have been enjoying probably not legal files of Sea Patrol on youtube. I didn't need subtitles!

(We shall not mention what happens to Quebec TV programs when shown in France. Or the summer I spent at a French company's Canadian plant and met the French staff and learned what the French think about the language of Quebec).

[Jacques René Giguère]

And what we think of the French is unfit for a fine family blog. Hearing the France translation of a baseball match in a movie goes way beyond the grotesque and reach the perversely sublime. As for a hockey game, Leafs and Habs ( even Nordiques) fan would lie down in peace and harmony.
You would have enjoyed my friend Charles from Oz trying to court my former sister-in-law in the France french he had tried to learn in Sydney while she responded in the mix of British and US english we learn in QC in the pseudo-French accent she had to use at the international body where she worked.
It had all the involuntary charms of an international scientific conference where no one has any idea of what the talk is all about. Rarely had a family gathering been so funny.

[Dan Kervick]

I really don't care what the central bank decides to target. I don't think it will make any substantial difference to the real economy one way or another, other than to the relatively small crowd of speculators in financial assets whose behavior is based on central bank watching and arbitrage.

The central bank is a sideshow. 95% percent of the ink and electrons spilled over it are waste of resources.

[J. V. Dubois]

Kosta: "Are you suggesting that at some time in the future, there will be a period where NGDP growth would be 10% above trendline, and that through NGDPLP targetting, NGDP will be reduced to trendline by removing the inflation?"

Yes, and no. That is what Nick was talking about, that even now the same things happen with inflation targeting. Look on the Bank of England - they are now ok with inflation above 4% (even if they have 2% target) exactly because based on the way the core inflation behaves they believe that withing next few years economy is heading to low inflation period. So they believe that by having the variable temporarily above the target, they will be able to maintain it on target in medium term. The same is valid for NGDPLP targeting, only it also looks backwards to catch up any fluctuations that were not dealt with in the past. Nick has a whole "Chuck Norris" series of blogs where he explains how this works.

So Yes, at least as I understand it, if for some reason CB did not do the job and allowed NGDP to be below 5% target let's say only 3%, then everybody would know that in the future they will have to offset it by allowing higher NGDP growth. It may be one year of 7% growth, or 2 years of 6% growth (sorry, no compounding).

So in short, there are two "innovations" in this idea. The first one is the "Level Path" targeting, that has a very large influence on the credibility of CB. With this approach, CB will be obliged to correct past mistakes. So it will be much harder for markets to ignore threats and targets set by CB, as it seems to be now, when if these targets are ignored, everything is reset at the beginning of the next year. Second novelty is the whole NGDP thing, that is basically about a way how to integrate dual mandate (inflation and unemployment) into one variable. And it actually makes sense. Even with level path inflation targeting, we basically admit that there can be (small, but still larger then we are used to) fluctuations in the inflation rate in the future. So if we are willing to come into such land, and we will devise ways how to deal with this problem, we may as well make that short step ahead and accommodate unemployment as well.

[Determinant]

Jacques:

That sounds like my university. I had a first-year Algebra prof whose first language was Mandarin. A fellow student, fresh from China, could not understand his heavily accented to the point of being broken English. The student liked me because I sounded like a voice training tape.

My brother was a TA to an MBA class at the same university in an accounting class. My brother's English is as pressed and starched as mine is: no slang, and a clear standard Canadian pronunciation as befits the sons of United Church ministers who preached for a living. My brother had a petition lodged against him by the ESL students who said his English was "too perfect" and they couldn't understand him. They wanted a more broken English (broken with Mandarin, preferably).

The prof laughed in their faces, dismissed the complaint and told them to suck it up. He said the students would be working with people who sounded just like my brother and they should get used to it.

[Too Much Fed]

Nick said: "TMF: Let's say there is 105% inflation, and 100% productivity growth?

Now what?"

In both cases (assuming the 5% NGDP target), the policy will eventually be rejected because of higher prices and lower employment.

I find the second scenario very unrealistic.

[Too Much Fed]

Kosta said: "Didn't we have this discussion in November ? A switch to NGDPLPT would result in periods of higher inflation. The losers would include people whose income would fail to keep up with the increase in inflation. One group of losers would be those who are living off of fixed income investments (that is seniors). The other would be workers whose pay raises fail to keep up with inflation, which would arguably be the majority of employees working at transnational companies such as G.M. and Caterpillar."

What if wages not keeping up with price inflation (negative real earnings growth) and currency denominated debt to make up the difference is how the economy (USA) got into its situation? If so, it seems to me that NGDP targeting of just raising price inflation will make the situation worse.

[Kosta]

J.V.: I'm going to echo Too Much Fed's concern and focus on wages under a NGDPLPT policy. In particular during and after a period of low real growth. Let's assume that the NGDPLPT policy is effective and credible targetting 5% nominal growth per year. Let's also consider a situation where economic growth is sluggish for two years, say 1% real growth per year, before returning to baseline levels of 3% per year. In the two years of low real growth, the BoC will induce inflation of 4% per annum to hit the 5% nominal growth rate. So what happens to wages during those two years?

Do they increase at a rate of the real growth (that is 1% per annum)? Or perhaps real growth plus a stock 2% adjustment for typical inflation? Or do they track nominal growth, increasing 5% per year?

If the employer's income is related to nominal growth rates (like in the oil and gas industry), then a compelling argument could be made that wages will track the nominal growth rate. Potentially you could extend this argument for companies whose entire business was contained within Canada (since if nominal GDP increased 5%, one could argue that the net income of business in Canada would also increase by 5%).

But what happens with multinationals, or companies that export a significant portion of their products internationally? For multinationals, while there would be pressure for the companies to increase their Canadian wages by 5%, the companies could also shift work to other nations whose salaries have increased by less than 5%. This would drive down wages for the Canadian workers of multinationals (sort of like what is happening with Catepillar right now).

For companies that export their products, the overseas prices would not rise 5%, and it would follow that their revenues would not increase by 5%. It's hard to see how these companies would be able to increase the wages they pay by 5%, given that their revenues haven't increased.

The NGDPLPT policy could quite easily read to price inflation which is not matched by wage increases for significant portions of the Canadian Labour market.

You suggested earlier that there would be periods of high growth with low inflation which would counterbalance these epochs of low growth + high inflation. I doubt these periods would occur at all frequently, as high growth would lead to inflation.

(my apologies if this is a double post)

[Nick Rowe]

Kevin: on using fiscal vs monetary policy:

Suppose you were in charge of fiscal policy and I were in charge of monetary policy.

Suppose you were setting an optimal fiscal policy looking at only microeconomic Cost/Benefit/distribution considerations and ignoring macro (AD): when do we actually need to build a new school because there's enough kids of the right age in the right area? when would be the most efficient and fair set of tax rates to set (to minimise the present value of deadweight costs of taxation, and to get some sort of intergenerational equity)?

Which would you prefer:

1. I came up to you and say "Don't worry about the macro AD side of things; I've got that covered with monetary policy, so you do the best job you can at dealing with all that micro stuff."

2. I said: "Look, sorry, but I've decided that I can't or won't do the macro AD stuff alone with monetary policy, so you are going to have to help out. When we are in a boom, you are going to have to postpone building that school for a bit, even though the kids want it now. And in a recession, you are going to have to build a school earlier than you wanted to. And you are going to have to increase tax rates in a boom, and lower them in a recession, even if that did increase the total deadweight losses of distorting taxes and cause intergenerational inequity."

You would prefer 1 to 2. 1 is your first best fiscal policy, and 2 is a second best.

That said, it is quite likely that your optimal fiscal policy under 1 would look like a countercyclical fiscal policy. You would tend to build more schools when interest rates are low and when construction workers are cheap and available.

[Nick Rowe]

Fiscal policy is a multi-tool; monetary policy is a hammer. The optimal assignment of tools is that you use the hammer to hammer all the nails, to free up the multi-tool for all the other jobs. The fact that you could use the multi-tool to hammer nails doesn't mean you should use it to hammer nails. And if using the multi-tool to hammer nails means the hammer is idle, and some screws aren't getting screwed in because the multi-tool is busy, that doesn't make sense.

[J.V. Dubois]

"You suggested earlier that there would be periods of high growth with low inflation which would counterbalance these epochs of low growth + high inflation. I doubt these periods would occur at all frequently, as high growth would lead to inflation" - And why should be it that way? If we have nominal GDP targeting, we have to have low inflation during periods of high real growth by definition. Or to say it other way, do you also believe that there is high inflation during periods of high growth if we stick to current inflation targeting regime? It does not make sense.

The only possible explanation for persistently higher inflation would be if real growth fluctuates much more then we expect. If 21st century is going to be a century of 1% real growth, then yes, we will have persistently "high" 4% inflation. And if you ask me, I can imagine worse things happening than 4% inflation.

[Kevin Donoghue]

Nick, if you were a central bank governor and you said "don't worry about the macro AD side of things; I've got that covered with monetary policy" I might believe you. If Alan Greenspan or Jean-Claud Trichet said it I certainly wouldn't. For them "I've got it covered" means something like: the people I really care about are doing alright.

There's much more to be said about this but there's no real need for me to labour these points. Simon Wren-Lewis has embarked on what looks like being a series of posts entitled Annoying Anti-Stimulus Arguments. Responding to him in new posts would be a more efficient use of your blogging time than responding to me in comments -- I certainly do appreciate your replies, but fewer people will see them.

[Nick Rowe]

Kevin: thanks. Yep. A new post is now circulating through my brain.

[Dan Kervick]

Monetary policy in general might be a hammer, or a potential hammer. But central bank policy alone is like one of those old Nerf hammers my son used to play with. A government can exert a profound impact on the economy, for good or ill, by a decision to expand monetary assets through programs that spend them directly into the real economy, or by a decision to drain monetary assets from the real economy through taxation.

But the central bank can only trade one kind of financial asset for another in the financial sector of the economy, in ways that might impact interest rates and yield curves a bit, but are hardly the hammer that is wielded by a more integrated policy. The central bank just does not possess the powers necessary to wield the monetary hammer. Nor should any right-thinking citizen in a democracy want to grant a central bank those powers - since doing so would mean ceding control over public spending and taxing decisions to an undemocratic institution of the government.

The distinction between monetary and fiscal policy is a conceptual distinction that is impractical in practice. The only question should be whether the government should in any given period engage in fiscal actions - taxing and spending actions - that are monetarily neutral, or should instead employ a fiscal policy that increases or decreases the net supply of money and other financial assets.

In a government exercising this kind of coherent and integrated fiscal-cum-monetary policy, it would be worthwhile debating whether macroeconomic policy should be guided by an NGDP target, a real GDP target, an employment target or some other measure. But yet another old monetarist debate about the adoption by the central bank of yet another "target" that the central bank will yet again prove unable to control is idle and impractically academic.

[Andrew F]

If the central bank is worried about economic stability, I can imagine them leaning on the government for certain fiscal or regulatory changes to ameliorate those concerns. One recent example is the tightening of lending standards in Canada (and China for that matter) on residential real estate, because the central bank was unwilling to raise interest rates for the economy as a whole, but was concerned about overheating in a sector of the economy. Another hypothetical example might be a central bank concerned about overheating in a certain part of the country, let's call it Alberta, and recommended slowing the rate of oil sands projects.

[Nick Rowe]

Dan: 20 years ago the Bank of Canada said it would target 2% inflation. Over the last 20 years, inflation has averaged almost exactly 2%. Canadian fiscal policy, meanwhile, has not tried to target inflation. And there have been massive changes in fiscal policy over the last 20 years. If monetary policy is a Nerf hammer, I can only conclude that the last 20 years have been an amazing fluke.