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PLPT is more persuasive if you believe in trend real growth instead of a unit root. A crisis makes people who believe in unit roots and false growth much, much louder.

Let's just focus on the bad shocks. How does NGDP targeting differ from announcing ex ante that there will be temporarily a higher inflation target (of a size and duration that depends on the size of the BSS's effects on inflation and output)if we ever hit the zero lower bound on the target rate?

Economists and Politicians, especially the politicians, can't seem to get over the 1970's. Inflation is the boogeyman and they see it under every bed. The fact that that wasn't the kind of crisis we had and perhaps we need a little more inflation for a short while is entirely lost on them. Doesn't it take a generation for a crisis to change the received wisdom of academe?

I never got past thinking about the dynamic inconsistency of price level targeting. I understand that we have rationales for the optimal level of inflation, so that an inflation target might be credible. But how can a central bank make a price level (or path) target credible? What incentive does the monetary authority have to stick to its target ex post?

I read something about the psychology behind all this the other day and now can't remember where, here's the gist of it...consider the people besides the economists and their 'hangers-on'(ahem). They normally wouldn't pay a lot of attention to any challengers, but if the challenger just wants to fix the status quo a little, it's usually okay with them. On the other hand if there is a clear seismic shift, suddenly people are noticing what's happening, but before anyone is allowed this time to do any tweaking and fixing, everyone's full attention is on the matter and on the challenger. Now the challenger doesn't get to do anything without a full inspection! So now that their attention is focused, the challenger has a chance to really change the status quo, at least perhaps.

Nick, aren't you making a mistake here that you yourself have warned against? You're assuming that the best way to think about restoring demand in the face of a shock is the Keynesian one of adapting the real interest rate to its new negative equilibrium. But we know that low equilibrium rates are a sign of (continuing) tight money. So shouldn't we really be thinking about it like this: if NGDP is expected to follow its trend path, then the IS curve shifts back into normal position and the equilibrium shifts to meet the actual rate. So all we need to do is restore NGDP expectations. Then the only deficiency of price level path targeting is whether or not expecting the trend price level is equivalent to expecting the trend level of NGDP. Just looking at AD/AS, it seems that regardless of the slope of SRAS, price level targeting achieves the same thing. But if there is a simultaneous supply shock, then this could be significant departure. In any case price level targeting is a lot better than you make it sound. Scott himself has said that the NGDP focus is mainly for political/pragmatic reasons; level targeting is far more important.

Science _explains_ stuff.

A scientist is someone who is interested what "BBS" phenomena consists in, why it happened, where it comes from and it's causes are and what is causal effects are.

That is science.

I'd encourage exonomists to be scientists, and not witch doctors or cargo cult bamboo & string aircraft tower engineers.

I wonder how do NGDPLPT and PLPT compare to estimates of the output gap? Presumably there should be a strong correlation. But it is interesting that of Q2 2011, PLPT was back to baseline whilst NGDPLPT was still quite a bit below baseline. What were the estimates of the output gap for Q2 2011? Was NGDPLPT or PLPT more accurate?

Sorry, I am double dipping today ;). This is perhaps a side issue, but I wonder how NGDPLPT and PLPT would affect wages? Inflation targetting controls inflation by inducing unemployment, which in turn depresses wages (arguably inflation targetting is the reason real median wages have not risen since the 1970s (US data)). Would the growth of wages be different under NGDPLPT and/or PLPT? A better pattern for the growth of wages might be an additional reason to change targetting regimes.

Angelo, a temporary inflation target may lack credibility if the central bank has no policy instrument to achieve it (e.g. fiscal policy). With a level target, the CB commits to keep trying even after inflation is no longer desired.

In other words, the CB can only get inflation in the present if it takes the risk of getting inflation when it doesn't want it.

Simon Van Norden nails it.

But I would go even further. The assumption that the central bank can keep any target is suspect. The central bank (one hopes) will respond to new information, including new information about how our economy works, about the causes of inflation and output variability, and what the best way of managing that economy happens to be.

Unless you believe that we know all that there is to know, you cannot believe that the CB will stick to any policy. it will keep refining its policy, and therefore the CB can never stick to a single strategy.

For example I don't believe that the CB can do anything at the zero bound of consequence, regardless of what it tries to target. I fully expect the CB to thrash around trying random things until it realizes this, and then it will stop thrashing around. It will learn (eventually) that it is impotent in a zero rate environment. It may take a while, but I don't see the U.S. exiting the current policy regime any time soon. Japan has yet to exit.

Therefore no central bank announcement is going to convince me otherwise, as I fully expect the announcement as evidence that my predictions are correct, this will re-enforce my belief that prices will not follow the planned stable path.

Angelo: I think it differs in two respects:

1. And NGDPLPT is simpler for people to understand, because it's always the same, and if they have always seen the central bank always aiming for and hitting that target in the past, they will expect it to be aimed for and hit again, so it's a lot more credible. Communicating a temporarily higher inflation target, and making that "new" policy credible, will be harder.

2. In the case of supply shocks, even when not anywhere near the ZLB, the NGDP target would be better.

In response to Max's comment, I want to try to clarify my point. In principle, the inflation target (or price level target) doesn't have to be a constant. It can be state contingent and can depend on history. Among the choices available, suppose the Bank of Canada announces that if we're ever again in the situation faced in spring 2009 (or worse) that it would target higher inflation until nominal GDP growth was running at 5% for a few quarters%. How would this differ from NGDP targeting when such bad outcomes occur? . Of course, issues of how it could achieve its targeted higher inflation path or whether it could be expected to keep its word (dynamic consistency) arise, but don't the same problems arise for NGDP targeting? (I focus on the big negative shocks because NGDP targeting seems particularly unattractive in the case of big positive shocks--would we really want deflation if Canada was hit with a positive 6% technology shock?)

Simon: I've been thinking about that. Two main thoughts:

1. If we were starting the economy de novo, then sure, the price level doesn't matter, and the level of NGDP doesn't matter either, while the inflation rate does matter. But the past price level path, and NGDP path, and those past expectations, are baked into the current economy. We (OK, not so much Canada right now) are in a recession now in large part because the level of NGDP is lower than the past trend would bring us to.

2. I really don't think it's that hard for a central bank to commit to a rule. Supreme courts do this; they don't just use discretion to do what's best for now, forgetting past rules. Why should central banks be different? Even inflation targeting means eschewing discretion. Mightn't it be better to cause a surprise inflation to redistribute wealth? Or reduce unemployment?

Saturos: I admit I did switch into conventional new Keynesian mode to write this post. But NK macro is the "dominant discourse", and this post is partly about that discourse. Plus, the point I'm making here can appeal to a wider audience than MM economists.

Nevertheless, true IS shocks can still happen. Even if the central bank is targeting NGDP, and successfully, there will be changes in the equilibrium interest rate.

Greg: "A scientist is someone who is interested what "BBS" phenomena consists in, why it happened, where it comes from and it's causes are and what is causal effects are."

Sure. But there's also the policy question: what sort of monetary system can best handle the inevitable shocks. And that policy question used to be discussed but is now (well, not quite) forgotten.

Nick: Blogs are a great way to start the day, aren't they? Thanks for your thoughts. Here's a response

"But the past price level path, and NGDP path, and those past expectations, are baked into the current economy."

Sure, but do they matter in the way that you think? I'm interpreting your "baked-in" argument to mean that there is an optimal *level* target now. Let's suppose that's right. I have to ask, how do you know the BSS didn't change that optimal path? I can draw my desired price level target line starting from any arbitrary point in the past (or expected future, for that matter.) How do I know which level is the "right" level to maintain? (If we really want to get ugly, think about what to do when we revise the GDP deflator and find the price level has changed from what we thought it was.....)

"I really don't think it's that hard for a central bank to commit to a rule."

Would you agree that it depends on the rule? Courts go out of their way to justify their decisions based on arguments about which is "right", based on fundamental principles of justice, statue and precedent. Central banks go out of their way to justify their policy based on economic goals. Making the price level/trajectory target credible will require a clear rationale. (Maybe linking the governor's pay to deviations from pre-announced targets could help at the margin....)

Simon: first point. If we are arguing about general time-consistency problems, then I think the idea that a BSS might temporarily change the optimal NGDP path would also apply to the optimal inflation path. See Angelo's argument, for example.

Second point. People (often) do act on past commitments. We make promises, and expect others to try to keep them, and put at least some weight on their past commitments. I don't see how it's any different for central bankers. We don't always act as if bygones are forever bygones.


I don't think inflation targets (or any kind of growth rate targets) are credible, except when they're easy to hit. If the central bank misses its inflation target, there is no penalty for missing the target, so there's no reason for people to have confidence that it will hit the target, unless the target is easy to hit. With a level target, there is a penalty for missing the target, in the form of a more aggressive target that will replace it if it isn't hit, and, perhaps more important, there is a penalty for private sector agents that bet that the central bank will continue missing its targets. With a growth rate (inflation) target, if there's some reason to be skeptical of the target, betting against it is more or less a one-way bet (sort of like betting against a currency peg). If the central bank misses and you expect it to miss again in the same direction, there's isn't a huge risk that it will miss in the other direction (although there's some risk, so it's not quite like a currency peg). With a level target, on the other hand, you have to be pretty damn confident to keep betting against the target.

Nick, I like these posts that explain stuff in simple terms! Reading it, it occurs to me: how does NGDP targeting work in an economy experiencing an uneven rate of population growth? Price level and inflation are both, in some sense, per capita variables, so population growth is not an issue, but NGDP isn't, is it?

Say there is a change in the foreign sector that forces us to devalue. The devaluation will create inflation, but only temporarily. At some point, the economy will re-adjust. Now, you are back to where you want to be -- unless you have a price level target. If you have a price level target, you are committed to future internal devaluation.

People rightly understand that no government will commit to unnecessary internal devaluation and unemployment "just because" the central bank picked a rule. They will all respond -- this is a bad strategy; we will replace you with someone who picks better strategies.

It is not the public that needs to be confident, it is the central bank. The central bank needs to be extremely confident about its understanding of the economy, that nothing could possibly require a necessary price level adjustment, and that the economy is perfectly frictionless under every conceivable shock.

The public is not going to be the one under pressure when it protests unnecessary rate hikes, but the central bank. The public need merely place bets on the rationality of the government that appoints the CB's leadership, and the fact that the central bank makes mistakes, which are not rectified by additional mistakes. That's a very safe bet.

Speaking of the whole Expectations thing, of which Nick is very fond, ISTM that his whole argument is that a Central Bank never bluffs or if it does, nobody ever calls the bluff and wins. But what about George Soros, who called the Bank of England's bluff and made a lot of money doing so? Central Bank mistakes are revealed when CB bluffs are called and the CB is shown to be bluffing and has no cards.


Niggling point: back in 1992, monetary policy was still under the control of the UK Treasury. As we've seen with the ECB, central banks can be ruthless in the pursuit of monetary policy objective in a way that democratically accountable governments cannot be. I'm not sure that makes much of a difference to Rowe's argument or your objection, however, since the UK government's behaviour prior to 1997 can presumably be modelled much in the same way as that of an independent central bank, with the Bank of England being equivalent to a group of civil servants in the Treasury.

(Nick Rowe can obviously deal with the non-pedantic issue here, which is interesting.)

Frances: Yep. Good question. It has come up a bit. Suppose you have a 5% NGDP growth target, with productivity growing at 1% and population growing at 2%, you get 3% real GDP growth in the long run, and 2% inflation. If long run population growth slows to 0%, your long run inflation rate will grow to 4%.

You could argue that that's a feature, not a bug. Because lower population growth means a lower equilibrium real rate of interest. So you want higher inflation to stop nominal interest rates falling, and get insurance against hitting the Zero Lower Bound.

Or you could say: target NGDP per capita.

rsj: You lost me right at the beginning. "Say there is a change in the foreign sector that forces us to devalue. The devaluation will create inflation, but only temporarily."

Under inflation targeting, or price level path targeting, if there is some change in the foreign sector that leads to a depreciation of the exchange rate, that is because the central bank allows the exchange rate to depreciate in order to prevent inflation falling below target.

So, price level targeting prevents oil embargoes? Or tariffs? You have to be really confident that the economy will not need an unanticipated price adjustment.

Determinant: good question. In a sense, a central bank (unless it is insolvent) can always hit any nominal target it wants. The BoE could have held the exchange rate fixed (unless it ran out of assets, and not just forex, to sell). But was it willing to pay the price? If it sold enough assets to defend the peg, the rate of interest could have gone very high indeed, which would have caused NGDP to fall very low, which would have caused a recession. Soros judged, correctly as it turned out, that the Bank of England was not prepared to let NGDP fall and create a recession just to defend the peg.

In a sense, you could say that Soros' success showed that NGDP is what central banks really care about.

It's not obvious how a latter day Soros would try to attack an NGDP target, and force the BoE to do something it didn't want to do just to defend the NGDP peg.

But that is an interesting thing to think about.

rsj: that's not what I am saying. Obviously inflation or price level targeting cannot prevent a supply shock. And I also think that inflation or price level targeting are bad policies in the face of a supply shock. It's one of the reasons I prefer NGDP.

rsj: OK. I now think I see what you are saying. Suppose there is some shock that the BoC doesn't anticipate, and so doesn't react to, that causes a rise in the price level. Under inflation targeting the BoC takes no further action. Under price level targeting the BoC needs to reduce the price level back down again. That might cause a recession. Yep, it might. There were pros and cons in the argument between IT and PLPT. The automatic stabiliser argument supported PLPT over IT. Other arguments went the other way.

Nick right! And I am also saying that because of this, level targeting cannot be as credible as rate targeting, as people understand these shocks will arrive and will not generally believe that the CB will stick to the level. That has repercussions for level targeting aside from the shocks themselves.

rsj: OK. And the usual response by PLPT people is to say: "OK, but:

1. the shock wouldn't cause the price level to rise as much initially under PLPT than under IT. Because under PLPT people know that prices will eventually go back down.

2. PLPT says the BoC will make the price level go back down *eventually*, but it could do it at a slow pace, so as not to cause a recession."

How strong these defences are, is of course debatable. And 1 and 2 do conflict with each other a bit.

But I get your point. It has some strength.

It's not obvious how a latter day Soros would try to attack an NGDP target, and force the BoE to do something it didn't want to do just to defend the NGDP peg.

That's the heart of why I am uncomfortable with your Expectations hypothesis. Calling a bluff is similar to fraud artists in that they will both exploit any weakness in a system. Given time, a bluff will be called or a fraud will appear to exploit the most minuscule weakness. It happens, we know it happens. Play poker long enough and your bluff gets called. The market (other players) need to see that your play is credible and so need to lose to ensure you aren't bluffing. Unlimited Credibility means that there must be an unbeatable super-weapon possessed by the Central Bank.

What is this super-weapon, why does it exist, what side effects does it have? If you can't answer those questions without hesitation or reservation, you don't have a super weapon and your bluff wil be called.

Somebody will, eventually, will call the CB's bluff, and since it does not have a super-weapon, there is the possibility that George Soros: The Next Generation will win, make lots of money, and monetary policy will fail. The CB will be out of weapons in the way that you decry and say can't happen, Nick. Shouldn't isn't the same as can't and it makes all the difference.

@W. Peden

Excellent point. The Treasury civil servants had the same levers the Bank of England had. You say they had the same goals and patience too. Which plays into my question "where's the super-weapon"?

Determinant: That's a bit like saying that we should do nothing, unless I can prove that doing something is absolutely safe. Central banks can't "do nothing". What does "doing nothing" mean? There is always something they are targeting, trivially.

Nick, as I understand it you've asserted that a committed central bank can always hit its target. Chuck Norris? Ok. You really mean nothing beats Chuck Norris' roundhouse kick. But what if someone pulls a Black Swan Punch and beats Chuck? In a world where Black Swans and their punches exist, Central Banks can and will fail to hit their targets at times. Which makes calling bluffs potentially profitable. Which means monetary policy has limits. In which case this whole expectations thing hasn't really got us anywhere, or so it seems to me.

On targeting, a Central Bank target could be a tautology, in which case of course the CB always reaches its target, the read-out never changes. But tautologies are fallacies because you haven't actually changed anything, you haven't managed anything. Managing something implies changing it so if a Central Bank manages Aggregate Demand, it can't actually do that if it targets a tautology.

For the CB to do something useful, it has to do something with a chance of that not happening, else the CB's actions are not useful.


"Excellent point. The Treasury civil servants had the same levers the Bank of England had. You say they had the same goals and patience too. Which plays into my question "where's the super-weapon"?"

Not having to stand for re-election could be seen as a super-weapon, although even totalitarian dictatorships are based on political coalitions.

I think Nick's point still stands, by the way: how does Soros break an NGDP target? My answer would be the reverse end of the impossible trinity from what happened at Black Wednesday: consider an economy like Canada, where having a particular exchange rate with the dollar is vital to a lot of important industries. If the US has a very inflationary monetary policy and Canada has say a 5% NGDP target, then the Canadian dollar is going to balloon in value relative to the US dollar. At that point, there will be a lot of pressure to change the NGDP target; IIRC, this was a major problem for Canadian money supply targets in the late 1970s. It was also the factor that led the Callaghan government in the UK to (effectively) abandon M3 targeting in late 1977. So not only can you get Black Wednesday scenarios (monetary authority abandons external target in favour of domestic objectives) but you can get the converse (monetary authority abandons domestic target in favour of external objectives).

This is a problem for any small-economy monetary policy regime. I seem to remember that both Keynes (in the 1920s?) and Friedman admitted that their economic policy regimes were only suitable for large countries for this reason, like the US and Britain. That's why Friedman was in favour of currency boards for some countries.

I would venture that the Canadian inflation targeting experience has only been successful because US monetary policy has been exceptionally hawkish since the early 1990s, so Canadian inflation targeting has implied either a reasonably stable exchange rate or a stimulative monetary policy during a crisis. If the ghost of Arthur Burns gets the Fed chair, the Bank of Canada is in big trouble, for reasons that Keynes had figured out in his greatest work (the Tract).

W Peden: suppose US monetary policy became very inflationary. Then I would say that it would be even more important for Canada to have a flexible exchange rate and its own domestic monetary target (whether IT, PLPT, or NGDPLPT). Otherwise, we have to have high inflation too.

Nick Rowe,

I agree, but the political pressure would be in the opposite direction. Even Thatcher u-turned in the face of an overvalued currency in 1980.

Do you mean political pressure from Canadian exporters? I can see that happening in the face of a *shock* that requires the *real* exchange rate to appreciate to keep domestic targets on track. (We see that happening a lot). But if it's a *permanently* loose US monetary policy and permanently high US inflation, we're talking about, that shouldn't affect the real exchange rate. (But then, maybe Canadian exporters would carefully ignore the distinction, if they wanted to exert political pressure.)

Nick: just getting to your reply @ 3pm yesterday.

Aren't your two replies at cross-purposes? You seem to be arguing that
1) sure the optimal reponse may change....
2) just because the optimal response changes is no reason to expect monetary policy to change.

Simon: Ah. I wasn't very clear.

What I was trying to say in my first point was that *if* someone did argue that a BSS would change the optimal NGDP time path, and that that would make NGDP targeting time-inconsistent and so not credible, they would have to face my reply "don't you think that same argument would apply to IT as well?" (I might also reject their premise that a BSS would change optimal NGDP, but I would try a "tu quoque" argument as well.)

Nick Rowe,

Yep. And a shock could last for some time e.g. if the US was in a World War II style situation with a loose monetary policy and big deficits, with Canada at peace, that could means years of hardship for exporters. I agree with you that the exchange rate should be allowed to appreciate under such circumstances, but as with tariffs, sadly economists like yourself have a record of being ignored.

they would have to face my reply "don't you think that same argument would apply to IT as well?"

Yup. What the CB is doing now is not IT per se, but following a Taylor rule. There is a "divine coincidence" that results in the current policies as appearing to be IT. Some CBs are really just inflation targeting, such as the ECB.

OK, that was a cheap shot! :P

But at the end of the day, it is welfare that we are trying to maximize, not any single metric.

The current economic management approach is not flawless. There is a divine coincidence in terms of unusually stable prices, but a hellish coincidence in terms unusually rapid private sector debt growth, a wide divergence between compensation and productivity, and parabolic growth in wealth inequality.

As we learn more about the economy, we will refine our economic management strategy, we will adopt new strategies, and the divine coincidence vis-a-vis inflation may go away.

One can argue that the divine coincidence has already gone away in certain nations.

But yes, I think it is an obvious mistake to target inflation per se. Whether or not it is a mistake to be following a taylor rule and "accidentally" target inflation is a separate question.

The Bank of Canada isn't following a Taylor Rule. It is doing IT. (At least, that's what it says it's doing, and last time I checked empirically, albeit many years back, it checked out.)

^^ And I forgot to mention a biggie, namely inequalities in current account balances. The last 20 years was a time of increasing global financial instability, currency crises, and banking crises, occurring with more and frequency and severity, culminating in the big bang. There is alot about our economic management that is, in retrospect, unsustainable.

An interesting source is here: http://www.luclaeven.com/Data.htm

Perhaps in the future, we will believe that it is better to trade accept price volatility in order to minimize current account imbalances. We may want start adjusting rates in response to asset price movements as well as in response to consumer price movements. We may find that we need all the tools in our toolbox: fiscal policy, monetary policy, trade agreements, financial regulation. Whatever the new policy regime will be, I would be surprised if it also has a divine coincidence in which we solely focus on consumer price inflation. I think such a narrow focus was a mistake because it created an environment in which a lot of other factors spiralled out of control.

The Bank of Canada isn't following a Taylor Rule. It is doing IT.

Really? Ok, I didn't know that. But the point is that as long as you are in the zone in which divine coincidence holds, then it doesn't matter. It only matters when the coincidence stops holding.

rsj, shocker!!! You've been on this blog how long and you missed the key and very public strategy of the Bank of Canada?!?

I shall have to lie down with a stiff drink.


Yes, have a brandy! It will keep you warm.

I understand inflation targetting is a symptom of the very real need for a conservative movement. The rising tide has been okay the last three decades; it was great at the tax rates and Crowns right after WW2. The conservative response of don't mess with a working machine is also why there is an aversion for new Crowns, for switching away from GDP = economy to GDP = a = b = c = economy.
If people have been taught to be motivated by their jobs, and the most efficient thing is to store surpluses and reeducate to health or materials science or whatever...that previous teaching need to be taken into account...

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