Steve Poloz on inflation targeting

Stephen Poloz is Governor of the Bank of Canada. Here is the speech he delivered at Western. The whole thing is worth reading.

Perhaps I'm reading too much into it. But I see a tension in Steve's speech. He recognises that Divine Coincidence has failed, and that inflation targeting has failed. But he doesn't want to change the "quasi-constitutional" (I think that was David Laidler's phrase?) 2% inflation target.

Two key parts:

"Many of us came to Western at that time to learn from the high-profile duo of David Laidler and Michael Parkin. I can remember David Laidler telling me, “Steve, monetary targets will help keep us out of trouble, but if we do get into trouble, they might not get us out.” And then there was Michael Parkin, who later was my thesis adviser, who said, “Steve, there are lots of monetary policy rules that deliver the same inflation outcome, but each will have very different consequences for the economy.” "

"As Agathe Côté said in her speech, nothing is broken, and the bar for changes to the inflation-targeting agreement will be high. In spite of the financial stability issues I have raised today, inflation targeting has served us well, and we remain committed to the concept. As I said at the beginning of my remarks, however, there are lots of monetary policy rules with the same inflation outcome, each with different implications for the economy, and we need to understand these better within an agreed inflation-targeting regime." [my bold]

Is he talking about different short-term instrument rules that give the same medium-term 2% inflation? Or is he talking about different medium-term intermediate targets, that give the same long-term 2% inflation? Like a 2% price-level path target, or an NGDP target that is slowly adjusted over time in response to long run real growth rates to give the same long-term 2% inflation?

Dunno. But Mike Parkin in the late 1970's would I think have been talking about different monetary policy rules that deliver the same long run inflation outcome.

("Medium term" means "around 2 years".)

Comments

[Majromax]

A few thoughts from the speech:

>> Confidence that keeping inflation low and stable would keep us out of trouble had bred complacency, and complacency bred calamity.

One possible policy modification from an inflation perspective is to keep inflation "low and less stable." In much the same way a growing tree is weak if it is too sheltered from the wind, a little bit of inflation variability over the short to medium term can promote more sensible levels of risk protection.

The Bank of Canada already has the framework to accomplish this, through its operational guideline of 1-3% inflation.

Adopting a 2% price level growth target while maintaining short-term inflation in the 1-3% range keeps long-term inflation expectations stable (even more stable than now) but permits greater short-run flexibility, in a way that can still be subject to policy rules. This is also essentially consistent with the Bank of Canada's conventional inflation-targeting mandate, since it is firmly targeting long-run inflation and weakly targeting short-run inflation.

Better still would be a 5% or so NGDPLT (although I'd probably prefer a 5% ngdp-per-working-age-capita target, to naturally include demographic shifts), but that would represent more of a policy target change than an operational change.

[anon]

The ECB is pretty much in the same boat, since it is committed to delivering "price stability" as part of its founding treaty. I agree that the best policy under these conditions is to accept inflation being less stable in the short-to-medium run, in order to stabilize NGDP istead (or rather, its high-frequency component). There's lots of ways to do this, but the easiest from a policy standpoint would seem to be having a crawling fluctuation band for the PLT, where you could be lower or higher within the band, depending on what happens to a suitably detrended NGDP. (Think of things like subtracting a 5-year moving average. You'd want something like that, to get a series that would vanish if NGDP has been on a stable trend for some time, whatever the trend is.)

[Andrew Baldwin]

Nick, my own interpretation of Governor Poloz’s remarks is that it is like a pre-announcement that the BoC intends to change its operational guide with the next renewal agreement from CPIX to the common component of CPI. If you think about it, the choice of core CPI measure could make a considerable difference to the things that the BoC reacted to and did not react to, and hence have consequences for the economy, without changing the average inflation rate over a span of years.
It is hard to see that the BoC would ever want to lower its overnight rate when the operational guide had been showing the underlying rate of inflation above target for September through December, and since the January interest rate announcement we find that the January CPIX inflation rate was also above target (2.2%). In fact, the BoC, which in the past has treated the underlying inflation rate and the CPIX inflation rate as synonymous terms, has consistently denied that the underlying inflation rate has been at or above target. (The old operational guide, CPIXFET, was at the target rate of 2.0% in October and November, and just below it in December an d January at 1.9%.) It obviously intends to replace the CPIX with the common component of CPI measure, which does show inflation rates consistently below 2% since at least the second quarter of 2012.
The 2006 renewal of the inflation-control agreement was supposed to show the fruits of an ambitious research agenda into how to improve the inflation targeting regime. As we know, there were no fruits at all. Absolutely nothing that mattered changed. The BoC should have changed its amateurish CPI excluding changes in indirect taxes to conform to international standards but neglected to do so. This would have had a substantial impact on the CPIX measure. The beauty of the BoC’s planned change, from the BoC’s point of view, is it avoids their having to dig into the nasty details of such tax adjustments, which it obviously finds rebarbative. Also, mortgage interest, which has been keeping the inflation rate down, but has absolutely no place in the inflation indicator of a central bank, will be reintroduced into the BoC’s official measure of underlying inflation. However, since it will be done in the context of a highly sophisticated data transformation not many people understand, the BoC is hoping that this will not be perceived as the highly reactionary move that it is. I hope everyone who reads Worthwhile Canadian Initiative pushes back strongly against this. There is no way that the measure of underlying inflation targeted by the BoC should contain property taxes, as it now does, or mortgage interest, as it will do again if the common component measure replaces CPIX in 2016.

[Nick Rowe]

Andrew: Aha! I never thought of that--replacing CPIX with some other operational guide (intermediate target) for "core" inflation, while retaining headline inflation at 2% as the long run target.

You might be right. I will have to think about the "common component" definition of core.