Price Level Targeting: A Step in the Right Direction

The Federal Reserve plans to review its inflation growth rate target and potentially select a new monetary policy target.Many Fed officials are in favor of the idea, includingChair Powell. And the latest FOMC minutes show that the Fed ’s policy setting committeehas discussed new targets.This is good news, because inflation rate targeting suffers from serious shortcomings. With a growth rate target, a central bank writes off past errors. Instead of deliberately correcting those errors, it “lets bygones be bygones,” allowing its mistakes to permanently alter the value of its policy target. For example, the Fed haspersistently undershot its 2% inflation target since adopting it in January 2012. Because it does not plan to atone for this prolonged period of undershooting the price level will forever remain below its original target path, at least so far as deliberate Fed actions are concerned.Successful price level targeting requires, on the other hand, that the central bank make up for past mistakes. Monetary policy is successful if the price level returns to the trend line it was growing along before the undershooting occurred. This makes the future course of the price level easier to predict. Inflation growth rate targeting cannot match this degree of predictability because its policy errors permanently change the long run price level, making the future path of the price level more like arandom walk.Improved price level predictability is one of the reasons that several F...

Source: Cato-at-liberty - June 12, 2018 Category: American Health Authors: Tate Lacey Source Type: blogs