Revisiting Central Bank Policy Frameworks: A Look at Price-Level Targeting
In a recent discussion in my previous article, I raised concerns about the Federal Reserve potentially veering away from a “level targeting” approach in its monetary policy. One of the criticisms of symmetrical level targeting is the fear of backlash from the public if the central bank were to bring down prices in a period of inflation overshooting the target path. However, a recent piece in the Financial Times suggests a different perspective:
Many major central banks have shifted towards using Taylor Rule models to guide their monetary policy decisions, anchoring interest rates based on the distance of the economy from the inflation target and the level of slack present. Surprisingly, recent elections indicate that the public may prioritize price-level stability over low inflation rates or full employment.
If this sentiment holds true, central banks may need to reconsider their policy frameworks and explore the concept of price-level targeting, as advocated by Professor Michael Woodford of Columbia University. Under this framework, monetary policy aims for a consistent increase in price levels over time, requiring proactive measures to counter any deviations from the desired price trajectory. This stands in contrast to the current approach, which may celebrate a return to 2% inflation despite missing the target for multiple years, leading to significant erosion of real purchasing power for households. By promoting early intervention to address initial price level divergences, this framework could potentially benefit consumers.
It is essential to tread cautiously when interpreting election outcomes. Should we witness a resurgence in high unemployment rates, public sentiment may shift towards prioritizing job creation over price stability. However, I believe there doesn’t have to be a tradeoff. A policy of Nominal Gross Domestic Product (NGDP) level targeting or a genuine “flexible average inflation targeting” strategy (distinct from the Fed’s current approach) could offer a balance of stable prices and employment in the long term. Ultimately, it is economic prosperity that garners political favor.
