On the 2% inflation target

Project Syndicate asked Mike Boskin, Brigitte Granville,  Ken Rogoff and me whether 2% is the right inflation target. See the link for the other views. I pretty much agree with them in the short run -- don't mess with it -- but took a different long run view. Apparently Greenspan was a fan of price level targeting and hoped to get there eventually, which is the sort of long run approach I took here. 

I also emphasize that any inflation target is (of course) a joint target of fiscal as well as monetary policy. Fiscal policy needs to commit to repay debt at the inflation target. 

My view: 

No, 2% is not the right target. Central banks and governments should target the price level. That means not just pursuing 0% inflation, but also, when inflation or deflation unexpectedly raise or lower the price level, gently bringing the price level back to its target. (I say “and governments” because inflation control depends on fiscal policy, too.)

The price level measures the value of money. We don’t shorten the meter 2% every year. Confidence in the long-run price level streamlines much economic, financial, and monetary activity. The corresponding low interest rates allow companies and banks to stay awash in liquidity at low cost. A commitment to repay debt without inflation also makes government borrowing easier in times of war, recession, or crisis.

Central banks and governments missed a golden opportunity in the zero-bound era. They should have embraced declining inflation, moved slowly to a zero-inflation target, and then moved gently to a price-level target.

Why not? Some focus on the short run and say that central banks should raise the inflation target, because getting inflation to 2% will require too much pain in the form of unemployment. But inflation is falling alongside very low unemployment, proving this argument wrong again. And shifting the goal posts undermines the stable expectations that allow relatively painless disinflation.

The other argument says that a higher inflation target creates more room to use rate cuts to stimulate the economy in times of recession. But that is like wearing shoes that are too tight all day, because it feels so good to take them off at night. This argument presumes that expected inflation is set mechanically by previous experience. Moreover, the evidence that slightly lower overnight rates provide much stimulus is weak. The potential benefit is not worth permanently abandoning a stable value of money.

from The Grumpy Economist https://ift.tt/fwUu7sB