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The case against price-level targeting

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Abstract

As the Fed begins to wrestle with how to stimulate growth in the next economic downturn in an environment of low interest rates, a number of possible changes in its policy framework are being entertained. One in particular that has gained considerable support is price-level targeting, based on the view that this approach would tend to move inflation and nominal interest rates up late in the business cycle, yielding more room for rate cuts when the downturn ensues. We outline the inherent difficulties involved in controlling the level of inflation under the current inflation-targeting regime. We then argue that requiring the Fed to meet the more stringent objective of a price-level target could introduce significantly greater volatility into output growth—potentially worsening economic downturns—than is the case under the current policy framework. We also consider a preferred course of action that adds a bit more flexibility to the current framework, at least for the near to the medium term, and how the Fed might deal with the next recession.

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Fig. 1

Source Haver Analytics and Deutsche Bank Research

Fig. 2

Source Deutsche Bank Research

Fig. 3

Source Congressional Budget Office and Haver Analytics

Fig. 4

Source Bureau of Economic Analysis, Haver Analytics, and Deutsche Bank Research

Fig. 5

Source Bureau of Economic Analysis, Haver Analytics, and Deutsche Bank Research

Fig. 6

Source Luzzetti and Weidner (2017a, b), Deutsche Bank Research

Fig. 7

Source Haver Analytics and Deutsche Bank Research

Fig. 8

Source Deutsche Bank Research

Fig. 9

Source Haver Analytics and Deutsche Bank Research

Fig. 10
Fig. 11

Source Haver Analytics and Deutsche Bank Research

Fig. 12

Source Haver Analytics and Deutsche Bank Research

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Notes

  1. The model developed by Holston, Laubach, and Williams can be found in Holston et al., (2016.

  2. See for example, Cashin et al. (2017).

  3. There is some debate about just how costly moderate increases in inflation in the 2–4% range would be. See, for example: Nakamura et al. (2017).

  4. Volcker noted that price stability exists when changes in prices over longer periods “are not a pervasive influence on economic and financial behavior.” See Volcker (1983), p. 5. Greenspan said “Price stability is that state in which expected changes in the general price level do not alter business or household decisions.” See Greenspan (1996), p. 51.

  5. A little over a decade ago, a BLS staff survey of the literature put the upward bias in the US consumer price inflation at roughly between 0.5 and 1.5%. See Johnson et al. (2006).

  6. See Brookings Institution (2018).

  7. The Fed staff includes a price-level target in its stable of policy rules in the Monetary Policy Report, and that has the fed funds rate still at zero. See Board of Governors of the Federal Reserve System (2018).

  8. The models shown in Fig. 6 include those by Laubach and Williams (2003), Holston et al. (2016), Lubik and Matthes (2015) and Curdia et al. (2015). For more details on this point, see Luzzetti and Weidner (2017a).

  9. The moving slope presented here was estimated in rolling regressions with a variant of the Phillips curve very close to one discussed by Yellen (2015). The instability of that model has been documented by Luzzetti et al. (2018). The problems structural models of inflation have predicting inflation more generally are well documented in Cecchetti et al. (2017) and Faust and Wright (2013).

  10. See Mahedy and Shapiro (2017) and Desplans et al. (2018).

  11. Recent analysis by Weidner et al. (2018) has found that when cyclical inflation is used (extracting acyclical inflation from overall core inflation) in the estimation of r*, the level of r* is raised to several tenths of a percentage point and could be showing some uptrend.

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Authors and Affiliations

  1. Deutsche Bank Securities, Inc, New York, NY, USA

    Peter Hooper

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  1. Peter Hooper
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Correspondence to Peter Hooper.

Additional information

The author thanks Matthew  Luzzetti, Charles Steindel, Laura Desplans, Brett Ryan, Torsten Slok, and Justin Weidner for their helpful comments and suggestions and Sourav Dasgupta… for excellent research assistance. This note is based on a presentation given at the session “Rethinking the Monetary Policy Framework in a Low Interest Rate Environment” at the NABE Economic Policy Conference, February 26, 2018. It also draws in part on a broader analysis of the Fed’s policy framework by Luzzetti et al. (2018).

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Hooper, P. The case against price-level targeting. Bus Econ 53, 145–155 (2018). https://doi.org/10.1057/s11369-018-0081-5

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