Abstract
One of the notable macroeconomic developments of the last two decades has been the apparent decline in the so-called neutral real rate of interest (or r-star). The declining level of r-star has significantly reduced forecasts of the steady-state federal funds rate associated with “normalized” monetary policy. Because a lower steady-state policy rate implies a heightened probability of reaching the effective lower bound on the federal funds rate in the event of an economic downturn, a debate has opened among academics and policymakers about potential changes in Fed’s monetary policy framework that might ameliorate the lower bound problem. This paper introduces a variation of price-level targeting that satisfies a definition of price stability that requires the central bank to keep the price level within a pre-specified percentage of a pre-specified target path for all time horizons into the future. The framework, referred to as bounded price-level targeting, is compared to other proposed frameworks. The paper discusses the conditions under which bounded price-level targeting is consistent with other proposals.
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Sources Bureau of Economic Analysis, Author’s calculations; Haver Analytics
Sources Bureau of Economic Analysis, Author’s calculations; Haver Analytics
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Notes
A very useful summary can be found in Wadsworth (2017). Though the Fed did not formally adopt its 2-percent goal until after the crisis, Federal Reserve officials had routinely offered the view that inflation in the range of 1 to 2 percent was compatible with their own views on price stability. See, for example, Janet Yellen’s remarks at the 2006 Annual NABE Policy Conference (Yellen 2006).
I am following St. Louis Fed President Jim Bullard (2012, 2018) in choosing 1995 as a reasonable starting point for the adoption of an implicit 2 percent inflation target in the U.S.
In President Bostic’s (2018c, d) macroblog posts on this topic, the framework I am discussing was referred to as “flexible price-level targeting.” In other contexts, the “flexible” terminology has been used to describe schemes in which policymakers take “output and employment considerations into account in determining the speed at which they return to the inflation or price-level target,” (Bernanke, 2017). Since the idea contained in Fig. 1 does not necessarily presume that the price-level returns to a specific target path, I am referring to it as “bounded price-level targeting” to avoid confusion.
In the Statement of Longer-Run Goals and Monetary Policy Strategy, the FOMC describes the symmetry of its goal as follows: “The Committee would be concerned if inflation were running persistently above or below this objective.” This statement on its own does not call out one interpretation over the other.
See, for example, Miller (2017).
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This essay is based on Bostic (2018a, 2018b, 2018c, 2018d) and the author’s February 26, 2018 presentation at the session Rethinking the Monetary Policy Framework in a Low Inflation Environment at the 2018 NABE Economic Policy Conference. Any errors or omission or commission are the author's. The views contained herein should not be attributed to the Federal Reserve System.
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Altig, D. A new twist on an old framework: bounded price-level targeting. Bus Econ 53, 156–162 (2018). https://doi.org/10.1057/s11369-018-0085-1
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DOI: https://doi.org/10.1057/s11369-018-0085-1