An overview of the difference between inflation targeting, NGDP - - PowerPoint PPT Presentation

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An overview of the difference between inflation targeting, NGDP - - PowerPoint PPT Presentation

Oct 23, 2022 252 likes •469 views

An overview of the difference between inflation targeting, NGDP targeting, and a Taylor Rule; An argument as to why NGDP targeting generally makes more sense; An argument to the effect that inflation targeting is particularly

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 An overview of the difference between inflation

targeting, NGDP targeting, and a Taylor Rule;

 An argument as to why NGDP targeting generally

makes more sense;

 An argument to the effect that inflation targeting is

particularly dangerous, because central bas that practice it can end up fueling unsustainable asset- market booms.

 Empirical evidence supporting the last argument

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Loss Function:

L = α(yt − yn)2 + β(πt − π*)2

β > α: More weight on inflation tan

  • utput

β < α: More weight on output tan

inflation

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Simple Inflation Target: α = 0 Taylor Rule: α and β > 0 NGDP Growth Rate: β = 0

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Changes in P are ultimate cause of

differences between yt and yn

  • Prices are Sticky (M-disequilibrium)
  • Prices are Flexible (Signal Extraction

Problem)

So, output loss automatically avoided

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Stable NGDP is equivalent to maintaining a stable level (or growth rate) of Aggregate Demand

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P1 AS1 AS2

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LRAS(1) LRAS(2) P1 P2 AD1 AD2 P Y A B D AS2 C Yn1 Yn2

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 Signal Extraction: Since they can have only one cause,

meaning of price changes is unambiguous.

 Sticky Prices:

  • Prices respond quickly to underlying changes in unit cost
  • Either output or input prices must change, depending on

whether AD remains stable or not; and output prices tend to be less sticky than input prices

 P stabilization in presence of productivity innovations

itself results in suboptimal output movements.

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 For simplicity, assume that labor and yt = At(Nt), where A is

  • productivity. Let w = nominal wage rate. As A increases, so does

equilibrium real wage, w/P.

 Price-level targeting requires higher AD and w in respone to positive

A shock.

 With sticky wages, w/P doesn’t adjust at once to new equilibrium.

Result is short-run “profit inflation.” Signal extraction problem prevents temporary nature of enhanced profits from being recognized

 Asset prices reflect discounted expected future profits.

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 rn is the “natural” rate of interest;  β is the time discount factor;  G is the total-factor productivity growth rate; and  n is the growth rate of the labor force.

rn = -ln(β) + σg + n

where

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Productivity Growth and Monetary Policy

TFP Growth Rate Real Federal Funds Rate

Percent

2001 2002 2003 2004 2005 2006

  • 3
  • 2
  • 1

1 2 3 4 5

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The Productivity Gap and Housing

TFP Growth Rate - Real FFR Housing Starts(4 Qtr Lag)

Percent Housing Starts

2001 2002 2003 2004 2005 2006

  • 2
  • 1

1 2 3 4 5 1100 1200 1300 1400 1500 1600 1700 1800

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 “We believe we can enter [2006] with a below-

equilibrium funds rate and still not generate any acceleration of inflation until later”

 “Faster productivity growth…could put further

downward pressure on prices…Partly for this reason, the shift in the balance of risks…does not call for a change in policy any time soon…we should continue to take our risks on the easy side of policy.”

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The Productivity Gap and Housing

TFP Growth - Real FFR Housing Starts(3 Qtr Lag)

Percent Housing Starts

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

  • 10.0
  • 7.5
  • 5.0
  • 2.5

0.0 2.5 5.0 400 600 800 1000 1200 1400 1600 1800

The Productivity Gap and the Output Gap

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The Productivity Gap and the Output Gap

TFP Growth Rate - Real FFR Output Gap(6 Qtr Lag)

Percent

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

  • 10.0
  • 7.5
  • 5.0
  • 2.5

0.0 2.5 5.0

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 Taylor Rule a compromise between inflation and NGDP

  • targeting. Attaches some weight to departures of y

from yn, and some to departures of P from P*.

 But precisely because it still treats P movements as

inherently “bad,” it is in fact inferior to NGDP targeting, which seeks to prevent AD from influencing P, without interfering with P movements based on supply (and especially productivity) innovations.

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The Productivity Gap and The Tay lor Rule Gap

TFP Growth Rate - Real FFR Taylor Rule FFR - Actual FFR

Percent

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

  • 15
  • 10
  • 5

5 10 15

The Expected Productivity Gap and The Tay lor Rule Gap

Expected Trend TFP Growth Rate - Real FFR Taylor Rule FFR - Actual FFR

Percent

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

  • 10
  • 5

5 10 15