Raising the inflation target rate to

The Fed lifted its short-term rate — a benchmark for many consumer and business loans — by a modest quarter-point to a range of 2 percent to 2. It was its eighth hike since late The central bank also stuck with a previous forecast for three more rate hikes in

Raising the inflation target rate to

First the most effective and reliable monetary policy instrument is to influence the real interest rate in the economy, which is the nominal interest rate less expected inflation. Combine the two and you have a severe problem in a recession, because to combat the recession real interest rates need to move into negative territory, and how far they can go into that territory is limited by the ZLB.

That means monetary policy alone may be unable to get us out of a recession. Raising the inflation target reduces the likelihood that interest rates will hit the ZLB.

That may be enough for a mild downturn, but as we saw in it is not enough for a major recession. That is probably enough to combat all but the worst kind of recession. This is sometimes referred to as secular stagnation. If you go through the arithmetic above, you can see why a lower long run real interest rate will make the ZLB problem worse.

The argument is that we now need to raise the inflation target to make sure we hit the ZLB less often in the future. This issue moved from an academic discussion to a real possibility in the US a few days ago. When Fed Chair Janet Yellen had been asked about raising the inflation target in the past, she has tended to dismiss the idea.

However she now says that it is something that the Fed will review in the future, and that it is one of the most important questions facing central bankers today.

This will undoubtedly give new impetus to the debate over whether the inflation target should be raised. We are in standard trade-off territory here. Economists generally agree a higher inflation target will in itself inflict greater costs on the economy, but they bring the benefit that the ZLB problem will occur less often.

But there is an alternative, and clearly much better way out of this dilemma. Governments have another instrument that has a reasonably predictable impact on aggregate demand, and which can be used to combat a recession: In the UK at the moment interest rates are at the ZLB in part because fiscal policy is contractionary austerity.

It would be far better to use this instrument to stimulate the economy in a recession than to raise the inflation target. Yet the institution of independent central banks have discouraged governments from using fiscal policy in this way.

It is no good central banks pretending that this is something which is up to governments, and that there is some unwritten law which means that central banks should keep quiet on such things. In reality, in both the UK and the Eurozone, the central bank actively encouraged governments to do the wrong thing with fiscal policy in the last recession.

In other words, they encouraged austerity. If there is something inherent in the institution of a central bank that makes them give inappropriate advice in this way, then we should be asking how central banks can be changed as a matter of urgency.

What should happen in a recession, as soon as the central bank thinks that interest rates will hit the ZLB, is that central banks should say, out loud in public, that fiscal policy should become more expansionary.

In addition central banks should say, out loud in public, that governments need not worry about rising debt and deficits due to the recession and any fiscal stimulus they undertake spooking markets because the central bank has that covered.

Both statements have the merit of being true. Of course governments will need to restore debt to desired levels at some point, but that point should be well after interest rates have left the ZLB because then debt correction can be painless. The immediate aim of fiscal policy in a recession should be to allow interest rates to rise above the ZLB as soon as possible.

That gives you the best macroeconomic outcome, and one that is far superior to raising the inflation target. The most important question facing central bankers today is why they failed to do that from Now it is possible that, if democracy is in a bad shape as it currently is in the US for examplethe government may ignore the advice it receives from the central bank.

In that case it is worth considering giving central banks some additional power to mimic a fiscal expansion, such as helicopter money for example. Or it may be worth considering institutional changes that allow nominal interest rates to go negative.

Why Do We Target 2% Inflation?: Penn Wharton Public Policy Initiative

Or raising the inflation target. But before doing any of those things we need to ensure that central banks give the right advice to governments when the next recession comes along.Apr 11,  · Buoyed by a strengthening economy and increased confidence that the Federal Reserve will reach its inflation target in the near future, central bank policymakers suggested the path of future rate.

An inflation target that is too low might lead to higher unemployment (Akerlof et. al suggest that an inflation rate close to zero might increase the long-run level of unemployment), might restrict the central bank’s ability to support a recovery in times of recession due to the zero lower bound on nominal interest rates (Meyer Apr 21,  · Raising the target would lead to greater inflation stability (sounds a bit like price stability) but lead to smaller deviations from full employment, if that means fewer and less protracted periods spent at the zero bound.

Raising the inflation target reduces the likelihood that interest rates will hit the ZLB.

Raising the inflation target rate to

To see why, note first that the long run (economists often say ‘equilibrium’ or ‘natural’) real interest rate is positive.

Let’s say it is 2%.

Raising the inflation target rate to

inflation rate that excludes shelter would be more than percentage points lower than the standard of percent as an inflation target is that it is supposed toallow the Fed room to boost the The impact of shelter in raising the core inflation rate is unusual in this period.

While inflation in the. This time, given our experience with low inflation and the risk of deflation, we took a good look at the idea of raising the target.

We considered this possibility seriously because central bank policy rates in many economies have been near, or at, historic lows, reaching the effective lower bound in some places.

A simple refutation of raising the inflation target - Philosophy of Money