Inflation targeting: what do economists think?

600 economists opine about the inflation target

In the last two years the Fed and the ECB announced changes in their monetary policy strategy. These announcements have triggered a debate on the optimal inflation target as well as the objectives of monetary policy. In this paper, Ambrocio et al. are trying to gauge the opinions of economists on the subject by analyzing the answers to an extensive survey of leading researchers in economics and finance from around the world. The survey was sent at the end of 2020 to a sample of approximately 6000 individuals. Of the 613 responses, 591 (96%) came from inflation-targeting countries or regions, 159 were from the Euro Area and 241 from the US. Their finding include:

• Most respondents prefer the central bank to have an explicit inflation target;
• Roughly half of them want their central bank to keep its current target. Among the rest, a higher target receives significantly more support than a lower target;
• The potential loss of credibility is a clear concern about increasing the inflation target;
• There is concern that monetary policy has become less effective in achieving its goals;
• The average estimate of the equilibrium real interest rate in the sample is 0.6%.

What Should the Inflation Target Be? Views from 600 Economists
Authors: Gene Ambrocio, Andrea Ferrero, Esa Jokivuolle, Kim Ristolainen
From: Bank of Finland, University of Oxford, University of Turku

The problem with the theoretical foundation of inflation targeting

The Swedish economist Knut Wicksell (1851-1926) in his groundbreaking treatise, “Interest and Prices,”  proposed price stability as the rule for monetary policy. His work established the theoretical foundation of inflation targeting and  recommended a monetary rule where the policy rate should be set equal to the natural rate. Nevertheless, the financial crisis of 2008-09 showed that the focus on consumer price stability has fostered financial instability. In this paper, Lars Jonung argues:

[T]he problems with inflation targeting today can be traced to Knut Wicksell as well. He excluded the financial system and asset markets in his model of the cumulative process, in this way ignoring the occurrence of financial crisis caused by excessive credit growth and balance sheet effects. The same exclusion holds for the neo-Wicksellian approach and thus for inflation targeting central banks today. They suffer from a Wicksellian tunnel vision that focuses on consumer price inflation and the policy rate, ignoring the rapid growth of credit and the rise in asset prices outside the tunnel during recent decades of inflation targeting.

The problems of inflation targeting originate in the monetary theory of Knut Wicksell
Author: Lars Jonung
From: Lund University