Write your abstract
here.Larry Meyer has presented us with a fine paper
on practical problems and obstacles to
inflation targeting in the United States—a very
suitable paper for this great conference at the St.
Louis Fed. I find it a very thoughtful paper with
many good points. I agree with most of the points
Larry makes; I hope many people will read the
paper and, in particular, take seriously his proposal
for inflation targeting in the United States.
However, one issue that I believe Larry puts too
much weight on is his pet idea, the distinction
between a dual and hierarchical mandate. I do not
believe this distinction is very useful. We are all
flexible inflation targeters now. More precisely, we
are all talking about an intertemporal
loss function for monetary policy consisting of the expected discounted
sum of present and future period losses, that
is, of the form
,
where the period loss function is typically given by
.
Here, Et denotes expectations conditional on information
available in period t (typically a quarter), d
is a discount factor and fulfills 00 is the relative weight on
output-
gap stabilization relative to inflation-gap stabilization.
Alternatively, the period loss function can be
expressed in terms of
employment,
Lt t llt lt ,where lt and l
–
t denote log employment and log
equilibrium employment, respectively, lt –l
–
t is the
employment gap, and ll>0 is the relative weight
on employment-gap stabilization.1
Let us look at the loss function in terms of the
output gap. There are three parameters there: d,
p*, and ly. The d, the discount factor, is very close
to 1 and not a big issue. The p* is the inflation
target,
announced explicitly by an inflation targeter. There
remains only one parameter, the ly, the relative
weight on output-gap stabilization. The adjective
“flexible” in “flexible inflation targeting” has to do
with the value of ly.
The issue is really how to describe a loss function
of this type in words rather than a formula. I do not
believe the dual-hierarchical distinction helps in this
respect. But, if we must use it, we can think of this
loss function as saying something about the first
moments, the long-run means, of the target variables,
inflation and output; and the second moments, the
variability of the target variables around those means.
Regarding the first moments, there is a target
for long-run mean inflation, p*. This target is subject
to choice by the central bank or by its principal, the
government or the parliament, depending on the
institutional setup in the country. But the target for
output is not subject to choice. It is a “fact.” It is given
by the economy, by its potential output. Since potential
output is an unobserved variable, it requires
estimation. We can say that the output target is subject
to estimation, but it is certainly not subject to
choice. Alternatively, we can say that the output-gap
target is given at zero, and also not subject to choice.
Since there is a meaningful choice of the target for
long-run inflation but not of the target for long-run
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