Frankel: The Death of Inflation Targeting

Jeffrey Frankel says inflation targeting is falling out of favor, but it's not clear what will replace it:

The Death of Inflation Targeting, by Jeffrey Frankel, Commentary, Project Syndicate: It is with regret that we announce the death of inflation targeting. The monetary-policy regime, known as IT to friends, evidently passed away in September 2008. The lack of an official announcement until now attests to the esteem in which it was held, its usefulness as an ornament of credibility for central banks, and fears that there might be no good candidates to succeed it as the preferred anchor for monetary policy. ...

Regardless of the form it took, IT began to receive some heavy blows a few years ago... Perhaps the biggest setback hit in September 2008, when it became clear that central banks that had been relying on IT had not paid enough attention to asset-price bubbles. ... [A]nother major setback was inappropriate responses to supply shocks and terms-of-trade shocks. ... CPI targeting ... tells the central bank to tighten policy in response to an increase in the world price of imported commodities – exactly the opposite of accommodating the adverse shift in the terms of trade. ...

One candidate to succeed IT as the preferred nominal monetary-policy anchor has lately received some enthusiastic support in the economic blogosphere: nominal GDP targeting. The idea is not new. It had been a candidate to succeed money-supply targeting in the 1980’s, since it did not share the latter’s vulnerability to so-called velocity shocks.

Nominal GDP targeting ..., unlike IT, it would not cause excessive tightening in response to adverse supply shocks. Nominal GDP targeting stabilizes demand – the most that can be asked of monetary policy. An adverse supply shock is automatically divided equally between inflation and real GDP, which is pretty much what a central bank with discretion would do anyway.

A dark-horse candidate is product-price targeting, which would focus on stabilizing an index of producer prices... Unlike IT, it would not dictate a perverse response to terms-of-trade shocks.

Supporters of both nominal GDP targeting and product-price targeting claim that IT sometimes gave the public the misleading impression that it would stabilize the cost of living, even in the face of supply shocks or terms-of trade-shocks, over which it had no control. ...