The Corner

Economy & Business

Level Best

A proposal to shift from inflation targeting to price-level targeting is “gaining traction” at the Federal Reserve, according to Pedro da Costa in a report for Business Insider.

The difference between the two policies is how they deal with mistakes. Let’s say you have a Fed that is shooting for 2 percent inflation. If the price level is at 100 in year one, it should be at 102 in year two, 104 in year three, 106.1 in year four, and so on. That’s what the path of prices should look like under either a price-level or an inflation target.

But what if the Fed overshoots inflation in the first year, so that the price level is at 103 in year two? If it is targeting inflation, then it still aims for a 2 percent increase each year. It should aim for 105 in year three, 107.2 in year four, and so on. If, on the other hand, it is targeting the price level, it will try to stick to the path it planned to be on. So it will try to hit 104 in year three, which means keeping inflation below 2 percent for that year.

The point of level targeting is to keep the price level from drifting away from the Fed’s original target over the long term. It should it easier to predict the price level ten years from now if you know that the Fed will try to correct an undershoot or overshoot in one period.

In theory, that should make level targeting superior to inflation targeting. But I have the same puzzlement about this proposal that I do about other proposals to change the Fed’s target, like the misguided proposal to increase the inflation target to, say, 4 percent.

For the last decade, the Fed had first an implicit and then an explicit 2 percent target. Leaving aside whether or not having a 2 percent target was a good idea, the Fed was not especially committed to hitting it. It undershot the target for years, and even while undershooting it took measures, such as raising interest rates, that nearly everyone understood would exert downward pressure on inflation.

I’m not sure how a level target would have changed the Fed’s behavior over the last decade. If in practice it isn’t going to try to follow the rule it has announced, what’s the point of changing that rule?

Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg Opinion, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.

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