Defending inflation targeting
After seeing David Parker claim that inflation targeting was dead, I felt obliged to chip in with my two cents – which Rates Blog kindly allowed me to do.
In the article I looks at the critique of RBNZ policy based on “imported price spikes” and “credit flows” and point out how the RBNZ framework for this does makes sense – and does not need a change.
My conclusion shifts the blame for any perceived imbalances:
The determination to change what the Reserve Bank does is surprising to me. Our central bank helped to guide New Zealand through one of the largest global shocks imaginable, helped to keep our core banking system together, and by all but the strictest measures they have achieved their monetary policy mandate.
A clear target for monetary policy, a respect for their role in financial stability, and their credibility with the public were the things that helped them achieve this. It makes no sense to turn around and change what the Reserve Bank is doing after such a success.
Instead, those in government should be looking at themselves.
Policies to favour investment in residential property (through tax status and other regulatory focuses) helped to drive the “imbalances” New Zealand faces.
A failure to take into account population aging is making the government fiscal situation look increasingly unsustainable.
Transfers to the middle classes, which we may feel are fair, still come with a cost – bidding up house prices, and reducing capital investment.
If we want to explain the “imbalances” in the country, and what should be done, we need to look at government policy, and the interventionist policies taking place overseas – the monetary policy of the RBNZ is an unrelated scapegoat.
Governments aren’t honest about the costs of their policies. The decision to introduce working for familes, and generally increase targeted spending, reduces inequality – but it reduces economic activity and “competitiveness”. We may believe these transfers are fair, that is fine, but no amount of blaming the RBNZ will change the trade-off we face.
Politicians are either lying or are naive about the trade-offs – either way, their bleating is giving you the wrong information, and it threatening to disestablish the institutions that have helped New Zealand do relatively well in the last 20 years.
Matt,
You make some very important points. The long term current account balance in NZ is all about a policy environment that aggressively discourages savings and encourages debt, and a combination of policy reform and macro- and micro-prudential regulation appears to be the first cab off the rank.*
However, I do think you were a bit quick to dismiss David Parker’s argument. Although he didn’t make his points well, the reference to Ambrose Evans-Pritchard is really a reference to the Sumner Critique. This movement does have deep intellectual foundations, is really the most electrifying discussions in macro, and has won an amazing amount of support from high profile academics in a short time. And without repeating them here, I think the critique goes a lot deeper than David Parker let on.
(*some kind of a limit on LVRs would be a start).
If we are solely to focus on optimal monetary policy settings, I am not viciously against NGDP targeting in any sense.
My willingness to look past inflation targeting in a practical sense came about when I was studying, after reading Mankiw discussing wage growth targeting:
http://scholar.harvard.edu/mankiw/files/target.pdf
In this piece he accepted inflation tageting, and it has been widely discussed on the net that Hall and Mankiw had discussed targeting the level of nominal income as an alternative, and potentially superior, target in the early 1990s:
http://www.nber.org/chapters/c8329.pdf
This is all well and good. However, given the mainstream view of “why” we target inflation, and how this improves outcomes, NGDP level targeting has some undesirable properties relative to targeting growth in “slow to adjust” prices.
One of the key examples is a negative supply shock – such as the increase in imported good prices mentioned above. A lift in imported good prices, even without any market failures, should lead to lower output. If we targeted the level of NGDP instead of growth, then the monetary policy rule increases the variability in prices and output, worsening outcomes relative to a price growth rule.
Now while I can live with NGDP targeting (although I do not believe it is the optimal policy rule for a small open economy), my issue with this sort of talk is that politicians are trying to lay the blame for “imbalances” on the central bank – when these have nothing to do with the monetary policy regime (which is a cyclical issue). In truth, policy makers are making the RBNZ a straw man for other failures – a view that can only lead to worse policy outcomes.
As a side note, I’d also point out that a number of the articles currently supporting NGDP targeting, eg:
http://www.kansascityfed.org/publicat/sympos/2012/mw.pdf?sm=jh083112-4
Are doing so in the context of needing a “credible commitment” to deal with the issue of interest rates being pinned to the zero lower bound in a number of countries. It is a form of communication that can be used in a specific circumstance, rather than the policy rule that should be used over an economic cycle.
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