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Daddy, my tummy hurts!

Summary:
Once a week the family gets a pizza and the little boy always eats too much. Later he moans that his tummy hurts. When the father tells his son not to eat so much, the little boy responds that pizza is yummy. His dad understands “revealed preference”, and hence is not very sympathetic. Back in the 1980s, we all thought it was great when Volcker got inflation down to 4%. At that rate, inflation was hardly even noticeable. I actually think 2% inflation is even better than 4%, but only a tiny, tiny, tiny, tiny bit better. There’s almost no difference.Today, economists often moan that we are cursed with sluggish recoveries from recessions because of the zero bound problem with interest rates. If you point out that the zero bound problem could be easily eliminated merely by

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Once a week the family gets a pizza and the little boy always eats too much. Later he moans that his tummy hurts. When the father tells his son not to eat so much, the little boy responds that pizza is yummy. His dad understands “revealed preference”, and hence is not very sympathetic.

Back in the 1980s, we all thought it was great when Volcker got inflation down to 4%. At that rate, inflation was hardly even noticeable. I actually think 2% inflation is even better than 4%, but only a tiny, tiny, tiny, tiny bit better. There’s almost no difference.

Today, economists often moan that we are cursed with sluggish recoveries from recessions because of the zero bound problem with interest rates. If you point out that the zero bound problem could be easily eliminated merely by raising the trend rate of inflation enough to keep nominal interest rates positive, they moan that they’d rather keep the inflation target at 2%.

Revealed preference suggests that if they aren’t even willing to take a trivial and almost costless change in the inflation target to fix this supposedly really serious problem, then obviously the problem can’t be all that bad. I conclude that the economics establishment is not sincere; they must have a hidden agenda somewhere.

In order of preference, I favor:

1. A 4% NGDP level target combined with a “whatever it takes” approach to “target the forecast”.

2. A 4% inflation target and Great Moderation-style monetary policy.
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3. The current 2% inflation target.

So I don’t favor raising the inflation target to 4% as a first best policy. Lower inflation really is a little bit better. On the other hand, current policy is so bad that a 4% inflation target would be far better than current policy. Indeed it’s not even close.

PS. And please don’t say, “But they struggled to raise inflation to 2% during 2015-18, so what makes you think they could target 4%?” Yes, it’s tough to raise inflation during a period of time where the Fed raises its target interest rate nine times. LOL.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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