Raising the inflation target rate to

This time, she seemed downright open to the idea. Beyond these tactical considerations, however, changing the FOMC's long-run inflation objective would risk calling into question the FOMC's commitment to stabilizing inflation at any level because it might lead people to suspect that the target could be changed opportunistically in the future.

Raising the inflation target rate to

First the most effective and reliable monetary policy instrument is to influence the real interest rate in the economy, which is the nominal interest rate less expected inflation. Combine the two and you have a severe problem in a recession, because to combat the recession real interest rates need to move into negative territory, and how far they can go into that territory is limited by the ZLB.

That means monetary policy alone may be unable to get us out of a recession.

The current 2 percent per year inflation rate is appropriate and is a good choice for the Federal Reserve’s target. The unemployment rate at percent is already so low that employers are having a hard time finding workers without offering wages that would accelerate inflation. One strategy: Raise the Fed's inflation target from 2 percent currently, to, say 3 percent. Williams's call for new thinking is timely. Central bankers around the world are coming to the view that the interest rate that keeps the economy's supply and demand in balance is lower now. On the other hand, the argument against raising rates is also compelling: The world economy simply is not growing very quickly. In the U.S., gross domestic product grew at an annual rate of only 1.

Raising the inflation target reduces the likelihood that interest rates will hit the ZLB. That may be enough for a mild downturn, but as we saw in it is not enough for a major recession.

That is probably enough to combat all but the worst kind of recession. This is sometimes referred to as secular stagnation. If you go through the arithmetic above, you can see why a lower long run real interest rate will make the ZLB problem worse.

The argument is that we now need to raise the inflation target to make sure we hit the ZLB less often in the future. This issue moved from an academic discussion to a real possibility in the US a few days ago. When Fed Chair Janet Yellen had been asked about raising the inflation target Raising the inflation target rate to the past, she has tended to dismiss the idea.

However she now says that it is something that the Fed will review in the future, and that it is one of the most important questions facing central bankers today. This will undoubtedly give new impetus to the debate over whether the inflation target should be raised. We are in standard trade-off territory here.

Economists generally agree a higher inflation target will in itself inflict greater costs on the economy, but they bring the benefit that the ZLB problem will occur less often.

But there is an alternative, and clearly much better way out of this dilemma. Governments have another instrument that has a reasonably predictable impact on aggregate demand, and which can be used to combat a recession: In the UK at the moment interest rates are at the ZLB in part because fiscal policy is contractionary austerity.

It would be far better to use this instrument to stimulate the economy in a recession than to raise the inflation target.

Raising the inflation target rate to

Yet the institution of independent central banks have discouraged governments from using fiscal policy in this way. It is no good central banks pretending that this is something which is up to governments, and that there is some unwritten law which means that central banks should keep quiet on such things.

In reality, in both the UK and the Eurozone, the central bank actively encouraged governments to do the wrong thing with fiscal policy in the last recession. In other words, they encouraged austerity. If there is something inherent in the institution of a central bank that makes them give inappropriate advice in this way, then we should be asking how central banks can be changed as a matter of urgency.

If the FOMC believes the economy is growing too fast and inflation pressures are inconsistent with the dual mandate of the Federal Reserve, the Committee may set a higher federal funds rate target to temper economic activity. “The Fed would have to clearly and convincingly communicate the rationale for raising the inflation target and the potential economic benefits. Otherwise the central bank will lose in the court. Raise the inflation target. One alternative to the Fed’s current approach would be to keep targeting the inflation rate, but to raise the target from the current 2 percent, perhaps to 3 percent.

What should happen in a recession, as soon as the central bank thinks that interest rates will hit the ZLB, is that central banks should say, out loud in public, that fiscal policy should become more expansionary.

In addition central banks should say, out loud in public, that governments need not worry about rising debt and deficits due to the recession and any fiscal stimulus they undertake spooking markets because the central bank has that covered.

Both statements have the merit of being true.

Simon Wren-Lewis What are the costs and benefits of inflation targeting? Should the Fed adopt an inflation targeting monetary policy regime?

Of course governments will need to restore debt to desired levels at some point, but that point should be well after interest rates have left the ZLB because then debt correction can be painless. The immediate aim of fiscal policy in a recession should be to allow interest rates to rise above the ZLB as soon as possible.

That gives you the best macroeconomic outcome, and one that is far superior to raising the inflation target. The most important question facing central bankers today is why they failed to do that from Now it is possible that, if democracy is in a bad shape as it currently is in the US for examplethe government may ignore the advice it receives from the central bank.

In that case it is worth considering giving central banks some additional power to mimic a fiscal expansion, such as helicopter money for example. Or it may be worth considering institutional changes that allow nominal interest rates to go negative.

Or raising the inflation target. But before doing any of those things we need to ensure that central banks give the right advice to governments when the next recession comes along.Inflation was % well above the 2% target and after the increase in interest rate in the past months to % and also an anticipated increase in interest rate has led the inflation rate to .

between inflation rates and the housing market is difficult to grasp, but one can introduce this paper with the general assumption that, given all the different elements that are part of the construction process, as well as many of the correlated services such as insurance, there is some positive correlation between inflation and the housing.

Raising the inflation target reduces the likelihood that interest rates will hit the ZLB. To see why, note first that the long run (economists often say ‘equilibrium’ or ‘natural’) real interest rate is positive.

by Tom Startup on June 17, at am in: From the blogs, Resilience, United States. When the Federal Reserve met this week, it surprised hardly anyone by raising its Federal Funds rate for the fourth time since , in this case to a target range of from 1% to 1 ¼%.

To reduce the real policy rate further, the Fed would either have to lower the nominal interest rate into negative territory, raise expected inflation (by raising the inflation target), or both. The Bank of Canada is on the verge of raising interest rates.

It balked at doing so this week, electing to leave the benchmark rate at per cent for the third consecutive policy meeting.

A simple refutation of raising the inflation target - Philosophy of Money