Unconventional: A Policymaker's Reflections on Crisis to Recovery
"Like many economists at the St. Louis Fed and throughout the Federal Reserve System, Jim Bullard has spent his career within the Fed researching and writing papers to contribute to a better understanding of the macroeconomy and monetary policy. He has continued this type of work throughout his time as president. Most recently, he has explored whether price-level targeting or nominal GDP targeting might lead to even better outcomes than inflation targeting, which is the current standard among many central banks."
—David Wheelock, Group Vice President and Deputy Director of Research
James Bullard shared some reflections on his first 10 years as Bank president during recent conversations with staff. The following are excerpts from those discussions.
Over the last two decades, central banking around the world has been primarily focused on inflation targeting as a way to keep inflation low and stable (although, as I noted earlier, the Fed was relatively late to the party on establishing an explicit inflation target). Committing to an inflation target has generally led to good outcomes for inflation and inflation expectations. But I have wondered if we could have even better outcomes going forward.
One of the waves of the future in central banking may be a move to price-level targeting or nominal GDP targeting as a way to conduct monetary policy in an environment in which policymakers are trying to maintain their inflation target. In many macroeconomic models, these alternative approaches—rather than inflation targeting—are optimal policy.
After I discussed a paper by economist Kevin Sheedy at a Brookings Institution event in 2014, I started writing, with co-authors, papers that are versions of the story Sheedy told in his paper. In particular, I explored models where the optimal policy is nominal GDP targeting or some variant.
The simplest version is price-level targeting. The idea would be to keep the price level on a path that would be upward sloping and associated with a central bank’s inflation target. If the actual price level moved off that path, monetary policymakers would always be striving to get back to it. Therefore, under this framework, the goal would be to hit the inflation target on average over the medium term, meaning that periods of inflation that are higher or lower than the inflation target would be allowed as needed. This contrasts with inflation targeting, which allows misses on inflation and does not do anything about them. Nominal GDP targeting is related to price-level targeting, but the former takes into account both inflation and real GDP growth.
I have argued that de facto price-level targeting occurred from 1995 to 2012 in the U.S. In recent years, however, the U.S. has fallen off the price-level path because inflation has mostly been running below the 2 percent target since 2012. The actual price level (measured using the personal consumption expenditures price index) is currently between 4 percent and 5 percent lower than the previously established path. If the FOMC were following a price-level targeting approach, this would suggest allowing inflation to be above target for some time to return to that price-level path.
Price-level targeting is optimal policy in some macroeconomic models. De facto price-level targeting occurred from 1995 to 2012, when the U.S. maintained a 2 percent price-level path. Since then, however, the actual price level has been below the previously established path.
SOURCES: Bureau of Economic Analysis and Bullard’s calculations.
These alternative approaches—price-level targeting and nominal GDP targeting—could be an improvement on inflation targeting and might be a better way to operate, especially in the low interest rate environment that has the zero lower bound threatening all the time. This is an ongoing issue and one that other FOMC participants have also discussed. Of course, it requires further study and debate, but in my view, adopting one of these alternatives may be a wave of the future in central banking.
NEXT: 9. Lessons Learned