Most central banks in the world have a mandate for price stability, and since the international monetary system regained its footing on a fiat basis after the inflation of the 1970s, this has usually meant a low inflation target. However, in recent decades, a growing number of economists have proposed an NGDP target. In George Selgin’s classic formulationjust as we expect the prices of certain goods to fall as that industry becomes more productive, the price level should track changes in overall productivity, as this minimizes the total number of prices that need to change.
What I want to argue here is that it is not only the price level that is decisive wrong objective for monetary policy, it is also an unnecessary goal blurred compared to viable alternatives such as NGDP.
Price, quantity and quality
Since Covid, we have all become familiar with the two ways in which companies can deal with rising nominal costs: the usual way – increasing the price for the same container of yoghurt – or ‘shrinkflation’ – reducing the quantity yogurt at a certain price.
The same applies in reverse, when nominal costs decrease. Companies can reduce the price of a particular item. Or they can improve the article.
If it’s not clear that product improvements are just reverse shrinkflation, think about the “quantity” of something, not the number of units purchased, but the satisfaction you get from the services it offers. I paid more for my current OnePlus phone than I did for my first smartphone, a Nexus 5, in 2013. But while they can both be considered ‘one’ phone, the OnePlus offers a lot of larger numbers of things I really care about: communications services, entertainment services, emergency services, and so on. Although the price of a phone has increased since 2013, the amount of services packed into it has plausibly increased even moremeaning the price of these things is what I care about fallendidn’t get up, even in nominal terms.
A price index, which measures inflation, should track price over time meeting these needsnot the price of individual goods, which may or may not be comparable over time in the needs they meet. So any inflation index that looks at the latter rather than the former will seriously do so exaggerate inflation.
But the argument here is broader than just a productivity standard. Think about what you are looking for when you buy the latest summer fashion. It’s not just fabric to cover your body. Are style services. And last year’s fashion offers a lower quantity than last year, despite being physically the exact same item. Productivity is just a special case of that point Similar goods can package different bundles of services over time.
And this makes it difficult to parse price changes of certain goods in quality changes (i.e. changes in the quantity of services it provides), vs factual changes in the price of those services.
Since we can only observe things like ‘the price of telephones’ and ‘the price of shirts’, and not things like ‘the price of communication services’ and ‘the price of stylish services’, Consumer Price Index Handbook suggests a number of different ways to tackle this problem:
- Ignore it and just follow the item prices, which is equivalent to awarding all price increases lead to inflation, not quality changes. This approach is specifically not recommended and leads to dramatically higher inflation estimates.
- Choose a benchmark sector and attribute higher prices up to the benchmark to inflation, and the rest to quality improvements. This of course depends on the right choice of benchmark that a particular industry should work with No quality or productivity changes.
- Find overlapping goods. If a new and an old model are sold at the same time, it can be assumed that the price difference reflects quality differences. But this does not take into account considerations such as future-proofing or the value of novelty as such.
- Explicitly adjust for quality based on expert advice. This brings with it all the obvious disadvantages of attributing expert preferences to actual consumers.
The actual price indices appear to be so terribly sensitive to the specific methods used here. Overall, index and aggregation theory is well developed and rigorous in considering how factual data should be interpreted in terms of subjective meaning. I am registered defending the imputed rent equivalenceone of the more misunderstood and controversial aspects of price index calculations. But the fact is, There is simply no satisfactory way to incorporate quality differences over time into a price index.
Inflation targeting in a progressive economy
While most statistical agencies are smart enough not to completely ignore quality changes, in practice each of these methods is applied conservatively enough that we can be confident that reported inflation is measured systematically. aboutdeclared. One might even think of a 2% inflation target as implicitly compensating for the systematic mismeasurement of inflation.
But can we do better?
George Selgin, Scott Sumner, David Beckworth, and many others have made compelling arguments that targeting the NGDP is better for financial and macroeconomic stability than targeting inflation. But besides that it is Also has the advantage of avoiding the issue of decomposing changes in the price of goods into changes in the quantity of the services they provide, or into changes in the price of those services themselves.
Undoubtedly there is still a place for price indices, imperfect as they are, in important policy issues such as keeping the purchasing power of benefits more or less stable, or in macroeconomic issues such as growth accounting (how much of NGDP growth represents real growth versus inflation? But for monetary policy, relying on indicators that correspond more directly to something economically meaningful – indicators like nominal GDP, which simply add up nominal expenditures, rather than price levels, which require complex hedonic adjustments to make economic sense – has a number of benefits. addition to financial stability:
- An NGDP target provides the Fed itself with clearer information about when monetary policy is on the right or wrong track to achieve its long-term goals.
- An NGDP target improves accountability. No matter how vague the price level is, the success of monetary policy cannot be evaluated exclusively on the behavior of the price level, even afterwards. A single, clearer benchmark reduces the room for excuses for monetary policy failure (and similarly makes it clearer when monetary policy not debt).
- Clearer purpose reduces the incentive to issue rules for the cart before the horse in order to increase clarity of purpose. For example, price regulations in the EU mandating prices per kilogram rather than per piece are partly justified by their effect on statistical collection, and the collection itself can involve significant overhead in many industries.
This argument does not uniquely identify NGDP as a target. Indeed, the money supply could work just as well, provided we measure it correctly. But it do suggest that, in an economy where taste and technology change from year to year, inflation in particular, is far too vague to be an appropriate target for monetary policy.
Cameron Harwick is a monetary economist and associate professor of economics at SUNY Brockport. Follow him on Twitter at @C_Harwick.