Bullard and Price Level Targeting

Jim Bullard (St. Louis Fed President) gave a talk yesterday which has some interesting ideas in it. In the second chart in this post, you can see that the pce deflator, which is the Fed's favorite measure of the price level, is currently very close to a 2% growth path starting in 2007. Bullard's slides show that this is the case even if our base year is as far in the past as 1995. Thus, while the Fed speaks a language that might make you think it believes past inflation is irrelevant, in practice the Fed appears to be targeting a 2% price level path.

But why do that? Bullard makes the case that this is the prescription that comes out of a Woodford sticky-price model. While I think price and wage stickiness is at best of second-order importance, I think there are other good reasons to think that price level targeting is a good idea. For example, such a policy rule appears to have good properties in terms of minimizing the inflation uncertainty associated with long-term nominal debt contracts.

But there is more on Bullard's mind. He seems to want to make the case that, in spite of the weak recovery we have been experiencing in the U.S., monetary policy has been close to optimal. In support of that argument, he enlists Reinhart and Rogoff, who document a slow recovery as a regularity in the aftermath of previous financial crises. One could say that Reinhart and Rogoff don't have a theory to explain the regularity, or that there may be something policy could do in response to the slow recovery, in spite of the regularity. For example, some people think that high inflation, which would redistribute wealth from creditors to debtors, would be a good idea in current circumstances. In response to that, Bullard argues that inflation redistribution would do more harm to the Fed's credibility than it's worth. One could argue as well that, if redistribution is the answer to our problems, then fiscal policy is a more efficient vehicle for doing it than is monetary policy.

A point that Bullard emphasizes is that nominal GDP targeting in the current circumstances would be the wrong policy. Basically, there is nothing much that monetary policy can do about the slow recovery so, for example, targeting 5% nominal GDP growth would give us too much inflation. By implication, it seems Woodford is contradicting himself. Bullard argues that the policy we have (optimal, he says) is the one Woodford would recommend. But Woodford's Jackson Hole paper seems to view nominal GDP targeting favorably. Woodford-optimal policy and NGDP targeting appear to be two different things.