Inflation Targeting - Not Gonna Happen

Since the financial crisis started, people have occasionally recommended inflation targeting.  Even pretty conservative economists like Kenneth Rogoff and Gregg Mankiw have recommended it, only to be immediately and borderline hysterically shouted down.  During the lost decade - before we entered our own liquidity trap - I believe it was fairly mainstream for American economists to recommend that Japan raise their inflation target and to marvel at why Japan didn't try it.  


Most recently, Matt Yglesias recommended inflation targeting and set off a crazy back and forth about neoliberalism that was interesting, but did nothing to address the substance of inflation targeting.  I suspect the debate took this left turn, in part, because no one really understands inflation targeting or, more specifically, the problems with inflation targeting when you're in a liquidity trap.


And that's not a criticism.  I certainly didn't understand it.  But I decided to do what I could to figure it out.  As usual, I've turned to PK.  I think the critical blog posts are here and here.  These posts and the links cited therein do a pretty good job of explaining what inflation targeting entails and laying out the case for and against doing it when you're in a liquidity trap.  


The upside of inflation targeting - and the reason it's coming up - is that we don't need Congress to do anything.  Since Congress can't even raise the debt ceiling, fiscal stimulus is clearly not happening.  So, tragically, monetary policy is the only game in town.  This is tragic because it's not clear monetary policy will work at all and, even at it's best, it's clearly not as good of an option as fiscal stimulus.


But I don't think a lot of people realize what inflation targeting would actually entail.  PK is saying you would have to raise it fairly high (he recommends 5%) and for fairly long (he recommends 5 years) and you would have to commit to producing the inflation even if the economy recovers.  According to PK, you can't go half way with this - you can't go for 2.5% (but he has recently recommended 4% so, apparently there is some give here).  But, in general, changing expectations requires commitment.  It's go big or go home.  


Keep in mind no country in a liquidity trap has ever tried it; it's completely theoretical at this point.  Moreover, what we do know is that in a liquidity trap, a lot of the usual rules do not apply - printing money, even a lot of money, didn't produce inflation in Japan.  Printing money is always supposed to produce inflation.  I cannot find anyone certain that the Fed actually would be able to produce the inflation required to meet the target - they could set the target, pursue the inflation-producing policies (like printing money) and not be able to produce the inflation.  So, the Fed would be experimenting with, of all things, inflation - the bogeyman of economics.      


Our most recent recession involved stagflation.  Without going into what stagflation is all about, what's important here is that for this generation of economists - who believed the problem of depressions had been solved - inflation was public enemy number one.  But even without a stagflation obsession, Zimbabwe-style hyperinflation is one of the worst things, if not the worst thing, that can happen to an economy. 


Given the fact that effects of inflation targeting in a recession are currently unknown and given economists general aversion to inflation, I think it's really unlikely that inflation targeting will happen.  At this point, it's hard to say which is less likely - fiscal stimulus or inflation targeting.  But I'm going to have to go with inflation targeting as the less likely option.