A key question for any inflation-targeting framework is what the inflation target should be. Theoretical and practical considerations have led central banks in advanced economies to target a 2% inflation rate. However, the consequences of the global crisis, with years of ‘low-inflation’ and the effective lower bound (ELB) limiting central bank policy rates, challenged the consensus. One proposal to limit the recurrence of ELB episodes in the future is to raise the central bank’s inflation target (Blanchard et al. 2010, Ball 2013, Krugman 2014).1
Our new study (Ambrocio et al. 2022) contributes to this debate with an expert survey on inflation targeting and related monetary policy conducted by the end of 2020, with responses from more than 600 economists worldwide.2
Our four main findings are:
1. Most respondents prefer central banks to objectives other than just price stability.
2. Proponents of inflation targeting express a significant preference for maintaining the current numerical target. Conditional on supporting a change, however, the preference for increasing current targets is two to one.
3. The main reason for keeping the current target seems to be the credibility cost for the central bank, while the main reason for raising the target is the ELB concern.
4. Only 25% of respondents would raise the inflation target after a permanent decline in the equilibrium real interest rate (r*).
Objectives of central banks
After the hyperinflation experienced in the 1970s, the focus of monetary policy increasingly shifted to price stability (Meltzer 2009). However, after the 2008 crisis – an episode of relatively stable prices but high levels of financial turmoil and large unemployment fluctuations – many critics questioned the proper balance between price stability and other objectives of monetary policy (DeGrauwe 2008, Leijonhufvud 2008).
Against this background, we asked participants about their views on the mandate of monetary policy. Only 14% of respondents support a single price stability objective (see Figure 1). Most prefer a central bank that also has other objectives, either equal weight with price stability (48%) or subordinate to price stability (38%). A Fed-style ‘dual mandate’ receives significantly more support from US respondents. Conversely, euro area respondents are evenly split between supporting a ‘subordinate mandate’ to the ECB and a dual mandate. In written responses, the most popular other objective is (un)employment, although just over 40% of respondents would set a target for a secondary objective, such as the inflation rate (see Figure 2 in Ambrosio et al. 2022).
Figure 1 What should be the objective(s) of central banks?
Possible alternatives – such as the price level, the level of nominal GDP or its growth rate – received only marginal support
On the next question regarding the specific price index the central bank should use, we find nearly equal support for headline and core CPI (27 vs. 25%) as the target price index. However, a much stronger preference for the core index (CPI = 27%, PCE = 33%) emerged in the US sub-sample.
About 80% of respondents want their central bank to target inflation.3 To answer that the preferred numerical inflation target is comparable across countries, we define:
Changes in individual preferences i = individual’s preferred inflation target i – where is the country’s actual inflation target i lives in
Figure 2 Changes in Inflation Targeting Preferences
Among respondents from inflation-targeting countries or regions, more than half (54%) support the central bank’s current target, about 30% would prefer a higher target, while 16% would prefer a lower target (see Figure 2). The deviation of the median choice from the current target is one percentage point in either direction.4
Cost of changing goals
Central bank credibility is a major concern amid the potential costs of changing inflation targets. A change in the target may dampen inflation expectations, especially if the private sector begins to believe that further changes may occur in the future.
We indirectly investigate the extent to which such costs affect respondents’ opinions by setting up a hypothetical scenario in which the central bank starts targeting inflation with a clean slate. About 12 percentage points fewer respondents prefer no change in this hypothetical scenario than in the current situation. Most people who change their perspective prefer to increase their goals. Our hypothesis is that loss of credibility is the main cost of changing targets in the current situation.5
Determinants of optimal inflation targeting
Schmitt-Grohé and Uribe (2010) recently surveyed the academic literature on optimal rates of inflation, dating back at least to Friedman (1969).6 We asked respondents to ‘rank’ the reasons for setting the inflation target in order of importance. We then consider mean scores by subsample, divided by preference to keep, decrease, or increase the current target. ELB on the monetary policy rate emerged as a significantly more important factor for supporters of the target increase than for supporters of no change (see Table 4 in Ambrocio et al. 2022).
The equilibrium real interest rate
The debate over the secular decline of r* (Summers 2014), strongly related to the frequency of ELB episodes, is a key factor behind the renewed interest in the optimal choice of inflation target (Kiley and Roberts 2017).7 We find the mean estimate of r* for respondents in the full sample to be 0.6% (see Table 1). However, opinions about r* do not predict preferences for raising the inflation target, even among respondents who believe in a negative relationship between r* and the optimal inflation rate (Andrade et al. 2019).
Only 25% of survey participants want to raise the inflation target by a hypothetical one percentage point in response to a permanent decline in r*, while 34% would leave the target unchanged in such a scenario.8 This provides further evidence that many experts envision significant costs for changing the inflation target.
Table No. 1 View at r*
On Government Debt and Inflation
High levels of public debt in many jurisdictions have revived discussions on the interaction between monetary and fiscal policy. Policy measures taken in response to the Covid crisis have further increased debt levels and thus exacerbated the issue.9 As Tellis and Tristani (2021) point out, the financing of large fiscal shocks can also have implications for optimal inflation.
Motivated by such considerations, we investigate whether the public debt-to-GDP ratio in the respondent’s country of residence predicts the preference for raising the inflation target, and it does.10 One explanation is that a higher level of debt may require a higher inflation target to reduce its value in real terms.11
Although the recent high-inflation environment may sideline the inflation target shift debate, our results should be useful for thinking about the trade-offs associated with future inflation target shifts.
Adam, K, E Gautier and H Weber (2022), “Why central banks should aim for a positive inflation target”, VoxEU.org, 6 June.
Ambrocio, G, A Ferrero, E Jokivuolle and K Ristolainen (2022), “What should the inflation target be? The opinion of 600 economists”, CEPR Discussion Paper 17289 and Bank of Finland Research Discussion Paper 7/2022.
Andre, P., J. Galli, H. Le Bihan and J. Matheron (2019), “Top Inflation Targets and the Normal Rate of Interest”, Brookings Papers on Economic Activity Autumn 2019: 173-249.
Ball, L (2013), “The Case for 4% Inflation”, Central Bank Review 13: 17–31.
Bernanke, B (2010), “Economic Outlook and Monetary Policy”, Speech at the Jackson Hole Economic Policy Symposium.
Blanchard, O, G Dell’Ariccia and P Mauro (2010), “Rethinking Macroeconomic Policy”, Staff Position Note 10/03, IMF.
Blinder, A (2000), “Central-Bank Credibility: Why Do We Care? How Do We Build It?”, American Economic Review 90: 1421–1431.
Cochrane, J (2021), “A Financial Theory of the Price Level”, Unpublished.
DeGrauwe, P (2008), “There’s more to central banking than inflation targeting”, VoxEU.org, 14 November.
Friedman, M. (1969), The best amount of money, Macmillan.
Ehrmann, M, S Holton, D Kedan and G Phelan (2021), “Monetary Policy Communication: Perspectives from Former Policy Makers at the ECB”, ECB Working Paper 2627.
Kiely, M and J Roberts (2017), “Monetary Policy in a Low Interest Rate World”, Brookings Papers on Economic Activity Spring 2017: 317-372.
Krugman, P (2014), “Rethinking Inflation Targeting”, Unpublished.
Leijonhufvud, A (2008), “Central banking doctrine in light of the crisis”, VoxEU.org, 13 May.
Meltzer, A (2009), History of the Federal Reserve, Volume 2, Book 2, 1970-1986, University of Chicago Press.
Reichlin, L, K Adam, WJ McKibbin, M McMahon, R Reis, G Ricco and B Weder di Mauro (2021), “The ECB strategy: The 2021 review and its future”, VoxEU.org, 1 September.
Reichlin, L, G Ricco and A Tuteja (2022), “Two-dimensional characteristics of ECB monetary policy”, VoxEU.org, 14 April.
Schmitt-Grohé, S and M Uribe (2010), “The Optimal Rate of Inflation” in B. Friedman and M. Woodford (Eds.). Handbook of Financial Economics, Volume 3, Chapter 13, Pages 653-722. Elsevier.
Summers, L (2014), “Reflections on the “New secular stagnation hypothesis”, in C Teulings and R Baldwin (eds), Secular stagnation: incidence, causes and remedies, Chapter 1, pp. 27-38. CEPR Press.
Teles, P and O Tristani (2021), “The Monetary Financing of a Large Fiscal Shock”, Bank of Finland-CEPR 2021 Conference on New Approaches to Monetary Policy.
1 In line with the outlook for raising the target, the ECB raised its inflation target from “close to but below 2%” to 2% in July 2021. Despite the target remaining unchanged at 2%, the Fed has adopted an average inflation targeting framework, which requires periods of above-target inflation to “make up” periods of below-target inflation (and vice versa). See here and here, respectively (see also Reichlin et al. 2021). Bernanke (2010) notes that a higher inflation target also carries costs.
2 Our sample includes all top 10% researchers according to RePEc, as well as CEPR and NBER Research Fellows in the fields most closely related to these topics. Most participants came from the US (39%) and the Euro area (26%). Our view is related to the one taken by Blinder (2000).
3 Almost all survey participants (96%) live in countries with inflation targeting central banks.
4 A clear minority in the US subsample prefers zero inflation. Some of these respondents explicitly mentioned the Friedman rule (Friedman 1969) in written comments.
The next 5 questions of the survey support this hypothesis. The important role of central bank credibility also emerges from the results of Ehrmann et al. (2021), who surveyed former ECB Governing Council members focusing on monetary policy communication.
6 Adam et al. (2022) recently presented a new argument for a positive inflation target based on relative price trends.
7 Despite the current bout of deflation, some observers have not fundamentally changed their views on the secular decline of r* (see, for example, Olivier Blanchard’s interview with Martin Wolff in the Financial Times, 26 May 2022).
8v16% would actually reduce the target and a significant share (25%) had no opinion.
9 At the time of this writing, sovereign bond markets have become increasingly concerned about the financial stability of highly indebted member states in the euro zone as the ECB prepares to raise rates to tackle current inflation. Richlin et al. (2022) analyzed alternatives to the ECB.
10v See Table 5 in Ambrosio et al. (2022). The results are robust enough in the euro area sub-sample (available from the authors upon request).
11 Cochrane (2021) presents an alternative explanation based on the monetary theory of the price level.