ï»¿Inflation Targeting in a Deflationary World
Marc recently noted the Bank of Canadaâ€™s announcement that it was cutting interest rates to increase future inflation up to the 2% target. In the comments section, Stephen argued that there is nothing noteworthy about the Bank trying to achieve this target. Everyone else contended that the Bankâ€™s new line deviates significantly from its previously hawkish position on inflation.
It strikes me that the Bankâ€™s longstanding inclination toward below-target inflation is not a matter of conjecture. Arun pointed to the IMF study. I would point to the Bankâ€™s own research/consultation program on inflation targeting:
The research program will focus on two broad sets of questions:
What are the costs and benefits of an inflation target lower than 2 per cent? Would an inflation target lower than 2 per cent generate significant net benefits for the economy and for Canadian households?
What are the costs and benefits of replacing the current inflation target with a longer-term, price-level target? Would a price-level target produce significant net benefits for the economy and for Canadian households?
There is apparently no possibility of discussing a target higher than 2%. The Bankâ€™s instincts are (or were) quite explicitly in the direction of an even tighter inflation-rate target or price-level target.
The Bankâ€™s effort to explain current policy in terms of inflation targeting is somewhat contrived: “further monetary stimulus will likely be required to achieve the 2 per cent inflation target over the medium term.” The main purpose of “further monetary stimulus” is not to ensure a nominal inflation rate of 2% rather than 1% in 2009, but to stimulate the deteriorating real economy. The Bank has invoked the prospect of below-target inflation in 2009 to fit current interest-rate reductions into its inflation-targeting framework.
Of course, keeping inflation positive to avoid deflation is a worthy objective. However, a target of precisely +2.0% has no particular merit in that regard.