The Credibility Trap

Recently many economists have come to question whether the central banking community hasn’t gone too far in pushing low inflation, a dissident school of thought that got a big boost when Olivier Blanchard, Giovanni Dell’Ariccia, and Paolo Mauro brought the idea up in an IMF staff position note on “rethinking macroeconomic policy.” The Economist mounts a series of counterarguments including the idea that “[a] central bank could not credibly commit itself to a 4% inflation target having broken a pledge to keep inflation close to 2%.”

This is superficially plausible, but it really leads to absurd conclusions. Suppose the Economist didn’t believe in any of the other arguments it offers for super-low inflation and was convinced that having adopted a two percent target was a mistake. Would they really maintain the view that even though four percent would be better than two percent that we should stick with two for the next five years? For the next fifteen years? For the next fifty years? For the next five hundred years? Should mankind forever be held hostage to semi-arbitrary decisions undertaken in the late-1980s?

It seems to me that the best way to deal with this problem would be to say that you want the recent past of monetary policy to be reinterpreted as targeting a level rather than a rate and what you want to do now is catch-up to the previous trend. That seems about as credible as “we’ll pursue a low inflation target forever, irrespective of the consequences.”