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Price Level Targeting

Here’s Michael Woodford writing back in October about how the Fed should go beyond QE2 and embrace price level targeting to ensure maximum efficacy of monetary stimulus:

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Instead, as suggested in a recent speech by William Dudley of the Federal Reserve Bank of New York, the Fed should commit to make up for current “inflation shortfalls” due to its inability to cut interest rates. If, for example, inflation was predicted to run half a percentage point below the Fed’s target for the next two years, the Fed could announce plans to offset this by allowing an additional one per cent rise in prices after that. Once the shortfall has been made up, the Fed would return to its previous, lower target.

Critics will say this will undermine the Fed’s credibility on price stability. They are wrong because the price increases allowed under this “catch-up” policy would be limited in advance. Catch-up inflation would simply put prices back on the path they would have followed had the Fed been able to cut interest rates earlier.

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Woodford doesn’t have a Nobel Prize, but he is author of a book “which has quickly become the standard reference for monetary theory and analysis among academic economists and their colleagues at central banks”. Not bad. And by coincidence there’s a seat opening up on the Federal Reserve Board of Governors.