Norway's peculiar decision
By Scott Sumner
At a recent Brookings event, Janet Yellen discussed the possibility of adjusting the inflation target:
I suppose that with the type of reasoning that led us to the 2 percent inflation target–which was partly based on estimates of how often you’d hit the zero lower bound–we probably would come out with a higher inflation target now if we were starting from scratch. But moving to a higher inflation target is a tricky business. I’m not sure that Congress would regard it as consistent with their mandate of price stability. I think the transition from a lower to a higher inflation target would be a difficult one and could succeed in unanchoring inflation expectations that I interpret as reasonably well anchored around 2 percent.
I think that’s exactly right. If we knew then what we know now, then the Fed would have obviously chosen a higher inflation target—high enough to prevent the zero bound problem from occurring. (That might have meant a target around 3%.) But there are costs to moving the inflation target, once it has been established, as it reduces central bank credibility.
This make’s Norway’s recent decision especially hard to understand:
Norway this month made the first changes to its framework in 17 years, lowering the inflation target to 2 percent from 2.5 percent. This brings it in line with the target of other central banks and is a reasonable step because the massive inflow of oil revenue into the economy will start abating, the government argued. It also formally enshrined that inflation targeting shall be “forward-looking” and “flexible” to contribute to “high and stable output and employment” and inserted a phrase that said the bank shall also counteract the “build-up of financial imbalances.”
If Norway is to change its inflation target (and I’m not sure they need to), I’d expect them to increase the rate to 3%, not cut it to 2%. Why did they do this? The comment about bringing it into line with other central banks makes no sense, partly because the ECB does not have a 2% target, nor does Australia, but more importantly because the Norwegian currency floats, so there is no reason why they should have the same target as other central banks.
The oil revenue comment also confuses me. I’d expect declining oil revenue to reduce Norwegian growth. If the trend RGDP growth rate in Norway were about to slow, you’d want to raise the inflation target, not reduce it.
PS. Yellen also has this to say:
So it’s certainly worth considering the costs and benefits, but it’s not a clear, ‘yes, we should have a higher target.’ That takes you to other systems, like nominal GDP targeting that has some interesting advantages, or price level targeting…I think they’re worth studying, debating, because this is an important issue.
This caught my attention, as Bernanke has recently advocating a shift to price level targeting when the economy is at the zero bound.