medium-run inflation target. A formulation proposed in Stan’s 1994 paper is that a central bank should always be able to project that inflation will return to the target rate if things evolve as currently expected, over a definite, fairly short horizon --- say, within two years. I don’t think this is a suitable general principle, if one allows for the kind of more serious macroeconomic disturbances encountered recently. There is no reason to think that the time that it should take for convergence back to a long-run steady-state position should be independent of the nature and the size of the economic disturbance. There is also a problem of intertemporal consistency with a criterion that only requires a promise that the target will be reached two years in the future. If, a year from now, one expects the central bank also to be content with an expectation of reaching the target only two years further in the future, then one should not expect now that the target will be actually reached within two years, if things develop as can currently be anticipated. A solution, in my view, would be to define acceptable short-run departures from the inflation target, not in terms of the time expected to be required to reach the target, but in terms of the presence of other imbalances that justify not proceeding more rapidly to the target rate of inflation. For example, the appropriate short-run policy stance might be defined to be the one that keeps nominal GDP as close as possible to a pre-announced target path. Such a criterion would allow for temporary departures of the inflation rate from the long-run target rate if they coincide with temporary departures of real GDP growth from the potential growth rate. At the same time, the target path for nominal GDP could be chosen so to guarantee an average rate of inflation equal to the target rate over periods of several years, as long as real GDP can be expected to equal potential on average over sufficiently long periods of time. Defining a desirable criterion for short-term policy decisions, which can clarify the way in which alternative short-term objectives should be balanced, however, is admittedly a more difficult task than simply designing a desirable medium-run inflation target. The answer is more sensitive to specific assumptions about the structure of the economy, and so judgments about it will therefore be more controversial.
medium-run inflation target. A formulation proposed in Stan’s 1994 paper is that a central bank should always be able to project that inflation will return to the target rate if things evolve as currently expected, over a definite, fairly short horizon --- say, within two years. I don’t think this is a suitable general principle, if one allows for the kind of more serious macroeconomic disturbances encountered recently. There is no reason to think that the time that it should take for convergence back to a long-run steady-state position should be independent of the nature and the size of the economic disturbance. There is also a problem of intertemporal consistency with a criterion that only requires a promise that the target will be reached two years in the future. If, a year from now, one expects the central bank also to be content with an expectation of reaching the target only two years further in the future, then one should not expect now that the target will be actually reached within two years, if things develop as can currently be anticipated. A solution, in my view, would be to define acceptable short-run departures from the inflation target, not in terms of the time expected to be required to reach the target, but in terms of the presence of other imbalances that justify not proceeding more rapidly to the target rate of inflation. For example, the appropriate short-run policy stance might be defined to be the one that keeps nominal GDP as close as possible to a pre-announced target path. Such a criterion would allow for temporary departures of the inflation rate from the long-run target rate if they coincide with temporary departures of real GDP growth from the potential growth rate. At the same time, the target path for nominal GDP could be chosen so to guarantee an average rate of inflation equal to the target rate over periods of several years, as long as real GDP can be expected to equal potential on average over sufficiently long periods of time. Defining a desirable criterion for short-term policy decisions, which can clarify the way in which alternative short-term objectives should be balanced, however, is admittedly a more difficult task than simply designing a desirable medium-run inflation target. The answer is more sensitive to specific assumptions about the structure of the economy, and so judgments about it will therefore be more controversial.
BOIsrael.docx