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It’s all about that Target

July 24, 2015

It’s fairly common to see someone waxing about macroeconomic policy and describe a desired central bank action without any reference to a policy target. Some examples: “The Fed shouldn’t do any QE”, or “The Fed should raise interest rates” (of course no mention of when and by how much).

Monetary policy, like all human action, is a purposeful activity. You do it so that some goal is achieved. The purpose of macroeconomic policy is to hit one, and only one, target. The central bank can either make policy looser or tighter. If policy becomes looser, prices will go up, and vice versa. They can only hit one target, since if two prices move in different directions, they have to pick one.

Example
Suppose your target is the price of apples. Both apples and oranges cost $1. If the price of oranges goes up to $1.20, and you try to get it to go back to $1, you’ll have to lower the price of apples by 20% as well. The relative prices won’t change and you’ll have abandoned your apple price target. You can target the average price of apples and oranges if you like, but it has to be one thing that gets targeted.

Obliviousness to the Facts
Before saying that monetary policy should be looser/tighter make sure inflation isn’t already at an all time high/low. If deflation is higher than it’s ever been, and expected inflation is lower than it’s been since the Great Depression, maybe it’s not a good time to demand even more contractionary policy. For some reason, when inflation is high, people call for more inflation. When deflation is high, they call for more deflation. I have no idea why this is, but it happens.

In any event, beware of any pundit who expresses a policy preference without a target. Sometimes monetary policy is wrong and needs to change, but we get nowhere if we just advocate a policy without specifying what that policy should actually achieve.

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2 Comments leave one →
  1. October 30, 2016 10:04 am

    I was writing a paper on monetary policy, and I wondered if anyone had made a Meghan Trainor reference with respect to central bank actions. Congratulations, you’re the only one :). https://www.google.com/webhp?#q=%22all+about+that+target%22+central+bank

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