Springtime in the Southern Hemisphere is wonderful, and I have been having fun here for the past 10 days, keynoting at two great conferences, with one talk on central bank independence at the Central Bank of Chile and another talk on inflation targeting at the South African Reserve Bank.
Olivier Blanchard joined me in the keynote in Chile, which brought out differences between us that were obvious to everyone (for example, he made the case for capital controls or at least “capital flow management”). In contrast, the differences between me and Lars Svensson, who joined me in South Africa, were small. We both argued that monetary policy should not deviate from inflation and output stability goals for so-called macro-prudential reasons.
I had more disagreements with the paper John Williams presented in South Africa. He started off with an incidental, but misleading or at least incomplete reference to Milton Friedman. John said “To paraphrase Milton Friedman ‘we are all inflation targeters now’” informing the audience that Friedman once admitted that “we are all Keynesians now.” What Milton actually said was “In one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian,” as he explained in his autobiography with Rose (p. 231) adding that “The second half is at least as important as the first—the first sense had to do with rhetoric, the second with substance.”
But more seriously, the evaluation of inflation-targeting as a strategy for monetary policy in John’s paper—the main purpose of the paper—was also misleading or at least incomplete. Rather than consider the performance of both inflation stability and output stability—as virtually all monetary policy evaluation studies have done for the past 40 years—he looked only at the first—inflation stability. To paraphrase Milton “the second is at least as important as the first.” Yes we know that inflation has been low and steady in recent years. The problem is that output or employment performance has been terrible—in the US we have had the Great Recession and the Not-So-Great Recovery. That deterioration should be part of the evaluation too.
A number of years ago I developed a framework—the so-called Taylor Curve—to do such a two-sided evaluation, and it has been used many times since then by central bankers. Here is a version that Ben Bernanke used ten years ago, which I have updated. It shows improved macro performance from A to B and then deterioration of performance from B to C. In evaluating monetary policy one cannot simply hide the vertical axis of the Taylor curve, as the paper by John Williams effectively did