Be simpler, and prices will reach you – Newspaper Kommersant No. 189 (7390) of 10/12/2022

Along with theoretical disputes about the ideal model of monetary policy (MP) of the central bank, another aspect of the problem exists and is important – the perception of alternative inflation targeting (IT) MP by society. In 2021, experts from the Bank of Canada conducted a laboratory experiment in this area, finding out that IT as a standard has its main advantage precisely in its simplicity and clarity, and for monetary policy, which in some cases looked more effective, in which the price level is targeted, and not a specific indicator, it is necessary change the communications of the central bank with society.

Olena Kostitsina and Zhin Yan of the Bank of Canada and Luba Petersen of the Simon Fraser University of Canada in the NBER Series of publications are devoted to a topic that has been extremely often discussed in macroeconomic circles in recent years: despite the fact that most of the world’s central banks use “pure” monetary policy as a model inflation targeting, or at least close models, alternatives to them are described in theory, and these theories sound attractive. First of all, this is the targeting of average inflation for a certain period (AIT, usually the periods of the last four and ten quarters are considered, formally adapted by the US Federal Reserve since August 2020), the “dual mandate” system (DM – targeting both inflation and employment, formally an obligation the same Fed), price level targeting (PLT) and, finally, targeting the nominal level of GDP (NGDP), which is very fashionable in the circles of macroeconomists. There are enough theoretical arguments for and against each of the rather motley list of monetary policy models, while many models were used very rarely by central banks in the world (for example, PLT – only in Sweden in the 1930s) or never (NGDP).

The study by Kostitsina, Zhin Yan and Petersen was conducted as part of the Bank of Canada’s 2021 monetary policy review, when the regulator’s mandate was “updated” for the next five years. The arguments for and against the Bank of Canada’s change in the monetary policy model were explored, with this group of researchers conducting a fairly large laboratory experiment examining to what extent and how society is ready to implement alternative monetary policy models in practice. Recruited by a group of student researchers in Canada and the United States regularly made “personal” macro forecasts (thus forming a mockup of inflationary and other expectations of professional analysts and society), and this work was paid, certain types of behavior were rewarded. First of all, it was important for the authors to understand to what extent monetary policy models, which are difficult to explain to the public and depend on the previous dynamics of macro indicators (especially PLT and NGDP), are perceived by “ordinary people” and how this understanding can help or hinder the central bank from achieving its goals.

The overall results of the experiments by Kostitsina, Zhin Yan, and Petersen are unusual. In fact, the main advantage of standard IT over both more complex AIT and over PLT and NGDP is its ease of use by the public: explaining to students imitating experts how it works and what should happen, in this case, is simpler, plays a key role — Anchoring of inflation expectations in IT is largely due to the fact that this is a very understandable model. In order for PLT and NGDP to work, it is necessary to radically change the system of communications of the central bank, while all regimes based on targeting the “level of something” (prices, nominal GDP, etc.) perform better in a number of parameters than regimes based on targeting the “value of something” (inflation index at a particular moment, the percentage of unemployed), despite the fact that theory usually predicts the exact opposite of the results of the experiment. Finally, the “short” AIM (for four quarters) worked clearly better than the “long” one (ten quarters) in terms of expectations stabilization in the experiments.

Based on the results of this and other works, the Bank of Canada did not change anything in 2021.

Dmitry Butrin