The Other Rule

Brad DeLong’s famous rule (Originally: “If you think Paul Krugman must be wrong, you severely overestimated Niall Ferguson“) needs a corollary.

If Olivier Blanchard says your macroeconomic policy doesn’t work, and that you should double your inflation target to make it reasonable, it’s worth trying:

The International Monetary Fund’s top economist, Olivier Blanchard, says central bankers should consider aiming for a higher inflation rate than they do currently to lessen the chances of repeating the recent severe recession.

…[T]he global economic downturn revealed flaws in macroeconomic policy, especially the reliance primarily on interest rates to manage economies. Although Japan had fallen into a decade-long funk despite low inflation and low interest rates, “most people convinced themselves that the Japanese didn’t know what they were doing,” Mr. Blanchard said in an interview.

In particular, [Mr. Blanchard’s new paper with two other IMF economists, Giovanni Dell’Ariccia and Paolo Mauro] suggests shooting for a higher-level inflation in “normal time in order to increase the room for monetary policy to react to such shocks.” Central banks may want to target 4% inflation, rather than the 2% target that most central banks now try to achieve, the IMF paper says.

At a 4% inflation rate, Mr. Blanchard says, short-term interest rates in placid economies likely would be around 6% to 7%, giving central bankers far more room to cut rates before they get near zero, after which it is nearly impossible to cut short-term rates further.

None of the major Macro work ever done, from Barro forward, has ever found damage to economic growth from 4% inflation.

The paper is available here (PDF).

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