Price-level targeting would improve economic stability

The value of money would be more predictable in the long term

Price-level targeting (PT) would ensure greater long-term stability in the value of money, whilst also enhancing general economic and financial stability, according to a new study* from the Institute of Economic Affairs, authored by Professor Steve Ambler**, former Special Adviser to the Bank of Canada.

Under the inflation targeting (IT) regime currently followed by the Bank of England and most other central banks, the price level becomes increasingly hard to predict in the longer term because a sudden burst of inflation or deflation will not be reversed. And while the formal adoption of IT has been associated with increased price level and output stability, the onset of the current financial crisis has changed this perception.

Price-level targeting always ensures that the price level is returned to its target path. It therefore makes it easier for central banks to ensure stability in the value of money in the long term. Work on price-level targeting also shows how in times of deflation it is easier to bring the economy back into balance.

The greater long-term stability in the value of money associated with PT improves the functioning of the price system and thus the efficiency of the allocation of resources. The more stable are prices the more straightforward it is for individuals to enter into the kind of long-term contracts that enable the allocation of long-lived resources such as energy and transport infrastructure.

The study on price-level targeting forms part of a wider study on central banking, monetary stability and financial stability. The authors – who comprise some of the world’s leading authorities on financial regulation – suggest a series of reforms to central banking systems that could help prevent a repeat of the current crisis. These reforms include proposals by leading German economist Roland Vaubel which challenge the prevailing orthodoxy in favour of international coordination of banking regulation.

*
"Is it time for price-level targeting?" by Steve Ambler**, in
Central banking, monetary stability and financial stability
, Economic Affairs, Volume 29, No. 3, September 2009.

** Steve Ambler was Special Adviser to the Bank of Canada for the year 2006-2007. He is Professor of Economics at the Université du Québec à Montréal, Canada.