Inflation is the wrong target and central banks should target nominal GDP trend growth Show more Show less
Targeting inflation is the wrong approach. An NGDP-targeting regime could also be more transparent and market-driven than the current interest-rate targeting regime. To further improve transparency, the Fed could engage in level targeting.
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Targeting interest rates only affects demand, not supply
Both NGDP targeting and inflation targeting respond to demand shocks by adjusting the money supply to offset any change in the velocity of money (the rate at which money passes from one holder to another). However, NGDP targeting also responds appropriately to a supply shock in any sector of the economy.
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Nominal GDP is, simply put, a nation’s income. Central banks should target nominal GDP trend growth instead of inflation. By targeting interest rates, only demand (and not supply) becomes affected. If a central bank targets inflation, it will tighten monetary policy whenever the inflation rises. If a central bank targets nominal GDP trend growth, it will either loosen monetary policy or not alter it at all. Therefore, central banks that target inflation will reduce the economy's real GDP as input costs increase.  Central banks that target nominal GDDP, on the other hand, help support growth in spending, thereby preventing falling nominal GDP and high inflation rates.  Another reason central banks should target nominal GDP growth is that several countries in the global economy have high instances of nominal debt to nominal GDP. If central banks focus on inflation, monetary policy will be tightened, thereby decreasing a country's nominal debt without much control over the nominal GDP growth.  This can be a problem if a country faces supply shocks such as political instability.