Should central banks target stable prices or stable incomes?
On Voxeu Arvind Subramanian, India’s chief economic advisor, argues that: “for monetary transmission to work, both consumer prices and producer prices are relevant, but for different sets of agents.” while consumer prices show, in India, a much higher increase than producer prices.”. Which means that the central bank should not just look at consumer price inflation but also at producer price inflation. In the June issue of The Journal of Economic Issues I stress a similar point in “Metrics Meta About a Meta Metric: The Consumer Price Level as a Flawed Target for Central Bank Policy”, though going one step further (fifty free downloads here). From the abstract:
Inflation targeting is currently the policy of choice for central banks. This policy invariably targets consumer price inflation, which is only one of many available price level indices (such as prices of new investments and house prices). As there is no stable relationship between these price levels, and as differences in developments between the different price levels might induce destabilizing behavior, there is no reason why “low and stable” consumer price inflation should guarantee monetary and financial stability. Following John Maynard Keynes, a “low and stable” increase of average nominal wages might do a better job. As price levels are designed to estimate the purchasing power of spending power and as income, and spending power are used to not just consume or invest but also to pay down many kinds of (gross) debt, it is advisable to use a joint definition of monetary and financial stability, which combines stable purchasing power of monetary income with a stable ability of households and companies to pay off debts.