Blogs & Comment

Fixing the error in monetary policy

For nearly 20 years, the Bank of Canada has anchored monetary policy to an inflation target of 2% in the consumer price index (CPI). But the Canadian central bank is reportedlynow looking at changing to price-level targeting.
Under this system, if the CPI goes under or above the 2% target, the banks policy will be to try to make up that difference in the future.
Im not sure if this would keep asset bubbles from forming. As Iargued in Ensuring Financial Stability, the inflation target should take into account asset price inflation. You dont want to build a mountain of debt on rising prices for a major asset class like housing or stocks. When prices reverse, it will be like a house of cards collapsing i.e. debt-deflation of the kind economist Irving Fischer wrote about in the 1930s.
Keeping asset prices under control may require periods of negative change in the CPI. But a price-level target would not likely permit the CPI to decline temporarily. Andthat is what may be needed to keep the secular uptrend in debt from growing faster than GDP, like it has for the past 10 years.