Hi Britmouse,

With the CPI I find it interesting to think about why we are changing the underlying basket – it is because the fundamental basket of goods changes through time, and so as a result revising the past series to represent a basket of goods that is not relevant for that time sort of makes sense.

However, it does show the inherent weakness of CPI as a measure of “the price level” and of growth in the CPI as a measure of “inflation”. I’ve always had a preference for skipping the concept of CPI altogether and estimating actual inflation – which is what we do over in NZ with a factor model. We are targeting the comovement in prices, so we might as well actually measure what we are implicitly targeting.

But one point which I think has been overlooked: the reason why the CPI is not revised is not fundamental to the concept of a price index, it’s simply a policy choice. As price index methodology changes *we don’t apply it retrospectively*.

In the UK this debate seems partly absurd – we have about ten different measures of inflation – a new one announced just this week – *exactly because* we keep coming up with new inflation methodology and refuse to apply it retrospectively.

So I think Scott Sumner’s proposal on this subject was necessary and correct; we would need to adjust the desired level path of NGDP – “base drift”, as and when GDP methodology changes happen to revise the past level of NGDP.

The ZLB only happens very very occasionally – as I was suggesting above. During the Great Depression people thought we had fallen into a new normal as well, when in truth we are experiencing a very specific occasional phenomenon.

In that environment, you have to just communicate the change in state – when the policy instrument is non-zero, prices will go up X% if there is no change in specifics for the market … however, when the policy rate hits zero the Fed will buy bonds and accept inflation > X%. We can commit to this policy credibly (as our credibility on inflation targeting may undercut it) by instead targeting nominal income during that period – a way that also allows us to communicate how policy changes during this rare period to the public.

We make up for shortfalls during periods where the CB decides we’re at a ZLB but not otherwise? Doesn’t that make it rather hard for agents to form expectations, given that whatever nominal variable you target will have neither a stable growth nor level path? I’m sure I’m wrong because Woodford/Mishkin took your view in their WSJ article, but it just seems really odd.

Really? If we have previously determined that we prefer growth targeting to level targeting outside of the ZLB, and we can make a policy rule that allows authorities to “precommit” at the ZLB, then why does it make sense to use level targeting?

Before the crisis economists were saying “oww, if we hit the ZLB we just need to precommit and we’re sorted” – the advantage of NGDP targeting is simply that it is an imperfect proxy for this commitment … as Woodford said, this isn’t best policy, or the best way to pre-commit, but its the only practical form of precommitment that seem politically feasible right now!

We can replicate it, and ensure that we keep the benefits of growth targeting, just by setting it up that we “make up for shortfalls during periods where we’ve hit the ZLB”.

On the first point I remain unconvinced by a policy rule that varies with the, apparently poor, data. If it is good enough for the difficult time then it is probably good enough for the easy times!

But instead of targeting NGDP, we can simply revise PTA’s to have a clause where, when cash rates hit zero central banks switch from targeting growth to a level – thereby providing them the commitment they need in that circumstance.

I’m not convinced we are going to be stuck in a ZLB type world for a persistent period of time – if we think that we are moving towards a situation where people are retiring and trying to draw down savings, fundamental interest rates are pretty likely to head upwards in the long term.