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title: 'Path targeting',
clickbait: 'Don't say "We want this price to go up at 2%/year", say "We want this to be $1 in year 1, $1.02 in year 2, $1.04 in year 3" and don't change the rest of the path if you miss one year's target.',
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text: '[summary: Suppose you're a [ central bank] targeting 2% annual [ inflation] (leaving aside whether this is a good idea). On path targeting, you should *not* say:\n\n"Each year, we want the measured number for widget prices to be around 2% higher than last year."\n\nAnd instead say:\n\n"We want the price of widgets to be \\$1 in year 1, \\$1.02 in year 2, \\$1.04 in year 3, etcetera."\n\nEven if you undershoot or overshoot on year 2 and the price comes it at \\$1.01 or \\$1.03, you still target \\$1.04 in year 3.\n\nThe argument is that a path of 2%, 2%, 1%, 3%, 2% is *more* stable and *less* damaging than a path of 2%, 2%, 1%, 2%, 2%. The first path is less likely to bankrupt somebody who finds that their nominal loans from year 1 are an unexpectedly high burden in year 5.\n\nPath targeting is also argued to be *far* more stable if the central bank isn't great at hitting its targets and often misses in the same direction. Under annual targeting, a shaky central bank can end up with a path like 1.3%, 1.5%, 0.5%, 1.3%, 1.6%.]\n\n**Path targeting** or **level targeting** is a policy proposal which says that if, e.g., you are a [ central bank] whose [ sole nominal target] is the price of widgets, you should not say:\n\n"Each year, we [ want the increase] in widget prices to be around 2%."\n\nInstead you should say:\n\n"We want the price of widgets to be \\$1 in year 1, \\$1.02 in year 2, \\$1.04 in year 3, and so on."\n\nThen even if you undershoot the target in year 2 and get a price level of \\$1.01 instead of \\$1.02, you don't change the targeted level of \\$1.04 in year 3. You just create additional money in year 3 to hit the same price target as before (aka, you try for 3% inflation to "make up" for the previous undershoot).\n\nOn a path target or level target, a central bank's error in one year has no effect on expected prices in future years: everyone still expects the bank to target \\$1.04 next year, then \\$1.06. Even if the central bank is consistently undershooting its target by \\$0.01 every year, on a level target this merely means the actual path for year 2 and on is \\$1.01, \\$1.03, \\$1.05.\n\nConversely, targeting "2%/year inflation", *without* targeting a stable future path, means that if you undershoot and only get \\$1.01 in year 2, you will now say you want a \\$1.03 price level in year 3. This means that when you create too little money in year 2, you've now *also* said you want to create less money in the future, which adds an *additional* deflationary force. This is a form of destabilizing feedback.\n\nWe could evaluate the wisdom of path targeting for e.g. inflation (though a better target might be [644 NGDP]) by asking the key question of whether measured inflation of 2%, 2%, 1%, 2%, 2% is experienced by the economy as being more destructively volatile than 2%, 2%, 1%, 3%, 2%. E.g., consider these two channels of damage:\n\n- "Oh, no! I didn't expect money to be worth *that* much in year 5! I can't afford to pay off the nominal loans I took out in year 1!"\n- "Oh, no! My computer automatically prints menus where the numbers go up by 2% from whatever they were in the previous year, and now I have to reprint my menus!"\n\nWe'd like to have a less straw example above, and solicit suggestions. In our defense, we're finding it hard to come up with a case where the causal impact is clearly being mediated by the this-year-vs-last-year ratio, and not by the ratio for this-year-vs-2-years-ago.\n\nPath targeting is particularly advocated by [645 market monetarism], an [ NGDP]-centric view which suggests that *stable long-term growth* in NGDP and *predictable levels* of future NGDP are economic factors of far greater importance than the isolated ratios for this-year-vs-last-year.\n\nThe prominence of path targeting in [645 market monetarism] also reflects concern by market monetarists that in [ sluggish modern economies] (e.g. Japan, the European Union, arguably the USA), the actual sequence of inflation numbers often tends to look like 1.3%, 1.5%, 0.5%, 0.3%, 1.5%. In other words, where the central bank is turning out to be not very good at hitting its targets and is [ repeatedly missing in the same direction], a path target should be *much* more predictable and *much* less volatile than targeting the this-year-vs-last-year ratios as isolated numbers.',
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