Nominal Income Targeting vs Strict Inflation Targeting: A Comparison.

Abstract

This paper shows that the instability of nominal income targeting in a simple backward-looking macro model disappears if the policymaker chooses to adopt a hybrid nominal income target. This form of nominal income targeting is compared to a strict inflation target so as to establish the conditions under which the former strategy is preferable to the latter. We derive a U-shaped policy frontier which divides the parameter space into two areas: one where hybrid nominal income targeting is preferred to strict inflation targeting and the other where strict inflation targeting is preferred to hybrid nominal income targeting. For most coefficient estimates reported in the literature hybrid nominal income targeting is likely to dominate strict inflation targeting as a strategy of monetary policy.

We also trace out a policy frontier for the two strategies of monetary policy using a forward-looking specification as our baseline model. This policy frontier is not U-shaped; instead it implies a monotonic trade-off between the relevant parameters. In this model the strict inflation target becomes more attractive relative to the hybrid nominal income target as the Phillips Curve parameter increases in size.

A strict inflation target is more likely to dominate a nominal income growth rate target than a hybrid nominal income target for certain values of the Phillips Curve parameter.

JEL Classification: E5