Inflation targeting is not always the best option
Nations must consider the misery index — the sum of the inflation and unemployment rates — while making policies
The US, Europe, and Japan are all making positive economic strides. In the US, the unemployment rate is falling, and now stands at just over 4%. Yet there is one key area where progress seems to be lagging: inflation. While there are good reasons to strive to meet the inflation target, when it comes to people’s wellbeing, meeting the inflation target is not always the best option. Of course, reining in high inflation is beneficial, as it preserves the value of existing money. But raising below-target inflation to 2% leaves people worse off, as it causes their savings to lose value continuously, thereby undermining their prosperity. The late Arthur Okun created the so-called misery index, which goes beyond headline GDP growth or the unemployment rate to provide insight into how the average citizen is faring economically.
Okun’s index – the sum of the inflation and unemployment rates – is based on the assumption that an increase in inflation, like an increase in unemployment, creates economic and social costs for a country. The reality is that the inflation target is a means to an end – to facilitate full employment and faster GDP growth – not an end in itself. And, at least in Japan, progress toward that end has been made, despite the failure to meet the Bank of Japan’s inflation target. Signs of full employment in the market for permanent workers could set the stage for a moderate wage-price increase. That was not the case before 2013, when the implementation of Japanese Prime Minister Shinzo Abe’s economic-reform programme, so-called Abenomics, ended a period of austere monetary policy. But this has not deterred critics of Abenomics from harping on the non-fulfillment of the inflation target. The question is why.
Not long ago, I posed that question to a monetary-policy authority. Rather than provide a straightforward answer, he replied that it was “tricky,” finally landing on the statement that, no matter how low the unemployment rate, the inflation target should be pursued. Older economists, however, thought differently, assuming that most economic outcomes in the real world are the result of behaviour that is at least partly irrational, meaning that expectations should be viewed more as reasonable possibilities than near-certainties. Because I belong to the generation taught by old sages, I think this is a worthwhile assessment.
While it is important to recognise the merits of inflation targeting, the misery index, too, has a role to play in helping us to assess the state of our economies – and the success of our policies. New Year, new hopes! Let us welcome the New Year this time with greater willpower and hopes to achieve what could not be achieved so far. The first thing that most of us would do is to make a long list of resolutions, in order of importance.
At the beginning of every year, I too make a list in which some of the things look like dreams, even sheer madness. But I always tell myself repeatedly that everything that one could describe as big begins