"But suppose there's a productivity growth slowdown and real GDP growth slows to (say) 2% in future. Your 2% inflation target would then mean that NGDP would only grow at 4%. That's the problem with inflation targeting. If long run real growth rates vary, inflation targeting would mean variable NGDP growth. Unless you adjust the inflation target to take account of changes in the long run real growth rate, but then it isn't really inflation targeting, is it?"

Now suppose that some heretic then came along and said that Canada should switch to targeting 2% inflation instead. I can guess what the reaction would be:

Just suppose, in some alternative universe, the Bank of Canada for the last 20 years had been targeting 5% NGDP growth rather than 2% inflation. And that everyone had gotten used to NGDP growing at 5%. And suppose that, like in the real world, real GDP growth had been around 3%, and inflation had been around 2%. (3% real growth + 2% inflation = 5% NGDP growth).

Forget about the short run benefits of NGDP targeting. This post is about the long run benefits.

That's a question-begging argument, of course. It simply assumes that variability of NGDP growth is a bad thing, and that variability of inflation isn't.

But I hear that same question-begging argument, only the other way around, in the real world.

"But suppose there's a productivity growth slowdown and real GDP growth slows to (say) 2% in future. Your 5% NGDP growth target would then mean that inflation would increase to 3%. That's the problem with NGDP targeting. If long run real growth rates vary, NGDP targeting would mean variable inflation. Unless you adjust the NGDP target to take account of changes in the long run real growth rate, but then it isn't really NGDP targeting, is it?"

After 20 years of inflation targeting in the real world, people simply assume that variability of inflation is a bad thing, and that variability of NGDP growth isn't. We are so used to inflation targeting we don't notice they have assumed the answer.

(Our great grandparents would probably have told us that both policies are bad because either would cause variability in the price of gold.)

What's the question? We need to make sure we ask it the right way.

Here's the wrong way to ask the question: Suppose that every decade the Bank of Canada tosses a coin. If it throws heads it loosens monetary policy; if it throws tails it tightens monetary policy. That's a bad policy, of course. Is it bad because it makes inflation more variable? Or is it bad because it makes NGDP growth more variable? I can't make sense of that question. It's just the same bad policy in both cases.

Here's the right (or a better) way to ask the question: Suppose every decade Nature tosses a coin. If she throws heads she increases productivity growth rate. If she throws tails she decreases productivity growth rate. How should the Bank of Canada respond? Should it keep inflation constant (adjust the implied NGDP growth rate target every decade)? Or should it keep NGDP growth constant (adjust the implied inflation target every decade)?

That's a real question about the choice between two different monetary policies.

I can think of three reasons why keeping NGDP growth constant might be better:

1. For some reason, despite uncertainty about future inflation and future NGDP growth, people often make long term loans without indexing to either. Since capacity to pay a fixed nominal debt depends more on nominal income than the price level, keeping NGDP growth constant would reduce the default risk relative to keeping inflation constant. It does this by sharing the risk of real income growth between debtor and creditor, rather than putting all the risk on the debtor.

2.There are theoretical reasons for believing that changes in long run real GDP growth would usually cause the equilibrium real rate of interest (the "natural rate") to change in the same direction. For any given inflation target, that would mean a bigger risk of hitting the Zero Lower Bound on nominal interest rates when real GDP growth is low. That would be a good reason for raising the inflation target if long run real growth slowed.

3. There are empirical reasons for believing there is some sort of Zero Lower Bound on nominal wage growth. And empirical and theoretical reasons for believing that slow real GDP growth would usually cause slow real wage growth. For any given inflation target, that would mean a bigger risk of hitting the Zero Lower Bound on nominal wage growth when real GDP growth is low. That would be a good reason for raising the inflation target if long run real growth slowed.

If it weren't for the ZLB on nominal interest rates and nominal wage growth, I can't think why we would be targeting 2% inflation in the first place. Wouldn't targeting 0% inflation be better? If you advocate a 2% inflation target I think you are already implicitly acknowledging the force of my second and third arguments for NGDP targeting.