Advantages

Disadvantages

Potential Modifications

Inflation Targeting Regime

Inflation Targeting provides a high degree of transparency and accountability.

With a single, easily quantifiable objective, it is typically easy to evaluate central bank performance.

A credible central bank commitment to price stability should lead to better macroeconomic outcomes.

Given the inherent prioritization of the price stability goal, it is possible that a central bank’s ability to aggressively pursue full employment might be limited.

Traditional inflation metrics often fail to capture asset price inflation (and asset bubbles).

Potential for excessive policy tightening in response to adverse supply shocks or term of trade shocks.

Recent challenges with near zero inflation and disinflation has led many to suggest raising the inflation target to 4% rather the sticking with 2% (the current norm in advanced economies).

Financial instability may ensue even when inflation is kept under control. As such, closer scrutiny of key asset values (equity market and real estate) is needed.

Price-Level Targeting Regime

The advantages noted above for inflation targeting also apply to price-level targeting.

Inflationary shocks do not lead to a permanent shift in price-level paths.

In case of negative demand shocks (reduction in output and decline in inflation), central banks can pursue full-employment more aggressively.

Adverse supply shocks can be problematic if strict adherence to price-level targeting is expected― central banks would be forced to tighten monetary policy aggressively to fight rising prices.

Returning the economy to the designated price level path after even a temporary supply shock may require sharp monetary tightening to offset initial above trend inflation.

As suggested by Hall [45] and Ball et al. [46] , an “elastic” price-level targeting system that allows the price-level target to depend on labor market conditions (unemployment rate) may be superior to a strict price-level targeting regime.

Nominal GDP Targeting Regime

The advantages noted above for inflation targeting also apply to NGDP targeting.

NGDP targeting focuses on stabilizing aggregate demand―an appropriate goal for monetary policy. NGDP targeting may be more effective at attaining full employment―central banks have more room to maneuver. When faced with an effective lower bound (or ZLB) situation, it might be easier to raise inflation expectations under NGDP targeting.

Supply shocks are automatically split between inflation and real GDP, which eases the policy response burden significantly.

Central banks might find it hard to stick to NGDP targeting if inflation spikes sharply.

Structural changes to the economy may affect potential output and consequently the sustainable real GDP levels.

Data on inflation, unlike real output, are available at higher frequencies and subject to fewer revisions.

Sumner [47] suggests a futures contract approach―monetary policy should respond to expected future NGDP instead of current NGDP. This could help overcome an inherent drawback― NGDP responds rather slowly to monetary policy.