Michael Woodford - Inflation Targeting during Credit Market Turmoil

Run, don't walk, to read Woodford's BOE presentation "Inflation Targeting during Credit Market Turmoil".

Key takeaways:

• Central bank policy stance has three independent dimensions:
• quantity of reserves
• interest paid on reserves
• composition of asset side of CB balance sheet (credit easing)
• Zero lower bound is solved by committing to maintain low interest rates for a time, even after it becomes possible to again achieve inflation target without violating the bound.
• Price level targeting is essential during credit crisis
• automatic creation of expectations of reflation
• it is an inflation targeting regime with commitment to error correction
• Credit easing may be optimal in the case of large financial disruptions
• size of credit spreads as a justification for credit policy
• unrelated to whether zero bound on policy rate reached (ECB in August 2007)
• Interest on reserves is desirable during credit market turmoil - for credible exit strategy

Scott Sumner does not agree with Michael Woodford Woodford (and me):

• Sumner says interest on reserves is a key mistake
• Sumner says large financial disruptions can be avoided by credible NGDP targeting - no need for CB credit policy

What I didn't like:

• Woodford says QE doesn't work when treasuries are purchased and when QE is withdrawn when conditions normalize (see Japan 2001-06). But there is a possibility that Japan would be even worse without such QE 
• Joint optimality of three dimensions of monetary policy not considered