This will be a confusing post, because I'm writing it to try to get my head clear on something. And it's still not clear. There are no answers here: only questions, and strange thoughts.
1. Lots of people believe the Inflation Fallacy: "Inflation makes us worse off because a 1% rise in prices means we can afford to buy 1% less stuff, duh!". It is hard work to explain to people why this is wrong, and each new generation has to be taught it anew. Ours the Task Eternal.
But if the central bank targeted NGDP, the Inflation Fallacy would be true. With the central bank holding the path of nominal spending constant, every extra 1% of inflation really would mean that real spending falls by 1%. Ordinary people would understand macroeconomics better, without us having to teach them anything. Would that be a Good Thing?
It might be a good thing politically, because it is hard politically for an inflation-targeting central bank to try to increase inflation, when inflation is below target. But then it might be equally hard politically for an NGDP-targeting central bank to try to reduce NGDP, when NGDP is above target. "Why is the central bank trying to make us poorer?" would be heard in both cases.
Or maybe the economy would work better if people's macroeconomic understanding were more in accordance with macroeconomic reality? Macroeconomic coordination failures might be less likely, if ordinary people's expectations were closer to rational expectations.
2. There's a second macroeconomic fallacy. And it's even harder to explain why it's wrong. It doesn't have a name, so I will call it "the Interest Rate Fallacy": "If you want higher interest rates, then the central bank should just set a higher interest rate, duh!". I think many economists believe this fallacy too. After all, it does sound rather obviously true. We saw this fallacy at work in Sweden recently. The Riksbank wanted higher interest rates, to reduce the dangers of financial instability, so it set a higher interest rate. But the only result was that the Riksbank needed to set an even lower interest rate a little while later. Lars Svensson understood the Interest Rate Fallacy, but then ordinary people are not Lars Svensson.
Would it be better to change the world to make the Interest Rate Fallacy true? It is possible to do this in principle, but would it work in practice? And would the world be a better place if we made it work in practice?
I have already explained (one example of) how it could work in principle. The central bank pays out new (base) money as interest on old (base) money. So if the central bank sets a (nominal) interest rate of 5%, this means that the (base) money supply growth rate is also 5%. Higher money growth causes higher NGDP growth, which causes higher equilibrium nominal interest rates. Doing this converts an unstable system into a stable system. It converts an inverted pendulum, where you have to move the pivot point of the pendulum the "wrong" way initially, into a regular pendulum, where you move the pivot point of the pendulum in the same direction you want it to go.
But I'm not sure this would work well in practice. Most base money is currency, and it's hard to pay interest on currency. Plus, if some exogenous shock caused the demand for currency to increase by 100% over the course of one year, the central bank would need to pay 100% interest on currency for that year, just to prevent deflation. I don't think that would work very well.
But if something can work in principle, there must be some way to make it work in practice. That's why God created engineers.
Maybe some variant of Irving Fisher's Compensated Dollar Plan could make it work in practice. Set the dollar price of gold as a crawling peg, and change the rate at which the peg crawls. The central bank would loosen monetary policy by announcing that the dollar price of gold would be rising at a faster rate until further notice, and loan markets would respond by raising (nominal) interest rates. It doesn't have to be gold, of course.
But I don't understand this very well.
(And don't say I didn't warn you, if you have read this far and are disappointed.)
Worthwhile Canadian Initiative 
Miami: John Cochrane’s model was an FTPL model, not a monetarist model. But I showed you could get exactly the same results as he did, using a monetarist model, if you added his assumption that all new money was paid as interest on old money.
Nick,
“1. Lots of people believe the Inflation Fallacy: “Inflation makes us worse off because a 1% rise in prices means we can afford to buy 1% less stuff, duh!”. It is hard work to explain to people why this is wrong, and each new generation has to be taught it anew. Ours the Task Eternal.”
Do you happen to have a link to a good clear explanation of why this is wrong?
Philippe: Here is my old post on the inflation fallacy. Maybe someone else has a clearer version, somewhere on the web, but it was the best I could do.
In NGDP terms, output equals income, whatever the level of inflation.
So the perception of inflation as a problem or a solution depends on the distribution of inflation across each side of that equivalence and one’s perspective in looking at that distribution.
It’s prime territory for the fallacy of composition.
My god, what a mess macroeconomics is if impoverishing pensioners, welfare recipients and people whose income is only revised upwards with time lags (most employees and workers) is considered as of no importance. The reason given is that the higher nominal income of the sellers equates out the lower real income of the buyers so the total income in the economy is not reduced.
What does that have to do with real life?
Speaking of fallacies, that is the fallacy of division which thinks that something true for the whole must also be true of all or some of its parts or: Not seeing the trees for the wood.
Macroeconomists seem to fall for it.