Is the Fed even trying to reflate?

This might seem like an odd question.  Everyone seems to agree that Bernanke has done everything humanly possible to boost the economy.  But there is a difference between doing a lot, and doing things that are effective.  My hunch is that we will get a recovery soon, or perhaps I should say that is my reading of market expectations.  But I see little reason to believe it will be adequate.  Last month the Fed promised to buy up to a trillion dollars in bonds as a form of quantitative easing.  The monetary base is higher than a month ago, but it is still lower than at the beginning of the year.  The single most important thing the Fed can do right now (in addition to an interest penalty on excess reserves) is to clearly communicate its intentions to raise the five year expected inflation rate from 0.8% closer to its target of 2%.  See if you think this passage from an April 14 speech by Bernanke effectively conveys the Fed’s determination to reflate:

“I mentioned earlier that the Fed’s mandate from the Congress is to foster price stability as well as maximum sustainable employment. The FOMC treats its obligation to ensure price stability extremely seriously. Price stability supports healthy economic growth, for example, by making it easier for households and businesses to plan for the future. In practice, price stability does not require that inflation be literally zero; indeed, although inflation can certainly be too high, it can also be too low. Experience suggests that inflation rates that are close to zero or even negative (corresponding to deflation, or falling prices) can at times be associated with poor economic performance. Cases in point include the United States in the 1930s and the more recent experience of Japan. In their latest quarterly projections of the economy, most members of the FOMC indicated that they would like to see an annual inflation rate of about 2 percent in the longer term. Right now, because of the weakness in economic conditions here and around the world, inflation has been running less than that, and our best forecast is that inflation will remain quite low for some time. Thus, the Fed’s proactive policy approach is not at all inconsistent with the goal of price stability in the medium term.

Although inflation seems set to be low for a while, the time will come when the economy has begun to strengthen, financial markets are healing, and the demand for goods and services, which is currently very weak, begins to increase again. At that point, the liquidity that the Fed has put into the system could begin to pose an inflationary threat unless the FOMC acts to remove some of that liquidity and raise the federal funds rate. We have a number of effective tools that will allow us to drain excess liquidity and begin to raise rates at the appropriate time; that said, unwinding or scaling down some of our special lending programs will almost certainly have to be part of our strategy for reducing policy stimulus once the recovery is under way.

We are thinking carefully about these issues; indeed, they have occupied a significant portion of recent FOMC meetings. I can assure you that monetary policy makers are fully committed to acting as needed to withdraw on a timely basis the extraordinary support now being provided to the economy, and we are confident in our ability to do so. To be sure, decisions about when and how quickly to proceed will require a careful balancing of the risk of withdrawing support before the recovery is firmly established versus the risk of allowing inflation to rise above its preferred level in the medium term. However, this delicate balancing of risks is a challenge that central banks face in the early stages of every economic recovery. I believe that we are well equipped to make those judgments appropriately. In addition, when the time comes, our ability to clearly communicate our policy goals and our assessment of the outlook will be crucial to minimizing public uncertainty about our policy decisions.”

I was OK with the first part of the first paragraph.  I prefer a NGDP (or wage) target to inflation, but if he wants to define “price stability” as 2% inflation, so be it.  He also recognizes the problems of undershooting the inflation target””it leads to “poor economic performance.”   When he says they’d like to see an annual inflation rate of 2% in the “longer term” he loses me.  Why longer term?  Do they wish to see lower inflation in the short to medium term?  At that point the speech becomes strangely passive.  He suggests inflation will remain “quite low for some time” and then indicates in the very next sentence that that is consistent with the Fed’s goal of price stability.  So now price stability doesn’t mean 2% inflation, it even includes less than 2%.  This year’s forecast is for deflation.  Maybe that’s price stability too.  The beginning of the second paragraph is also very passive, as if the Fed is simply a spectator watching all this happen.  I can’t help contrasting this with FDR’s expansionary monetary policy adopted in March 1933, which raised the WPI 14% in 4 months, and raised industrial production 57% in the same four months.  FDR wasn’t passive.

In paragraph three he wakes up from his slumber.  Now policy will act on a “timely basis” to prevent high inflation in the future, a problem the bond market doesn’t see.  No more waiting around for “the time . . . when the economy begins to strengthen, financial markets are healing.”  Now the Fed is promising to be proactive, to make it happen, to keep inflation from exceeding his target.  I was dubious of Earl Thompson’s argument that central bankers had an asymmetrical reaction to inflation, but I have to admit that this supports his view.

In addition, Bernanke seems to be under the strange illusion that issuing interest-bearing reserves that are hoarded by banks represents some sort of inflationary time bomb.  I don’t see it, the world’s leading expert on interest on reserves doesn’t see it, and the bond market doesn’t see it.  On the other hand I see a risk of undershooting “for some time” as does the bond market and (apparently) as does the Fed.  No effective policies on a “timely basis” to deal with that actual problem, but lots of policies already prepared for the imaginary problem of future high inflation.

Someone might object that I quoted selectively, that Bernanke was addressing the risk of high inflation.  OK, look at the entire speech and tell me where he commits to boosting inflation, or to boosting NGDP growth.



27 Responses to “Is the Fed even trying to reflate?”

  1. Gravatar of JimP JimP
    17. April 2009 at 11:54

    I agree. It is this weird passiveness that is so very troubling. It is like he doesnt realize he is in charge of anything – this it is his job to just expect the future – along with the rest of us. And every time he makes another sad comment – like today saying that:

    “The damage from this turn in the credit cycle — in terms of lost wealth, lost homes, and blemished credit histories — is likely to be long-lasting,”

    he just abdicates his role and drives expectations ever lower.

    It is his job to set expectations – not to comment on them. He just does not get what his job is at all.

  2. Gravatar of Jeremy Goodridge Jeremy Goodridge
    17. April 2009 at 14:25

    Can you explain in more detail why you prefer an NGDP target versus and inflation target? I generally agree with you, and I have my reasons, but I wonder if they line up with yours.

    My reasons are:

    1. NGDP is subject to less measurement error than inflation. NGDP is a ‘first-order’ measurement. Inflation is a ‘second-order’ measurement. First you have to have measure NGDP — what people actually spend/invest. Then, you have to decide how much of this is actually an increase in quantity versus prices. For simple products, this is easy, but when QUALITY increases and prices rise, this often looks like a price increase when, in fact, it’s not.

    2. Under an inflation target, the monetary authority ends up printing more money when productivity increases and less money when productivity falls. But a productivity rise/fall is often due to ‘real’ factors (such as a scientific discovery) and should have nothing to do with monetary policy. The obvious example is a drop/increase in the price of oil. This affects inflation but not in a way a monetary authority cares about. The Fed knows this and so they start making use of the concept of ‘core’ inflation, but that’s highly imperfect since sometimes, energy price falls/increases are monetary in nature and so SHOULD be taken into account. The whole thing would be simpler if they just focused on aggregate demand directly (i.e. NGDP).

    3. It seems just obvious that if you want to stabilize an economy, you should stabilize the variable that best measures the economy as a whole — and that’s NGDP. Isn’t what we want a stable growth curve in incomes? Inflation feels like an indirect measure of things. Who really cares about inflation? What people care about is that the economy as a whole grows as fast as it can, with as much as stability as possible.

    4. At a theoretical level, it seems an ideal monetary environment would be one in which ‘price’ of money was constant. And the price of money isn’t the price level (which I think is what led economists to inflation as the indicator to target in the first place), but instead the willingness people have to part with money — and that’s aggregate demand. The price level is the amount of stuff that money can buy at a particular time/place, and that is affected by productivity/seasonal things/location, etc, etc.

    And finally, one technical point: we talk about NGDP as if there are no other countries in the world that use dollars for purchases. But of course, there are. Also, NGDP subtracts out imports, but imports are purchased with dollars. NGDP also adds in exports, which are usually purchased with other currencies. It feels like the ideal measure would be one that measured the value*quantity of all goods purchased with dollars, where-ever produced and where-ever that sale took place.

    Thanks again for a fabulous blog. I have learned so much about monetary issues, and other things too — like school vouchers in Sweden (which I had no idea about).


  3. Gravatar of ssumner ssumner
    17. April 2009 at 15:59

    Thanks JimP, If I was sitting on a bus and the driver said he expected the bus to gradually drift off the road to the right, and talked about the bus as if it had no driver, I would be a very nervous passenger.

    Jeremy, Those are a lot of the same reasons that I would give. I would just add a couple points. I think the NGDP rule does a bit better in a world of sticky wages, so employment should be more stable. The other argument is purely pragmatic. When we have ex post reason to think that policy may have been off track (too easy in 2004-06, too tight since last fall), the NGDP number gives much clearer warnings than inflation. Measured inflation wasn’t very high in either the tech or housing bubbles. I do think some people put too much blame on monetary policy for those bubbles, but it is reassuring to note that in retrospect, NGDP would have done a bit better.

  4. Gravatar of JimP JimP
    17. April 2009 at 18:23


  5. Gravatar of Jon Jon
    17. April 2009 at 22:39

    “In addition, Bernanke seems to be under the strange illusion that issuing interest-bearing reserves that are hoarded by banks represents some sort of inflationary time bomb. I don’t see it, the world’s leading expert on interest on reserves doesn’t see it, and the bond market doesn’t see it.”

    I don’t think the ‘bond market doesn’t see it’ is necessarily the case. Obviously there is a possibility that that bond market expects the Fed to contain the risk.

    I fail to see how the interest policy can ensure perfect sterilization of the inflationary risk. As we discussed before, it’s the perception that the reserves are temporary which sterilizes them and halts what would be an inflationary process. Part of this perception arises from ‘hard line’ speeches.

    One concern is that as the reserves persist, we risk them being perceived as POMOs, but necessarily this happens in the future, not now, meaning it happens when the recovery is in place, not when it is needed to jolt the recovery forward.

  6. Gravatar of Bill Woolsey Bill Woolsey
    18. April 2009 at 03:26

    The “long run” part of the speech is fine, in my opinion.

    But I agree with Scott. I would like to see, slow economic
    growth here and aboad, our internal forecasts, blah blah, show continued weakness in the short and medium term with inflation rates being below our target of 2%. There for, we plan to expand our program of quantitative targeting, further increasing base money to approximately $2 trillion.
    We will continue to closely make adjustments in base money until rapid drop off in spending at the end of 2008 is reversed.

    And then all of the business about the need to pull this back out once the economy begins to recover.

  7. Gravatar of Bill Woolsey Bill Woolsey
    18. April 2009 at 03:31

    I would also like to see Bernanke begin to advocate that banks relearn their traditional business and start holding loans on there balance sheet. Waiting for securitization to recover so that loans can regularly be sold and then held by somebody else in the form of CDOs is not realistic. The Fed’s efforts to funnel money back into securitization has not be sucessful. Instead, the Fed is going to focus on maintaining spending in the economy. Trying to micromanage credit markets has been a failure.

  8. Gravatar of Steve Roth Steve Roth
    18. April 2009 at 06:40

    Scott, this is a good reply to an earlier comment of mine, suggesting that everyone pretty much knows that the Fed wants 2% inflation.

    The question is what they’re doing to attain that goal.

    But your statement…

    “The single most important thing the Fed can do right now… is to clearly communicate its intentions to raise the five year expected inflation rate … to its target of 2%.”

    …doesn’t make sense to me.

    They’ve communicated that intention. What they need to do is *demonstrate* that they’re going to achieve that intention, even at risk that future inflation will be harder to control.

  9. Gravatar of Steve Roth Steve Roth
    18. April 2009 at 07:29

    Just after posting, I run across this from John Mauldin:

    “Understand, the Fed is going to keep pumping money until we get inflation. You can count on it. I don’t know what that number is, I’m guessing $2 trillion. I’ve seen some studies. Ray Dalio of Bridgewater thinks it’s about $1.5 trillion. It’s some big number, some number way beyond $300 billion, and they are going to keep at it until we get inflation.”

    This suggests that expectations out there are pretty clear…

  10. Gravatar of David Pearson David Pearson
    18. April 2009 at 07:53


    I agree with your post. I think there are two reasons for the Fed’s seeming asymmetry:

    1) The Fed really does believe it is not engaging in QE, but in so-called (by the Fed) Credit Easing. According to this view, the mis-pricing of credit is just a big misunderstanding of default tail risk. If the Fed just insures that tail risk, the misunderstanding goes away, credit spreads fall, asset prices rise, credit and velocity increase, etc. Easy. The Fed therefore just has to focus on how to mop up reserves once growth resumes.

    2) The Fed is speaking to its foreign dollar asset holders when it stresses inflation fighting over deflation fighting. The reasons are obvious. The trend lately has been for Foreign Central Banks to buy Bills instead of longer maturity Treasuries. The Fed risks being left all alone as the sovereign buyer of T-bonds, and it wants to manage that risk. They are afraid of losing control over long term interest rates as this defeats the effectiveness of Credit Easing (i.e. what good are low mortgage spreads if mortgage rates are high?)

    The second point may sound a bit conspiracy-minded, but consider the context: the essence of having a reserve currency is that you choose currency stability over economic growth. You might argue that dollar weakness and growth are a good combination for our foreign dollar holders. Maybe so. But the question is not do you see it that way, but do they see it that way. Remember, foreign Treasury holders do not need the U.S. to grow: that is why they are buying “risk free” Treasuries. They just need repayment in stable currency.

  11. Gravatar of Jon Jon
    18. April 2009 at 07:53

    “Understand, the Fed is going to keep pumping money until we get inflation. You can count on it. I don’t know what that number is, I’m guessing $2 trillion. I’ve seen some studies. Ray Dalio of Bridgewater thinks it’s about $1.5 trillion. It’s some big number, some number way beyond $300 billion, and they are going to keep at it until we get inflation.”

    For what is by many accounts a ho-hum recession, that’s a radical position. The economy is going to rebound on its own provided Fed policy is at least neutral.

    The take away from this blog (for me) is that this recession is drifting longer because Fed policy is defective in subtle ways; not because we need a heavier hammer in a gross fashion.

    Domestic Currency + Required Reserves << 1 Trillion Dollars.

    Do you really believe that velocity has contracted 5x?

  12. Gravatar of JimP JimP
    18. April 2009 at 08:42

    Maybe I have been unfairly harsh toward Bernanke. Scott has said elsewhere that it is not so much any one person as the general ideas of many people – who fear inflation more than deflation.

    And one of those is Volcker. Witness this:

    Kohn is a Fed lifer and has long opposed inflation targeting. I have read that Bernanke has worked hard to bring him around – but Volcker will clearly never move. Thank god he is not running the Fed now.

  13. Gravatar of JimP JimP
    18. April 2009 at 08:49

    Although – there was – in another Bernanke speech referenced in the above article – this weird passiveness again. It really bothers me:

    “because of weakness in economic conditions … inflation has been running less than that (2%), and our best forecast is that inflation will remain quite low for some time.”

    Again – describing his expectations rather than setting ours.

  14. Gravatar of Steve Roth Steve Roth
    18. April 2009 at 08:59

    JimP: “describing his expectations rather than setting ours.”

    Very well put.

    Scott, I think, is suggesting that by describing his expectations, he *is* setting ours.

    We assume he knows more about what he’s planning to do than we do. So if this is what he expects–a slow rise to 2% over the next year or two–it’s the best-informed guess we’ve got on what to expect.

    Really comes down to timing–are they going to push harder and faster to get to that 2%, or let the business cycle bring it about more…”naturally”?

    The expectation he’s setting–by stating his expectations–is the latter.

  15. Gravatar of JimP JimP
    18. April 2009 at 09:07


    And hopefully repayment in a stable currency is just what China will not get.

  16. Gravatar of JimP JimP
    18. April 2009 at 09:22


    Exactly. He is acting like what he is – a college teacher. But he does not seem to understand that he is not a teacher now. He is a leader. He is the guy who has the gold – the golden rule – he who has the gold makes the rules. And he just refuses to act like that.

    The contrast between him and Roosevelt just could not be greater. Roosevelt knew that, because of his position, he could not just describe. Whatever he said was going to be read as a prediction. As you say, the only thing we can predict is grinding deflation – because that is what Bernanke expects and he is the one and only person in the world who could actually deliver something other than that – which he is exactly not doing.

  17. Gravatar of JimP JimP
    18. April 2009 at 09:46

    On Don Kohn – in the WSJ of today:

    This I take to be good news. Kohn is now putting an explicit inflation target on the table. I do agree that NGDP targeting is a lot better – but I will take an explicit inflation target. Hopefully the Fed – Kohn – is setting the table for one. Stating that they do not consider policy to be aggressive enough. That would be good.

  18. Gravatar of ssumner ssumner
    18. April 2009 at 10:09

    Jon, I think the “no inflation now and too much later” scenario would be the worst of both worlds. But here is why I think Bernanke made a mistake even if he does see the need to reassure markets that high inflation is not coming later. The bond markets show that long term inflation expectations are well anchored, so while I don’t criticize Bernanke for providing some reassurance there, he says nothing in the area where we clearly do have a problem, where we do need to shift expectations.

    Bill, I agree. And just to follow up on my previous point I see a need for more inflation over the zero to 5 year range.

    Steve, And continuing from my previous replies, the 5 year inflation epxectations are only 0.8%, whereas the ten year is 1.3%. That means the implied 2014-2019 is around 1.8% which is not too bad. I think people get lulled by the long term being close to 2% into thinking we have no problem in the near to medium term. Let’s define near as now to 12 months, and medium term as 1-5 years. I see a problem in both of those time horizons. Does anyone think we are likely to have a robust recovery soon with inflation that low? Eventually the Phillips Curve will shift down, but that may take a few years. Because inflation is below target, there’s no reason to wait for shifting Phillips curves and nominal wage adjustments.

    David, Those are very interesting observations and you may well be right. But if that’s what the Fed is thinking I have two responses:

    1. The credit approach has failed because it doesn’t address the root problem of NGDP. Even if small credit improvements help velocity a bit, the falling NGDP does even more damage on the downside. I think we need monetary policy not (or in addition to) credit policy.

    2. I’m not excessively worried about foreign bond holders. They may move out of dollars, but not because we have two percent inflation. Any successful recovery would mean somewhat higher interest rates (even from fiscal stimulus) and thus some loss to foreign bond holders. Plus, higher long term rates are not a cause of recovery aborting, they are a symptom of a successful recovery. Higher nominal yields will raise velocity over time–which boosts NGDP.

    Jon#2, I agree that the problem is not a lack of base money. Your “defective in subtle ways” comment about Fed policy is exactly right. The base money is there, the subtle defects are the interest on reserves and the lack of an explicit short and medium term target. With an interest penalty on excess reserves we would have plenty of cash, indeed we’d have to pull some out right now to prevent overshooting.

    JimP#2, Thanks for the Volcker piece. I see why the Obama people have pushed him aside. His anti-inflation stance was exactly right for the early 1980s, but that’s not the current problem. As Bill Woolsey says, if we go to stable prices, it should be gradually and at a future date when we are not facing a financial crisis. I wish Volcker had made that point clear (assuming he understands it.)

    Steve, Let me just add one point about your comment, which I generally agree with. The remark about the economy “naturally” recovering has some merit, if understood in the proper context. Wage contracts can gradually adjust to a lower inflation rate (we have a pay freeze at Bentley this coming year.) If inflation does stay at 0.8%, and goes no lower, the economy will eventually adjust and output will rise. This may eventually push up real rates, and if the Fed keeps nominal rates at zero it is even possible we could get a robust recovery at some point. But we also know from the early 1930s that we cannot count on a “natural” recovery, if deflation set in there would be no natural recovery process. So I am assuming that Bernanke will at least allow no more deflation, and I still do think the most likely outcome is a bad recession, not a depression. But that prediction hinges on policy. So I agree with the prediction embedded in your “natural” remark, I just want to people to be clear that it does partly depend on the Fed avoiding even worse mistakes.

    JimP, Your interpretation of Bernanke may well be right. I corresponded with Earl Thompson by email and he was also struck by the contrast with FDR.

  19. Gravatar of David Pearson David Pearson
    18. April 2009 at 12:24


    I agree that Credit Easing (maybe we should call it “velocity targeting”) will be unsuccessful, but I don’t matter — Bernanke does, and he obviously thinks otherwise. Thus, you should expect an inflation-fighting bias until he realizes that Credit Easing will not free up the flow of credit. What would convince him of this fact? Well, a downturn in NGDP expectations (as communicated by equity and corporate bond markets). So, as long as this rally lasts, plan on being disappointed with the Fed’s actions. When it aborts, Bernanke will be further behind the curve and have more to do to fight deflation. This, of course, will raise the probability of an inflationary overshoot later on. Our Central Bank is fallible, and we should keep that in the forefront when proposing policy.

    As for foreign dollar holders, again, there’s what you and Bernanke believe (no overshoot likely), and there’s what they may fear. Much financial behavior involves the hedging of risk. If you are a Central Bank, do you buy bills or bonds on the margin? You already own bonds. What now? Bills and you reduce the risk of an inflationary overshoot in exchange for foregoing income. The decision is only partly economic, and it has to do with career risk and other factors. If they decide on Bills (on the margin), the outcome could well be higher long term interest rates even in the absence of a robust recovery. Recent evidence is pointing in this direction: note that the 30yr yield is now above the level where the Fed surprised the market with their intent to buy longer term Treasuries.

    I believe structural deficits will eventually cause economic forecasts and bond yields to be inversely correlated. The idea is the higher the deficit, the higher the sovereign risk premium. Heresy for the U.S., dogma for much of the rest of the world.

  20. Gravatar of JimP JimP
    18. April 2009 at 13:16

    And now Mankiw – pushing for inflation. For a firm price target.

    In today’s Times.

    He had said this on his blog but got no attention – and after talking to Scott. Now he is in the Times.

    As he says:

    “Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.”

    Thats right. There are worse things than negative NGDP. And there are better things – such as positive NGDP. That is the job of the central bank. Let’s get on with it.

  21. Gravatar of Dilip Dilip
    18. April 2009 at 15:56


    Its even worser than that. Take this quote by Mankiw in that NYT piece:

    “The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it.”

    Here is what Scott wrote on the very same topic when Dr. Mankiw first wrote about that crazy idea by one of his students in his blog post long ago:

    “And of course Gesell proposed a similar idea back in the Depression. But the plan is very easy to implement for reserves, and almost all of the base hoarding has been in reserves. Why hasn’t the Fed done this already?”

    Notice the reference to Gesell?

    I think Scott is getting a raw deal here because the mainstream popular economists for whatever reason don’t seem to accord him what little credit he deserves.

    Not fair at all.

  22. Gravatar of JimP JimP
    18. April 2009 at 17:30

    Dilip –

    Agreed. And he deserves more than a little credit. As I have said before, I think this is the best blog on the crisis there is. Scott said above that he has corresponded with Earl Thompson by email. I had never heard of Thompson till that earlier post of a couple weeks ago – but he is one smart and interesting guy. I wish he would come here and chat with us.

  23. Gravatar of ssumner ssumner
    19. April 2009 at 11:49

    David, From a political perspective you might well be exactly right. Here are a few random responses to your other points:

    Thirty years of spectacular economic growth has raised China from abject poverty to poverty. That’s pretty much how I feel about the effect (so far) of QE on NGDP growth expectations.

    Is the People’s Bank of China worried about its long term Treasury bond portfolio? Perhaps. But if so then logically the Chinese should be thrilled with the past year, after all, they have massive capital gains as yields have fallen. Now I’m sure you could give me many reasons why they might not be thrilled by the last 12 months (20 million factory jobs lost, losses in riskier assets) but the point is that the very factors that caused those losses would probably reverse if our Fed boosted AD.

    I am strongly opposed to big deficits, which is why I favor an expansionary monetary policy. However I expect the positive correlation between yields and growth (which I believe is true for most developed economies)to continue for the foreseeable future.

    JimP and Dilip, Thanks for the support. In fairness to Mankiw, someone else emailed him about the Gesell point (and he updated his post after the email.) More attention for this blog would certainly be great, but after his very nice piece on my efficient markets post, I can’t work up any outrage. Plus he has been unusually willing to both meet me in person and communicate by email–which is not true of many other famous economists. In our email exchange I failed to persuade him that my reserves-only approach was better.

    We are making steady progress. I have been getting a lot of links in the past week. In my next post (on Nick Rowe) I say a bit more about Mankiw. I hope to have a “quotable post” ready by Monday or Tuesday.

  24. Gravatar of Wills Wills
    20. April 2009 at 08:38


    I’ve been reading Mish’s Global Economic Trend Analysis, and he has a recent post with criticisms inflation targeting, namely that it is impossible to measure inflation accurately and even if it weren’t there is no tool precise enough to hit a target. I’m interested in your take on a few of those criticisms if you have the time. I’ve included part of his post below. The entire post can be found at
    Three Fatal Flaws

    1. It is impossible to pick a representative basket of goods, services and assets.
    2. Even if one could by pure luck manage to do so, measuring that basket is in and of itself impossible.
    3. Even if a magic fairy told the Fed what the basket was and how to measure it, it is virtually impossible for the Fed to tweak interest rates and money supply to hit that target.

    There are simply too many factors in a global economy for the Fed to control prices that closely. Here are three of them: currency fluctuations caused by changing interest rate differentials, currency fluctuations caused by other central bankers printing money, increasing or decreasing demand for goods and services in emerging markets.

    How anyone can possibly dispute those points? However, let’s wave our magic wand one more time and suppose all three of those fatal flaws did not exist.

    Would inflation targeting be a good idea? Of course not. The simple fact of the matter is inflation benefits those with first access to money (banks, the already wealthy, and government). By the time those on the lower socioeconomic scales have access to money, asset prices are inevitably too high for them to benefit.

    Inflation Target Is Moral Hazard

    Given that inflation benefits those with first access to money, any targeted inflation at all is morally wrong. Finally, for all this silly talk about inflation fighting and inflation targeting, its important to remember what inflation really is. Inflation is an expansion of money supply and credit, where credit is marked to market. Prices generally follow money supply but there is a variable time lag, productivity and consumer sentiment are huge factors, as are a host a host of global factors including interest rate differentials and currency fluctuations.

    So even if the Fed could achieve that magic 2%, the whole shebang would eventually blow sky high anyway (as it just did) because wages will not keep up with prices causing asset bubbles to pop.

  25. Gravatar of ssumner ssumner
    20. April 2009 at 17:51

    Wills, There is too much here to fully address, so I’ll also suggest you my look at some of my other posts. Let me just make several points:

    1. He doesn’t understand monetary policy. The Fed doesn’t have a “magic wand,” they have a 100% monopoly on the production of base money. That allows them to control the value (or purchasing power) of base money. Because of policy lags they can’t do it perfectly, but they can at least target expected inflation–and they are not even doing that.

    2. His intuition about CS-CPI may be right, but I would argue for the wrong reason. We should be targeting NGDP growth at about 5%. Because CS-CPI follows NGDP more closely than it follows the regular CPI in recent years, we end up with much the same critique of the Fed, but for different reasons. And I think my reasons are sounder, as they would have outperformed CS-CPI during earlier periods.

    3. Your final sentence is completely wrong. The whole thing blew up precisely because we stopped targeting inflation at 2%. If we had continued the 2% inflation target last fall, we might not have even had a recession. The reason things fell apart is precisely because the Fed suddenly adopted deflationary monetary policies, which are incredibly destructive to a banking system already reeling from the subprime fiasco. We are repeating the mistakes of 1929-32 (at a much milder level.)

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  27. Gravatar of GIRBAUD » さらに負の利子率について GIRBAUD » さらに負の利子率について
    22. April 2009 at 20:49

    […] 経済学会で僕だけがこの考え方を持ってるわけじゃないよ。何人かの有名な経済学者は、銀行が持っている準備金(総額かもしくは超過分)に対して課金する策について研究している。例えば、ホール&ウッドワード、エドリン&ジャフィー(.pdf)、そして、スコット・サマーだ。その課金は、準備金保有に対する負の利子率とも言える。この案は、現金のリターンに影響するものだけれども、私がタイムズ紙でした様な過剰な反応のようなものは生まないない、と。 […]

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