More evidence that inflation targeting has failed
Commenter Bonnie sent me the following 2005 article from BW/Bloomberg:
Why does Bernanke favor inflation targeting?
He thinks that a more “transparent” Federal Reserve policy would promote stable, noninflationary economic growth by giving businesses and consumers more certainty about the future course of interest rates and inflation.Why is Greenspan against it?
He thinks the Fed can control inflation without announcing a target rate. Plus, he worries that an announced rate would make it harder to respond flexibly and intuitively to a financial crisis or changing economic conditions. Greenspan recognized from a variety of subtle indicators in 1997 that rapid productivity growth was likely to curb inflation — even though most conventional forecasts predicted accelerating inflation. He persuaded fellow Fed policymakers to not raise interest rates, allowing the economy to flourish.Does Bernanke admit that inflation targeting would decrease the Fed’s flexibility?
No. He says that in a crisis the Fed would do whatever it takes to stabilize the economy. Frederic Mishkin, a Columbia University economist and longtime Bernanke collaborator, says that establishing credibility with the financial markets as an inflation hawk gives an inflation-targeting central bank more, not less, flexibility to tackle recessions.
Bernanke has recently announced that it would not be appropriate to do further stimulus to “tackle” the recession. And why not? He says it might lead to higher inflation. Thus Bernanke and Mishkin were wrong in 2005, inflation targeting does inhibit the Fed’s ability to tackle recessions, as compared to NGDPLT.
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24. May 2012 at 11:51
close your eyes and repeat after me, three times:
ngdp targeting performs better when the output gap is uncertain
24. May 2012 at 12:16
1 thing that doesn’t bother me about this, if bernanke is the face of IT, how to give him a face saving exit strategy.
24. May 2012 at 12:17
I came across the very same article last week and quoted it at Economist View in a post on David Altig’s defense of Inflation Targeting (IT):
http://economistsview.typepad.com/economistsview/2012/05/is-inflation-targeting-really-dead.html
We were doing alright under Greenspan’s Constrained Discretion. IT is the problem.
24. May 2012 at 12:30
I favor NGDPLT, but if you are going to do IT, at least target a range rather than a fixed point. Australia does this. If the Fed targeted 1.5% to 3.0% inflation then they’d have flexiblity to deal with financial crises while maintaining an iron 3.0% ceiling on inflation. (Admittedly, this works because it enables closet NGDP targeting.)
24. May 2012 at 12:38
dwb,
close your eyes and repeat after me, three times:
ngdp targeting performs better when the output gap is uncertain
I hear if you do that, John Taylor appears in a mirror and scratches your eyes out.
24. May 2012 at 13:22
Steve,
That cuts both ways. It gives doves the flexibility to allow a little more inflation, but it also gives hawks the ability to oppose further easing when inflation is sitting at 1.5%.
The part of the Australian mandate that interests me is “2-3% CPI inflation on average over the cycle“. The “on average” part, if interpreted rigidly, means if inflation falls below trend the RBA will have to allow a period of above trend inflation for the average to be on target. If we put a lot of weight on the “on average” part of the mandate, it’s sort of a de facto price level target. Of course we haven’t had a sufficiently large price level shock so far, so I’m not sure how seriously the RBA takes that part of the mandate.
24. May 2012 at 13:22
Bernanke has recently announced that it would not be appropriate to do further stimulus to “tackle” the recession.
M2 is rising at 9.8% annualized YoY April 2012, however it has recently slowed to 4% annualized the last few months.
What non-stimulus is he talking about? He hasn’t stopped goosing the financial markets. Last year alone he monetized over 60% of all the treasuries issued.
24. May 2012 at 13:38
” I hear if you do that, John Taylor appears in a mirror and scratches your eyes out.”
I am disappointed it’s not penelope cruz
24. May 2012 at 14:22
I agree with all the comments (except obviously MF)
The odd thing about flexible inflation targeting is you are supposed to have low inflation during the booms, and high inflation during the recessions, but most central banks do it backwards.
24. May 2012 at 14:23
A historical what if question — suppose Greenspan had headed the Fed throughout the Great Recession, would the Great Recession have happened?
24. May 2012 at 15:40
ssumner:
I agree with all the comments (except obviously MF)
Those are facts I cited:
M2 growth:
http://www.federalreserve.gov/releases/h6/Current/
Over 60% monetization of treasuries:
http://i.imgur.com/jmqUp.jpg
Are you saying you don’t agree with the facts just because I relayed them?
24. May 2012 at 15:40
“1 thing that doesn’t bother me about this, if bernanke is the face of IT, how to give him a face saving exit strategy.”
Vote for Romney, then with the changing to a new administration, Ben and the Fed will INSTINCTIVELY (lizard brain level) see loosen Monetary policy as the right and natural thing to do.
Whats funny is this, there is a date certain, but unknown, that IF Romney looks electable…
THEN, the entire MM cause will need to pull for him with all their might.
For at that date certain, MM will finally have to ADMIT their immediate best chance is no longer screaming at Ben, it is screaming at Democrats.
I suspect that date is late Sept.
——
What will be fun is watching the faux MM crowd say getting Monetary easing isn’t WORTH it.
Fun times ahead perhaps.
24. May 2012 at 16:07
Scott Sumner wrote:
I agree with all the comments (except obviously MF)
Scott, feel free to economize in the future. Everyone knows the parenthetical remarks are superfluous at this point.
24. May 2012 at 18:34
The problem is not so much inflation targeting as it is the Fed’s 2% inflation target. Pick a nominal anchor, and you invariably endogenize every other nominal variable, NGDP included. The key, whichever anchor you select, is to specify the right value. 2% inflation (or “a bit less”) is strangling the US economy, but there is some inflation target (or some nominal exchange rate target, or some money supply target, or…) which would implement the optimal macroeconomic equilibrium. Nothing special about NGDP.
On the other hand, if policy is characterized by “sticky targets”, then some nominal variables make for better targets than others. As Scott has pointed out, an NGDP level target that is “stuck”–i.e., not a moving target–motivates better AD policy under most circumstances than an inflation target. But just like it is useful to think about a world of flexible prices, even though prices are sticky, it is useful to think of a world of flexible policies, even though policies are sticky. When we do, we see that inflation targeting is OK so long as the Fed is prepared to adjust it as the economy bounces about. The special case for NGDP level targeting isn’t sticky prices, it’s sticky policies.
24. May 2012 at 18:51
BobMurphy:
See MF, respectable Austrians want nothing to do with you.
24. May 2012 at 18:54
“1 thing that doesn’t bother me about this, if bernanke is the face of IT, how to give him a face saving exit strategy.”
Vote for Romney, then with the changing to a new administration, Ben and the Fed will INSTINCTIVELY (lizard brain level) see loosen Monetary policy as the right and natural thing to do.
yeah, that thought has crossed my mind many times.
24. May 2012 at 19:49
Saturos:
See MF, respectable Austrians want nothing to do with you.
Haha, nice.
Murphy was just saying it’s superfluous for Sumner to say he doesn’t agree with me, because Murphy knows me and knows I don’t agree with Sumner (on money).
I know you WANT to believe what you said, but here’s the thing about that ol’ chap: Even if every single “respectable” (by whom?) Austrian economist on the planet “wanted nothing to do with me”, it would not in any way be a source of doubt, self-loathing, or cause for me to change my views for that particular reason.
I’m not here to make friends, I’m not here to be popular with a clique, and I am not going to accept your claim that if one respectable Austrian wants nothing to do with me, that you can pluralize it.
I am not as weak as you where I worry about popularity. I graduated from high school a while ago.
24. May 2012 at 20:23
Scott, check out the latest EconTalk: http://www.econtalk.org/archives/2012/05/coase_on_extern.html
Ronald Coase discusses China and his new book on it, amongst other things.
24. May 2012 at 21:11
Richard:
The recession might have happened under Greenspan, but the I doubt the financial crisis would have. I found an article from 2006 where an investment adviser is telling his readers about Bernanke’s plan for IT and how they should be getting ready for it in case things get rough. I don’t know how widespread that sentiment was, but if it was pervasive I can see just the suggestion that monetary policy was going to change having an effect on the markets.
That is part of the problem I see with, maybe not inflation targeting per se, but the fear of creating inflation leading Bernanke and his colleagues to not react to things until the damage is done. They keep doing it too, saying they don’t see a need to ease with the turmoil going on over in Europe and elsewhere. It probably isn’t Europe roiling the markets as much as it is the Fed not getting out in front of this and doing damage prevention. We’re just asking for more problems because of it.
24. May 2012 at 21:31
I just want to add to my last comment that I really question the value of IT as a Fed mindset because the of economic vulnerabilities that behavior creates, and damage to markets and the economy simply begets more, we’re just asking for one crisis after another. We lose far more money and productivity than we get from it and I really don’t think we can afford it.
25. May 2012 at 04:33
i think this shows that people knew Bernanke’s and the FOMC’s mind before he did, the markets are smarter than the FOMC.
i don’t think i would mind IT so much if the Fed were targeting purely domestic prices or wages, like the GDP deflator. Unfortunately about 20% of the PCE is driven by oil, which sends exactly the wrong signal about which way to lean. You can only cut oil prices by reducing demand, i.e. massive unemployment.
25. May 2012 at 04:42
Ram:
True, if Jesus returns and runs your monetary policy.
25. May 2012 at 05:34
Saturos,
Thanks for the link. I’ve had an open folder waiting for some more Coase notes.
25. May 2012 at 05:51
Bill–
Jesus would probably support a return to the gold standard. Paul Krugman might better handle inflation targeting. I agree with Scott that inflation targeting is inferior to NGDP level targeting, I’m just pointing out that it’s not fundamentally for economic reasons that this is the case. It’s a bit like his observations about interest rates. Spell out the current setting of, and expected forward path for, nominal interest rates, and you endogenize a lot of other stuff. The funny thing about interest rates, though, is central bankers become Old Keyensians when they go to zero. That’s an argument against interest rates, but it’s not an economic argument.
25. May 2012 at 06:35
As soon as Bernanke – the IT freak – came on board, a “depression” followed. I don´t call that coincidence!
http://thefaintofheart.wordpress.com/2012/05/18/a-last-ditch-defense-of-inflation-targeting/
25. May 2012 at 08:07
Richard, I think it would have been about the same.
MF, Not facts, interpretation.
Bob Murphy, Like a broken clock, he’s correct once and a while.
Ram, But in what sense is an inflation target that moves around actually an inflation target at all? Interest rate targets can be adjusted, but that’s because interest rates are controllable in real time.
Maybe we are talking past each other. Some people use “target” in an intermediate sense, others as a goal variable.
Thanks Saturos, I’ve purchased the book already.
dwb, Yes, the deflator would be better.
Marcus, But surely it was partly bad luck.
26. May 2012 at 07:15
Ram:
Jesus is omniscient.
Paul Krugman is not.
Jesus is perfectly benevolent.
I am not sufficiently sure about Krugman.
To me, you are assuming that you and Krugman know the
“true” model and are completely ignoring agency problems.
That is why I support a rule. Defining the time path of interest rates? And then since everyone knows the model and gives perfect creditililty to the central bank, then we can maximize the representative agents utility function in any number of ways.
Why are we doing this?
26. May 2012 at 09:00
Ram –
“Jesus would probably support a return to the gold standard.”
Unlikely. The only record we have about what Jesus thought about money is this:
“Is it lawful to give tribute to Caesar, or not? But Jesus knowing their wickedness, said: Why do you tempt me, you hypocrites? Show me the coin of the tribute. And they offered him a penny. And Jesus says to them: Whose image and inscription is this? They say to him: Caesar’s. Then he says to them: Render therefore to Caesar the things that are Caesar’s; and to God, the things that are God’s. ” – Matt 22:17-22
Jesus didn’t ask what the coin is made of, or if it can be traded in for gold. He asked whose picture is on it, i.e., what entity issued it for what purpose. Like Aristotle, Jesus understood government money is a legal unit of account for paying taxes.
26. May 2012 at 10:36
Scott, Bill & Negation —
Needless to say, the Jesus and Paul Krugman comments were jokes. I support rules over discretion, too. Think about it this way: Suppose the Fed is targeting nominal variable X(t) at a value of x(t). At every instance, the Fed is adjusting its stance so as to ensure that E[X(t)] = x(t). x may vary with t, and yet this is still a rule in the only sense that matters, because it’s spelled out in advance, and adhered to without exception. Even if t (time) isn’t the dependent variable–say the output gap is, as in flexible inflation targeting, for example–it’s still a rule if the Fed implements it in a wholly non-discretionary manner (say by having some set, publicly communicated model of potential output). Nothing about the advantages of rules over discretion favors targeting one nominal variable over another.
Now, suppose I have a rule that says at any and all times, I will pursue inflation target I(o), where o is the size of the output gap. Suppose also that I is increasing in o. In that case, there is a sense in which I’m targeting inflation, in that at any and all times my objective is to keep inflation at a particular level. It’s just that when the output gap gets really big, that level is higher then when the output gap gets really small. If pursued rigorously (as a rule), then what the Fed would do right now is say: “Listen, normally we like 2% inflation because we’re normally able to keep the output gap at a tolerably low level. Right now, however, with interest rates really low, it’s getting bigger than we’d like. So we’re going to target 4% inflation until the output gap falls back to tolerably low levels, after which we’ll go back to our normal 2% target.” This would be following a rule, it would be targeting inflation, and it would overcome the zero lower bound. In a perfect world, it would be optimal, just as optimal as the right NGDP level target.
What the crisis has shown, Scott and I believe, is that in practice it’s really hard for the Fed to follow a rule of that kind. Why? My answer is sticky policies, or sticky targets. I don’t have good microfoundations for such stickiness, but then I never really bought any of the micro-stories behind price or wage stickiness either. Stickiness in the data is enough to convince me. In light of sticky policies/targets, some policies that would be just as good as others in the flexible policy world are better than others in the stick policy world. NGDP level targeting versus flexible inflation targeting is such an example. But it’s useful to note that sticky policies are a fact of political life, not a fact of economic life per se.
27. May 2012 at 10:15
Ram, Excellent comment.
31. May 2012 at 13:39
Scott,
Not sure if you’re still checking this thread, but I think this post is totally wrong. Yet before I make an ass of myself, I just want to check two things:
(1) What do you mean by “inflation targeting”? Does that mean singlemindedly focusing on hitting a precise rate for (price) inflation, no matter what else is going on?
(2) If that’s what it means, then we never had it. So how can you have a post talking about how it failed?
1. June 2012 at 21:21
Bob Murphy:
Reminds me of socialists saying capitalism failed if the economy goes into recession and the economy is not communist. As if there is no other alternative other than anarcho-capitalism and Stalinesque communism.
Blame the non-existent enemy so as to make one’s counter-program more attractive.