Sunday, September 28, 2014

Will the Fed Raise the Inflation Target to 4%

The Federal Reserve's official price inflation target is 2%. Although in the EPJ Daily Alert, I argue that the real target is currently 3%. 

Now discussion has emerged that the target rate should be increased to 4%.

Carola Binder, an economics graduate student at UC Berkeley, points out, that Jared Bernstein, who was from 2009 to 2011, the Chief Economist and Economic Adviser to Vice President Joe Biden,  refers to a paper by Laurence Ball suggesting that a 4% target could be preferable.

She goes on to note that, surprise, Paul Krugman is not happy with the 2% target and she then adds this juicy bit:
Another paper, which I would guess influenced some people at the Fed, is by George Akerlof, William Dickens, and George Perry in 2000. They build a model in which some agents in the economy are "near rational" instead of fully rational in the way they think about inflation:
"when inflation is low it is not especially salient, and wage and price setting will respond less than proportionally to expected inflation. At sufficiently high rates of inflation, by contrast, anticipating inflation becomes important and wage and price setting responds fully to expected inflation."
As a result, there is some moderate positive level of inflation that is optimal for employment. They estimate that this optimal rate of inflation is between 1.6 and 3.2 percent.
Who does Binder think may have been influenced at the Fed by the paper? She slyly doesn't say. But it isn't difficult to connect the dots. Akerlof is the husband of Fed chair Janet Yellen and they have often collaborated in their work. They are both inflationists.

It should be further noted that this idea of a price inflation "target," first emerged at the Fed as policy under chairman Ben Bernanke. Prior to that the Fed pretty much saw all price inflation as evil.

Bloomberg provided historical perspective with a report it issued when Alan Greenspan was Fed chair:
Federal Reserve Chairman Alan Greenspan rejected the idea of using an inflation target to set U.S. interest rates, saying it is ``highly doubtful'' such a policy would improve policy making...

Inflation targeting, where a central bank names a numerical goal for inflation and tries to achieve it over a specified period of time, is used by the Bank of England, the European Central Bank, the Bank of New Zealand, the Bank of Mexico, and at least a half-dozen other central banks around the world.

Some Fed policy makers, including Philadelphia Fed Bank President Anthony Santomero and St. Louis Fed Bank President William Poole, have advocated the U.S. central bank adopt an inflation target as well. Fed Governor Ben Bernanke also is an advocate of announcing inflation goals.
The Austrian school perspective on this targeting is, of course, that it is utterly absurd. The idea can only take hold in the mind of someone, who doesn't understand the beauty of free markets and how there is a self-adjusting mechanism for prices and activity in the economy, based on supply and demand, with no need to create inflation to "get the economy going.". Alternatively an advocate of targeting could be a person who is just a tool of the crony elite, who benefit from inflation.

Take your pick, it is not pretty.

Price inflation adds nothing to an economy other than distortions, since money created by a central bank does not end up in all hands simultaneously---the edge is always to those who are first in line to receive new money. SEE: Ludwig von Mises on the Meaning and Significance of Deflation.



  1. Audit the New York Fed

    We’re not so concerned one way or another whether the Fed has been captured by Goldman. The way to stop that racket is to end the era of fiat money and establish a constitutional system in which the dollar is defined as a set amount of specie, gold or silver.

    That’s the way to keep the Fed honest. It’s the method to put some backbone in the New York Fed. It’s the way to put Goldman Sachs in a situation that can be supervised. For if the money is not connected to anything real, what at the end of the day are the examiners the Fed sends out supposed to examine? No less a figure than the greatest of the modern Fed chairmen, Paul Volcker, has called for a New Bretton Woods. The chairman of the Joint Economic Committee of the Congress has called for a centennial review of where the Fed stands at the start of its second century. An audit of the Fed would be just the place to start, beginning with an audit of the New York Fed.

  2. so they want to double the amount of money they are stealing from me?

    Tom, does the fed have a reason to exist without fiat? just saying...

  3. Why stop at 4%? Why not 40%? That'll really get the economy rolling...right?

    1. When Central Bankers Become Central Planners Macroprudential regulation is not likely to prevent asset bubbles. But credit allocation will depress growth.

      Stanley Fischer, vice chairman of the Federal Reserve, has been tapped to head the Fed's new financial stability committee. In recent speeches both Mr. Fischer and Fed Chair Janet Yellen have argued that so-called macroprudential regulation can prevent asset bubbles from erupting while the Fed maintains near-zero interest rates. There is not much evidence that these policies prevent financial bubbles. But there is great risk in allowing a small group of unelected technocrats to determine the allocation of credit in the U.S. economy.

      Macroprudential regulation, macro-pru for short, is the newest regulatory fad. It refers to policies that raise and lower regulatory requirements for financial institutions in an attempt to control their lending to prevent financial bubbles.
      These policies will not succeed.

      Banks adjust their lending in response to a host of factors including pressure from bank regulators, changes in their funding cost, losses on their outstanding loans and other factors. Changes in regulatory capital and liquidity requirements have only the weakest detectable effects on lending.

      Few if any centrally planned economies have provided their citizens with a standard of living equal to the standard achieved in market economies. Unfortunately the financial crisis has shaken belief in the benefits of allowing markets to work. Instead we seem to have adopted a blind faith in the risk-management and credit-allocation skills of a few central bank officials.

      Government regulators are no better than private investors at predicting which individual investments are justified and which are folly. The cost of macroprudential regulation in the name of financial stability is almost certainly even slower economic growth than the anemic recovery has so far yielded.