David Altig blogs on “How are we doing?”, about the recent FOMC making explicit an inflation target. Read the whole thing, but the “scary thought” is in bold:
In particular, think about monitoring policy performance against a stated inflation objective over some “medium-term” horizon. “Medium-term” is itself a term of art, but I find it attractive to think about a three- to five-year horizon. Given the continuous arrival of shocks to the economy, uncertainties about the timing of policy effects, and the desirability of trading off precise control over inflation against the risks of destabilizing influences on real economic growth, I think it is still unrealistic and unwise to expect that an inflation target will be hit precisely even over a medium-run horizon. This is the reason, I believe, that an exact point target for inflation is relegated to the long run. But I think it is realistic, and wise, to expect realized average inflation to fall within a reasonable tolerance range about a long-run target over something like a three-to-five-year medium-term horizon.
People can disagree about what constitutes a reasonable tolerance range, but one option that I find sensible would be along the lines of the average volatility of medium-term inflation (calculated over a period in which inflation outcomes were deemed to be acceptable, which I’ve chosen to be the period since the mid-1990s). With this in mind, the following chart plots realized inflation over three-, four-, and five-year horizons. (For reference, the chart highlights the 2 percent target with upper and lower limits that are plus and minus 1 percentage point.)
The plus or minus 1 percentage point threshold in the above graph is somewhat above the standard deviation of medium-term outcomes shown in my earlier chart, so one might want to tighten up the bounds. But if you are willing to accept that it’s close to your definition of tolerable deviation, the record does support the position that, over the past two decades or so, the Fed has delivered on the its now-explicit long-term objective, or taken sufficient steps to correct matters when it wasn’t.
In practice “taking sufficient steps” meant “derailing” the economy after mid 2008!
And I´m a bit at a loss because before the above paragraph Altig reproduces a speech by his boss Atlanta Fed president Lockhart on February 14, who states:
“The 2 percent inflation target is an aid to understanding how the FOMC will react to developments in the economy within an overarching approach that can be called ‘flexible inflation targeting.’
“The word ‘flexible’ describes and qualifies the committee’s exercise of judgment in reaction to adverse developments. The word ‘flexible’ also reflects the principle that it is not always feasible or desirable to hit the target in the short run. Short-lived shocks to the economy can temporarily move measured inflation well away from the 2 percent target.”
And goes on to say:
“Consider last year’s energy and commodity price increases. Those cost pressures pushed up inflation in the early part of the year. Then, as expected, their influence dissipated as the year progressed.
“Had the FOMC tightened monetary policy early last year in response to the inflation threat, we might have compromised progress on growth and employment to no particular benefit with respect to our inflation mandate…
“As I see it, this is a recent, real-world example of a balanced approach in action. It illustrates the idea of flexible inflation targeting.”
To me it´s a case of “bolting the stable doors after the horses have taken off”!
