It´s past the time to change the target

The GDP release today showed things are even worse than expected, with real growth coming in below expectations. Of course there are those who pretend to find “golden nuggets” inside the entrails of the aggregate number, but mostly it´s wishful thinking.

What´s interesting is that even given the substandard number, the discussion quickly veers towards “inflation”. This post by Tim Duy is a good example:

I think we can conclude, by Bernanke’s statement’s in the past and the actual path of inflation now, that Bernanke has embraced the recession as yet another exercise in opportunitistic disinflation in which the Fed can knock another 40bp off the expected rate of inflation.

The story gets more interesting. In his press conference, Bernanke says:

So it’s not a ceiling, it’s a symmetric objective and we tend to bring inflation close to 2 percent. And in particular, if inflation were to jump for whatever reason and we don’t have, obviously, don’t have perfect control of inflation, we’ll try to return inflation to 2 percent at a pace which takes into account the situation with respect to unemployment.

Avent rightly calls foul on this claim:

Perhaps more telling, the Fed gives a range for projected inflation over the next three years with 2% as the upper extent. If the Fed does indeed have a symmetric approach to the target, as Mr Bernanke asserted yesterday, one would expect 2% to be at the middle of the range, not the top. This is particularly damning as the Fed’s estimate of the natural rate of unemployment doesn’t appear at all in the projected unemployment-rate range over the next three years; the closest the Fed comes to meeting that side of the mandate is in 2014, when the bottom end of the projected unemployment-rate range gets within 0.7 percentage points of the top end of the natural-rate range.

Bernanke is clearly misleading us when he claims the target is symmetric as the Fed’s own projections clearly treat the target as a hard ceiling.

Apart from this there´s the question of which price index to use. And inside the Fed there are those who think that, for example, “the core is rotten” (see also here).

As I like to say, the inflation obsession (and paranoia) is a formidable barrier to progress. And the obsessive pursuit of an inflation target is a sure way to get the economy to fall into a “bad equilibrium” as it did after mid-2008.

Update: Just ran across another take on the “inflation obsession”, only they call it the “2% Catastrophe“.

Update 1: Evan Soltas proposes a quantitative measure of the “obsession”:

I empirically determined the relative weights central banks put on deviations in real growth and inflation at different times — their “loss functions” — interpreting the consistent discretionary choices of policymakers as NGDP-style rules, with additional weights on real growth or inflation. I further combined the two weights into a single measure which I called an H-value; a positive H signifies a policy which is intolerant of inflation deviations relative to real growth deviations, a negative H signifies the opposite, and an H of zero is an NGDP rate target.

Applying this research, my perspective was to rephrase Karl Smith’s question as: Does the Fed’s H-value change at or near the zero lower bound?

The answer I got was yes, and the effect is substantial. For every percentage point the nominal federal funds rate falls, the Fed becomes 17 percent more sensitive to deviations in inflation relative to deviations in real output.

6 thoughts on “It´s past the time to change the target

  1. “… we don’t have, obviously, don’t have perfect control of inflation”

    That’s because you don’t target the forecast, you dimwit. There’s no excuse for that.

  2. One of the things that bothers me is that even under a gold standard, there were bouts of inflation (as measured by a price index) caused by supply shocks. These inflations inevitably reversed when supply was fixed. But now, the Fed is killing the economy in response to supply shocks, and then trying to perform CPR once the supply shock has passed.

  3. What’s interesting is that just last month, Bernanke said he was going to focus on the “drag on income” (NGDP?) instead of headline inflation.

    “The chairman said, ‘We think it is transitory, we are sticking to our guns, we are going to focus on the drag on income’,” Crandall said. Bernanke explained in his testimony how under a strategy of flexible inflation targeting, “a temporary spike in the price indexes can be a reason for the central bank to be more generous rather than less,” Crandall said.

  4. Pingback: It´s past the time to change the target « Economics Info

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