2% Target: “Bernanke´s Cross of Gold”

This from Tim Duy:

Bottom Line:  Monetary policy might have a bigger impact on shaping the underlying growth rate of the economy than policymakers believe.  Some of what they think is exogenous may be at least in part endogenous.  Ultimately, within a certain margin, we will get the economy the Fed wants us to get.  And right now we are getting the economy that is defined by central bankers living in mortal fear of any inflation rate greater than 2%.  With the exception of a few policymakers, the cost of 2.5% inflation far exceeds the possibility of learning to what degree the underlying structure of the economy is exogenous or endogenous.

I increasingly believe that the Fed made a massive policy error in defining their mandate as 2% inflation.  I think they believed it would give them more freedom to use new tools by solidifying inflation expectations.  Instead, the target has placed policymakers in a straitjacket.  It is Bernanke’s cross of gold.

My only quibble: It´s not that monetary policy “might have a bigger impact” but that it does have. And Tim recognizes that when he writes: “And right now we are getting the economy that is defined by central bankers living in mortal fear of any inflation rate greater than 2%”.

In this post I criticize Bernanke´s formal inflation targeting approach:

Note the irony. In trying to avoid the 1970s he (Bernanke) was “presented” with the 1930s! And I think that was because he “misinterpreted” Greenspan´s policy approach. But that´s not surprising because Greenspan himself didn´t know exactly what his “policy approach” was, just that it “worked”!

The panel below, if anything, confirms the view that the “Fed rules”. Since it closely controls nominal spending, it can gear the economy towards rising inflation like in the second half of the 1960´s, to almost perfect nominal stability like in the 1990´s (up to 2006) or to a “Great Recession or Lesser Depression” like after mid-2008.

2 thoughts on “2% Target: “Bernanke´s Cross of Gold”

  1. Excellent post.

    Moreover, how accurate are measures of inflation, in a world of rapidly evolving goods and services.

    Who uses a film camera anymore?

    I can talk for free, globally, where long-distance calls used to be expensive.

    The kids seem to be able to access any music for free. I used to have to buy expensive LPs.

    New, cheaper retailers have opened in the USA in recent years, the ubiquitous $1 stores.

    Could Bernanke be carrying a Cross of Gold and one that is falsely heavy?

  2. Even the Fed’s own internal research is showing that the slump in the labor market is primarily due to a lack of aggregate demand if you read in between the lines:

    “Mismatch across industries and occupations explains at most one-third of the total
    observed increase in the unemployment rate, whereas geographical mismatch plays no
    apparent role. The share of the rise in unemployment explained by occupational
    mismatch is increasing in the education level.”

    “…If mismatch only accounts for a portion of the persistently high unemployment rate, what
    are the other economic forces at work? As we explained, both the aggregate vacancy rate and
    aggregate matching efficiency are still well below their pre-recession level of 2006. Weak
    aggregate demand combined with wage rigidity (Shimer, 2012), uncertainty about future
    productivity (Schaal, 2012) and future economic policy (Baker, Bloom, and Davis, 2011),
    or selective restructuring by firms during recessions (Berger, 2012) do, qualitatively, imply a
    slow recovery in job creation. The disincentive effects on job search effort from prolonged
    extension of unemployment benefits (Farber and Valletta, 2011), and the diminished recruitment
    intensity on firm’s side (Davis, Faberman, and Haltiwanger, 2012) are consistent with
    the fall in aggregate matching efficiency. Going forward, disentangling these channels will
    be paramount in achieving a comprehensive picture of the Great Recession.”


    Click to access sr566.pdf

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