A Guest post by Benjamin Cole
Recently Federal Reserve Bank President Charles Plosser opined that even periods of mild deflation could be welcome in the United States, and that Fed should have but a lone goal, and ideally that is zero inflation.
Hardly anyone blinked an eye at the Cato Institute conference at which Plosser spoke, and certainly no one at the United States central bank sought to distance the Fed from Plosser’s comments. There was no outrage, or even eyebrow-raising, either in right- or left-wing media outlets.
But think about it: Would anyone at the Fed assert, “Oh, a period of five percent inflation would not be such a bad thing.”
In other words, for a few months or years the Fed would endure an economy with an inflation rate 3 percent above its long-term 2 percent inflation target.
No, no one at the Fed would make such a statement. If they did, we could expect pique and indignity in the usual circles, and maybe even an exit from Fed association.
But Plosser could and did talk about mild deflation. If we assume “mild” is 1 percent deflation, then Plosser could and did talk about a rate that was 3 percent below the Fed’s 2 percent target.
The message to the market? Three percent above target is a cardinal sin, the unspeakable. Three percent below target? Not so bad, even possibly “positive,” to quote Plosser.
Curiously, following Plosser’s commentary there was no storm of purple-prose about unfair costs to debtors, or that dollar stability is sacrosanct. The Wall Street Journal has opined countless times that inflation is unfair injury to creditors…but is deflation unfairly detrimental to debtors? Not so much…
Message to the Market
What does the Plosser commentary tell the market?
It says the market is wise to have less faith in the Fed’s resolve to boost economic growth, than in its internal fixation on inflation. Keep your horns pulled in, the Fed does not like inflation, any of it.
Inflation? Did someone say inflation? Where? The PCE index (the Fed’s preferred inflation measure) for the last year is at 0.9 percent. Get out your microscopes.
The inflation hysterics have been intuitive about one thing: They said QE would mean inflation could not be restrained within single digits. They were right: Inflation is now below single digits.
The Fed is already undershooting its target rate by more than half, but there is no public self-flagellation about that failing. Instead, we hear rhapsodizing about deflation.
Explaining Plosser, the Fed
The answer to the Fed’s behavior, and Plosser’s pontifications, lies not in economics, but in organizational behavior. The Fed is an independent public organization.
Never crushed by competition, but needing to justify existence, public agencies tend towards ossification, self-exaltation, and their own ethos, norms, and glorified mission statements. At independent public agencies—such as the Fed—all of those attributes are magnified.
Some organizational theorists have posited that the longer an independent public agency exists, the more reified and exacting become the internal norms and standards—a sort purification process sets in. Individuals who do not genuflect to organizational icons are sidelined, banned or self-select out.
The process becomes self-reinforcing. With the survivors narrowed to a harder core, an organization’s internal norm moves ever closer or higher to a theoretical ideal, worshipped by true believers. The process rarely appears sinister, as there are those exalted goals touted about.
Long ago, organizational thinker William H. Whyte, Jr., put it this way, in defining Groupthink: “We are not talking about mere instinctive conformity—it is, after all, a perennial failing of mankind. What we are talking about is a rationalized conformity—an open, articulate philosophy which holds that group values are not only expedient but right and good as well.”
Think about it: When was the last time someone in the USDA food stamp program said, “We are a nation of fatties, and it is obvious. Why food stamps?”
Who was the last Joint Chief of Staffs member who said, “We expect no military to attack the United States; our only adversary is a few stateless terrorists, who have no army, navy, air force, or even a single tank. We can just about stand down for a few years anyway.”
Within organizational context, the ideas above are unspeakable sentiments. Outsiders may think both ideas have merit.
And at the Fed? That some inflation is tolerable, even good? Is that becoming unspeakable?
Single Mandate: Monetary Noose Around the Economy’s Neck
Perhaps the greatest menace to American prosperity is not Obamacare or Big Wall Street or plutocracy, but Plosser’s proposal that the Fed have a lone mandate to fight inflation to a draw, come economic hell or high water.
(It helps that Fed staffers and board members are also largely insulated economically from the impact of their decisions—indeed, one may assume deflation favors the typical Fed staffer, who marches on step grades to seniority and higher nominal pay.)
Thus, it appears the internal idealized norm of absolutely stable prices—or maybe even a divine hint of deflation—threatens to become dominant in the halls of the U.S. Federal Reserve Board, if it is not already.
A few more diffidently Presidential appointments to the Federal Open Market Committee, and we may see the day that the Fed pursues zero inflation, as did the Bank of Japan. Plosser has already proposed as much. The putative utopia of zero inflation, even deflation, captivates and enchants central bankers everywhere, and not a few economists—despite the sorry lessons of Japan.
Call us The United States of Japan?
After 1992, The Bank of Japan did obtain mild deflation for 20 years, while the yen surged—the same two decades in which the island nation all but became an economic backwater while mainland China zoomed forward.
The People’s Bank of China typically targets inflation between 3 percent and 4 percent, and has never had to resort to QE. You would think that would be interesting to the Federal Reserve. It is not.
Since 1992 (until very recently) it has been monetary asphyxiation and stagnation (the Bank of Japan) versus accommodation and growth (The People’s Bank of China). Quite a real world test.
I expect about the same results for the United States, should the Fed gain a single mandate to bring inflation to zero and keep it there. Even the current Fed predilection for inflation well under 2 percent is leaving the economy blue in the monetary face.
Is Chinese permanent residency hard to obtain?
Within the current organizational set-up, there is probably no cure for Fed insularity. Placing the Fed into the Treasury Department, and having the Fed Chief report to the President (dispensing with the FOMC) is a nice idea, but unlikely, to say the least.
About all we can hope for is that President Obama tosses aside tradition, and fills empty FOMC seats with brash outsiders, perhaps members of the manufacturing, construction, labor and real estate trades. People from the real economy. A mix of ideas, to balance inward bankerly obsessions.
If the Fed succumbs to Groupthink, let us hope at least for a big Group.