False Precision

Paul Volcker wrote an op-ed for Bloomberg accusing the Fed of "false precision". On that score, as well as inflation targeting, his criticisms are accurate.

Please consider What’s Wrong With the 2 Percent Inflation Target by Paul Volcker.

In 1996, Federal Reserve Chairman Alan Greenspan had an exchange with Janet Yellen, then a member of the Fed’s Board of Governors, that presaged a major — and, I think, ill-advised — change in the central bank’s approach to managing the economy.

Yellen asked Greenspan: “How do you define price stability?” He gave what I see as the only sensible answer: “That state in which expected changes in the general price level do not effectively alter business or household decisions.” Yellen persisted: “Could you please put a number on that?”

Since then, under the chairmanship of Ben Bernanke and then under Yellen [the answer] has been translated into a number: 2 percent.

I puzzle about the rationale. A 2 percent target, or limit, was not in my textbooks years ago. I know of no theoretical justification. It’s difficult to be both a target and a limit at the same time. And a 2 percent inflation rate, successfully maintained, would mean the price level doubles in little more than a generation.

I do know some practical facts. No price index can capture, down to a tenth or a quarter of a percent, the real change in consumer prices. The variety of goods and services, the shifts in demand, the subtle changes in pricing and quality are too complex to calculate precisely from month to month or year to year.

It is also true, and herein lies the danger, that such seeming numerical precision suggests it is possible to fine-tune policy with more flexible targeting as conditions change. Perhaps an increase to 3 percent to provide a slight stimulus if the economy seems too sluggish? And, if 3 percent isn’t enough, why not 4 percent?

I’m not making this up. I read such ideas voiced occasionally by Fed officials or economists at the International Monetary Fund, and more frequently from economics professors. In Japan, it seems to be the new gospel. I have yet to hear, in the midst of a strong economy, that maybe the inflation target should be reduced!

The fact is, even if it would be desirable, the tools of monetary and fiscal policy simply don’t permit that degree of precision.

Amazing Discussion

Volcker goes on to blast the risks of deflation, noting "fear [of deflation] can in fact, easily lead to policies that inadvertently increase the risk.

Volcker accurately stats that the danger comes from encouraging inflation and its close cousin of extreme speculation creating bubbles and excesses threaten financial markets. Ironically, the “easy money,” striving for a “little inflation” as a means of forestalling deflation, could, in the end, be what brings it about.

Volcker's article is an excerpt from his upcoming book “Keeping At It: The Quest for Sound Money and Good Government,” by Paul Volcker with Christine Harper.)

End the Fed

The only thing Volcker missed is a failure to tackle the notion that there needs to be a central bank at all.

Otherwise, his rant is 100% spot on.

I have commented on this more times than I can count, for at least a decade. Here are a couple examples:

Economic Challenge to Keynesians

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My Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.

BIS Deflation Study

The BIS did a historical study and found routine deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,”stated the study.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

How Much is the CPI Understated?

In How Much is the CPI Understated? I made these inflation comments:

Of course, there is no such thing as a representative basket of goods and services in the first place.

Moreover, it makes little sense to average all the components the way the BLS does.

To top it off, the CPI fails to factor in clear bubbles in financial assets. Those financial bubbles are a direct representation of unreported inflation.

Bubbles Everywhere

As a direct result of the Fed's total incompetence in understanding inflation, bubbles are readily apparent in equities, in junk bonds, and in Bitcoin speculation.

Those bubbles will burst bringing about the very deflation the Fed hoped to prevent.

Mish on Inflation Targeting

  1. The Fed's Miserable Inflation Targeting Performance in Pictures
  2. Rethinking the Fed's 2% Inflation Target: Spotlight On an Absurd Debate
  3. Central Banks Rethink 2% Inflation Target (In the Wrong Direction of Course)

The lead image is from number 2 above. Please give it another look.

Bloomberg, the Financial Times, the Wall Street Journal, and the New York Times all turned down articles by me with nearly identical statements as Volcker made.

Mike "Mish" Shedlock

Rethinking the Fed's 2% Inflation Target: Spotlight On an Absurd Debate

Is the Fed's 2% inflation target too high or too low? That's the big debate now amongst central bankers.

Nonsensical Global Worries Over Subdued Inflation: Yellen, Draghi, Kuroda

Central bank presidents at the Fed, the ECB, and Bank of Japan are all concerned over low inflation. The Fed wants to hike anyway, but the Bank of Japan will keep pursuing aggressive monetary easing. Meanwhile, asset prices are in the biggest ever bubble.

“Bad Options” Regarding 2% Inflation Targets (And Other Silly Notions)

The Wall Street Journal and Bloomberg both posted ridiculous articles regarding today regarding inflation. The former was on “bad options” the latter on “inflation expectations”.

The Fed's Miserable Inflation Targeting Performance in Pictures

Core personal consumption expenditures (PCE) is the Fed's preferred measure of inflation. Core PCE excludes food and energy. Let's investigate how close the Fed has been to its target since the history of the series, dating to January 1960.

Inflation Targets: If You Can't Hit the Goal, Raising the Goalpost Won't Help

The ECB is wondering if it can produce more inflation if it has higher targets. The notion is complete silliness.

Central Banks Rethink 2% Inflation Target (In the Wrong Direction of Course)

If Central Banks wanted to make a positive impact on the global economy, they would abolish themselves and let the free market set rates.

Amidst Inflation Scare, Price War intensifies between Costco, Target, Walmart

You're not imagining things. Stuff is a little bit cheaper at Costco, Target, Walmart, and Kroger this year.

Japan Expects to Hit 2% Inflation in 5 Years, Aggressive Easing Will Continue

The BOJ thinks Japan may hit its 2% inflation target in 5 years. Kuroda says risks are to the downside.

If You Can't Hit the Target, Do You Move It Further Away?

Some Fed presidents want higher inflation targets. About 84% of economists think the Fed should stick with a 2% target.