Do we need an inflation target?
Tyler Cowen thinks that the Fed should adopt a 3% inflation target; Jim Surowiecki is inclined to agree. What’s more, they also agree that it’s not going to happen. Tyler has an interesting theory, on this front:
Maybe we are in a new political economy equilibrium where each government agency is given “one shot” at a problem. Treasury had its one shot with the stimulus plan. The Fed had its exotic monetary policy operations and deal-making during the crisis. Maybe in bad times voters aren’t happy no matter what, and no one is allowed to try twice. We have not yet thought through the political economy of this scenario.
In general, both of them talk a lot about the politics of inflation: Tyler points out that conservatives are in denial about the inflation which accompanied the Reagan boom, while Surowiecki talks about the way in which voters hate inflation, even more than unemployment.
Which leads me to the conclusion that a lot of what we’re seeing is a lack of genuine independence at the Fed, which became indistinguishable from Treasury during the crisis, and which has yet to break free from Treasury’s grasp.
I think it’s pretty clear that some kind of rise in the price level would be a great thing for the economy. Steady 3% inflation is one way of achieving that; I also very much like Daniel Davies’s idea:
What is needed is a step-change shift in the price level. These are two distinct concepts – we want a change in P with constant dP/dT, not a change in dP/dT. This has the effect of a one-off windfall redistribution from nominal creditors to nominal debtors, a one-off increase in the ratio of collateral to credit. If anticipated, it would encourage an investment boom, as owners of nominal assets attempted to exchange them for real assets…
Several of the world’s most important central banks have it written into their constitutions that they need to control inflation or target price stability. I think a good lawyer could make a case that a decision to target stability, but stability at a higher level would be consistent with the letter if not the spirit of these laws.
The problem, of course, is how do we get there from here: as the Bank of Japan knows only too well, creating inflation can be very hard indeed. And if you say that you’re going to create inflation and you fail, then you lose precious credibility.
Bond investors like Marshall Auerback will scream loudly every time this subject comes up, saying that “we should be targeting policies needed to generate full employment” (yes) and that such policies by their nature have to be fiscal rather than monetary (no). But I do think that the Fed’s full-employment mandate is all that it needs to pursue inflationary policies: it doesn’t really need an inflation target on top of that.
My feeling about an inflation target is that its mere existence is not going to convince anybody that inflation is on the way. So unless and until the Fed can credibly explain how it’s going to create 3% inflation, it shouldn’t even think about unveiling a target. And if it can credibly explain how it’s going to create 3% inflation, then it doesn’t need the target at all.
So. Inflation? Yes please. Inflation target? I’m not so sure.