Three percent price inflation

by on December 18, 2009 at 2:19 pm in Economics | Permalink

Many bloggers are commenting on Bernanke's response to Brad DeLong's question about whether the Fed should target three percent price inflation to stimulate aggregate demand and lower unemployment.  I'll offer two points:

1. We no longer have an independent central bank in this country, at least not for the time being.  There is no particular reason to think current monetary policy is Bernanke's personal decision, most of all because he is up for reappointment.  He may well know better and arguably his remarks signal as such.

2. I still favor a two percent target (three would be fine too) for the rate of price inflation today.  But it matters when we implement such a policy.  The longer we wait, the more we miss out on its potential benefits.  For instance it's easier for AD-robust market conditions to signal to employers not to lay off workers than it is for market conditions to signal that workers should be rehired.  The longer we wait, the more the inflation (and its expectation) loses its potency.

Furthermore nominal wages adjust sooner or later, even if the downward ride is a bumpy one with some negative cumulative spirals along the way.  I don't personally think we are close to the point where three percent is a bad target but that's a guesstimate rather than based on hard science about the state of the labor market this spring.  In any case three percent will become a bad idea at some point and we need to start asking ourselves when, no matter how good an idea it was a year ago.

Yancey Ward December 18, 2009 at 2:43 pm

Why not target 10% if 3% is better than 2?

sp6r=underrated December 18, 2009 at 3:01 pm

God this is an idiotic argument:

“Why not target 10% if 3% is better than 2?”

As everyone knows plenty of things can be beneficial in small doses but harmful in large doses (examples: medicine, red wine).

gabe December 18, 2009 at 3:07 pm

Bernanke repeatedly asserts that it is the central banks job to address the goals of the public(read the political powers). One of the big selling points of the central bank for the advocates of it are that it is a independent. Bernanke gives lip service to the great value of this independence but then he starts chipping away at it. He implicitly supports thinking about two types of independence: †goal independence† and “instrument independence†. He advocates giving the central bank instrument independence, but not goal independence. On page 35 Bernanke says “this strategy[his strategy] calls for inflation targets themselves to be set by the political process in which central bankers consult with the appropriate legislators or ministers. The execution of the policy is then left completely to the central bank.† Wow! So when Bernanke thinks of independence he thinks of a private in the army digging a hole exactly the depth his seargent tells him to(goal independence for the seargent)), but the private gets to pick whichever tool(instrument independence) he wants to do it. Aren’t academics great! This guy can walk around and feel like he is really an honest person when he says he supports and independent Fed, yet he has defined independence to mean pretty much the exact opposite of what it really means! Good god! my maid has instrument independence!

gabe December 18, 2009 at 3:27 pm

Actually push media you are kind to point that out. In my blind hatred I did leave out the fact that Bernanke does qualify the timing of creating a “target of 5-7%”. However, he says a open inflation target should be created when inflation is low. Of course when he says inflation he means the CPI..so that should mean now. It would be good if more people read his book on inflation targeting. He really does say 7% may be a good target. I actually would rather have a stated target as it would be a little more fair and one step closer to a milton friedman computer…but of course it ain’t happening.

The insiders that run things make so much money off of knowing what the next move will be before we do that they are just as likely as to give up that power as Sauron himself is likely to throw away the golden ring.

Mr. Econotarian December 18, 2009 at 3:43 pm

What ever happened to the Taylor Rule?

Don the libertarian Democrat December 18, 2009 at 3:50 pm

“But it matters when we implement such a policy. The longer we wait, the more we miss out on its potential benefits. For instance it’s easier for AD-robust market conditions to signal to employers not to lay off workers than it is for market conditions to signal that workers should be rehired. The longer we wait, the more the inflation (and its expectation) loses its potency.”

For a person, such as myself, who supports the Chicago Plan of 1933, QE plus a Reinforcing Stimulus, this is true. And, frankly, a second dip, even if smaller and less panicked than the first, will also be harder to get out of than many people assume. That’s also why I think an Incentive for Hiring, which is generally not a great idea, would help now.

pushmedia1 December 18, 2009 at 3:54 pm

Mr. Econotarian, the Taylor rule depends on the deviation of inflation from the target. The folks arguing for a higher target are using Taylor rule like arguments suggesting a higher target will cause the Fed to ease more. The hope would be that this would increase AD (and decrease unemployment through whatever mechanism that drives Okun’s law). The problem is if expectations are anchored (i.e. they equal the target) then AS, which depends on expectations of inflation, will adjust to undo these changes. All changing the target does is risk unanchoring expectations.

My bet is the *permanent* changes to the level and volatility of inflation resulting from unanchored expectations would have much greater welfare costs than the *temporary* high unemployment we’re experiencing now.

E. Barandiaran December 18, 2009 at 4:09 pm

First, a minor cut in the minimun wage. Now, a minor increase in the inflation target. Then, what? An increase in the marginal income tax of 0,00001%? What’s the purpose of discussing how some ants are eating when the elephants are dancing (in Copenhagen but that’s where Obama is right now with over 150 presidents, kings and primer ministers) and the monkeys are singing carols in Congress?

Mr Bilderberg December 18, 2009 at 5:03 pm

This is a topic that cannot be debated because it would reveal the logical fallacies of central banking something-for-nothing-cranksterism fiat money.

You sheeple are supposed to just shut up and take whatever monetary policy we give you, WE ARE THE EXPERTS!

You are our wage slaves!

Yancey Ward December 18, 2009 at 5:18 pm

Really, sp6? Even Tyler couldn’t muster an argument for or against 3%. And I see numbers bandied about from 1 to 7%. I have read the arguments, and none of them answer why your initial assertion had any validity. So, why is 10% too big a dose, but 3% isn’t? When does it get to be too much? If there are strong arguments that have been made, then certainly you should be able to parrot them. All I see from the various economists amounts to nothing more than hand-waving claiming their target is right and others are wrong.

Lee Kelly December 18, 2009 at 6:43 pm

A 3% inflation target would be like trying to score a goal in soccer by aiming a few feet to the goalkeeper’s right. Although you might usually score (assuming the goalkeeper doesn’t make a save), the goalkeeper will sometimes be in a position where you’ll shoot wide. It’s a much better strategy than aiming for the corner flag (which present monetary policy seems to be doing), but it’s still wrongheaded. Aim for the goal: nominal expenditure (or monetary equilbirium)!

Scott Sumner December 18, 2009 at 7:55 pm

Since my blog’s broken for the 100th time, I’ll come over here and blog. I agree that the longer we wait the smaller the benefits, and indeed we have already lost most of the benefits that would have accrued from adopting the policy last fall. But all of those points refer to this business cycle. If we were now to “overreact,” i.e. to push inflation above it’s long term target, it would actually help us in the next cycle. One of the most stablizing things a central bank can do as an economy is buffeted by a severe negative AD shock is to promise to catch up for any near term undershooting of its nominal targets. Most Keynesians would explain this in terms of lower ex ante long-term real interest rates. Alternatively, if you recall that current NGDP is very much impacted by expected future NGDP, then the knowledge that a central bank will adopt a highly expansionary policy “too late” in the business cycle, actually tends to raise current NGDP, for reasons analogous to the fact that higher future expected commodity prices raise current commodity prices. Of course all of this depends on the assumption that any Fed change of heart is likely to carry over to the next cycle. But I think that’s a reasonable assumption, much as what we learned late in the Iraq War is likely to influence our current strategy in Afghanistan.

Mr. E December 18, 2009 at 9:16 pm

“I think more realistically the choice is somewhere inflation that could go over 20% before being brought back under control and deflation.”

It’s true.

Inflation makes old money less valuable compared to physical objects. Physical Objects decay. Why shouldn’t money?

I don’t understand why money should be a long term store of value.

Andrew December 19, 2009 at 4:43 am

I hate it. I think inflation is fraud, and a “target” that they actually hit can only be such. Maybe the fraud is the feature, but I’d sure be willing to suffer the consequences of doing without it.

Gabe December 19, 2009 at 9:49 am

The progressives still support the Fed because of what we call controlled opposition. Read books on how the CIA works in other countries and you will see the strategy at work in this country. The leaders of the Democrats are all pro-fed…while the grass root progressives are not….why do you think that is? Is .

This only works if the topic itself is taboo. Your not supposed to be interested. It is impolite to talk politics anyway, especially impolite to talk about anything but Sarah Palin’s wardrobe, Obama’s dog or the bills that are currently before congress.

Andrew is right, people who think about this can bet accordingly and come out pretty good….but for the overall economy it is still a bad thing. Too bad, the poor people can keep getting poorer if this is what they want.

babar December 19, 2009 at 3:56 pm

i have always been puzzled why we only have one kind of money. why not different moneys for services and objects for example? why not blog money? why would having different money for different things not lead to a more free and libertarian era?

Bob Murphy December 19, 2009 at 8:06 pm

Does it matter that when the December numbers come out, CPI inflation during 2009 will probably be about 2.9%?

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