The Real Price Of Inflation Targeting

While still a professor of Economics at Princeton, future Federal Reserve Chairman Ben Bernanke was also a Research Associate for the NBER. In 1999, in his capacities with the latter organization, Bernanke advocated for widespread adoption of inflation targeting. At that time, only a few central banks had experimented with it and there wasn’t much evidence for its effectiveness.

Publishing a paper on that topic, he would return to this theme (transparency increases effectiveness) that would have, if 2008 hadn’t intruded, probably defined his official tenure. Inflation targeting worked and worked well, he claimed when it was incorporated into communications.

Central bank habit was at that time changing. An older generation, those like Alan Greenspan, preferred the monetary policy doctrine of Montagu Norman. The long-ago Bank of England chief had said, “never explain, never apologize.” When there was money in monetary policy, you could act this way.

Though Greenspan would worry about monetary evolution, it was Bernanke who would push the policy direction. It’s one of the few areas with which I find myself in agreement with him; if you don’t have money then you better explain yourself. Only, the “maestro’s” successor never really contemplated the full range of implications.

What if you end up in a situation that calls for an actual monetary solution?

The whole idea behind inflation targeting was to make sure this would never happen. So long as everyone believes in monetary policy no one should care about monetary evolution. In the parlance of the doctrine, expectations remain firmly anchored no matter what.

What changes, or what becomes policy, is communication and signaling about whichever central bank’s intent. Even QE was written out this way, as St. Louis Fed President James Bullard recently acknowledged. The Fed never printed money as many had come to think, rather it signaled its intent to “accommodate” (via psychology) playing on inflation expectations in that manner. This is their magic trick, or puppet show if you will.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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