Remarks from Ben Bernanke indicate that the Fed is shooting itself in the foot:
“I have rejected any notion that we are going to try to raise inflation to a super-normal level in order to have effects on the economy,” [Bernanke] said.
In fact, the Fed should engage in level targeting, as I have been pushing in the last few posts. It should commit to a higher target for nominal expenditure in order to return to the previous trajectory from the Great Moderation. That requires a higher level of NGDP growth than is “normal” in order to catch up. One way to do this under the current monetary regime is to create higher inflation expectations. Do they need to be much higher? I don’t think so, but it’s not entirely unreasonable to disagree.
So we know that most members of the FOMC view 2% as the preferred inflation target. We now also know that the Fed is holding true to that target, come hell or high water. 2% is better than 1%, but a temporarily higher target would produce a much more robust recovery. Arguably, the Fed is in the business of providing stable NGDP growth consistent with high employment and low inflation. It allowed NGDP to plummet and now they should be trying to make up that lost ground as quickly as possible. This statement is clearly against that goal.
We’re in for a rocky road if our monetary authority sees it fit to tie its hands.
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Monday ~ November 8th, 2010 at 8:25 am
Andy Harless
The loophole is that Bernanke uses the word “try.” If the Fed were to set a NGDP target, it arguably would not be “trying” to raise inflation to a super-normal level: it would be trying to raise RGDP, and it would risk raising inflation instead. Scott Sumner would probably argue that, if the Fed were to set such a target, it would not need to raise inflation “to a super-normal level” because RGDP would rise sufficiently (with inflation rising only to a “normal” level). So the Fed can get around Bernanke’s statement by buying into (or pretending it buys into) Sumner’s optimism. Presumably many market participants will be less optimistic and expect that “super-normal” inflation will actually result, and the Fed can, without agreeing with them, take advantage of the reduced money demand that will result from their belief, to help it achieve its objective.