In my money and banking classes in the mid 80s the dominant opinion was that the Fed should be opaque in order to prevent the economy from adapting before a policy change and neutralizing the impact.
Inflation targeting in a liquidity trap / deflationary environment (like 2008-2009) might have a valid use, in order to stimulate consumption and investment, but otherwise I don’t see the point.
This is a change in thinking based mainly on the reflexivity revolution. In the Keynesian era, the idea was that unexpected monetary expansion can create real growth.
But per rational expectations, an economic theory that depends on the actors not understanding the theory for its predictions is void. So this kind of thinking is gone.
The idea now is to create credible policy so that the public’s expectations match and reinforce the policy direction. Inflation targeting is a reasonable way to do that. Not the best way, but a way.
Right. Some target and a credible method for reaching that target is better than no target. But a nominal GDP target or even a price level target is better than an inflation rate target. The problem with a rate target is expectations accumulate - if your target is 2% and you hit 3%, you should really be targetting just over 1% the next year. This is why people feel inflation long after its gone - their price level expectations on which their wage and debt agreements were based are upset and only slowly correct over time. A level target would make up for this. Of course, the converse is true - arguably in 2006 the Fed unintentionally tightened monetary policy by coming in below its inflation target and that was one of the sources of the pressure on the banks that led to the GFC.
In my money and banking classes in the mid 80s the dominant opinion was that the Fed should be opaque in order to prevent the economy from adapting before a policy change and neutralizing the impact.
Inflation targeting in a liquidity trap / deflationary environment (like 2008-2009) might have a valid use, in order to stimulate consumption and investment, but otherwise I don’t see the point.
Agreed - “Fedspeak” serves the need opaqueness well, but explicit inflation targeting makes little sense in this respect (and in most respects)
This is a change in thinking based mainly on the reflexivity revolution. In the Keynesian era, the idea was that unexpected monetary expansion can create real growth.
But per rational expectations, an economic theory that depends on the actors not understanding the theory for its predictions is void. So this kind of thinking is gone.
The idea now is to create credible policy so that the public’s expectations match and reinforce the policy direction. Inflation targeting is a reasonable way to do that. Not the best way, but a way.
Fair point and I did read Soros’ “The Alchemy of Finance” back in the day. I see no issue with markets effectively doing the Fed’s work for it.
But I think there are more robust ways than a rigid inflation target for the Fed to establish and maintain credibility.
Right. Some target and a credible method for reaching that target is better than no target. But a nominal GDP target or even a price level target is better than an inflation rate target. The problem with a rate target is expectations accumulate - if your target is 2% and you hit 3%, you should really be targetting just over 1% the next year. This is why people feel inflation long after its gone - their price level expectations on which their wage and debt agreements were based are upset and only slowly correct over time. A level target would make up for this. Of course, the converse is true - arguably in 2006 the Fed unintentionally tightened monetary policy by coming in below its inflation target and that was one of the sources of the pressure on the banks that led to the GFC.