Not that I need anyone to tell me. But many others need to know and I am hoping that as the debate rages in the UK, some of it will rub off over here in the United States and we can talk rationally about the fragility of inflation targeting and what it means to nominal income expectations.
The two things that bother me the most about inflation targeting is that 1) in order stabilize prices, NGDP has to be below trend and 2) in order to have price stability we are always forgoing some potential output and nominal income.
The other things that bother me about inflation targeting that aren’t necessarily inherent in real price stability but prevalent in the brand of inflation targeting that was attempted by many major central banks are these:
1) Perverse incentives for the central bank to not make up for undershooting. The huge plunge in NGDP was inevitable for the Bernanke Fed because it was focused on doing nothing other than not overshooting its understood 2% target. So it sat there while passively undershooting the target by -6%, making lots of unemployment and a financial crisis inevitable.
2) There is an irresistible temptation to broaden the definition of inflation to include import prices, such as petroleum products – and I don’t think it is appropriate for a guy in the Peoria to lose his job because some Nigerian rebels decide to commandeer an oil rig, for example. It doesn’t make any sense.
3) There is no level targeting. Monetary policy is adjusted for yesterday instead of tomorrow; and that distorts tomorrow.
4) There are too many measures of inflation and none of them agree.
5) Using this brand of IT with interest rate pegs is risky in a low inflation environment; it almost guarantees arriving at the ZLB without a process for reinflating the economy for a lift off.
6) As in #5, it stabilizes inflation at disaster levels and as in #1 and #2, it incentivizes monetary tightening before there is a recovery.
7) There are perverse incentives to do nothing about market instability at the ZLB, leveraging crisis as a means of controlling inflation when traditional interest rate tools are inoperative, sending wave after wave of price adjustments into markets. When they expect the employment market to recover in this environment is quite beyond me.
The objections I have concerning the Fed doing this in particular are these:
1) It’s against the law for the Fed to behave this way
2) It’s against the law for the Fed to behave this way and…
3) It’s against the law for the Fed to behave this way… but it did it anyway
4) Even the new stimulus commitment still violates the law because the Fed is directed to manage credit and monetary aggregates commensurate with the economy’s ability to produce. That means that if it chooses an inflation target, it is long run target. It must make up undershooting and close the output gap in the long run. It still isn’t doing it; and it can’t while maintaining the 2% target or even committing to 2.5% at most.
5) I have no idea what it plans to do about the predicament of production capacity loss while it was ignoring the law. This makes it more likely that inflation will rise higher than it wants before getting to full employment. Setting the tolerance level at 2.5% inflation appears very arbitrary and still unlawful, not being directed at closing the output gap.
There’s more that I will think of later, but these are probably the worst of the low hanging stinkers.