Explicit inflation targeting is no exception.

I have been very annoyed with Goodhart’s recent comments about price level stabilization vs. income expectations stabilization.  He may very well be one of the most prolific economists of recent memory as he is touted as being. Being a newbie and a novice, I can hardly pass judgment.  But it isn’t necessarily the economics that I am having trouble with; and I feel at least somewhat qualified to criticize the fact that there is a whole other side of his price level argument that he isn’t talking about.

The one thing that I have always hated about buying a new car was finding out all of the things about the particular model that I didn’t know beforehand and wished I had. Those things are what the makers like to call unanticipated “features”.

When the price level/inflation targeters come out to justify their ideas they paint this rosy picture of how stable the economy will be when prices are anchored around some particular target. But they don’t tell us about the unanticipated “features” while telling us that they can keep prices stable so that we can better plan our financial lives.

They tell us that monetary policy has little control over the real economy and that just printing money can’t make anyone rich. That is partly true. The lie in the notion that monetary policy can produce an economic utopia by stabilizing the price level, however, is that monetary policy also cannot control all price movement. Monetary policy can do nothing about hurricanes wiping out every oil ring in the Gulf of Mexico, for example. It also cannot do anything about droughts or other price disruptions caused by real factors, some of which hit major commodities and can be long lasting.

These people also don’t tell us how much our economic world changes when monetary policy attempts to control things that it cannot fully control, like the price level. They don’t tell us that stabilizing the price level stabilizes all prices, including wages or that sticky wages makes wage adjustments very painful; wages are very slow to adjust and the necessity for adjustment causes a bunch of unemployment instead. Do we really want our jobs put in jeopardy because Nigerian rebels commandeer an oil rig?

In order to stabilize the price level, NGDP has to necessarily be some degree below trend. And what that means is that in order to produce the stable price environment, some percentage of income growth is shaved off the top per annum, necessitating wage adjustments. Price level “stabilization” has a downward bias and income growth is adjusted downward by a larger degree to keep it stable. Adjust it downward too much, as in adjusting for large price spikes caused by real factors, and we get 2008 all over again. This is EXACTLY what happened – nominal income was adjusted to compensate for price spike in oil which tightened monetary policy when it should have been more accommodating. We paid for the high gas prices and our nominal incomes got socked in the gut at the same time.

And so what does this mean for average Joe? It means the job market will be bearish to go along with shrinking demand until at some point it flat lines and turns into Japanese style deflation with negative real growth as far as the eye can see – price level targeting with a built in downward bias from real factors has a very short shelf life before it causes a lot of damage. We are currently living the inflation-targeter’s dream. If you don’t like what life is like at this point in time, you shouldn’t listen to what they have to say any longer.

Sure. Monetary policy cannot make people rich; but it sure can have a huge impact on our standard of living and make us feel very poor.

Advertisements