I’ve done some posts on the Fed mandates in the Full Employment and Balanced Growth Act in the past (here, here, and here). I’ve also done some on the evils of inflation targeting (here and here). I was reading a post today at World of Interest about Bernanke’s testimony to the Joint Economic Committee and it occurred to me that I never really tied the two concepts together in a single post. When writing about these, my passions sometimes get the better of me, and I end up saying some colorful things without being very succinct; and I like to clear it up.
First, the Fed mandate(s):
[The Federal Reserve] shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
If following the standard rule of construction, interpretation of an article of text so that meaning is given to all parts, which is easy to do considering that the mandate is a single sentence, it appears that there is only a single mandate: “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production…” These are the effects the Fed is supposed to produce.
The detail then, separated from the first part of the mandate with a comma, is exactly that – detail. If the Fed is single-mindedly focused on everything prior to the comma without over doing it, the proceeding items, maximum employment, stable prices, and moderate long term interest rates should follow. In other words, Congress put the economy’s long run ability to produce as a first and foremost objective for the Federal Reserve, and it is to meet that objective in a way so as to promote maximum employment, stable prices, and moderate long-term interest rates.
It is also interesting that in two places the mandate calls out the long run. If, for some reason, the Fed falls short of its objective, it is required to ensure that the long run evens out. It is probably much better to keep a sense of nominal stability to ensure that the ability to produce is maximized on a constant basis. But should an output gap develop, it is expected to be closed at some point; and now would be much better than never.
Moving on to the main point, however; inflation targeting under a legal mandate such as this one is entirely illegal. It’s illegal because the focus is not the economy’s long run ability to increase production, but solely on movement in prices; and prices can move with changes in patterns of supply and with varying degrees of productivity that have very little to do with monetary policy. An example might be a negative oil supply shock under which the Fed would, if focused only one movement in prices, manage monetary and credit aggregates in such a way as to idle resources in order to reduce demand and lower prices; which, by the way, is what happened starting in 2006. Remember those successive 25 to 50 basis-point increases in interest rates that lasted throughout 2007 while energy prices were headed through the roof and were being translated into higher prices of goods? On the day of Obama’s inauguration gas prices were in the area of $2 per gallon – the Fed broke the back of energy prices at the expense of employment and the financial system with hard core inflation targeting.
Are eurozone officials correct when they say inflation hurts consumers? No,supply shocks hurt consumers, and if the ECB prevents the supply shock from leading to inflation, consumers will be hurt EVEN MORE THAN IF PRICES DO RISE. The harm to consumers has NOTHING TO DO with prices rising.
At the risk of flipping on the rant switch, this is exactly why the entire concept of inflation targeting and how these Fed bureaucrats imposed this ghastly policy on us without proper due diligence leaves me feeling quite incensed. It simply is not supposed to happen; and no one with the authority to remedy the situation has done anything about it while scores of millions of people have been needlessly reduced from self-sufficiency to destitution, an order of magnitude of financial misery that takes my breath away – like being punched in the gut.