An article on Bloomberg.con on Thursday that mentions Bullard’s suggestion for a symmetrical inflation target peaked my curiosity about some other things he might have been saying and I took a “stroll” on over to the St. Louis Fed website to have a look. The newest paper listed under his authorship, about the death of the fiscal policy stabilizer for the economy theory is from April 2012. There isn’t all that much to disagree with on that one; so I moved to the next one down the list that was sorted from newest to oldest – from May 2011 – “Measuring Inflation: The Core is Rotten.”
Due to the masterful PDF “styling” that is used for Mr. Bullard‘s posted a PDF, ordinary copy/paste inserts a carriage return after each letter so as to make it tedious to quote. I’m working on finding better OCR software so that I can make my points about the things he says statement by statement because they are really horrendous. For now, I suggest following the link to the document and perhaps saving a copy locally for posterity. One never knows when such works might one day just disappear.
In a nutshell, he makes nearly the same argument for headline as opposed to core inflation targeting as Mishkin made in an October 2007 speech that I documented here – To preserve credibility for the central bank in the eyes of the public. Certainly the public knows a price increase when they see one. Although, he augments the point with some strange counter arguments to anti-headline-targeting claims he labels as “popular” which I have either never heard before or heard only rarely: more volatility, core predicts headline, and relative price.
None of these address the basic reason that monetary policy has nothing to do with supply side issues and that tightening policy in response to a negative supply shock is rather sadistic to the public at large, or that the potential to lose control over policy if policy is tightened too much is a real hazard. Both of these things happened starting in 2007; and for illustration, I’ll compare a graph posted by David Beckworth showing the share of Treasuries held by the Fed with a graph of inflation included in Bullard’s paper.
It seems like a strange coincidence that the share of Treasury securities held by the Fed began a very rapid decline in May of 2007 that continued through 2009 when, according to Bullard’s graph, headline inflation had declined in 2007, then had a mysterious spike again in 2008. It would be very interesting to hear the explanation for draining liquidity out of the system in 2007 and why headline inflation continued to spike before turning into headline deflation while the operation continued. Could it really be that monetary policy can do almost nothing about the price of oil without creating a mini depression? Has anyone ever informed the public of this side effect? A bit of honesty on the part of monetary policymakers would be much more helpful; yet, considering that this paper was published in 2011, the inconvenient facts about headline inflation targeting continue to be buried under reams of BS such as this paper.
And of course I can’t leave out the other obvious fact to be gleaned from Bullard’s own figures – that deflation was allowed to persist at least as long as from the dramatic plunge in headline inflation in late 2008 to the end of the graph time period. What’s up with that while everyone was scratching their heads about why there was no recovery for the same period? If using what Bullard terms as “rotted conventional wisdom” the lack of recovery is because of the persistent deflation in core CPI that is likely the least optimistic measure.
The history of the time span from 2007 to 2010 on these two graphs illustrates exactly why the central bank should NOT target headline inflation. Everything that could go wrong did go wrong and it seems as if the old conventional wisdom isn’t quite so “rotted” after all.