Here’s a quote from a popular economist and critic of inflation targeting:
Supply shocks were an issue in 2002-2004 when the much-ballyhooed productivity boom (a positive supply shock) of that time made Fed officials worry about deflation. They consequently kept interest rates low even though the housing boom was taking off. Supply shocks were also an issue in the fall of 2008 when Fed officials were concerned about rising commodity prices (a negative supply shock) and, as a result, decided to do nothing at their September FOMC meeting despite the collapsing economy.
I cringed when I first read the paragraph; and it seems like the cringe-inducing sentence sandwiched between rational statements on either side of it just doesn’t fit. The paragraph would be much better, and more logically consistent without it.
Now, of course, I am hard pressed to quibble with Fed-bashing over sheer incompetence. But I like the idea of examining situations in the counterfactual. What kind of economic circumstances would have been the outcome if the Fed had not lowered interest rates in 2002? In asking that kind of question, one can get the idea that this short cut isn’t quite as simple as it may seem considering the 2002-3 recession; and the suggestion that it is okay to throw the baby out with the bathwater, use tight credit to prevent bubbles, in one instance and not in the other is a bit astounding. Perhaps there was a bubble in energy in 2008.
Come to think of it, maybe this paragraph on the whole isn’t very good at all.